Building Replacement Value v Purchase Price

Accounting Business Acronym Rcv Replacement Cost ValueI received the following question from a broker:

Hi Allan,

I have been through your website to see if there is a reference I can use to provide to clients outlining the difference between Building Replacement Value and Purchase price and why you shouldn’t set the Purchase price as the Building Sum Insured.

I’m fully aware of the difference and reason but I often have clients when reviewing the sum insured after we provide a Cordells Replacement report questioning the value as it is a lot more than what they may have paid for the property. I can explain this but just want a better more succinct explanation I can use to put in writing.

I would appreciate it if you could refer me to any Material that references this

Regards

Simon [surname and email provided]

 

The simple answer here is the answer is based not on the market price or selling price of the building, but rather its replacement value.

While I assume the question is in respect of a home, the principle is the same for a commercial or industrial building as well. When you purchase a home you are purchasing not only the building but also the land.

Insurance policies specifically exclude land and only cover the structural improvements on the land which includes the building itself, pathways, fencing and a few other things that would transfer with the sale of the home such as a swimming pool, flag pole or other permanent structure.

This means that the market value of a home with its land could in fact be higher than the replacement value of the home itself and its structural importance.

Depending on where the home is located however, and the age of the home, its condition and a number of other factors, the cost of physically replacing or rebuilding the structural improvements could be greater than its market value.

When you insure your building you also have to consider things such as the cost of upgrading the building to current building regulations, removal of debris and the rental value of the property which depending on the insurance policy could be in included in the sum insured or one or more of these benefits could be provided as an additional benefit, over and above the sum insured but always limited typically to a percentage.

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