Replacement cost vs. actual cash value

The reason you’ll likely be disappointed with your claims payout

There’s a valuable disclaimer on your insurance policy you probably ignored, but it’ll likely be the reason you’re disappointed with your insurance claim payout. You’re not alone. According to a survey, nearly half of respondents don’t understand replacement cost vs. actual cash value and what it means for their insurance coverage.

Many of us review our policies and declaration pages only to instantly file them away. Did you understand what it said on the page? The numbers show how much you’ll receive in the event of a claim, but they represent the maximums, and there are limits. These numbers tell you how much you could potentially be paid, but not how much you’ll receive.

To understand the differences, let’s look at replacement cost vs. actual cash value (ACV).

ACV definition

The actual cash value is equal to the replacement cost of the lost or damaged item, but it includes depreciation. ACV is how much you could sell your car for at current market value, not how much it costs to replace. Homeowners insurance might repair your roof, but ACV will call into question the current age of the roof.

Note that this is different then the book value accountants use to calculate depreciation on something like a business laptop. The book value is when an accountant takes the purchase price of the computer and deducts the accumulated depreciation to show its current value on a balance sheet.

ACV is how much the purchased item is worth in today’s value. To better understand depreciation, insurance companies use standard depreciation tables to help them determine ACV. Often they’ll also hire a professional appraiser to help them get an accurate estimate of the item’s value.

So, let’s say, your laptop is stolen. Your insurance company tells you laptops have a useful life of 10 years. The original laptop you bought was worth $1,500, and a similar one to what you have today costs $2,000 due to factors like inflation. Your stolen 5-year-old laptop, according to deduction tables, had 50% (5 years) of its life remaining. The actual cash value equals $2,000 (replacement cost) multiplied by 50% (5 years of useful life left), so you’ll be compensated $1,000. You’ll have to pay a deductible before money is released to you, say $500. That means ACV gives you about $500 towards buying a new laptop.

So, how does replacement cost insurance work?

Replacement cost insurance will help you restore your life much faster and with less financial stress but will cost you more in your monthly premiums. Replacement cost insurance gives you money to replace the lost or damaged items equal to the amount you’d need to replace that item with a new or similar product.

Examples of how this works with claims

In any claims process, an insurance adjuster will evaluate the value, be it with your car or your home. Depending on whether you have ACV or replacement on your policy, here are the different ways it might work. Note: with car insurance, a lot will depend on who is at fault and whether or not you have collision and comprehensive on your insurance policy.

Home insurance claims – comparing replacement cost vs. actual cash value

A pipe bursts under your kitchen sink, destroying your hardwood floors, the drywalled ceiling in the basement below, and the entertainment system underneath. First, you need to shut off the water supply, clean up the mess, call a plumber to fix the pipe, and then – call your insurance provider.

Your insurance provider will review the list of items you wish to claim – your hardwood floors, drywall repair, and the HD TV and sound system. The claims process is much easier if you have a detailed home inventory of what you own and ideally, the accompanying receipts. The level of contents insurance you have will affect your payout, so, without going into details, know that there are limits on items unless you have special endorsements.

Actual cash value

Insurance companies will often use depreciation tables to help determine the amount of money you will receive after you submit your claim.

Here’s a table of the offer to you for the property damage. This is only an estimate. If you want to do your own estimate, check out this depreciation tool.