As the market for insurance grew in both volume and breadth of coverage, insurers incorporated replacement cost coverage into homeowners and commercial property policies, usually with a coinsurance requirement stipulating that the amount of insurance be at least 80 percent of the replacement cost.
The spread of replacement cost insurance led to some problems, however.
For one thing, in the eyes of insurers, replacement cost coverage gave rise to an inordinate number of claims for roof replacements. As roofs age, they show wear and become discolored. Even minor damage can require complete replacement of a roof as new roofing for a damaged section would not match the older, weathered sections. In recent years insurers have introduced endorsements providing for ACV coverage on roofing for structures that are otherwise covered on a replacement cost basis. Nonetheless, roofing losses remain at high levels in areas of the country prone to wind and hail storms.
Another problem with replacement cost coverage came with older structures that have features which are obsolete, such as lath and plaster walls, or clay roofing, as well as decorative features such as hand- carved woodwork or masonry ornaments. Such features are very expensive to repair and replace — and to insure given the 80 percent coinsurance requirement.
Functional replacement cost coverage emerged as a cost-effective alternative for the owners of older structures with unique or obsolete features. Typically provided by endorsement to property policies, FRC coverage stipulates that the insurer will pay to replace damaged property with less expensive and more current materials and workmanship, provided they fulfill the same functions as the original property.
Under FRC building coverage, lath and plaster walls are replaced with wallboard or plywood; roofing tiles are replaced with shingles; and elaborate woodwork and ornamental fixtures may be removed. As for personal property, outmoded or unusual furnishings and equipment are replaced by more common modern equivalents.