Insuring your home and contents is a vital part of any financial plan, but not all insurance policies are created equal. While the vast majority of homeowner’s insurance policies pay out the replacement cost of an item, some policies pay out the “actual cash value” of the item in question.
Understanding key insurance terms like this is pretty important. You don’t want to experience any unpleasant surprises after filing an insurance claim.
Actual cash value is a measurement for payment that insurance policies to determine how much you will receive if a covered item is lost or damaged. This can be applied to many types of insurance policies, including coverage for renters, condo owners, and home owners.
If you have an actual cash value policy, the payment you will receive is based on the value of the item minus any depreciation. Your insurance policy will likely have a definition that states how it calculates ACV.
Many companies define it as “the replacement cost less a deduction that reflects depreciation, age, condition, and obsolescence.”
In plain language, that means the price that the item would likely garner if you sold it on eBay or at a yard sale. A $2,000 sofa might only be worth $50 after 10 years of constant use. Similarly, a bunch of old clothes stored in your basement could be worthless while the clothes you wear to work each day valued much higher. It is important to remember that you’ll never get the full price you paid for an item through actual cash value, as depreciation will always be applied.
This is twice as important to remember when it comes to car insurance, because those things depreciate quickly.
To determine how an insurance adjuster will place a value on an item following a loss, be sure to read the clause in your contract. If you’re unsure, ask your insurance provider to explain how they deal with ACV.
In the simplest of terms, actual cash value pays what an item is worth at the time of the claim, while replacement cost pays the cost to replace the same item at today’s price. This means that if you make a claim for damages to the sofa you paid $2,000 for in 2008, the insurance company may pay $2,500 (accounting for inflation) so that you can replace it with a similar sofa at today’s price.
Similarly, if you own clothing that was ruined by a burst water pipe, your insurer would pay the cost to buy new clothing of a similar quality.
The difference between what you would receive with Actual Cash Value versus Replacement cost can be significant. Be sure you understand the coverage you’re being offered before you commit to a buying or renewing your policy.
With such major differences between the way Actual Cash Value and Replacement Cost are calculated, why would anyone choose ACV?
The answer is simple: money.
Since an insurer can expect to pay a lot less for a claim on a policy with ACV, they can afford to charge significantly less for that policy. Those savings get passed on to customers who may choose the low price instead of a better replacement option.
For many people, this trade-off makes sense. They are looking for basic coverage and will settle for less money in the event of a claim. But the reality is you get what you paid for, and in the case of insurance, you want to ensure you make that decision having all the facts before you—and that decision should start with a call to your insurance advisor.