Replacement Cost vs. Actual Cash Value

Actual Cash Value vs. Replacement Cost: Which One Will Never Pay Your Full Claim?

Homeowner roof in need of replacement

When you buy homeowners insurance and other types of property insurance, you’re likely to have to make a choice between two coverage options: replacement cost and actual cash value. What do they mean, and which should you choose?

Luckily, these two concepts are pretty simple once you cut through the jargon. They’re the key to turbocharging your homeowners insurance, so you can get the right coverage for you at the right price point. Once you’re ready to pull the trigger, expert independent insurance agents can do the hard work for you. They’ll round up quotes, find you discounts and answer all your questions, so you can shop confidently.

What Is Replacement Cost?

Replacement cost means exactly what it sounds like. It’s the cost of replacing something with a brand-new version. If your TV gets fried by a lightning strike, it’s the cost of buying a comparable model at the store. If your favorite pair of blue jeans get ruined in a flood, it’s the cost of—you guessed it—buying a comparable pair at the store. If your couch burns to a crisp in a house fire, then it’s—well, we think you get the picture.

When it comes to things like TVs, jeans and couches, it’s pretty easy to estimate replacement cost. You can look up the same brand and model online (or, if the item is no longer sold, its closest match) and see what it’s selling for at your favorite stores.

Figuring out the replacement cost of your home and other buildings is a little trickier. In that case, the replacement cost is the cost of the materials and labor needed to rebuild the structure. (Replacement cost has nothing to do with the value of the land beneath the building.) Some replacement cost policies may also include money for you and your family to stay in a hotel while your home is rebuilt.

Don’t confuse a home’s replacement cost with the amount you paid for it when you bought it—replacement cost is a much more stable number based on the cost of materials and sometimes labor and design costs, whereas the real estate value of a home can vary wildly based on your neighborhood’s desirability, hot or stagnant housing markets, and a bunch of other big picture factors. A home’s replacement cost is the cost of rebuilding, pure and simple.

What Is Actual Cash Value?

Actual cash value also means exactly what it sounds like. It’s the actual cash value of an item, as opposed to what it would cost to replace that item with a brand-new version. Over time, the value of almost everything declines. Your TV slowly goes on the fritz. Those jeans fray and get holes. That couch soaks up a few too many grape juice stains. Stuff wears out. You pay way less for thrift store stuff than brand-new stuff for a reason.

This loss of value over time (called depreciation) can be estimated using math. Using a few different methods, economists and insurance adjusters figure out an item’s actual cash value based on its replacement value, its age and its “salvage value,” or the amount an item could theoretically be sold for at the end of its useful life. The older something is, the less it’s worth—most of the time.

Certain rare items actually experience appreciation, or gained value, over time. This is especially true for art, precious metals and gems, firearms, fine jewelry and some antiques. These items will need special treatment in your insurance policy to make sure that they’re covered for their full value, and you may need to purchase additional insurance. If you own items that you think could appreciate, be sure to let your independent insurance agent know.

Like replacement cost, actual cash value works a little differently for homes and buildings than it does for objects. If you choose actual cash value coverage, the age of your home’s walls, roof, floors, lighting and more are all taken into consideration, and you will only be paid for their depreciated value, not the money it will cost to actually replace them. That means you could be on the hook for a lot of money if you need to rebuild.

This is a big drawback of actual cash value coverage, and the reason most homeowners insurance is based on replacement value by default. But there are a few situations where it can still make sense—more on that in a minute.

Luckily, when you buy insurance, you don’t have to do any of this math yourself. The important part is understanding the principles behind replacement cost and actual cash value, so you can decide which type of insurance coverage is the right fit for your budget.

What’s the Difference between Replacement Cost Insurance and Actual Cash Value Insurance?

Replacement cost insurance and actual cash value insurance are different coverage options for homeowners insurance and other types of property insurance, such as commercial property insurance for businesses. Replacement cost insurance is often the default option, but you can actually ask to choose between these options. Replacement cost insurance pays for more in case of damage and theft, but it also costs more in premiums. Actual cash value insurance pays for less but saves you money on premiums.

