Homeowners Insurance Claims: Replacement Cost vs. Actual Cash Value

When people make a homeowners insurance claim, the amount of damage to property has to be assessed whether you have an actual cash value or replacement cost policy.

Let's define the difference between ACV and Replacement cost.
Replacement Cost is the amount it would cost to replace your property with the same kind and quality materials at today's costs. There is no subtraction for depreciation. Depreciation is the decrease in value to property over time due to wear and tear. Because depreciation is not a factor in a replacement cost policy, the premiums are usually substantially higher than an actual cash value policy.

Actual Cash Value (ACV) is the replacement cost of property minus the depreciation. Actual Cash Value policies are much cheaper than replacement cost policies because when a claim has to be made, the insurance company can deduct the decrease in value of the insured's property & pay them only what the property is worth at the time of the claim instead of the full amount it would cost to purchase new materials.

Example:
Newly weds, Michael and Jullian purchase a home, insure it for $300,000 with a 1% deductible and go on vacation for a week in the Dominican Republic. When they get home, they find 3 inches of water spread across the entire downstairs in each and every room. Quickly they stop the burst pipe under the sink from gushing water and call their insurance agent immediately.

An insurance adjuster comes out and estimates a total of $75,000 in damages. (For the purpose of keeping this example simple, we'll just use round numbers.)

TOTAL REPLACEMENT COST = $75,000

Replacement Cost Claim Scenario

The total replacement cost of the damaged items is $75,000. The agent subtracts the 1% deductible (.01 X 300,000 = 3,000) from the $75,000 and writes a check for $72,000 for Michael and Jullian to make necessary repairs and purchase new items. ($75,000 - $3,000 = $72,000)

Actual Cash Value Scenario

The total replacement cost of the damaged items is $75,000. (For simplicity purposes, we'll use 50% depreciation for all structural property and 25% depreciation for all personal property.) Total Depreciation = $30,000. The insurance agent writes a check for $42,000 for Michael and Jullian to make repairs but they have to come out of pocket the $30,000 of depreciation.
Replacement Cost($75,000) less depreciation ($30,000) = Actual Cash Value ($45,000)
Actual Cash Value ($45,000) less Deductible (1% or $3,000) = $42,000

TOTAL ACTUAL CASH VALUE = $45,000

In The End

Replacement Cost Policy Paid out $72,000 to replace the damaged property.
Actual Cash Value Policy Paid out $42,000 to replace the damaged property and Michael and Jullian have to come out of pocket the $30,000 needed to replace the items new today.