Homeowners Insurance: Replacement Cost or Actual Cash Value?

They say you don’t know what you’ve got until it’s gone. This simple phrase can sum up the thoughts and disappointment homeowners have after they learn their policy provided only actual cash value coverage.

Insurance is a financial tool that allows you to transfer your risk of potential loss to an insurance company. You will undertake any amount of risk not transferred to an insurance company. As an example, if your homeowner’s insurance policy has a $500 deductible, it means you are carrying $500  of the risk of your home becoming damaged or destroyed. Understanding what is at stake when deciding between Actual Cash Value (ACV) and Replacement Cost Value (RCV) coverage will help you decide which is the best option for you.

Actual Cash Value (ACV) – An insurance policy will only pay what your property is worth in today’s dollars. The payment will be calculated subtracting depreciation factors (age, condition, etc.) from the cost of new replacement. ACV policies are less expensive than replacement cost value policies.

Replacement Cost Value (RCV) – An insurance policy will pay the cost to replace your property with new property without reducing the amount for depreciation. This means you will receive an amount equal to the cost to replace property of the same type, kind, and quality without paying more than you deductible. RCV policies are more expensive than ACV policies.

Let’s imagine you own a home with a 15-year-old roof. The roof is damaged and must be replaced as a result of a passing storm. The cost to replace your roof is $35,000. If your policy provides replacement cost coverage, your insurance policy will pay $35,000 minus your deductible.

However, if your policy pays on an actual cash value basis, your insurance company will base your payment on the roof replacement cost minus any depreciation. If the average life span of a roof in your area is 30 years, you can expect to receive $17,500 minus your deductible.

When choosing whether to purchase ACV or RCV coverage on your insurance policy, consider the potential out-of-pocket cost to you should you need to file a claim compared to the monthly premiums.