Understanding Replacement Cost vs. Market Value in Home Insurance

Posted on: Feb 22, 2022 | 3 mins | Written by: HDFC ERGO Team

Understanding Replacement Cost vs. Market Value in Home Insurance

Your home is probably the most costly asset not only because it holds monetary value but also the emotional factors that are associated. Having a home insurance policy is ideally suggested for your home so that you can get financial assistance whenever an adverse situation affects your house and the fear of financial loss hovers over you. However, when it comes to buying a home insurance policy, one factor that becomes quite tricky to understand is whether to purchase the policy at market value or the replacement cost. For this, you need to understand these terms well so you leave no stone unturned to get the best coverage for your house.

The first and foremost thing to understand is the replacement cost of a house/ property and the market value of a house/ property are two different things. These are two concepts that are distinctly different from one another and are thus estimated using different standards. While both help in estimating the value of a property, they are both different approaches. Let us take a look at them individually first, to understand their meanings and their importance.

Understanding Market Value

Market value, as the term suggests, is the market price of your house. Suppose a house is being marketed between a seller and a buyer in the open market under all fair rules, the value it will be sold at, is known as the market value. As per the Insurance Regulatory Development Authority of India, market value is the cost of the house at which you originally bought the house.

In case you have a home insurance policy under market value and a part of your house gets affected due to any reason, say fire or earthquake, you will have to file a claim. When the company settles the claim, it takes into consideration the depreciation value of the part of the house to exclude the wear and tear cost from the claim amount. Therefore, the amount that you receive may not be sufficient to get a replacement. You may have to dig into your savings in order to manage the damage.

Understanding Replacement Value

Replacement value, on the other hand, is the cost of replacing your house. Speaking broadly, the replacement cost refers to the overall cost of replacing your home with the exact new home with the exact same location, area per square, dimensions of the house. When you have a home insurance policy under replacement value, you get the exact amount disbursed that will be required to rebuild the same house.

Replacement value is the most preferred selection for home insurance policies because there is no depreciation cost calculated at the time of claim settlement. From the point of view of a homeowner, replacement value would be more beneficial than the market value when it comes to settling a claim. After all, when you buy a home insurance policy, the actual aim is to get compensation for the loss that you have to bear so that you can replace it easily.

Market Value vs Replacement Cost: What do they mean?

Understanding market and replacement value is essential in order to decide which would be the most beneficial property insurance policy for your home. You may hear these two terms being used interchangeably, but as discussed they are not similar and have some striking differences. Let’s have a look at the differences:

Particulars	Replacement Value	Market Value
Home’s Age	Calculated	Calculated
Construction Cost	Calculated	Not Calculated
Labour Cost	Calculated	Not Calculated
Demolition Cost and Removal of Debris Cost	Calculated	Not Calculated
Architecture of the Home	Calculated	Calculated
Value of the Land	Not Calculated	Calculated
Demand and Supply of the House	Not Calculated	Calculated
Demand and Supply of Labour and Construction	Calculated	Not Calculated

This tabular comparison gives a quick idea about which factors are included in the replacement value and which factors are included in the market value and allows you to judge which one can be more beneficial for you. However, it is essential to note that in some cases, the market value can be higher than the replacement cost and vice-versa.

When is the replacement cost more than the market value?

It is not uncommon for the replacement cost to be evaluated higher than the market value under several circumstances. Due to some reasons, the replacement value can shoot higher than that of the market value of a house. These factors include:

1. Material used for construction

Some houses are built with rare materials and these can be costlier. However, when it comes to the market value, the buyers may not be willing to pay for these factors which is why the market value comes down. In the case of replacement value, the cost of the construction and the materials used are also included and the exact amount is paid.

2. Location of House

In the open market, the houses built at several locations may not be preferred by buyers like rural areas, houses built at locations that are more prone to natural disaster, etc. However, in the replacement value, the exact value of the house is calculated irrespective of its location which gives the replacement value of that house an upper hand over the market value.

3. Zoning Laws

Suppose your house is built near a flood-prone area, the cost of construction to avoid water accumulation is not taken into account when it is about the market value. However, when it comes to the replacement value, this cost is calculated as well. So, in such a situation, the replacement value surpasses the market value.

When is the replacement cost less than the market value?

As the cost of replacement does not get influenced by factors such as cost of land, the neighbouring area and the demand and supply of the housing market, the cost of replacement can sometimes also be lower than the market value.

Conclusion

A home insurance policy is a major decision because a home itself is a valuable asset. So, when you are planning to purchase a policy for your house, make sure you weigh the pros and cons of each. Analyze if you want replacement value or the market value for your asset. Taking into account several factors that affect the value of a house, you can easily calculate which one suits you the most. Know in detail about the company you choose to buy the home insurance policy from and then only make the final decision.

Disclaimer: The above information is for illustrative purpose only. For more details, please refer to policy wordings and prospectus before concluding the sales.

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