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What is Replacement Cost?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 22 August 2016
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    2003-2016
    Conjecture Corporation
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Replacement cost is usually interpreted as the current amount that must be paid to acquire an asset of the same value as a replacement for an asset that is no longer functional or viable. True replacement costs are not concerned with what was paid for the original asset, but what would be required to replace that asset at today’s market value. The calculation of replacement cost is a common element in many insurance coverage plans, as well as building projects and other commercial ventures.

The application of replacement cost in terms of auto insurance is a good example of how a lost asset is replaced with one of equal value. Most auto coverage includes specific guidelines that apply to vehicle replacement in the event the insured car or truck is considered permanently inoperable and irreparable by the insurance company. Once the provider has declared the vehicle to be a total loss (or totaled), the insured party is issued a cash payment for the current value of the vehicle in most cases. The idea is that the recipient can use the funds to secure a vehicle of similar make, model and age, effectively offsetting the loss.

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Home replacement costs tends to function in the same manner. The insurer provides specific terms and conditions that must apply to the loss in order to receive full replacement cost. As with a vehicle, it is generally necessary for an adjuster to assess the condition of the damaged home and determine if there is a reasonable possibility of repairing the structure and making it safe for habitation once again. If not, then there is a good chance the insurance provider will issue a payment based on the average replacement cost for a home of that size and in that particular location.

It is important to remember that insurance replacement costs on a home or automobile are governed by the terms and conditions found in the insurance contract. Those terms are normally designed to be in compliance with local laws or regulations that are currently in force, as well as the specific scope of coverage defined by the issuing party. For this reason, it is important to read the sections pertaining to replacement cost. Doing so will make it much easier to understand how the insurer interprets replacement cost within a given situation and what actions are likely to ensue once the claim is filed.

Companies also tend to look at replacement costs when contemplating the construction of new facilities. Typically, the idea is to determine what it would take to build a new plant or other facility that would be large enough to house all the functions currently handled in another facility. If the replacement cost indicates that moving operations to a new structure at a new location would eventually save the company money, the move is usually considered a good one. Should it be determined that the replacement costs are prohibitive in some manner, there is a good chance the building project will be shelved or abandoned altogether.

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