Replacement Cost vs Actual Cash Value
Actual cash value and replacement cost are the two main loss settlement options provided by insurance companies. “What is loss settlement?” you might ask. Well, loss settlement is how your insurance company decides the amount to pay you for the loss of an insured item. The type of loss settlement option you have agreed to in your homeowner’s policy largely determines your payout.
What Is Replacement Cost?
Replacement cost pays the amount required to replace damaged or stolen property with property of the same kind and quality, i.e., the amount you receive is enough to buy a new version of the item you lost. Your insurer will not factor in depreciation. So if someone were to steal your worn-out, insured camera, this insurance coverage provides you with the full cost of replacing it with a brand new camera of like-kind.
It’s rather easy to estimate the replacement cost for items like furniture such as sofas, dining tables, wedding rings, watches, TVs, smartphones, designer clothes, and firearms. It’s just new for old. But with homes and other buildings, it gets somewhat more complicated. The loss settlement amount, in this case, covers the cost of the materials and labor needed to rebuild your home.
What else does homeowners insurance cover?
Aside from dwelling, your homeowner’s policy covers your personal property as well. But for highly valuable items, you will need to purchase an additional policy provision called a rider. Moreover, the policy can include additional living expense insurance coverage, which pays for additional costs of living while your house is uninhabitable. Such expenses include:
- Hotel stays
- Storage fees
What Is Actual Cash Value (ACV)?
The actual cash value means the “fair market value,” which is the amount a buyer is willing to pay, and a seller is willing to sell under normal circumstances. Another definition would be the cost for a new item of like kind minus depreciation. You’ll, therefore, have to pay out of pocket to replace the item with a similar one or settle for one of lower quality.
Here’s an example. Let’s say the stolen camera we mentioned earlier had depreciated by $3,000 at the time; it’s no longer worth the $9,000 you paid when it was new nor the $7,000 it costs today. Regardless, under the replacement cost coverage, your payout would have been its current cost: $7,000. But under the ACV settlement option, your payout will be its cost today minus depreciation, which in this case would be $7,000 – $3,000 = $4,000.
What of property that doesn’t depreciate?
While most items depreciate over the years, some like fine art, precious metals, jewelry, and select antiques gain value over time. Such items may require you to purchase additional insurance coverage to have them insured for full value. And as for homes and other buildings, ACV factors in the age of your home’s walls, floors, roof, lighting, etcetera. So you’re only paid their depreciated value, not the money it will cost to replace them.
So What’s the Difference?
Although significantly more costly, the replacement cost option pays whatever is necessary to replace your lost or damaged item with a brand-new version. Whereas, actual cash value insurance pays only for the depreciated value, i.e., the amount you could expect to receive for the item if you sold it in the marketplace.