Chances are, you’ve heard the terms “actual cash value” or “replacement cost.” But do you know what they mean? If you have a home insurance policy, then understanding these two terms is of the utmost importance. We dig deeper into these two ways of valuing items in our actual cash value depreciation guide below.
Actual cash value vs. replacement cost
Let’s start with the basics. Actual cash value and replacement cost are two ways of valuing items in the insurance world. Where actual cash value is the amount needed to replace or repair an existing item, less depreciation, replacement cost is the cost of replacing a brand-new item.
With replacement cost insurance, policyholders can rest easy knowing that when an item needs to be replaced as part of an insurance claim, they won’t miss out on any potential money, even if the item’s value has depreciated. But when your policy includes actual cash value coverage, which takes into account accumulated depreciation according to age and condition, you may have to pay the difference between the payout from the insurance company and the replacement cost out of pocket. Generally speaking, what all of this translates to, is that if your insurance policy features replacement cost coverage, the payout you will receive will be greater than if your policy features actual cash value coverage. That said, adding replacement cost insurance to your policy is likely to increase your premium.
Actual cash value defined
The simplest way to define actual cash value is as the price that an item would be sold for today. In the insurance industry, actual cash value means that you will not receive a payout equivalent to the amount of money it would cost to buy a brand new version of the lost or damaged item today. Instead, you will receive a payout that equals the amount of money the item was valued at when it was lost or damaged. The key difference being that the cost of the item has most likely depreciated since it was first purchased. Therefore, if your car insurance policy includes actual cash value coverage, the amount of money an insurance company may reimburse you for in the event your car was stolen is not the same amount you would have paid when you first bought it. Instead, it will be an amount equivalent to the vehicle’s current worth, which will be less. From there, it will be the policyholder’s responsibility to cover the difference out of their own pocket or purchase an older or used version of their vehicle that is closer to the actual cash value they were given. Similarly, if your home insurance policy included actual cash value coverage and your ten-year-old flat screen television was stolen during a break-in, your insurance company may write you a cheque for the current market value of the old TV, not for the amount it would cost to replace the old TV with a brand new version today.
To help you further understand how actual cash value works, let’s look at a more specific example. Generally speaking, when someone is estimating the actual cash value of an item, they will take into account the purchase price of the item and deduct the accumulated depreciation from that to reveal its current value. Therefore, actual cash value can be viewed as the replacement cost of an item minus depreciation. Insurance companies typically use depreciation tables to determine actual cash value. In some cases, they may also hire a professional appraiser to estimate an item’s value, such as a home. Now let’s examine how an insurance company may calculate depreciation for a claim made on an actual cash value insurance policy using the example of a laptop.
Let’s say, your laptop, which was originally purchased five years ago for $1,000, was stolen from your home. You have a home insurance policy and it features actual cash value coverage. So the original price of the laptop was $1,000, and a similar one today, due to inflation and the current state of the economy, is closer to $1,500. According to depreciation tables, your laptop had 50% of its life remaining, or five years. Thus, the actual cash value equals $1,500 (the replacement cost today) times 50% (the amount of life it had left), which is $750.00. However, before this money arrives in your bank account, you will need to pay your policy deductible. Depending on your policy, your deductible may be as little as $250 or upwards of $2,000. If you had a $250 deductible, then your insurance payout would amount to $500, leaving you with $500 to replace your stolen laptop.
How do insurance companies determine actual cash value?
As discussed above, insurance companies typically determine actual cash value by estimating how much it would cost to replace a specific item and then subtracting any accumulated depreciation from that amount. Although the calculation methods may vary slightly between insurance companies, generally, the company will assign a lifespan to an item and then, upon confirming the age of the item, will estimate its remaining lifespan as a percentage. From there, this percentage is considered the accumulated depreciation, and it will be multiplied by the replacement cost to determine the actual cash value of the item.
When an insurance claim is filed, it is usually an insurance adjuster that works for your insurance company or who has been hired independently and represents your insurance company who will determine the payout you are entitled to. Therefore, the insurance adjuster is the person who will likely be calculating the actual cash value of any item(s) involved in the claim.
If you are unhappy with the replacement cost or accumulated depreciation calculated by your insurance company, you may be able to negotiate this or seek a second opinion by hiring an independent insurance adjuster. For more information on this, contact BrokerLink.
