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Functional Replacement Cost
Functional replacement cost in property insurance refers to the cost of constructing a building that is able to serve the same functions as the one that is to be replaced.
Sometimes, because of the architecture or other features of a building, it cannot be adequately replaced with a totally similar building.
This could be cause of technology, materials, and even the location, etc.
In such cases, due to the endorsement for loss settlement, insurers might compensate the insured with the amount required to build a new building that is able to serve the same functions of the one that is to be replaced.
This means that this new building might not look the same or even remotely resemble the original building. But it is able to do the things which the original building could do.
For example, an old factory complex suffering a total loss might be replaced with a modern one with latest technology capable of manufacturing the same products. This factory might be less costly to build and might even have a smaller floor area. But it still retains it’s functions.
This should not be confused with replacement cost as the valuation method is different.