Difference Between Actual Cash Value and Replacement Cost

Whats the difference between actual cash value and replacement cost? 

It is very important that you elect to have replacement or reimbursement cost on your home and personal property.  You want to be able to replace your belongings in the event of a fire or some other occurrence, don't you? Most standard homeowners policies come with replacement or reimbursement cost unless the customer asks to fore go this coverage.

Replacement or reimbursement simply means depreciation is not calculated at the time of the loss.  This means that you are paid the full cost to replace any item that is stolen or damaged with an item of like kind or quality. 

The way replacement cost payments are made may differ from carrier to carrier. For example some companies may initially pay the actual cash value of an item, and after you have purchased an item to replace the loss, reimburse you the remaining amount.

 Then what does actual cash value mean (ACV)?

Many people interpret actual cash value as the "market value."  For example the ACV of a car might be somewhere near the Kelly Blue Book value or the NADA value.  However, market value is often hard to determine because in reality the market value of a vehicle is only determined by how much a buyer is willing to pay.

For this reason many insurance companies define actual cash value as the cost to replace an item with a new one of like or kind quality, less depreciation.  The only difference between replacement cost and ACV is the deduction for depreciation, which can be very significant.

 How could this effect me if I still want an actual cash value policy?

Lets use the example of damage to a home's roof due to a wind storm.  Lets say your home is twenty years old, and the roof has never been replaced.  If a storm causes $30,000 in damages to the roof, and the roof has a estimated lifetime of 30 years, a deduction will be made for depreciation based on how old the roof is (20 years) and how long a roof normally lasts (30 years in the case). If the roof depreciates $1,00 per year, the insurance company may only pay $10,000 for this loss based on the ACV (twenty years of depreciation=$20,000 minus the initial value of $30,000). 

The moral of the story?

Always opt for replacement cost coverage on your dwelling and personal property. The cost of this coverage is negligible.