[US,CA] Mortgage Insurance Requiring Full Replacement Value not Modified Functional

Hi all, Im having a huge issue with my lender refusing to accept my california home owners insurance policy because it has an endorsement for "modified functional replacement cost loss settlement." They are demanding full replacement cost coverage.

Per the lender, they think Fannie Mae issued new guidance saying that modified functional replacement cost is just another way of saying "actual cash value". I think it's completely moronic but Fannie Mae's seller guide says that the insurance must provide "100% of the replacement cost value of the improvements". and also says this: "The property insurance policy must provide for claims to be settled on a replacement cost basis. Property insurance policies that provide for claims to be settled on an actual cash value basis are not acceptable. Policies that limit, depreciate, reduce or otherwise settle losses at anything other than a replacement cost basis are also not acceptable."

I think that last line there might be the problem – unfortunately my home was built before 1950 – afaik, no one or very few insurers are going to write a full replacement cost policy on a house that old. This all seems insane to me and I question how anyone in california is able to get a policy the lender will accept

Am I crazy?