Property insurance policies typically stipulate whether your coverage is based on replacement cost value (RCV) or actual cash value (ACV). Selecting the right type of dwelling coverage can safeguard your property against damage from covered perils.
Replacement cost in insurance is the amount it would cost to repair or replace your damaged property, rebuild a destroyed home to its previous design, or purchase new items to replace ones that were damaged or stolen. Replacement value coverage considers the “like-kind” and cost of rebuilding your home or replacing damaged items. Most importantly, replacement cost does not include a deduction for depreciation or a coinsurance penalty.
In contrast, the actual cash value of an item at the time of loss considers its current replacement cost, but deducts the amount of depreciation for that item over time. So, if your 10-year-old roof was damaged by a covered loss, RCV would cover the full repair or replacement of the roof with the same kind and quality of materials, while ACV would only cover the depreciated value of the roof.
Actual cash value, or ACV coverage, is typically a lower-cost type of coverage for your property; that’s because the ACV of a structure or personal belongings depreciates over time due to factors like obsolescence and wear and tear. Therefore, claims on damaged or destroyed items covered by an ACV insurance policy are less expensive for your insurance company.
That said, there are some cases in which personal belongings can increase in value over time. For example, antique jewelry, vintage cars, and other rare collectibles may not depreciate the way everyday items do. For these, property owners should consider getting separate, specialized personal property coverage policies in case of damage, theft, or destruction with the aid of appraisals to help establish their insurable value amount.
Replacement cost insurance usually carries a higher premium because the loss settlements are of higher amounts for the insured at the time of loss. However, while an ACV policy can save you money in the short term, it can greatly increase your costs in the event of a claim.
Let’s say that same, 10-year-old roof was damaged beyond repair, and needed to be replaced. An ACV policy will only pay out the current value of the roof based on its original price minus depreciation.
Now, consider how prices for both materials and labor have changed in the last 10 years. Between the impact of inflation, potential labor shortages, and material supply availability, the cost to rebuild that roof to the same quality it had originally could cost 10-20% more.
In this scenario, your ACV claim payout would likely fall short of covering the whole bill, leaving you to pay a hefty out-of-pocket price. A replacement cost insurance policy accounts for all of those changes, and allows you to set coverage limits for 100% (and sometimes even more) of your property’s value, which can protect your wallet and peace of mind.
No matter which type of policy you choose, remember that insurance will cover only what it costs to replace a comparable property. Policies will not pay for an upgrade to a more expensive option, and you will need to pay the difference if you choose to use a loss as an opportunity to do some home improvements. In addition, before your insurance company will pay for your loss, you will first need to meet your policy’s deductible.
Neither replacement cost value nor actual cash value are the same as market value. For one thing, while actual cash values tend to lower over time, market values can fluctuate significantly based on a number of economic factors. Market value also takes into account property aspects like the size of the lot and the property’s location. Depending on the state of the market, the market value of a home could be much lower or much higher than the cost to rebuild the structure of your property itself.