When a property insurance policy states that damaged property will be replaced with functionally similar property, what is this called?

When a property insurance policy specifies that damaged property will be replaced with functionally similar property, this is referred to as functional replacement cost. This term indicates that in the event of a loss, the insurer will provide a settlement based on the cost to replace the damaged item with a new one that serves the same purpose, even if the exact item is not available. This approach recognizes that the original materials or specific design might not be necessary, and modern alternatives that perform the same function can be used instead.

Functional replacement cost is particularly beneficial in cases where older items or structures must be replaced, as it allows for flexibility in utilizing available materials while ensuring the insured maintains the same level of utility. This is in contrast to other methods such as actual cash value, which takes depreciation into account, or replacement value, which focuses solely on replacing the item at the same cost regardless of functionality.