Q. What is actual cash value coverage for homeowners insurance?
I’m looking to buy my first home and will have to purchase homeowners insurance. I want to know how my insurance company will reimburse me if I have a total loss. What is the difference between replacement cost coverage and actual cash value coverage? How will my possessions be reimbursed? How does the insurance company determine the value of my home for insurance purposes?
The main purpose of homeowners insurance is to protect you from the costs of property damage caused by events like fires, storms, tornadoes, and so on. Your homeowners insurance should be there to help you repair or rebuild your home and replace damaged possessions. In order to ensure that your home is properly insured—that you have enough coverage to rebuild your home back to its original state—you need to know the difference between actual cash value and replacement cost coverage for homeowners insurance.
Actual cash value policies reimburse claims based on the amount needed to replace or rebuild lost or damaged property, less depreciation. Depreciation is determined by the age and condition of the item.
If you have an actual cash value homeowners insurance policy, you will be reimbursed for what your items are worth now, not what it would cost to purchase a comparable item at today’s prices.
Actual cash value policies are generally less expensive than replacement cost policies. But in this case, cheaper is not necessarily better. If you have a loss, you may not be able to rebuild your home or replace your belongings sufficiently, with far greater financial consequences for you than saving a few dollars on your monthly premium.
Q. What is the difference between actual cash value and replacement cost coverage?
Replacement cost policies pay claims based on the amount needed to replace or rebuild your property or repair damage using similar materials to what you had before. If you have replacement cost coverage, you should be able to make repairs or rebuild using the same or similar materials, at today’s prices.
It is important to remember that your home’s replacement cost is not the same as its market value, or how much you could sell it for. A home’s replacement cost for insurance purposes is based on a number of variables that determine what it would cost to rebuild your home with similar materials at today’s costs. The variables that make up your home’s replacement cost will fluctuate over time, so the number is not set in stone. You will need to review your policy at least annually to make sure that your replacement cost figure is keeping up with the times.
When you file a homeowners insurance claim, your insurance company will need to determine how much to pay you for your lost or damaged property. The insurer will need to evaluate the cost to replace your property with new property of the same type and quality if you have replacement cost coverage.
But if you have actual cash value coverage, depreciation will be included in the calculation. The amount you will receive will probably not be enough to repair or replace your lost or damaged possessions at today’s prices, leaving you with expenses that you must cover on your own.
Many homeowners make the mistake of purchasing only enough coverage to pay off the mortgage, and others only purchase an insurance amount equal to the market value of their home. But what is the actual cost of rebuilding your home? It is likely to be quite different from the market value on a good day, and when labor and supplies are in high demand after a disaster like a tornado or a hurricane, costs can skyrocket overnight and leave you underinsured.
Some insurers offer guaranteed replacement cost coverage, an expensive option that protects you from sudden increases in building costs. Guaranteed replacement cost policies pay whatever it costs to rebuild your home.
Q. What is contents replacement cost coverage?
It is important to be familiar with your policy language. Even if you have replacement cost coverage for your dwelling, your home’s contents might have actual cash value coverage.
Don’t assume that both are covered the same way. You may have to specify that you want replacement cost coverage for your personal property when you purchase your policy. And remember that every insurance company is different. Some may have caps on replacement cost coverage, and others may exclude certain items or categories of items from replacement cost coverage.
Q. How do insurance companies calculate replacement cost for homeowners insurance?
How should you determine your home’s proper replacement cost? Your insurance company will probably ask you a series of questions about your home and your responses will be plugged into a model that determines its replacement cost.
Your job is to have some idea of whether the figure is accurate so you can be assured that your home is properly protected or that you are not overinsured. In order to estimate your home’s replacement cost, you need to be able to determine the value of all of your home’s interior and exterior finishes, including those in any attached structures, as well as the costs of labor.
There are several things to consider. Here are some tips.
- Talk to a few homebuilders in your area to determine an average rate per square foot to build a home the same size as yours. Multiply your home’s square footage by the average rate per square foot to come up with an initial estimate for the cost to rebuild your home. This calculation will give you a general idea, but is not the whole picture. Your estimate then must be adjusted to account for what is unique about your home, such as luxury finishes, high-end appliances, and any other variations that could increase (or decrease) the cost to rebuild your home to its current state.
- Compare your cabinets, appliances, and other fixtures in your kitchen and bathrooms to new items at local retailers. Do the same for flooring, carpeting, and all other interior features.
- Determine the value of your home’s exterior (e.g., vinyl siding, brick, etc.) if it were purchased today. Talk to a roofer to get an estimate for what it would cost to replace your roof.
Putting all of these calculations together can help you get an idea of what it would cost to rebuild your home and how much insurance you should buy. Be sure to listen to your insurance agent’s recommendations as well, and work with them to come up with a figure that is acceptable.
Don’t forget to evaluate your personal property coverage, as well. Personal property coverage in a homeowners insurance policy typically starts out at a percentage of your home’s dwelling coverage, but if you feel you need more coverage because of certain valuable items, don’t be afraid to increase your personal property coverage limit or add special riders or endorsements to protect your valuables.
Preparing a home inventory is extremely helpful in determining if you have sufficient coverage for the contents of your home.
Once you have settled on a replacement cost figure, remember that it will need to be reevaluated every year to account for changes in building materials and labor as they fluctuate over time.
TrustedChoice.com Article | Reviewed by Paul Martin
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