As a homeowner, you may not understand terms like “Replacement Cost” and “Actual Cash Value,” however, it’s extremely important to understand both of those terms, and the difference between the two, when getting your house insured.
Insurance companies use several different methods to determine how much they will pay you for a claim. We’re going to discuss the meaning of both actual cash value (ACV) and replacement cost (RC), and the difference between the two, so that any homeowner can make an educated decision on which is right for them.
The Meaning of Replacement Cost
Replacement cost has a simple meaning. It means that claims will be settled, without deduction for depreciation. As an example, if you buy a car battery with a 60 month guarantee, and it goes bad after two and a half years, they don’t give you a new battery, they give you credit for half of the batteries cost.
If they have a replacement guarantee, then they give you a new battery. Likewise, roofs have a life expectancy, carpet has a life expectancy, (these are not the only things that depreciate) houses begin to show wear and tear, or the insurance term for that is, depreciation.
If you have an HO3 policy, it will include the “replacement cost” endorsement on the dwelling, but you have to add it to contents. If you do, there will be no depreciation deducted from your claim.
There are many types of house insurance policies, so don’t be shy and ask your agent if you have replacement cost on the house and contents. It’s OK if you don’t. You just have to be informed up front so that you can be prepared.
The Meaning of Actual Cash Value
Actual cash value is a little less cut and dried. For claims settlement, in addition to the deductible, a deduction for depreciation will be taken from the replacement value of the loss. The amount of that deduction is taken from the age of the item claimed. I will use a roof as an example.
A homeowner has a roof that would cost $5000.00 to replace. The shingle will include a life expectancy. A common life expectancy for a shingle is 20 years. If a person incurs a total loss to the roof after 10 years, there will be a deduction for a deductible and half, or 50 percent, for age depreciation. The claim would be reduced to $2500.00 and then the deductible will be applied.
Many insurance companies have a schedule they use for depreciation. A common one for roofs is 3% per year.
The Difference Between RC & ACV
Replacement cost insurance is simple due to not needing to apply a depreciation factor.
Replacement cost is more expensive and requires property to be in very nice shape. Insurance companies have strict eligibility rules that a homeowner must qualify under. Deductibles are higher. Some companies will add conditions to the policy that bring back actual cash value to the roof, once a roof gets older.
Actual cash value is a little more complex due to the depreciation factors. It’s usually less expensive. There are less eligibility requirements. Deductibles are usually lower, but the option for higher deductibles is there. They are good policies as long as you know what you have.
The Homeowner Decision
Deciding which policy is right for you starts with a good look at your own property. Evaluate the condition and cleanliness of your house and grounds. Insurance companies want to insure property that shows pride in ownership.
If you own a fixer upper, you may not qualify for replacement cost and that narrows down the conversation right up front. If you qualify for replacement cost, then you need to assess your values. Are you handy? Do you have time to do any repairs yourself? Are you good at saving money?
If you have a lender, they may have some requirements you need to include in your policy.
Don’t be misled that this is some quick, fifteen minute process. Schedule a time with a professional that will help you frame up the options available, because replacement cost is one of a dozen important considerations you need to make as a homeowner.
Give us a call today so that we can help you decide which route is best for you.
