Regardless of the type of property you have insured, you either have replacement cost or actual cash value protection. Does that sound like some insurance jargon to you? Well, it is. However, it’s critical jargon that you need to fully understand if you ever have to make a claim on your insurance policy. Home insurance, personal property insurance, and auto insurance are based on replacement or actual cash value coverage. Let’s dig into the definitions and differences between both.
Replacement Cost – What it does
The best way to describe replacement cost is through a couple of everyday examples.
What would happen if your stuff was destroyed because of a rooftop water leak? Your clothes, electronics, furniture, or housewares may have been damaged. What if the things that were ruined were all old and worn out? It does not matter what condition your belongings are in with replacement cost coverage. Replacement cost insurance gives you the luxury of purchasing a similar, brand-new item. So, the old couch with the infinite number of stains that would have fetched about $75.00 on Facebook Marketplace could now be worth about $1,200.
Now, consider your house. If your home were to be damaged due to hail or wind, it’d probably cost quite a bit to fix. However, if the roof was 22 years old and nearing the end of its useful life, and the aluminum siding was, well, aluminum siding, what would happen? Again, with replacement cost protection, you can expect a brand new roof and new siding. Hopefully, you see the importance of replacement cost coverage because we’ll discuss actual cash value insurance protection shortly. That one is not quite as friendly.
Replacement Cost – What it won’t do
Without question, replacement cost is the best form of protection if you want to have your things replaced. However, there are some limitations or what I’ll call misconceptions about this coverage. The first pertains to your claim check. Suppose you are insured for $100,000 for coverage on your belongings. After a fire, all of your things have suffered smoke, water, or fire damage. You might think that a check for $100,000 will be in your hand shortly, and you can begin shopping for your replacement items. You’re not alone in that assumption, and don’t feel bad because I also used to think the same. Rather than receiving $100,000, you can expect to begin with the depreciated value of your damaged items. That could mean that you start with about $40,000 to work with. As you replace each piece with a new one, you’ll be asked to show receipts to the insurance company. They will pay the difference between the depreciated value and the replacement amount. They just have to ensure that you’ve actually replaced the item. If that sounds terrible, you could find actual cash value coverage intriguing (don’t worry, we’re getting there).
A little while ago, I snuck in the word “similar.” What you purchase as a replacement should be as close to similar as possible, and I do not mean age or condition. If your Amazon Basics dishware burned up, a new set from Lennox is probably not in your future. Target, or maybe Pottery Barn, but nothing exceptionally fancier than what was lost.
Even though there are some misconceptions about replacement cost coverage, it is fundamentally the only type of protection that would make you whole again.
Actual Cash Value – Finally
Take the money and run.
We’ve now arrived at your worst nightmare: Actual Cash Value (ACV) insurance protection. I’m kidding, but only slightly. This form of coverage means that you will receive only the depreciated value of the lost item. The insurance adjuster will review the damaged property’s age, style, and condition. Once that value is determined, you’re given a check, and you are free to do whatever you want with it. You can go to Vegas and put it all on black if you’d like. ACV coverage does not dictate how you have to spend the money in the way that replacement cost coverage does.
If that sounds good to you, then why isn’t ACV more popular? Oddly, it is very common, and if you insure a car, you’ve had ACV the whole time. If your vehicle is in an accident, the insurance carrier comes back with a check for the vehicle’s depreciated value. You’ll never see a 2003 Toyota Corolla replaced with a 2022 version on the insurer’s dime!
The serious pitfall with ACV is when it is applied to the coverage of a building. If your house is insured for its actual cash value, you will be unpleasantly surprised when making an insurance claim. Using ACV this time, let’s go back to the hail-damaged roof and siding. The 22-year-old roof will cost you $11,000 to replace, and the aluminum siding will run another $10,000. Those losses will only be paid on a depreciated basis. The actual cash value of the roof could be $3,500, and the siding could be $2,000. Rather than covering up to $21,000, the carrier issues you a check for $5,500. The insurance adjuster will wish you the best and close the file, leaving you to shoulder the balance. That is the dirty secret about ACV that few know about but ought to.
If you are like I was, now no longer blissfully ignorant but now filled with questions, fear not. We are accustomed to explaining and educating on this topic. I encourage you to contact us and go through any further information. Once in a while, ACV makes excellent sense for a person, and that could be you. Either way, we’ll review it with you and provide our best advice!