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Actual Cash Value vs. Replacement Cost

Many homeowners don't know the difference between 'Actual Cash Value' (ACV) and 'Replacement Cost' homeowners insurance policies. Don't be one of them.

house on fire

The distinction between 'Actual Cash Value' (ACV) and 'Replacement Cost' is one of the most important concepts in homeowners insurance. Do you know what the difference is? If you have home insurance, you should. Let us break it down for you.

What “Replacement Cost” Means

Replacement cost is the amount needed to replace your destroyed, damaged or stolen items after a loss. The replacement cost is often calculated as the initial amount you paid for the item.

If the item is no longer available, replacement cost policies pays you the price of the item. That way you're free to find a similar replacement. If the item you purchased is still available but at a reduced price. Your claim may reflect this change in value.

A replacement claim may sometimes be paid out in two installments. Often, the insurer will send one payment for the ACV of the item/component. Or half of its total replacement cost. Once you've done repairs or bought a replacement, you can send proof to your insurer to recover the remaining reimbursement.

Actual Cash Value (ACV) Explained

Actual cash value (ACV) is a policy that covers your home and possessions for market value when lost. Since your items are used, “market value” means that depreciation will be factored in when your insurer pays your claim.

How Insurers Calculate Depreciation

Different insurance carriers will have different ways of calculating depreciation. One of the most common methods is to calculate the item’s value as a portion of its life expectancy.

For instance, a roof predicted to last 30 years will be have zero value at the end of that timespan. So, if the roof is destroyed after 15 years, the ACV will be half the original cost of the roof.

Here's another way to look at the “lifespan” mode. Divide one by the life expectancy of your item to find the annual depreciation rate. An item with a 10 year lifespan will depreciate by 10 percent or .1 percent a year. Use this figure multiplied by the years you used your item to calculate its depreciation.

Besides life expectancy, your insurer may use market data to determine the cost to replace your home. For example, say your twenty year old bay window assembly is destroyed by a storm. Your carrier may try to find a wholesaler who offers twenty year old bay window assemblies to get a price.

This method requires more effort. But insurers may have access to a pricing network or depreciation estimation software that accomplishes the same task. You'll be able to take into account the condition of the item. And that's better than assuming all of your belongings have the same useful life.

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Replacement Cost Trumps ACV

For almost every home owner, a replacement cost policy would be preferable. Coverage like this will pay the true retail cost of replacing lost, ruined or stolen possessions. Replacement cost will always save you in the long run. See how you can save on replacement cost coverage for your home when you comparing quotes from multiple insurance companies.

With expensive electronics, actual cash value usually just will not suffice when you're trying to replace what you've lost. For example, a laptop purchased for $2,000 three or four years ago would actually be worth far less than that now. An insurer will likely write you a check for $700 or so to cover the actual cash value of the item. Finding another comparable laptop at that price would prove challenging, if not impossible.

The truth is that after a disaster or major loss, you're looking to replace your items. Replacement coverage makes the most sense. It's nearly impossible to find a store selling the exact same TV or couch you want replaced. And even if you found one it wouldn't be in the exact same condition at the ACV price.

One reason many people opt for ACV policies over replacement cost policies is price. Replacement policies are more expensive than ACV. In most situations, the better coverage of replacement cost policies make homeowners much happier after a loss.

Depending on how many valuables you have, paying a little extra to get the upgrade might be worth the money. You could also usually offset the extra cost by raising your deductible. After all, home insurance is there for most people to protect them from major catastrophes, not everyday accidents.

Valuable, Antique or Collectible Items

Even with a replacement policy, your most valuable belongings will only be covered for a portion of their value. Items like jewelry or electronics typically have a $1,000 cap on per-item claims. With art, antiques or collectibles, this amount could be as little as $2,500 for your whole collection.

There's another problem with certain rare items. The true replacement cost may have actually gone up since your initial purchase. Insurers will rarely accommodate this appreciation in value, instead opting to pay for your initial purchase value. Thus, a signed jersey by a famous athlete may only be worth the money you paid for the jersey. In actuality, this item could be worth thousands of dollars and be nearly impossible to replace.

For items like these, you can purchase special “floaters” or riders to cover your most valuable or irreplaceable possessions. Other times, you can purchase a separate policy especially made to cover rare and valuable collections.

Why an ACV Policy May Be a Bad Idea: An Illustrative Example

Joe and Flo Smith live in a home with their two children. The home was recently appraised at $200,000. And it was built 30 years ago without any major upgrades or renovations since that time. An ACV insurance policy covers the home and their belongings.

One night, frayed wires in the master bedroom wall sends a spark that catches the wall stud on fire. The fire spreads quickly through the walls up to the ceiling of both the master bedroom and guest room.

Fortunately, the smoke alarm goes off and the family evacuates safely. A local fire station responds quickly and puts out the fire before it spread to the roof or other rooms. The house is still very much intact. But there's a large region damaged by fire, smoke and water from the fire department.

When the Smith family files a claim, an insurance claims adjuster estimates that the damage will take $25,000 to repair. This is the replacement cost. However, the estimated structural lifespan of the home in its pre-fire condition was 60 years. So the depreciation has a big impact on the ACV claim offer.

After the calculations are performed, the adjuster can only write a check for $12,500. Joe and Flo will have to pay out of pocket for the other half to restore their home.

Worse, when calculating all of the various possessions damaged, the family is faced with an even bigger deficit. The adjuster estimates that the destroyed items like the beds, TV, couch and other furniture will cost $10,000 to replace. Once the depreciation calculations are added up, the Smiths could get as little as $4,000 to cover “big ticket” items.

A vivid example like this illustrates why ACV insurance can do too little to reduce the cost of recovering.

Making Sure Your Insurance Coverage Works for You

When speaking to an agent, you must be absolutely clear about the kind of policy they're offering you. Make sure that you get every cent of coverage you need to prepare for common and likely catastrophes.

Obviously, the most important thing home insurance covers is your actual home. Opting for limited coverage of your possessions paired with complete coverage of your dwelling could possibly make the most sense. Take an inventory of your possessions and decide what is right for you and your family.

Whatever coverage you pick, always be sure to speak with multiple agents. This way you can make sure you get the best rates for your coverage, and that your coverage is adequate.

Get a free no-obligation quote and compare Actual Cash Value vs Replacement Cost policies from multiple insurance companies.

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