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Actual Cash Value vs. Replacement Cost and Why It Matters to You

May 13, 2014

Old homeSCREEECH SCREEECH SCREEECH!

At 1:00 AM Sunday morning I awoke to the loud, obnoxious screech of a smoke detector. I grabbed my dog, put on my shoes, and headed out the door to see what was going on. It was pouring down rain and a group of neighbors was gathered in the parking lot in front of my condo. It ends up my next door neighbors had a branch fall through the roof next to the smoke detector, which set off the alarm and allowed the rain to come gushing into their bedroom.

Unfortunately for them, the process of getting the roof repaired, contacting insurance, making a claim, getting their furnishings replaced and everything else that was going to have to happen the rest of the day had only just begun. Luckily for me, I got to go back to bed once the fire department was able to turn the alarm off.

When it comes to replacing their items, however, the insurance company will have to determine the value of what was damaged or destroyed and then come to an agreement on payment. The two most common ways this is accomplished are using either Actual Cash Value (ACV) or Replacement Cost.

ACV is generally defined as the “fair market value” of an item. The value of the items in your home that were damaged will be calculated, minus the depreciation. In simple terms, let’s assume the branch in the roof that allowed the rain in is a covered cause of loss under their insurance policy, and that the rainwater through the roof damaged their mattress. If their insurance used ACV to determine the value of their items, they would determine the cost of the mattress (for this simplistic example, let’s pretend the mattress would cost $1,000 to replace). They would then figure out how old the mattress is and use some form of depreciation to determine its current value. If we continue a simple example and use a straight-line depreciation of $100 a year, for a two-year-old mattress my neighbors would receive $800 (minus their deductible).

$1,000 mattress – $200 for two years of depreciation = $800 (and then subtract the deductible)

While an insurance company may not use straight-line depreciation, and the process is not necessarily this simple, it gives an idea of how the ACV method is determined.

Now let’s pretend my neighbor’s insurance used replacement cost. If they had the same two-year-old mattress that originally cost $1,000, the insurance company would pay them the cost of a similar mattress for sale on the market today. Let’s pretend their mattress is still being sold two years later and costs $1,000 still. The insurance company would pay them $1,000 (minus their deductible). Some insurance companies will only write a check for the ACV and replace the additional amount after receiving a receipt for the new item.

With ACV, my neighbors would receive $800 for a new mattress and with replacement cost they would receive $1,000. While this is a simplistic example using only one item in their home, it’s easy to see how the difference in values can add up over time. Not sure what your policy uses? Contact your agent and find out! Replacement cost policies will generally cost you more in monthly premiums, but if a loss occurs, you will be glad to have it!

Your policy should indicate whether or not you have ACV or Replacement Cost, so be sure to speak with your agent about how your policy will make payments!

Article by: Kristen Skinner

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