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Actual Cash Value vs. Replacement Cost in Homeowners Insurance

Home insurers use actual cash value (ACV) and replacement cost value (RCV) to calculate home insurance and personal property settlements. An RCV policy pays the full market value to replace your home and property up to your policy's maximum limit. With an ACV policy, the home insurer subtracts depreciation from the RCV before issuing your final settlement.

Selecting an ACV or RCV policy can have a significant impact on your final settlement payout. On average, ACV policies offer lower premiums to customers; however, this coverage also provides lower settlements because insurers subtract depreciation. As a result, ACV policies may not fully cover the costs to repair or replace damaged items.

Learn how ACV and RCV can help you replace your home and belongings.

Actual Cash Value: Saving Money on Premiums, Lower Payout

Actual cash value (ACV) is a method that home insurers use to calculate personal property and home insurance claims. The ACV is an amount equal to an item's replacement cost, minus any depreciation caused by aging or wear and tear.

Actual cash value (ACV) is a method that home insurers use to calculate personal property and home insurance claims. 

ACV for Personal Property

Insurance companies typically use a straight-line depreciation formula to calculate a damaged item's ACV: Replacement Cost Value of an Item – Depreciation=Actual Cash Value.

With this formula, the item's value lowers uniformly over time until the asset reaches its salvage value, or the cost at the end of its useful life. 

If a house fire destroys your laptop, the insurer will calculate your computer's ACV by:

  1. Identifying the computer's replacement cost value (RCV) by researching how much a similar model sells at today's prices.

  2. Calculating your computer's depreciation, then subtracting this amount from the item's RCV

  3. Issuing a settlement check for the ACV.

ACV for Dwellings

With an ACV policy, your home insurance company agrees to cover your dwelling's value based on its present condition and age. The claims adjuster factors in depreciation before issuing a  final settlement. The insurance company calculates depreciation  by:

  1. Determining your home's RCV.

  2. Evaluating the current condition and estimated lifespan of specific systems (such as your roof, HVAC, etc.).

  3. Issuing a settlement based on the ACV.

Suppose an attic fire destroys your home's roof? Your insurance adjuster will research your roof's RCV.  For instance, the adjuster may learn that a brand new roof with similar features costs $35,000.

Next, the adjuster will identify your roof's estimated lifespan. Your 12.5-year-old  roof may have a 25-year lifespan. If your roof depreciates at $1,400 (4%) per year, this means your roof has already lost 50% of its value. 

Your home insurer will factor in depreciation (12.5 years x $1.400=$17,500), then subtract this amount from the RCV ($35,000 - $17,500 =$17,500). You will only receive a $17,500 settlement to replace your roof, minus your deductible. 

Unfortunately, this settlement won't provide enough money to replace your entire roof with a new one. You may have to pay for these costs on your own.

Replacement Cost Value: Higher Premiums, More Peace of Mind

Replacement cost value (RCV) is the amount it takes to replace your home or personal property with new models without subtracting depreciation. When a loss occurs, the insurer will pay you enough money to buy a replacement of what was damaged, and you must only meet your home insurance deductible.

Replacement cost value (RCV) is the amount it takes to replace your home or personal property without subtracting depreciation.

RCV for Personal Property

With RCV policies, your home insurer covers your personal property at current prices and without accounting for depreciation. For instance, if a thief steals your two-year-old gaming system, an RCV policy will allow you to replace your console with a brand new one at current prices. The home insurer won't subtract two years of depreciation from your final settlement. It is important to note that RCV policies have higher premiums than ACV policies.

RCV for Dwellings

According to the Insurance Information Institute, most home insurance policies use RCV to calculate a home's structural damages. An RCV policy pays to repair or replace your damaged home with materials of a similar type and quality. Your insurer won't subtract depreciation of your old home's value from your final settlement.

Ask an independent contractor to assess your home's RCV so you can learn how much dwelling insurance you'll need to replace your home. These construction specialists can estimate the cost of labor and materials costs. In these estimates, the contractors don't consider the land value when calculating a home's replacement cost value, only the construction and material costs to repair or replace your home in full.

