Valuation Methods

How much will the insurance company pay when property is damaged or destroyed? The answer depends on the valuation method specified in the policy.

The Four Main Valuation Methods

1. Actual Cash Value (ACV)

Formula: ACV = Replacement Cost - Depreciation

Definition: The amount it would cost to replace property at today's prices, minus depreciation for age, wear, and obsolescence.

This is the default valuation method for most property insurance.

Example:

• 10-year-old roof (20-year life expectancy)
• Replacement cost for new roof: $20,000
• Depreciation: 50% (10 years ÷ 20 years)
• ACV = $20,000 - $10,000 = $10,000

Exam Tip: ACV is sometimes described as "fair market value" — what a willing buyer would pay a willing seller.

2. Replacement Cost Value (RCV)

Definition: The cost to replace or repair property with new materials of like kind and quality, without deduction for depreciation.

Key Points:

• Higher coverage than ACV
• More expensive premium
• Must actually replace the property to receive full RCV payment
• Common payment process:
  1. Insurer pays ACV initially
  2. Insured repairs/replaces property
  3. Insurer pays the depreciation "holdback"

Same Example with RCV:

• 10-year-old roof destroyed
• Replacement cost: $20,000
• RCV payment = $20,000 (no depreciation deduction)

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ACV vs. Replacement Cost Comparison

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3. Agreed Value (Agreed Amount)

Definition: The insurer and insured agree on the property's value at policy inception. In case of total loss, this agreed amount is paid without question.

Benefits:

• Eliminates coinsurance penalty
• No depreciation arguments at claim time
• Certainty for both parties

Best For:

• Unique or hard-to-value property
• Antiques and collectibles
• Fine art
• Historic buildings

Requirements:

• Professional appraisal usually required
• Periodic revaluation (often annually)
• Statement of values submitted

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4. Functional Replacement Cost

Definition: The cost to replace property with materials that perform the same function, even if not identical.

Example:

• Original building has ornate plaster crown molding
• Modern equivalent: Simpler molding that serves the same purpose
• Functional replacement pays for the modern equivalent, not exact restoration

Best For:

• Older buildings with outdated construction
• Commercial properties with obsolete features
• When exact replacement is impractical

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Market Value vs. Insurable Value

These are NOT the same thing:

Why the Difference?

• Land cannot be destroyed by insured perils
• A building worth $300,000 on $200,000 land has:
  • Market value: $500,000
  • Insurable value: $300,000 (building only)

Exam Alert: Never insure land value — it's not destroyed by insured perils.

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Depreciation Calculation

Depreciation reduces ACV payments. Common methods:

Straight-Line Depreciation

Most common method:

Annual Depreciation = Original Cost ÷ Useful Life

Factors Affecting Depreciation

• Age of property
• Condition and maintenance
• Obsolescence (functional or economic)
• Quality of original construction

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Choosing the Right Valuation