Understanding Actual Cash Value Vs. Replacement Cost Policies
When disaster strikes, our “stuff” is often the last thing on our minds—at least until the clouds pass, and it’s time to pick up the pieces. Protecting your hard-earned possessions with insurance is always a smart move, but when it comes to choosing coverage for your home and belongings, you may have some questions about the different types of policies on offer. Two of the most common—Actual Cash Value Policies and Replacement Cost Policies—each have specific benefits and limitations, and understanding the difference can help you make the smartest choice for your particular needs.
Value Versus Cost
Before choosing either type of policy, it’s important to have a grasp of the terminology you’re likely to see and hear from insurers.
- Actual Cash Value is defined as the amount of money an insured item is worth today; this value is usually arrived at by deducting depreciation from the item’s original cost.
- Replacement Cost is the amount of money required to replace the item with one of comparable value and utility today.
- Depreciation is the decrease in an item’s value due to time, damage, and everyday use.
Making a Claim
To put these terms into perspective, let’s look at how a claim works under both types of policy.
Let’s say a recent fire damaged your home and belongings. After making your claim and meeting your deductible, you are ready to replace your damaged possessions. Two years ago, you bought an HDTV for your family room at a cost of $1,800. The amount you receive from your insurance company to help with its replacement is based on which kind of policy you’ve chosen.
With an actual cash value policy, your insurance company will determine the value of your TV today, based on original cost and subsequent depreciation, and pay you (for example) $1500.
$1800 (original purchase price) – $300 (depreciation over two years) = $1500
With a replacement cost policy, the insurance company will pay you what it will cost to replace the TV today. So if the same TV (or a comparable model with the same features) costs $2100 today, you’ll receive that amount instead.
It’s important to note that, with replacement cost policies, most insurance companies will pay you the actual cash value of an item, and then ask you to submit a receipt showing the amount you actually paid to replace it in order to receive the difference.
So, in our example, after filing a claim, you would receive $1500 (the actual cash value of the HDTV today) from the insurance company. You then buy a new TV for $2100, and submit the receipt to your insurer, who sends you a check for the difference ($600, in this case).
A Matter of Choice
One other important consideration to keep in mind is the cost associated with the policies themselves. Perhaps unsurprisingly, replacement cost policies tend to carry higher premiums than their actual cash value equivalents—but the extra cost up front may prove well worth it when it’s time to file a claim and replace your lost possessions.
Whether you choose an actual cash value or replacement cost policy, it’s always a good idea to reach out to a qualified and licensed insurance agent who can help you make the right decision regarding the premium, coverage, and deductible that’s right for you.