Actual Cash Value vs Replacement Cost in Home Insurance

Actual Cash Value vs Replacement Cost in Home Insurance

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There are three ways to calculate the amount of protection your renters or homeowners insurance will provide: actual cash value (ACV), replacement cost value (RCV) and extended replacement cost value.

Most insurers offer all three options for policyholders to choose from. While replacement cost value policies are the most popular, understanding each option will help you choose the right balance of cost and protection for your coverage.

What is actual cash value coverage?

With actual cash value, your home's value is calculated in one of two ways:

  • By determining the market value of your home
  • Finding the initial cost of your home and personal property, and subtracting depreciation

Most standard homeowners insurance policies include coverage for the actual cash value of the insured’s personal property, as well as the replacement cost of your home's physical structure.

An insurance policy with coverage based on actual cash value will be the least expensive to purchase since depreciation is factored into the value of your home, and therefore the payments you receive for a claim are generally lower.

How is depreciation calculated?

Each home insurance company may calculate depreciation differently. A common method for determining depreciation takes into account an expected lifetime of an item, then subtracts a percentage of value for each year since its purchase.

For example, let's say you bought a $1,000 T.V. four years ago, and it's expected to last 10 years. The estimated straight-line depreciation calculation would calculate the annual loss of value like this:
  • $1,000 / 10 total years = $100 per year in depreciation
  • So after four years, the actual cash value of the T.V insured by your home policy would be $600.

As you can see, using actual cash value means that the insurance coverage for most of your personal belongings will decrease over the number of years you own them.

What is replacement cost value coverage?

Sometimes called "RCV", replacement cost value covers the amount of money it would take to replace your current home — if damaged or destroyed — with the exact same home or a similar home in today's market. The replacement cost is usually calculated in one of the two following ways:

The total, initial price tag paid for all items The cost of physically building the home when it was purchased

Some home insurance policies and endorsements also include coverage for replacing personal property that is damaged or destroyed, however RVC does not cover the value of the land your property is located on.

For example, say you purchased a new home for $350,000. That price likely included the cost of the lot it was built on and the cost of constructing the dwelling. If the lot was priced at $50,000 you only need to insure the cost of the home, which would be $300,000.

Replacement cost value is the most recommended coverage option, since it can help policyholders secure a living situation that closely resembles their previous home.

It's generally recommended that you get a contractor or appraiser to evaluate your house's replacement cost. They'll know how to price the cost of the building's construction materials (like granite, windows, or doors), any unique or valuable upgrades or additions, and determine your house's fundamental value.

Sometimes the replacement cost is paid in two installments. First, the insurer will pay either the actual cash value or half of the replacement cost. Then, once repairs have been made and you can send documentation to the insurer, they will pay the remaining amount.

Guaranteed or extended replacement cost

Policies with guaranteed or extended replacement cost coverage offer the most costly but extensive protection. This coverage is essentially an expanded version of RCV coverage, but it also pays the cost to rebuild your home exactly as it was before a peril, even if the cost exceeds the estimated value of the home.

One major advantage is that, unlike regular RCV coverage, extended replacement cost coverage protects you against increases in materials or construction costs, which often happens after a disaster strikes many homes in one area. If you live in an area prone to natural disasters, and your budget allows it, extended replacement cost insurance is a good option.

Another coverage option to consider is an extended replacement policy, which covers you for an additional 20% to 25% more than the replacement value of the home.

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