Replacement Cost vs Actual Cash Value

Too often, people don’t think about how much their insurance will pay them in the event of a covered loss until the time that they file a claim. One of the most important factors in determining how much you will receive is whether or not your policy offers replacement cost or whether it pays on an actual cash value basis.

Replacement Cost
The goal of a policy with replacement cost is to pay the insured an amount that it would take to replace covered damage with new material (minus the deductible). In the event your roof is ten years old, and it is destroyed by a covered peril, a replacement cost policy is usually designed to pay for a new roof—that is to REPLACE the roof.

Actual Cash Value
In the same hurricane example above, a policy that pays Actual Cash Value (ACV) would pay the insured the current (actual) value of the ten-year-old roof. In the case mentioned above, the insured would receive money for a ten-year-old roof, minus the deductible. (Technically the formula is the cost to replace minus depreciation minus the deductible.)

The same concept applies to all materials throughout the home, which could lead to a significantly lower claim adjustment on an ACV policy when there is a large claim. The difference in the claim amount could be tens of thousands of dollars. An ACV policy is generally only appropriate in a few circumstance. Generally, an ACV policy should only be purchased when:

• A sophisticated investment strategy calls for lower premiums and maintains enough cash to cover the gap between ACV and the sum it actually costs to replace the damage.
• A consumer really and truly only has a budget to cover the premiums for an ACV policy.  This is only advisable, however, when the consumer has cut out all other non-frivolous spending.  The difference between and ACV policy and a Replacement Cost policy may only be $30 a month, something may consumers may spend at a restaurant.
• An insured cannot obtain replacement cost.  Some dwellings are in such need of repairs, that many insurers will refuse to sell Replacement Cost policies.  The advice, in this case, is to make the repairs as soon as prudent, and then to purchase Replacement Cost policies.

The same concept applies to personal property covered in the home. If an insured has his personal property covered on a cash value basis, his damaged television will be paid based on its age. A TV worth $2000 fifteen years ago, obviously has a much lower value today. A replacement cost policy would pay much closer to the $2000 figure than a cash value policy, which may pay around $200, based on the model, age and condition.

Of course replacement cost policies tend to cost more money. The standard advice is to always buy replacement cost if it is in your budget, even if you have to do away with some spending on entertainment. With an ACV policy, depreciation will wipe out a large portion of your claim.  Sometimes the correct question is “can you afford not to buy Replacement Cost insurance?”  Talk to an experience insurance agent, like Hector Chavana Jr, to analyze your coverage options today.