Modified Replacement Cost Value

If you own an older home, your home insurer may not allow you to buy an RCV policy. You'll have to get a modified replacement cost value coverage instead.

Repairing older homes can be expensive because of their materials and distinctive features, such as custom moldings or hardwood floors. A modified RCV policy only pays for standard materials and modern construction methods to repair or rebuild an older home.

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Actual Cash Value vs Replacement Cost Value: Which Is Better?

ACV and RCV use different assessment methods to calculate insurance settlements for your home and property. Let's explore how ACV and RCV cover replacement costs differently.

Damaged Property

Suppose a pipe bursts in your kitchen and damages your five-year-old refrigerator that's worth $2,500.

With an ACV policy, the insurance adjuster will consider your refrigerator's RCV, then subtract depreciation from this amount.

For instance, the adjuster may determine your five-year-old fridge depreciates at a rate of $250 per year (5 x $250=$1,250), then subtract this amount from its RCV ($2,500 - $1,250=$1,250).

With RCV coverage, your insurer will pay the entire amount to replace your refrigerator with a new model with similar features at current prices.  The insurer doesn't consider or subtract the depreciation of your old refrigerator when calculating your final settlement.

Damaged Roof

High thunderstorm winds damage your 8-year-old roof. After meeting your deductible, your home insurer agrees to pay off the remaining damages.

Under an ACV policy, the insurer will consider the RCV of your roof minus depreciation. As a result, the settlement you receive from the home insurance carrier may be lower than what you need to repair your roof. You must pay the remaining cost yourself.

Under an RCV policy, your insurer will fully cover your roof repair costs up to your policy's maximum amount without considering depreciation. You can buy construction materials at current market prices, and you won't have to spend extra money to replace them.

The biggest advantage that ACV policies have over RCV coverage is lower premium rates; however, you’ll receive superior protection with RCV.

The single advantage that ACV policies have over RCV coverage is lower premium rates; however, you'll receive superior protection for your home and belongings with the more expensive RCV policy. 

What Is Extended Replacement Cost?

Extended replacement cost is an insurance endorsement that you can buy and add to your homeowners insurance coverage. Buying extended replacement cost coverage ensures that you have enough protection in case of increased costs. If a peril destroys your house, the rebuilding costs may exceed your dwelling coverage limit. Without extended replacement cost coverage, you may have to pay any remaining costs. 

Extended replacement coverage is sold in increments of 25% to 50% of your policy's dwelling coverage limit. If you purchase $300,000 of dwelling coverage for your home and buy an extended replacement cost policy worth 25% ($75,000), then you'll have $375,000 in dwelling coverage.

What Is Guaranteed Replacement Cost?

Guaranteed replacement cost is a dwelling coverage add-on that insures your home's full reconstruction value without considering depreciation or policy maximums.

Although your insurer won't consider depreciation with an RCV policy, your policy will still have coverage limits. If a disaster destroys your home, your policy may not cover all rebuilding costs.

Guaranteed replacement cost policies have no specific coverage limit and fully cover your home's replacement regardless of the rebuilding costs. Insurers suggest guaranteed replacement cost coverage for homes in high-risk areas where construction material prices and labor costs may balloon following a natural disaster.

ACV and RCV: Buying the Right Homeowners Insurance Policy 

With an ACV homeowners insurance policy, the insurer calculates the RCV of an item, then subtracts depreciation before issuing your final settlement amount after a loss. An RCV policy pays you the full market value to replace your loss, up to policy limits.

You can expand your homeowners insurance using two coverages: Extended replacement cost coverage, an endorsement that offers 25% to 50% of expanded coverage, or guaranteed replacement cost coverage, which pays the full reconstruction costs of your home.

If your home is not insured or you are not happy with your current insurer, SmartFinancial can help you find better, cheaper coverage that meets your needs. Get a free home insurance quote by entering  your zip code below and answering a few questions.

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