2.2 Valuation: ACV, Replacement Cost, and Functional Value

The Three Valuation Bases

Valuation answers a single question: how much does the insurer pay for damaged property? The three exam-critical methods are:

• Replacement Cost (RC) — the cost to repair or replace with new property of like kind and quality, with no deduction for depreciation.
• Actual Cash Value (ACV) — replacement cost minus depreciation. The classic formula is ACV = Replacement Cost − Depreciation.
• Functional Replacement Cost / Functional Value — the cost to replace with functionally equivalent but less costly materials (common on older, ornate, or historic structures).

Depreciation reflects age, wear, and obsolescence. Some courts and policies define ACV using the broad evidence rule, which lets the adjuster weigh market value, replacement cost less depreciation, and any other reasonable evidence of value.

Worked ACV vs. Replacement Cost Example

A roof costs $20,000 to replace new. It is 15 years old with a 30-year expected life, so it is 50% depreciated.

On an ACV policy the insured receives $10,000 now and must absorb the $10,000 depreciation gap. On an RC policy with recoverable depreciation, the insurer first pays the ACV ($10,000), then releases the remaining $10,000 after the insured actually repairs or replaces the roof. That two-step "hold-back" of recoverable depreciation is a frequent exam point.

Replacement Cost Conditions and Caps

Replacement-cost settlement is conditional, and the exam tests the conditions:

• The insured must actually repair or replace to collect the depreciation hold-back; until then payment is limited to ACV.
• Payment is the least of: the policy limit, the RC at the same location, or the amount actually spent.
• Homeowners forms require the dwelling to be insured to at least 80% of replacement cost to settle building losses on a full RC basis (otherwise a coinsurance-style penalty applies — see 2.3).
• Personal property is usually settled at ACV unless a Replacement Cost endorsement (HO 04 90 / the personal property RC option) is added.

Other valuation bases to recognize: Agreed Value (insurer and insured agree on a fixed amount, suspending coinsurance), Stated Amount (a declared ceiling, common on autos/equipment), and Market Value (sale price of land plus building — rarely the property-insurance basis).

Functional Replacement Cost — When and Why

Functional Replacement Cost (FRC), added on commercial property by CP 04 38 or built into certain dwelling forms, pays to replace damaged property with modern, functionally equivalent materials rather than expensive original-match materials. Example: replacing ornate plaster-and-lath walls with drywall, or original copper plumbing with PEX.

FRC matters most for older, historic, or over-improved buildings where strict replacement cost would over-insure relative to function. It removes the coinsurance requirement and sets the limit at functional value. Do not confuse FRC with ACV: FRC uses no depreciation deduction — it simply substitutes cheaper-but-equivalent materials, whereas ACV deducts depreciation from the original construction.

Depreciation, Obsolescence, and the Broad Evidence Rule

Depreciation is not limited to physical wear. Adjusters recognize three drivers:

• Physical depreciation — age and use (the 15-year-old roof above).
• Functional obsolescence — outdated design or systems (knob-and-tube wiring, single-pane windows).
• Economic/external obsolescence — value loss from outside factors (a declining neighborhood).

Under the broad evidence rule the ACV is not mechanically "RC minus depreciation"; the adjuster may weigh market value, the income the property produced, replacement cost less depreciation, and any other relevant evidence. This matters most on commercial and unusual structures where a strict cost approach distorts true value. On personal lines, expect the simple RC − depreciation formula unless the question signals the broad evidence rule by listing market and income data.

Stated Amount, Agreed Value, and Market Value

Beyond ACV, RC, and functional RC, the exam tests three more bases:

• Stated amount — the insurer pays the lesser of the stated amount, ACV, or cost to repair; common on hard-to-value items like older trucks.
• Agreed value — the insurer and insured agree on the value up front and the coinsurance condition is suspended; the agreed figure is paid for a total loss.
• Market value — what a willing buyer would pay a willing seller; it includes land and location, so it usually differs from replacement cost (which excludes land).

Trap: Market value can be far below replacement cost in a depressed area, or far above it for a desirable lot — never equate the two.

The Broad Evidence Rule and Total-Loss Valued-Policy Laws

When ACV is disputed, many courts apply the broad evidence rule — the adjuster may consider any relevant factor (replacement cost less depreciation, market value, obsolescence, expert appraisal, original cost, income produced) rather than a single formula. For total losses to real property, some states enforce a valued-policy law: if a building covered against fire is a total loss, the insurer must pay the full face amount stated on the policy, overriding the usual ACV/coinsurance math. The exam pairs the valued-policy law (total loss) with the standard ACV settlement (partial loss).