What Is Actual Cash Value vs. Replacement Cost?

When reading your home insurance policy – or any insurance policy, for that matter – it’s easy to get lost in the verbiage and jargon.

Two of the most bewildering terms for home policyholders are “actual cash value” and “replacement cost.” At first glance, one might mistake these policies as being similar or interchangeable, but they are not the same. Being unaware of the difference could affect your coverage.

With housing values going up (and insurance rates going up with them), it could be a good time to update your home insurance, particularly whether you are covered for actual cash value or replacement cost. It could mean more money in your pocket.

Actual Cash Value vs Replacement Cost

The big difference between actual cash value and replacement cost is depreciation: the decrease in value of an item due to factors such as age, obsolescence and wear and tear.

An actual cash value policy pays the amount needed to replace a lost or damaged item, minus depreciation.

Replacement cost provides the sum needed to replace a damaged item with one of similar kind and quality without deducting depreciation.

It is not always clear whether a policy pays actual cash value vs replacement cost. If you have any questions or doubts, review your policy with an insurance professional who can help you better understand how you are covered.

Think of It This Way…

When you make a claim, your insurance company determines your settlement or the compensation you will receive based on the type of policy you have. The Insurance Information Institute gives the example of a tree falling through your roof and onto your eight-year-old washing machine.

“If you had a replacement cost policy for the contents of your home, the insurance company would pay to replace the old machine with a new one. If you had an actual cash value policy, the company would pay only a percentage of the cost of a new washing machine because a machine that has been used for eight years would be worth less than its original cost.”

If the tree also damaged your 15-year-old roof so badly that it needed to be replaced, a replacement cost policy would pay the full cost of installing the new roof, while an actual cash value policy would only pay a percentage.

Choosing a Policy

“Oftentimes a policy that pays actual cash value will have cheaper premiums than one that pays replacement cost,” said Chris DiMartino, senior vice president of insurance services for AAA Northeast. But when it comes to getting sufficient coverage for your home, “don’t always go for the lowest cost option.”

What you save upfront may eventually end up costing you in the event you need it, especially in today’s volatile market. As the value of homes has gone up, so have building costs, and what was enough to cover repairs in the past, may not be enough now.

When you experience a loss, even if your entire home is damaged beyond repair, a standard homeowners policy will pay to replace it up to the limits of the policy. If your policy limit does not keep up with the current market where you live, you may not be adequately covered.

Some policies automatically increase your home coverage limits each year, which could be helpful, but still may not be sufficient in the current environment.

There is no time like the present to reach out to your insurance agent, review your policy and make any needed adjustments.

Schedule an appointment with a AAA insurance agent today.