What is Functional Replacement Cost?
Functional Replacement Cost is a term used in property insurance to describe the expense involved in replacing damaged property with materials that serve the same function, rather than restoring the property to its original form. This method allows insurers to replace or repair property with modern, more cost-effective materials that provide the same utility as the original.
In insurance, this approach is often used when replacing old, outdated materials would be unnecessarily expensive or impractical. For example, if a historic building with ornate plaster is damaged, it might be replaced with modern drywall instead, as long as the functionality remains equivalent. Similarly, in homeowners insurance, if vintage hardwood floors are destroyed, insurers may replace them with laminate or engineered wood that serves the same purpose but costs less.
This approach benefits both insurers and policyholders by lowering costs while ensuring that the property remains functional and useful.