Replacement Cost vs. Actual Cash Value Coverage

Homeowners insurance policies offer two types of valuation of your personal property. One is the replacement cost and the other is actual cash value. If your property is destroyed, your insurance policy will follow one of these two methods to replace that property.

  1. Replacement cost is what you would pay for the item if you went out to the store and bought it brand new today.
  2. Actual cash value is what you paid for the item when you bought it minus the depreciation.

Depreciation is a decrease in value due to wear and tear, which is the aging process.

Replacement Cost vs. Actual Cash Value

What does it all mean? Let’s say your home and the furnishings inside it were damaged by a fire. You make an insurance claim to your company and then pay the deductible amount associated with your coverage. Now you must replace the damaged furnishings. How much money will you receive from your insurance company to buy new furnishings? This depends on if you have replacement cost coverage or actual cash value coverage.

For example, last year you bought a sofa for your living room for $2,000. This year the same sofa now costs $2,100 at the store.

If you have replacement cost coverage, your insurance company will pay you $2,100 (less your deductible).

However, if you have actual cash value coverage, your insurance company might pay you $1,800 because that is the amount you paid for it ($2,000) minus the depreciation of the sofa over one year.

Calculating the Depreciation Rate

Depreciation is calculated based on the expected life of the item divided into the cost. This comes up with a per year depreciation rate.

In our case, the expected life of your sofa is 10 years.

$2,000 / 10 = $200 per year depreciation rate

Calculating the Actual Cash Value

The amount you paid for the item minus the depreciation rate for however many years you owned the item is the actual cash value.

One year has gone by since you purchased the sofa

$2,000 – $200 = $1,800

The actual cash value of your sofa after one year is $1,800. If you owned the sofa for two years before the fire, you would receive $1,600 actual cash value.

*Please note: For replacement cost coverage, most insurance companies will initially give you the actual cash value of an item and then require a receipt for the new item before paying you the remainder.

Why have Actual Cash Value Coverage?

Generally speaking, you’ll receive less money from the insurance company to replace your furnishings if you have actual cash value coverage. So why have it? Actual cash value coverage is less expensive on an annual basis than replacement cost coverage. It’s a way to save money on your insurance policy.

Record Your Personal Property

Remember, you need to have proof of your belongings for your insurance company. We recommend taking pictures of every room in your home from each angle to record your personal property.  Save the photos in two places so you have a backup copy. Do this every year or after a large purchase or renovation in your home.

For actual cash value coverage, your household financial system will be important (i.e. receipts, tax forms, etc.) because it shows the value of your personal property.

Know Your Coverage

It’s important to know your homeowners insurance coverage before you need to use it. You don’t want to be expecting to receive one amount and end up receiving far less. Know now if you’ll have to pay more out-of-pocket to replace your furnishings if they are damaged or if you’re paying more annually. This can also help you plan your savings for an emergency fund accordingly.

So take a look at your current homeowners insurance policy to see if you have actual cash value or replacement cost coverage for your personal property.

Contact us if you want assistance reviewing your current homeowners insurance policy or if you want to get a comparative quote.

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