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What is actual cash value vs replacement cost?

March 4, 2024

Understanding terms in your insurance policy means there’s no surprises in the event of a loss.

An important one to know is the difference between replacement cost and actual cash value. What type your insurance policy has will determine how your payout is calculated.

Let’s say there’s a flood in your basement family room. Your furniture, flat screen tv and sound system have been damaged. Do you know if your insurer will pay for the actual cost you paid for those items?

Defining actual cash value

Actual cash value (ACV) is the replacement cost of the lost or damaged item but factors in depreciation. If your family room television and sound system is 10 years old, it would consider what they are worth in today’s value. Similarly, your insurer may repair a damaged roof, but actual cash value will consider the fact that it’s 10 years old. ACV looks at current market values, not how much it costs to replace.

Generally, depreciation is calculated by evaluating an item’s replacement cost value (the current cost of repairing the item or replacing it with a similar one) and its life expectancy (the item’s average expected lifespan).

This means ACV considers things like deductions for depreciation, wear and tear, and the actual condition of the item when it was lost or stolen. Most insurance companies will use standard guidelines (known as depreciation tables) to determine an item’s actual cash value — or they’ll contact a professional retailer or appraiser to determine what a similar used item would cost to buy.

Pros and Cons

Pros: Premiums are generally less expensive, which helps keep costs down for policyholders.

Cons: Payouts are lower. Clients will often have to pay out-of-pocket to replace their items on top of whatever their insurance payment is.

Defining replacement cost

Replacement cost insurance helps you restore your life much faster and with less financial stress but it will cost you more in monthly premiums. This gives you money to replace the lost or damaged items equal to the amount you’d need to replace that item with a new or similar product. The idea behind this coverage is that you wouldn’t have to pay out of your own pocket to replace your items, since you would receive enough to cover a brand new replacement.

If your $1,500 laptop was damaged in a fire, for example, you would receive enough money to purchase a new replacement with the same features regardless how long you have owned it. In other words, depreciation is not a factor.

Pros and Cons

Pros: Replacement cost insurance pays out quite high, meaning policyholders don’t have to use their own money to ensure their lives return to the way it was before they had to file a claim.

Cons: Premiums can be costly for policies with this type of covered losses.

Which is better?

Only you can answer this question.

Generally, getting a policy that will cover the actual cash value of items that are lost or damaged is a good option if you are looking for protection with lower premiums.

However, if you’re looking for more protection for lost or damaged items and aren’t worried about paying higher premiums, getting a policy with replacement cost may be the best option.

Always know your policy. To determine what is best for your situation, speak with your insurance broker.