Actual cash value vs. replacement cost explained
You buy insurance for peace of mind. However, just because your belongings are insured doesn’t mean an insurer will pay you the full price it costs to replace the items. As such, it’s important to find out whether your policy replaces your belongings at actual cash value (ACV) or replacement cost value (RCV). The cost and breadth of coverage each provides can vary greatly.
Each of these terms relates to how insurance companies calculate how much they pay you in the event of a loss. You are likely to see this terminology on any insurance policy that covers property, be it homeowners, auto, or otherwise.
What do the terms actual cash value and replacement cost value mean, and which should you choose? The answer may depend on the sort of coverage you need and how much you are willing to spend on your premiums.
What is actual cash value?
Actual cash value insurance reimburses you for lost property with depreciation in mind. It looks at replacement cost and subtracts for the age and overall wear and tear of the property. As such, it is not likely to fully replace your home, vehicle, or other belongings. For instance, if you bought a new car five years ago, this coverage would not pay out the amount to purchase a new car: it will only pay the current value of your five-year-old vehicle, with depreciation subtracted.
If you're insuring less expensive items, actual cash value might be worth considering. Items requiring more money to replace are better-protected by replacement cost value. For example, a home covered at actual cash value would likely leave you unable to replace your current dwelling in the event of a loss.
What is replacement cost value?
Replacement value insurance does not factor in depreciation. It pays to replace your property at full cost, minus your deductible. This means that you can replace your property with that of similar kind and quality to that which you lost.
For instance, if your covered television is stolen, replacement value insurance will pay the full price of a new one with similar specs. That said, going back to the “similar kind and quality” clause, it will not replace your television with one that is larger or has higher resolution. This level of coverage is recommended for homeowners, at least for the primary dwelling.
What is extended replacement cost coverage?
While replacement cost coverage is far more robust than actual cash value, it can come up short in some cases, as it only covers your house up to a certain monetary limit. For instance, a home valued at $225,000 could cost $250,000 to replace to the same standard. This increase in cost can be attributed to increases in the cost of labor, building materials, or a number of other factors.
Extended replacement cost coverage goes a step further to protect your home. Your coverage will extend up to a certain percentage beyond your home’s value: usually between 10% and 25%. This is meant to offset any unforeseen costs that could keep you from rebuilding your home to its pre-loss standard.
This coverage can be extremely helpful in areas susceptible to natural disasters such as wildfires and hurricanes, as large-scale destruction can drive up building costs for an entire area.
Because you're getting coverage beyond the value of your home, you can expect to pay a higher premium for extended replacement cost coverage. How much a replacement cost coverage add-on costs depends on a number of factors. Everything from the value of your home to your credit score can influence your rates.
If you're faced with a catastrophic loss, knowing you'll be able to rebuild hassle-free may make the added cost worthwhile.
ACV vs. RCV home insurance
A house is the biggest purchase most people make. Keeping it properly insured is the best way to protect your investment. Some homeowners insurance policies provide coverage for your dwelling at replacement value, while others do not.
HO-3 and HO-5 homeowners policies, for example, will often cover a dwelling (your house and any connected structures) at replacement value. Other personal property, however, may only be covered at actual cash value — depending on your policy. If you choose a homeowners policy with less coverage — like an HO-1 or HO-2 policy — and carry only actual cash value insurance, you may have enough coverage to fully replace your dwelling.
ACV vs. RCV auto insurance
Standard car insurance policies offer coverage at actual cash value, or what your insurance company considers the car to be worth factoring in depreciation. Insurers don’t consult common value guides like the Kelley Blue Book, so your payout may not match numbers that you have researched. Each insurance company has its own methods of determining your vehicle’s actual cash value and will pay out accordingly.
Replacement cost coverage can, however, be added to some auto insurance policies through a new car replacement endorsement. This coverage will replace your car with the same model if it is deemed a total loss. Bear in mind that not every insurer offers this coverage. Those who do will insist that certain requirements be met in order to qualify. For instance, your car must be newer (falling under the insurer's mileage limits) and you must carry physical coverage such as comprehensive and collision insurance.
If you have a modified or classic car, you may want to look into a different method of valuation, such as stated value or agreed value. The true value of such items can be harder to determine and is often far more than the actual cash value.
ACV vs. RCV renters insurance
If you carry renters insurance, your belongings are covered in case of a loss. However, to what degree the insurer will pay out depends on your level of coverage. In the event of a loss, RCV coverage will go much further in helping you get back on your feet, paying out the full cost to replace listed items. Renters insurance policies are often affordable, with the difference between actual cash value and replacement value being marginal, making RCV a smart option.
Which is better: replacement cost value or actual cost value?
Unsurprisingly, replacement value coverage is better in the event of a loss. However, you will pay more for this type of coverage through higher rates. For some items, it may not be necessary to incur the extra premium costs. For other items — a home, jewelry, or art — replacement value coverage is highly recommended. Your coverage level will ultimately come down to your individual priorities and financial situation.