Replacement cost is the cost of an identical new product or item, while actual cash value incorporates depreciation
When it comes to reimbursing a policyholder for a financial loss, insurance companies have multiple ways to calculate the specific sum they’ll pay out. The most common options are replacement value and actual cash value.
Replacement cost value (RCV) is often considered best from a policyholder’s perspective, as it will reimburse an individual for the entire cost of replacing lost, damaged, or stolen goods. For example, if your car is stolen, a replacement cost insurance policy will pay out the full cost of purchasing a new vehicle identical (or nearly identical) to your previous one. This is even the case if your pilfered vehicle has 80,000 miles and a faulty transmission.
Actual cash value (ACV) may be considered somewhat inferior in the eyes of most policyholders, as it will pay an individual for the cost of replacement after depreciation has been calculated and subtracted from the total. In the situation above, it would pay the policyholder the exact cost of replacing a vehicle with 80,000 and transmission issues.
RCV vs. ACV for homeowner’s insurance policies
The differences between replacement cost and actual cash value may be the most important for those who hold homeowner’s insurance policies. These policies are designed to help policyholders replace damaged, stolen, or destroyed property without impacting their personal finances. For example, if an individual with a homeowner’s insurance policy has a dining room table destroyed during a hurricane, the insurance policy will likely cover the loss– but it will pay out different amounts depending on whether the policyholder has an RCV or ACV policy. If the homeowner bought the table two years ago for $1,000, and an identical, 2-year-old table can be purchased for $750, an ACV policy would likely reimburse the individual $750.
In contrast, an RCV policy would reimburse the individual the amount it would take to buy a similar item brand new from the store. In some cases, (often due to increasing prices) this amount may be more than the amount that the policyholder initially spent on the now-destroyed item. For example, if it now costs $1100 to buy a similar dining room table, a RCV policyholder will likely receive that amount.
However, if you have an RCV policy, it will likely pay this amount out in two parts:
1) The policyholder will receive a payment in the amount of the ACV of the item ($750 in the example above)
2) After submitting a receipt with the replacement cost ($1100 in the example) the insurance company will send a payment with the difference ($350 in the example) to the policyholder.
Those who purchase ACV policies may need to expect to open their pockets in the case of disaster
While ACV policies may allow many to save a considerable amount on their premiums, they could mean a big coverage gap for many consumers. This gap becomes especially apparent when dealing with expensive losses, such as serious roofing damage. Considering the fact that a 5 or 10 year old roof has significantly depreciated in value compared to a new one, an ACV roofing insurance policy could easily pay as little as 50-60% of replacing a policyholder’s new roof. With roofing costs often in the tens of thousands of dollars for many homes, many individuals may be forced to dip into their savings accounts to cover the difference.
For good or bad, the amount of ACV policies on the market has greatly increased in recent years in comparison to RCV policies, which have become somewhat less common. While ACV policies offer a significant upgrade from not having an insurance policy, they simply don’t fully cover many quickly-depreciating big ticket items– and anyone planning to buy an ACV policy should be completely clear on what it does, and does not cover before they purchase.
To learn more about which kinds of insurance may be able to help you reach your personal and professional goals, contact Avante Insurance today for a free consultation.