Functional replacement cost loss settlement in insurance refers to the reimbursement of a policyholder for the cost of replacing damaged property with a similar or equivalent item. Instead of receiving the actual cash value of the damaged property, the policyholder is compensated for the cost of a new item that serves the same function as the old one. This settlement option ensures that the policyholder can continue to use and benefit from the newly replaced item, even if it is not identical to the original.