When shopping for a homeowners insurance policy you may be asked whether you want an actual cash value or replacement value policy. Many homeowners are unaware of the difference in these types of policies and that confusion can result in a costly mistake.
We thought it might be a good idea to have a look at the important differences between these policy types.
Actual Cash Value Insurance (ACV)
An actual cash value policy will take deprecation into account when determining a payout amount on your claim. Basically, your policy will only pay what the property was worth when it was destroyed, not what it will cost to replace it with an item of similar quality. While these policies are cheaper, in the long run they can often end up costing much more.
Actual cash value can apply to your entire house, just certain sections or only your personal possessions.
As an example, the standard lifespan for a roof is about 30 years for insurance purposes. Let’s assume your roof is valued at $30,000 when it is new. Once your roof reaches 30 years old, it has zero value to an insurance company, meaning that you will be on the hook for the entire cost of a new roof.
The value of your roof will depreciate roughly $1,000 per year so if your roof is destroyed when it is 15 years old, your insurance check is going to be for $15,000 despite the fact that a new one is going to run you close to $30,000. You will need to write a check for $15,000 to get that new roof your house absolutely needs.
The same can be applied to the entirety of your home. Assuming your home is 30 years old and has a structural lifespan of 60 years for insurance purposes, if your home experiences a fire that does $25,000 worth of damage, an actual cash value policy will only pay out $12,500 because your house is halfway through its structural lifespan.
Actual cash value applies to your personal possessions as well and those costs can quickly add up. Your 10-year TV will have very little value if it is destroyed, leaving you on the hook for a new one.
Insurers calculate life expectancy differently so if you are carrying an ACV policy, ask your agent to explain how life expectancy is calculated for some of the more common items that you may have to file claims on, electronics, furniture and power equipment can be a good place to start.
A replacement value policy will pay out the amount that is needed to replace your damaged or destroyed property with something of similar quality, regardless of cost or depreciation.
In most cases, insurers will look at the amount that you initially paid for the item to determine a value on your claim. If the exact item is no longer available or the price for one has increased dramatically a replacement value policy will pay for one of similar quality.
On the other hand, if the price has dropped on a similar quality item, TVs are a good example, your payout may be less than you initially spent on the item but enough to purchase one of similar quality.
In many cases, a replacement value policy will pay out in two installments. The first payment will be for the ACV value of the item. Once you have purchased a replacement or made repairs to your home, you can submit receipts for the balance and your insurer will reimburse you.
Replacement value not only pertains to your personal possessions but your home’s roof and structure. A replacement value policy will pay to repair or replace your roof or fix your home without taking deprecation into account.
Guaranteed or Extended Replacement Cost
This type of policy offers the most protection but is also the most expensive option. A guaranteed replacement policy will cover the cost to rebuild your home exactly as it was before it was damaged or destroyed, regardless of cost, even if the cost exceeds the estimated value of the house.
This can be helpful in areas where construction or material costs are headed up dramatically. It is also helpful for older home where the original materials used can be extremely expensive.
Which is Best?
The cost difference between an actual cash value policy and a replacement policy is often fairly reasonable and the benefits are absolutely worth it. If your home is severely damaged or destroyed you may find yourself having to pay thousands, or even tens of thousands of dollars to repair your home or replace your items.
While a guaranteed replacement cost policy offers fantastic coverage, they are often pretty pricey. In most cases, unless you live in an area where large-scale disasters are common, this policy is not worth the more expensive premium.