Say your home is insured for $200,000, and a fire causes enough damage to result in a total loss. You might expect a check for $200,000 to rebuild. But if you have actual cash value coverage instead of replacement cost coverage, you could receive significantly less—perhaps only $150,000 after depreciation is factored in.
That's a $50,000 gap that could leave you scrambling to cover rebuilding costs out of pocket.
Many homeowners don't realize there's a difference between replacement cost and actual cash value coverage until they file a claim. This can lead to frustration and financial shortfalls when they discover their policy doesn't cover what they expected.
In this article, you'll learn the key differences between these two types of coverage and how each one affects your claim settlement. With this knowledge, you can make informed decisions about your insurance and work toward avoiding unexpected financial losses.
The Two Types of Coverage for Your Stuff
When you buy insurance, you're looking for assurance that if something happens to your home, car, or belongings, you'll have coverage to help address the loss. But there are several types of insurance coverage, and it's important to understand the difference between them.
Whether it’s your home, personal belongings, or vehicle, you’re either covered by replacement cost or actual cash value coverage. These terms may sound like insurance jargon, but they’re important to understand if you ever have to file a claim.
Let’s dive into the definitions and differences between the two.
Why You Should Choose Replacement Cost Coverage Over Actual Cash Value
Replacement cost is insurance coverage that pays for the full cost of replacing your damaged or lost items with new ones. To illustrate how it works, let’s look at some common scenarios.
Imagine that a water leak from your roof ruins your clothes, electronics, furniture, or housewares. What if these items were old and worn out? With replacement cost coverage, you don’t have to worry about their condition.
You can buy new items that are similar to the ones you had before. Meaning the stained couch that you could only sell for $75 on Facebook Marketplace could now be replaced with a brand-new one worth $1,200.
Now, think about your house. If it gets damaged by hail or wind, it would be expensive to repair. But what if your roof was 22 years old and your siding was outdated? With replacement cost protection, you can get a new roof and new siding.
That’s why replacement cost coverage is valuable, especially compared to actual cash value insurance protection, which we will explain shortly. That one is not as generous.
The Drawbacks and Limitations of Replacement Cost Coverage
Replacement cost may seem like the ideal coverage for replacing your damaged or lost items, but it has some drawbacks and limitations that you should be aware of. Here are some of them:
You won’t get the full amount of your coverage right away. For example, if you have $100,000 of coverage for your belongings and they are all destroyed by a fire, you might expect to receive a check for $100,000 to buy new items. However, that’s not how it works.
The insurance company will first pay you the depreciated value of your items, which could be much lower than their replacement cost. You might only get $40,000 at first.
Then, as you buy new items and show receipts to the insurance company, they will reimburse you the difference between the depreciated value and the replacement cost. This way, they make sure that you are actually replacing the items and not spending the money on something else.
You have to buy similar items to the ones you had before. This means that you can’t upgrade to a higher quality or more expensive item than what you had before. For instance, if your inexpensive dishware from Amazon was burned up, you can’t replace it with a fancy set from Lennox.
You have to buy something similar in quality and price, or else the insurance company won’t pay the full difference. You can go to Target or Pottery Barn, but not beyond that.
You may still end up paying some costs out of pocket. Even though replacement cost coverage is designed to make you whole again, there may be some situations where the insurance company won’t cover everything.
For example, if there is a limit on your coverage for certain types of items, such as jewelry or electronics, you may not get enough money to replace them with new ones. Or if there is a deductible on your policy, you will have to pay that amount before the insurance company pays anything.
Despite these drawbacks, replacement cost coverage is still often a strong option for many people who want to replace their items with new ones. It is a better choice than actual cash value coverage, which we will discuss next.
The Drawbacks of Actual Cash Value Coverage
Imagine getting a check from your insurance company after a loss and being free to spend it however you want. You could take the money and run to Vegas if you feel lucky. This scenario is possible with Actual Cash Value (ACV) insurance protection. But before you get too excited, let me explain why ACV is not as good as it sounds.
ACV means that you will receive only the depreciated value of the lost item, not the full cost of replacing it. The insurance adjuster will review the damaged property’s age, style, and condition and determine how much it has lost in value over time.
For example, if your car is totaled in an accident, the insurance company will pay you the current market value of your car, not the price you paid for it when it was new. You’ll never see a 2003 Toyota Corolla replaced with a 2022 version on the insurer’s dime!
This might not seem too bad for a car, but what if your house is damaged by hail? Suppose your roof and siding are 22 years old and need to be replaced. The replacement cost could be $11,000 for the roof and $10,000 for the siding. But with ACV coverage, you won’t get that much.
The insurance company will calculate how much your roof and siding have depreciated over 22 years and pay you based on that calculation. You might end up with a check for only $5,500 instead of $21,000. That's a big difference!
That’s why ACV is often called the worst nightmare of homeowners insurance. It leaves you with a huge gap between what you need and what you get.
Unlike replacement cost coverage, which pays for the actual cost of repairing or rebuilding your property, ACV does not require you to use the money for that purpose. But unless you have a lot of savings or another source of income, you might not have much choice.
ACV is very common in car insurance, but it is not recommended for home insurance. If you want to avoid unpleasant surprises and protect your investment in your home, you should opt for replacement cost coverage instead.
Replacement Cost vs. Actual Cash Value: Which Option Makes Sense for You and Your Belongings?
So, which type of coverage makes sense for you? It depends on your individual needs and budget. If you have expensive belongings, you may want to consider purchasing replacement cost coverage. This can help ensure that you're better reimbursed for your losses, even if your belongings have depreciated in value.
If you're on a tight budget, you may want to consider purchasing actual cash value coverage. This will be less expensive than replacement cost coverage, but you may end up paying more out of pocket if your belongings are damaged or stolen.
Understanding the difference between replacement cost and actual cash value coverage is an important step in making informed insurance decisions. But gaps in coverage knowledge can still leave you vulnerable to unexpected financial losses after a claim.
At Horan, we work with Central New York policyholders to help them understand their coverage options and make informed choices. We can review your current policy, explain your coverage, and help you explore options from the carriers we work with.
To get started, click the Get a Quote button below, and one of our licensed insurance agents will be in touch.
Not ready to do either? Keep reading to bone up on your insurance knowledge and learn how to increase coverage for your most valuable things by scheduling them.
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