The Conflict between Replacement Value and Actual Cash Value

There are few greater joys for a mission Executive Director than receiving a letter from an attorney and finding that the mission is not being sued, but is instead, the recipient of a bequest. After many years of effort to raise money for a new dormitory, some person has now passed and willed a 30,000 square foot building that can reduce the fund-raising needs by a few million dollars! Praise God for His grace toward the mission’s ministry! Now comes the surprise: upon calling the insurance agent you are told that this building that cost the mission nothing, must now be insured for $6,000,000, the calculated replacement value.

The conflict involving valuation is a complicated one. What a building is worth to someone is a function of utility. To the realtor, it is worth what an incentivized owner is willing to let it go for to an incentivized buyer; this is known as “market value.” To the Taxman, it is worth what the assessor’s office says it is worth, typically a percentage of predictive market value; this is known as “assessed value.” To the contractor, it is worth what it would cost to rebuild it with new components built by builders at prevailing wages; this is known as “replacement value.” To the person who recognizes its depreciated value and has no intentions to replace it should it be destroyed, there is the “actual cash value” defined as replacement value less depreciation. Lastly, there is the value that a building has for how it will be used even though it may be markedly different than for what the building was originally designed; this is known as “functional replacement value.”

When people compare what a building could sell for in the real estate market versus what it would cost to replace the same building with new construction, it is not surprising that people often prefer to buy an already-built building since it typically costs less. This reflects the fact that a ready-made building has begun to depreciate and is therefore worth less than new construction. Yet, if there was to be a property loss, the contractor would be replacing the damaged part with new materials. For this reason, insurance companies give you the option to insure for replacement value versus actual cash value. Knowing the difference before a loss is key to avoiding the conflict after a loss.

Merriam Insurance has been working with Rescue Missions and Homeless Shelters for over 100 years. We offer tools to help you calculate the amount of coverage for insurance purposes. Please contact us if you would like some free guidance in this important matter.

Brian H. Merriam, CPCU, ARM, AAI
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