The difference is that replacement cost insurance pays for the full replacement cost of your items in case of damage or theft, whereas actual cash value insurance only pays for the depreciated value. With replacement cost insurance, you’ll have enough money to replace your belongings. With actual cash value insurance, you’ll have to make up the difference between the depreciated value and replacement value if you want to replace your belongings.

Replacement cost insurance is more expensive, since the insurance company needs to pay out more if your home or stuff gets damaged.

They pass this cost on to you through higher insurance premiums. Actual cash value is cheaper, for basically the opposite reason. It’s cheaper for the insurance company to provide, so they need to charge you less to break even.

Neither replacement cost insurance nor actual cash value insurance will pay for you to buy more expensive stuff to replace things that were damaged. For example, if you owned a mid-range HD flatscreen TV, your replacement cost insurance won’t pay for you to upgrade to a top-of-the-line 4K model. (And actual cash value insurance will pay for much less.) This also applies to building materials for your home, so don’t plan on upgrading to marble countertops from Formica.

Which Is Better, Replacement Cost Insurance or Actual Cash Value Insurance?

It totally depends on your financial situation, your home and your stuff. Replacement cost insurance is the better option for most people, since you’ll be able to replace your home and belongings in case of disaster without needing to dip into your own money.

That’s especially true if you don’t have a lot of savings or if you’re in a lot of debt. In fact, a mortgage or other type of loan may require you to carry replacement cost insurance so they can be certain you’ll keep up on your payments in case the worst happens. In these cases, it’s better to deal with the higher premiums each month than to get hit with a nightmare scenario where you’re homeless or out essential belongings with no money to replace them.

But actual cash value insurance does work for some people. If you have lots of savings or other assets, you may decide that you’d rather take the chance of needing to dip into them rather than coughing up the cost of higher premiums. If you’re insuring a second home or vacation home, actual cash value can also be an attractive option, since you’ll still have your primary residence to live in while you save up for repairs.

What Is Extended or Guaranteed Replacement Cost?

If your home is totally destroyed, you might end up pushing the limit of your insurance policy in order to replace it—even a regular replacement cost policy. Insurance companies will not pay more than the limit of your policy even if it’s going to cost more than the limit to rebuild your home exactly as it was. (This could be because of a labor or materials shortage in your area that’s driving up construction costs, or because materials in your original home are now rare or difficult to work with.)

In response to this scenario, some insurance companies offer an extended replacement cost or guaranteed replacement cost option. Extended replacement cost policies extend your limit by a certain percentage, like 10% or 20%, if that money is needed to rebuild your home. Guaranteed replacement cost pays to rebuild your home exactly as it was, with no limit on cost.

Both of these options can be significantly more expensive than a regular replacement cost policy.

How Do I Buy Replacement Cost Insurance or Actual Cash Value Insurance?

In order to buy either replacement cost insurance or actual cash value insurance, you’ll need to speak to an insurance agent, who will help you pick a company and choose the coverage you want. Independent insurance agents aren’t bound to any one company, so they can shop around for multiple quotes—not just the best quote one company offers. They’ll help answer your questions and weigh the pros and cons of replacement cost vs. actual cash value insurance with you.

Before speaking to an independent insurance agent (and definitely before locking down a quote), you’ll want to make a preliminary list of the items you’d like insured, especially any valuable or appreciating items. Homeowners insurance usually covers your belongings up to a limit, but if you have a lot of expensive stuff, you may need to raise that limit or buy extra coverage.

Definitely tell your independent insurance agent if you own any of these items:

  • Valuable art such as sculptures or paintings
  • Precious metals and gems
  • Firearms
  • Fine jewelry
  • Antiques or heirlooms that you think could be valuable

It’s also smart to make a more general list of your belongings, including furniture, appliances, clothes, media (like books or CDs) and toys. This helps you buy the right insurance and makes filing a claim much easier if you ever need to down the road, since you’ll know exactly what you lost. Your independent insurance agent can help you do this effectively.

Whether you choose replacement cost insurance or actual cash value insurance, expert independent insurance agents are with you every step of the way. Good luck and happy shopping!

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