Q: What's the Difference Between Replacement Cost and Actual Cash Value?
I have been looking online for information about home insurance and keep seeing the terms "replacement cost" and "actual cash value" thrown around, but I'm not sure what they really mean and if one is better than the other. Help!
A: What this comes down to is depreciation. Actual cash value coverage takes depreciation into account, and replacement cost value coverage does not. Though it costs more, the replacement cost value is almost always the better choice.
When you purchase home insurance, the standard policy typically offers structural coverage at replacement value and content coverage at actual cash value. Depending on the depreciated value of your personal belongings, you may want to pay more to switch your contents coverage to replacement value as well.
It is extremely important that you ensure that you do not have actual cash value coverage for the structure of your home. Here’s why. Let’s suppose you purchase an older home and it burns down. If you have actual value structure coverage, you will only be entitled to the actual, depreciated value of the things that make up the structure of your home.
The depreciated value of older pipes, cabinetry, electrical systems, and flooring may only be a fraction of what it would cost you to replace them when you rebuild. This can leave you several thousands of dollars in the hole. On the other hand, if you have replacement cost value coverage, you will be able to collect compensation that will enable you to rebuild a home of the same like, kind and quality, up to your coverage limits.
It is possible that the amount of structural coverage you have is too low to enable you to fully rebuild a similar home without incurring out-of-pocket costs, so it is always a good idea to sit down with your insurance agent every few years to review your policies and coverage limits and make changes as needed.