Real value vs replacement cost

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Homeowners, tenants and condo insurance is designed to reimburse you for losses caused by a covered peril. Depending on the type of claim you file, your insurer will determine the cost to replace or repair your belongings or home by looking at the Actual Cash Value (ACV) or Replacement Value (RCV). Claims related to the physical structure of your home are usually settled on a replacement cost basis. Personal property claims can use ACV or RCV, depending on your policy.

Actual cash value coverage takes depreciation and normal wear and tear into account when settling claims. This generally applies to the personal property portion of your home insurance policy. For example, if you bought a new bed for $1,500 five years ago that was recently destroyed by fire, you are unlikely to be reimbursed for the full cost of the mattress. If this claim is approved, you will only receive the current estimated value, which will be a fraction of the original amount you paid, less any deductible.

Reimbursement also depends on your policy’s coverage limits and deductible amounts. For example, if your bed is assessed at $900 and your deductible is $500, your insurer will only reimburse you $400 for the damaged bed. Similarly, if your roof is damaged and the ACV is $15,000 but your policy limit is $10,000, your insurer will only reimburse you for expenses up to $10,000. You will be responsible for paying the remaining expenses out of pocket. Since ACV policies often offer less coverage than their RCV counterparts, they are usually the cheapest insurance option.

Unlike actual cash value coverage, replacement cost value does not take into account depreciation or wear and tear. Instead, it reimburses you based on the cost of replacing, repairing, or rebuilding your property at current prices.

As with ACV, your policy’s coverage limits and deductibles will apply. For example, your house was destroyed in a fire and your policy includes coverage for $300,000 in replacement value. If the cost to rebuild is $290,000, your insurer will reimburse you for the full cost of rebuilding your home minus your deductible. If, however, the total rebuilding cost is $350,000, you will have to pay the additional $50,000, plus deductibles, out of pocket.

Extended Replacement Cost Coverage is a policy add-on that increases your RCV, usually by a percentage, in the event that a covered peril results in costs that exceed your policy limit. Depending on the policy and insurer, this amount can be quite low, like 10%, or as high as around 50%. If you have a coverage limit of $300,000 on your home, for example, and you opt for an extended replacement cost of 20%, that would give you $360,000 to rebuild if your home were destroyed, minus any deductible of police.

Homeowners looking for maximum coverage may decide to purchase Guaranteed Replacement Cost coverage as a top-up to ensure they can rebuild or repair their home to its original condition. This coverage will reimburse the policyholder for the full cost (less deductibles) of restoring their home to its original size, specifications and finishes.

For example, if you have a limit of $300,000 on your home coverage and the cost of rebuilding your home is $425,000, you would be responsible for paying the difference. With guaranteed replacement coverage, this overage will be covered. With this type of policy, the only outlay incurred is your deductible. Some policies will even allow a small percentage for additional upgrades, such as adding a deck that wasn’t originally part of your home.

These types of policies are not available in all states, so you should check with your local insurers to see if guaranteed replacement cost coverage is an option.

If you own an older home or one of historical or architectural significance, you may need to purchase homeowners insurance with modified replacement cost coverage. Let’s say you own a home built in 1892 and it includes the original ornate crown molding, lath and plaster walls, and custom stained glass. Whether your home is damaged or completely destroyed, modified replacement cost coverage focuses on functional replacement rather than precise restoration. You will only receive the amount needed to rebuild or repair with current materials, including standard moldings, drywall and modern fixtures.

What is the difference between ACV and RCV cover?

While ACV generally applies to personal property policies, RCV can be applied to both home insurance and personal property coverage. A big difference between the two is that ACV takes into account the depreciation of lost or damaged items, unlike RCV. For policyholders looking to maximize the amount they receive on a claim, an RCV policy may be worth a higher premium.

How does actual cash value work?

Say you bought a TV two years ago for $1,000 and a recent power surge ruined it. Your personal property insurance uses the actual cash value to process claims. If your insurer determines that the value of the television has depreciated by half since you bought it, you will only receive $500, less any deductible.

How does replacement cost value work?

Your house catches fire and ignites. Your home insurance uses RCV to settle claims and your policy has a coverage limit of $500,000. The total cost of the reconstruction is estimated at $510,000. This means you will be liable for the amount that exceeds your coverage, in this case $10,000, plus any policy deductible. In most cases, if you had Extended Replacement Coverage or Replacement Warranty, you would also be protected against that $10,000 overage.

What is the actual cash value versus replacement cost in auto insurance?

If your car is stolen or badly damaged or destroyed in an accident, your insurer will reimburse you for the actual cash value of your car, not the cost of replacing a new equivalent. This could leave you owed hundreds or thousands of dollars if you leased or financed your new car, because vehicles start to depreciate as soon as you take them off the dealer lot. Some insurers offer auto insurance policies that provide replacement value coverage, but a better option may be to add a gap insurance policy.

Gap insurance is designed to fill the gap between what you owe on your car and what it is worth in the event of a peril or covered peril. If you leased or financed your vehicle, only made a small down payment, or have a loan term of five years or more, gap insurance may be worth considering.

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