Actual Cash Value Vs. Replacement Cost

You return home after a long day to find shattered glass, looted rooms, and stolen items. Your heart falls as you understand the scope of the burglary. Fortunately, you have home insurance. 

But here’s the catch: Will the insurance company pay enough to replace your stolen products with new ones? Or will you only get a portion of what you originally paid for them? 

Understanding the difference between replacement cost coverage and actual cash value will help you select the appropriate coverage for your requirements.

What is actual cash value coverage?

Actual cash value (ACV) coverage determines your claim payout using the item’s original cost minus depreciation. Depreciation is the gradual loss of value caused by wear and tear on an item over time. This means that the amount you receive may be less than the cost of replacing that item with a brand-new one. It is the most typical way to pay for personal property coverage.

Here’s an example. Someone breaks into your house and takes your two-year-old laptop. You have ACV coverage. The insurance company analyzes the laptop’s depreciated worth and pays you accordingly.

If you bought $2,000 for the laptop and the insurance company estimates it’s worth $1,400 now, you’d get that amount back, minus your deductible. Your deductible is the portion of your home insurance claim that you are liable for paying.

What is replacement cost coverage?

Replacement cost coverage enables you to replace damaged or lost stuff with new items of the same type and quality. It does not account for depreciation, so you will receive the entire cost of replacing the item, regardless of age or condition, minus your deductible.

Return to the example of the two-year-old laptop. Instead of actual cash value coverage, your policy includes replacement cost coverage. Replacement cost coverage would pay for a new laptop with comparable quality and features. 

So, if the closest model to your stolen laptop costs $2,200 today, you’d receive a single check for the real cash worth of your laptop ($1,400 in the previous example), less your deductible. Then, you’d purchase a new laptop, submit the receipt to your insurance carrier, and receive a second check to pay the difference.

Actual cash value vs. replacement cost

Your insurance policy may provide both ACV and replacement cost coverage, depending on what is covered. Your house is normally covered at replacement cost. By default, insurance companies provide ACV coverage for personal things such as electronics, furniture, and clothing.

Replacement cost coverage is likely to cost more than ACV coverage because it provides more complete protection. However, replacement cost coverage assures that homeowners can replace their valuables without paying out of pocket.

Not sure if ACV or replacement cost coverage is appropriate for you? Take the amount you’d save on premiums and compare it to the amount you’d pay out of pocket if you suffered a large loss. If you file a claim and the settlement is less than what you’d need to replace your lost possessions, the premium savings may be canceled. 

Types of replacement cost coverage

By default, replacement cost coverage pays to rebuild, repair, or replace your property, up to the policy limit. But what happens if you need more money than your coverage allows? These alternatives can provide you with additional coverage.

Extended replacement cost

Extended replacement cost coverage is an optional addition to your home insurance policy. It is intended to help cover the cost of reconstructing your home if the cost exceeds the policy maximum.

Assume your home is insured for $300,000 and you have a typical replacement cost insurance. If your home is damaged by fire and costs $375,000 to rebuild due to rising material and labor costs, your insurance company will pay up to the $300,000 policy limit, minus your deductible. You would be responsible for the remaining $75,000.

However, extended replacement cost coverage would pay an additional percentage beyond the policy maximum, often 20% to 25%. So, if you have 20% replacement cost coverage, your insurance company will pay up to $360,000 (less your deductible) to repair your home. This would make you accountable for $15,000 rather than $75,000.

Guaranteed Replacement Cost

With guaranteed replacement cost coverage, your insurance carrier commits to pay the full cost of rebuilding your home, regardless of the cost. In the case above, your insurance company would pay the entire $375,000 to repair your home. This means you won’t have to pay any out-of-pocket payments above your deductible.

Replacement cost vs. actual cash value: How to decide

Consider these facts to help you decide whether actual cash value or replacement cost coverage is right for you.

Budget. Actual cash value coverage is typically less expensive than other types of insurance. However, you may not receive enough to purchase new replacements for the items you lost, so weigh the savings on your premium against what you would have to spend out of pocket if you had to file a claim.

Risk tolerance. If you want greater financial security and are ready to pay more for it, replacement cost coverage might save you thousands of dollars if you have to file a major claim.