2.2 Valuation: ACV, Replacement Cost, and Functional Value

How Much Will the Policy Pay?

The valuation method sets the dollar basis for a covered loss, separate from the policy limit. The exam tests four methods and the exact dollar outcome each produces on the same loss. Always read the valuation clause on the declarations — a policy can be ACV on the building and replacement cost on contents, or vice versa.

The Four Valuation Methods

• Actual Cash Value (ACV): Replacement Cost minus depreciation (physical wear, age, obsolescence). Most courts and the ISO definition use the Broad Evidence Rule, but the testable shortcut is RC − Depreciation.
• Replacement Cost (RC): the cost to repair or replace with new property of like kind and quality, no deduction for depreciation.
• Functional Replacement Cost: replaces an obsolete component with a modern functional equivalent (plaster walls replaced with drywall) — often less than full RC.
• Agreed Value / Stated Amount: a fixed amount set in advance (used for antiques, fine art, and to suspend coinsurance); pays the agreed figure without an ACV/RC dispute.

Worked Example: $20,000 Roof, 25 Years Old, 40-Year Life

A roof costs $20,000 to replace new. It is 25 years into a 40-year useful life, so it has lost 62.5% of its life (25 ÷ 40).

The gap between RC and ACV ($12,500 here) is the depreciation holdback. Under most RC policies the insurer first pays ACV, then releases the recoverable depreciation only after the insured actually repairs or replaces and submits proof — a heavily tested sequencing point.

Exam Traps

• Replacement-cost settlement on dwellings is conditioned on insuring to at least 80% of replacement cost at the time of loss; fall below and the claim drops to ACV or a penalized amount.
• Personal property under HO forms is settled at ACV unless a replacement-cost endorsement (HO 04 90) is added.
• ACV is not market value and not original cost. Land value is never insured.
• Functional RC produces a payment between ACV and full RC — never higher than RC.

Replacement Cost Conditions and the 80% Rule

Replacement-cost settlement on buildings is not automatic; it is conditioned on the insured carrying at least 80% of full replacement cost at the time of loss and on actually repairing or replacing the property. Until repairs are made, most forms pay only ACV (the holdback) and release the depreciation withheld once the insured submits proof the work was completed, usually within 180 days. If the insured chooses not to rebuild, the claim is permanently settled at ACV. This two-step "recoverable depreciation" mechanic is a heavy exam topic.

Agreed Value, Stated Amount, and Market Value

Three alternatives to ACV/RC appear in stems. Agreed value suspends the coinsurance clause: the insurer and insured agree on a value at inception (supported by a signed statement of values) and pay that proportion without penalty. Stated amount caps recovery at a figure on the declarations but still settles at the lesser of stated amount, ACV, or repair cost — common on older autos and specialized equipment.

Market value (selling price) is generally not an insurance valuation basis because it includes land and location and can be below or above rebuilding cost; the exam expects you to reject market value as the answer for a building loss.

Functional Replacement and Depreciation Drivers

Functional replacement cost pays to repair with modern, functionally equivalent materials rather than obsolete originals — replacing plaster-and-lath walls with drywall, for example. It is used for older or historic buildings where like-kind-and-quality replacement would cost far more than the structure's utility justifies. Depreciation for ACV reflects age, physical wear, and obsolescence; the exam computes it on a straight-line basis using useful life, so always identify the asset's age and total expected life in the stem.

Remember that land, the cost of excavation, foundations below grade, and underground pipes are typically excluded from the replacement-cost figure, which is why a total-loss payment is less than a buyer would pay for the whole property.

Pair-Or-Set, Salvage, and Special Property Limits

Valuation interacts with special-property rules. Under a pair-or-set clause, the loss to one earring or one piece of a matched set is measured as the reduction in value of the set, not the cost to replace the whole set. Salvage reduces the net loss when the insurer sells damaged property it has paid for. Homeowners forms also impose special dollar limits on theft of jewelry, furs, money, securities, and firearms — these are valuation-adjacent because they cap recovery regardless of the item's ACV or replacement cost, and they are corrected only by scheduling the item on a personal articles floater (HO 04 61) at agreed value.

Quick Valuation Decision Rule

On any valuation question, run the same checklist: identify the property type (building, business personal property, or scheduled item), read the valuation clause on the declarations, then compute. Buildings and contents default to ACV unless replacement cost is elected; personal property in homeowners is ACV unless HO 04 90 is added; autos settle at ACV/lesser-of-repair; scheduled valuables settle at agreed value. Land, foundations below grade, and excavation are excluded from building replacement cost, which is why total-loss payments fall short of full market price.