What is meant by 'functional replacement cost'?

Functional replacement cost refers to the cost of replacing an item with a different, less expensive option that fulfills the same function. This concept is particularly relevant in insurance contexts where the goal is to restore functionality after a loss without necessarily replacing the item with an identical one. For instance, if a damaged high-end appliance can be effectively replaced by a more affordable model that serves the same purpose, insurance would cover the cost of that less expensive replacement rather than the original item's cost.

This approach helps in minimizing claims costs while still providing the insured with a solution that meets their needs. Insurers often apply the principle of functional replacement cost when items are outdated or when the original item is no longer manufactured, allowing for cost-effective resolution while still ensuring that the insured is not left without coverage.

Other options focus on aspects like market value, repair costs without depreciation, or amounts after depreciation, which do not align with the concept of functional replacement, emphasizing that it's specifically about substituting with a less costly alternative that still achieves the same intended function.