The terms “replacement cost” and “actual cash value” come into play when you file a claim with your insurance company. The terms refer to how your insurance company determines the value of your insured items that have been stolen, damaged, or destroyed. This, in turn, helps the company determine how much it will pay for your claim.
Replacement cost and actual cash value apply to auto, home, and renters insurance. Your policy contract states which approach the insurance company will use if you have a claim.
What Is Replacement Cost?
With replacement cost, the insurance company will base its payout on the cost to replace an insured item with a brand-new item of the same or similar make and model. There’s no factoring in depreciation, so you can expect to receive enough money to buy a brand-new item at current prices, minus your deductible.
For example, while you’re on vacation, a thief steals your camera bag with your three-year-old DSLR camera and two extra lenses. You return home and file a personal property claim with your renters insurance company. The policy contract states that your claims are based on replacement cost. Even though the camera and lenses had experienced some “wear and tear,” the insurance company settles the claim based on the cost to buy new items of the same make and model. That’s $1,200. You have a $500 deductible for this coverage, so the insurance company sends you a check for $700.
What Is Actual Cash Value?
With actual cash value, the insurance company will base your payout on the replacement cost minus depreciation. Insurers vary in how they calculate depreciation — there's no industry standard. You can, however, get a general sense of how depreciation affects value by looking at examples of your item on auction sites.
For a car, check resources such as Kelley Blue Book or NADA Guides. It’s important to stress that these resources can only offer a ballpark idea of an item’s depreciated value. Again, your insurance company will have its own way of performing this calculation.
Let’s return to your stolen camera bag. Your policy contract states that claims are paid based on actual cash value. The insurance company determines that the three-year-old camera and accessories are worth only $700. With your $500 deductible, you receive a settlement payout of $200.
Actual Cash Value vs. Replacement Cost in Car Insurance
Actual cash value and replacement cost come into play in car insurance if you have collision and comprehensive coverage on your policy.
With collision coverage, your insurance company will pay to repair or replace your car if you’re at fault in an accident involving another vehicle (or multiple vehicles) or a stationary object. With comprehensive insurance, the insurance company will pay if your car is damaged by weather, falling objects, fires, floods, or is stolen and not recovered.
The insurer will typically declare a total loss for these claims if estimated repair costs exceed the vehicle's value. With a replacement cost policy, the insurer will consider the value of a brand-new vehicle of similar make and model. With an actual cash value policy, the insurer will consider the depreciated value of your vehicle. The insurance company will be more likely to repair a vehicle if the policy specifies replacement cost.
If the car can’t be repaired (or if it’s stolen and not recovered), the insurance company will take possession of its title and pay you a total loss settlement. You can expect a much lower total loss payout with an actual cash value policy than with a replacement cost policy. And don't forget that the insurance company will subtract your deductible amount.
Actual Cash Value vs. Replacement Cost in Homeowners Insurance
Actual cash value and replacement cost come into play with a homeowners policy’s dwelling, other structures, and personal property coverage.
Your dwelling and other structures' coverages ensure you’ll be reimbursed if your home is damaged or destroyed due to fire, severe storm, or other catastrophe. A standard HO-3 homeowners policy provides coverage at replacement cost. This means the insurance company will base your payout on the cost to rebuild your home with construction materials at their current pricing. With an actual cash value policy, it’ll base your reimbursement on your home’s depreciated value.
Your policy’s personal property coverage ensures you’ll be reimbursed if items such as your furniture, clothing, electronics, small appliances, tools, or sports equipment are stolen, damaged or destroyed due to a covered catastrophe. If your homeowners policy contract specifies replacement cost, you can expect your insurance company to provide reimbursement based on the price of a brand-new item. If it specifies actual cash value, your insurance company will determine the depreciated value of the stolen or damaged item and base the claim payout on that number.
In all cases, a deductible will apply.
Actual Cash Value vs. Replacement Cost in Renters Insurance
A renters policy does not provide coverage for the dwelling or other structures (this is the landlord’s responsibility). But it does provide coverage for your personal property.
As with a homeowners policy (see above), your insurance company will provide reimbursement if your items are stolen or destroyed in a covered incident. Replacement cost ensures you’ll be reimbursed based on the value of a new item at current prices. Actual cash value means you’ll be reimbursed based on a depreciated value. Your personal property coverage deductible will apply.
Tips for Insuring Your Personal Property
It’s a good idea to create a home inventory and keep receipts of your expensive items, including things such as electronics, sports equipment, and furniture. The more documentation you can provide your insurance company when you have a claim, the easier it is for the insurer to determine value.
If you own items such as antiques, expensive jewelry, artwork, expensive computer equipment, or firearms, ask your insurance company about a scheduled personal property endorsement. Such items may have only limited coverage with a standard homeowners or renters policy. Adding a scheduled property endorsement would provide the extra coverage you need.
Final Thoughts: Replacement Cost vs. Actual Cash Value
With all other things being equal, having a policy with replacement cost means you’ll get a higher payout. However, it’ll cost you more in premiums than a policy with an actual cash value payout.
Now that you've learned a little about how insurance companies determine how much they will pay for claims, you may be wondering what your own policy specifies. Your auto, home, or renters policy contract should specify which approach the company will take. Make sure you understand and are comfortable with your policy — the worst time to be surprised is when you file a claim. Your insurance company or local agent can help if you have any questions.