What Is Functional Replacement Cost on a Homeowners Insurance Policy?

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  • What Is Functional Replacement Cost?
  • Is Functional Replacement Cost Right for You?
Home insurance can be costly to purchase for your property, especially when you don’t wish to ever use it. Insurance is a necessity for homeowners, though, but there are ways to save some money on your premiums. One such possibility is to purchase a policy with functional replacement cost provision.
What does functional replacement cost mean, and how does it affect your homeowners insurance? Here’s what you need to know.

What Is Functional Replacement Cost?

According to the International Risk Management Institute (IRMI), a functional replacement cost provision allows for an insurer to have damage repaired or replaced with property that serves the same function. While that might not seem like much of a difference, it can reduce an insurer’s cost to make you whole again by substituting the damaged property with something that serves the same purpose but isn’t necessarily the same value. In that way, it can keep your premiums lower since the cost to repair or replace the damage is likely to be lower.

What’s the Difference Between Replacement Cost and Functional Replacement Cost?

In the case of replacement cost, an item that’s damaged or destroyed in an insured peril would be fixed to its previous condition or replaced with a new item. Think about an appliance like a fancy stove that’s damaged in a fire. Although the stove might be several years old or even obsolete, it would be replaced with a new stove by an insurance company with replacement cost provisions.
With functional replacement cost, it’s recognized that the stove is no longer new and thus has lower value. Although it was worth $2,000 when it was new a decade ago, its depreciated value might be assessed at only $500. With a functional replacement cost provision, insurance might pay for a new stove that can perform the same functions but not the same quality, brand, or style.
Another example is a cedar shake roof. In a hailstorm, a bunch of cedar shakes may be damaged or broken off. The insurance company may not be able to source the materials or skill to replace the roof with cedar shakes or it might be exorbitantly priced. Functional replacement cost would potentially allow for the home to be re-shingled with common asphalt shingles or another substitute that serves the same function.

Actual Cash Value vs. Functional Replacement Cost

Another common option for insurance is an Actual Cash Value policy that calculates repairs or replacement that factors in depreciation or what’s considered fair market value. In that instance, the insured value of the property that’s been damaged or lost may not cover the replacement cost.
Thinking of the stove once again, imagine that it’s a 40-year-old appliance. Although it’s fully functioning and was a premium model when purchased new, it’s now obsolete and would’ve been worth very little to sell. The insurer could assess its actual cash value at $100 or so, which would be unable to cover the cost of a new appliance.
With functional replacement cost, the homeowner at least obtains a replacement that performs the same functions, even if it isn’t a premium appliance.

Is Functional Replacement Cost Right for You?

If you’re looking to save some money on your home insurance, both Actual Cash Value and Functional Replacement Cost provisions can help. You’ll have lower premiums than with a Replacement Cost policy, although the coverage isn’t as beneficial to you in the event of an unfortunate loss.

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