What is a valuation clause?
A valuation clause is a contract provision that specifies how the value of an asset or loss will be determined and how much the party will receive if a covered event occurs. Most commonly found in insurance policies, valuation clauses define the method an insurer will use to calculate reimbursement for damaged, lost, or destroyed property.
How valuation clauses work
When a loss occurs, the valuation clause in the policy or contract prescribes the valuation method and the resulting payment. Valuation can depend on factors such as depreciation, replacement cost, market conditions, appraisals, and any agreed-upon values negotiated when the contract was written. Understanding the clause helps policyholders or contracting parties know the likely payout and whether additional coverage or endorsements are needed.
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Common types of valuation clauses
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Actual Cash Value (ACV)
Pays the cost to repair or replace the property minus depreciation. ACV reflects the pre-loss value after accounting for age, wear, and obsolescence. -
Replacement Cost
Pays the cost to repair or replace the property with new items of like kind and quality, without deducting for depreciation. Replacement cost may not cover upgrades required by current building codes unless a law-and-ordinance endorsement is included. -
Stated Value
The policy lists a value set by the insured at the time the contract is written. At claim time, the insurer typically pays the lesser of the stated value or the actual cash value, unless the contract specifies otherwise. -
Agreed Value
The insurer and insured agree in advance on the value of the property. In the event of a total loss, the agreed amount is paid regardless of depreciation. This is common for unique, high-value, or hard-to-appraise items. -
Market Value
Values the insured property at what it would fetch on the open market at the time of loss. Market value reflects current demand and sale price rather than replacement or historical cost.
Special considerations
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Appraisals and underwriting: Insurers may require an appraisal or specialist review before issuing coverage, especially for antiques, collectibles, historic properties, or customized items.
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Inflation and cost changes: Periodic review and updating of insured values is important to keep pace with inflation, rising construction costs, or local building code changes.
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Law-and-ordinance (building code) coverage: Standard replacement-cost coverage may not pay to meet current building codes. A law-and-ordinance endorsement increases the payout to address code-based rebuilding expenses.
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Valued-policy laws: Some jurisdictions require insurers to pay the policy’s face value in the event of a total loss, rather than an ACV calculation. Local rules can affect claim outcomes.
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Reporting clauses: Some policies require insureds to periodically update values under a full reporting clause; failure to do so can lead to underinsurance.
Uses beyond insurance
Valuation clauses also appear in commercial contracts—for example, in mergers and acquisitions, licensing, or distribution agreements—to fix or determine the value of assets exchanged or transferred between parties.
Example
A driver’s auto policy includes an ACV valuation clause. If the car is totaled, the insurer pays the vehicle’s replacement cost minus depreciation, not the cost to buy a brand-new equivalent model. If the policy had been written with agreed value wording, the carrier would instead pay the pre-agreed amount for a total loss.
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Key takeaways
- A valuation clause defines how value and payouts are determined for insured or contracted assets.
- Different valuation methods lead to materially different claim payments—ACV tends to pay less than replacement cost or agreed value.
- Review valuation clauses carefully and update insured values as costs, codes, or market conditions change.
- Consider endorsements (e.g., law-and-ordinance) or agreed-value arrangements for high-value or specialized assets.
Frequently asked questions
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Do valuation clauses only apply to insurance?
No. While common in insurance policies, valuation clauses are also used in other contracts to establish asset value between parties. -
How does the valuation clause affect a claim?
The clause determines the basis for calculating the payment (e.g., ACV, replacement cost). It directly affects the amount the insured will receive for a covered loss.