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Replacement cost insurance defined
Replacement cost is the other way that insurance companies assign value to items. Replacement cost will typically result in a higher insurance payout. However, it will lead to an insurance premium increase. How replacement cost works is as follows: When you file a claim and have replacement cost insurance, your insurer will give you the amount of money needed to replace the lost or damaged item with a new or similar item. Similar to actual cash value coverage, during the claims process, it will be the insurance adjuster who is responsible for determining the value of the lost or damaged item and for researching the current cost of a new or similar item. The method used to determine the value of the lost item will depend on what that item is. For instance, if your home was lost in a fire, an insurance adjuster would assess factors like your home’s age, size, construction materials, and the value of the items inside of it to determine its current worth and how much it will cost to rebuild it.
Actual cash value vs. replacement cost home insurance example
To further highlight the differences between actual cash value and replacement cost in the world of insurance, we describe how each works in relation to home insurance below.
Say a pipe bursts in your bathroom and damages the floors, ceiling, and finished basement suite below. Of course, the first step is to stop the water by locating and turning off the water shutoff valve in your home. The next step is to contact a professional plumber to help resolve the issue. And the third step is to contact your insurance company. Your insurance company will ask questions about the incident. Namely, they will want a detailed list of which items and damages you wish to claim, such as the floors, ceiling, and basement. The claims process will go much more smoothly if you have a list of all items in need of repair before you contact your insurer. We also recommend taking photos of the damage from a variety of angles, as well as providing estimates for the cost of repairs from local contractors and a list of receipts for the cost of the damaged items if applicable. The type of insurance coverage you have, as well as whether your policy includes actual cash value or replacement cost coverage, will ultimately determine your payout.
In this scenario, if your policy included actual cash value coverage, your insurer would likely use a depreciation table to calculate how much money you will receive following your claim. They would add up the original cost for all items being claimed and subtract that from the depreciation. The depreciation formula usually looks something like this: the depreciation rate as a percentage per year, multiplied by the replacement cost value how much the item would cost to buy new today, multiplied by the age of the item in years.
Meanwhile, if your policy had replacement cost coverage, there would be no accounting for depreciation. Instead, your insurance payout would be based on the cost of a similar or new version of the item today. The only deduction on the replacement cost would be your policy deductible, which would be subtracted from your payout.
Actual cash value vs. replacement cost car insurance example
Actual cash value vs. replacement cost in the car insurance world looks a little different. This is because, in addition to determining the value of the vehicle, an insurance adjuster must also take into account who was at fault for the accident. Whether your auto insurance policy includes collision or comprehensive coverage will also come into play.
For the sake of this example, let’s say that your car is damaged beyond repair and needs to be replaced entirely. After calling your insurance company to inform them about the accident, they will send an insurance adjuster to assess the vehicle. The adjuster will appraise your vehicle and assign it a value based on how much your car would likely have sold for pre-accident.
If your policy includes actual cash value coverage, and the adjuster determines that your one-year-old car is worth $30,000, the amount you receive is likely to be far less than $30,000. A car’s value depreciates faster than you might think. In fact, research shows that a brand-new car can lose up to 20% of its value in the first twelve months alone, followed by another 15% to 25% in the following four years. This means that the adjuster is likely to immediately remove at least 20% of your car’s value. However, this number could be even higher - closer to 40% - depending on other circumstances. If an insurance adjuster determines that your car’s value has depreciated by 40%, you’re looking at a maximum payout of $18,000, which likely will not be enough to purchase a replacement car. Therefore, if your car insurance policy has actual cash value coverage and your car is totalled, you will need to prepare to pay for at least part of your new car out of pocket. Keep in mind that your policy deductible will also be subtracted from your insurance payout.
Meanwhile, if you have a replacement cost auto insurance endorsement, also known as the waiver of depreciation, depreciation will not be factored in. Considering how quickly cars depreciate in value, you will almost certainly receive a much larger payout from your insurance company than with an actual cash value car insurance policy. However, there are requirements that must be met in order to purchase this endorsement. An insurance adjuster will still be used to determine the replacement cost. However, without depreciation, you will receive a payout that comes much closer to covering the cost of a new car in the same class and year as your damaged one.
Actual cash value vs. replacement cost and your insurance rates
Adding actual cash value coverage to your home or car insurance policy will usually help reduce your premium, whereas replacement cost can lead to an insurance premium increase. Since actual cash value payouts tend to be lower than replacement cost payouts, choosing actual cash value coverage can save you money on your insurance policy. If saving money upfront is a bigger priority for you than saving money down the line in the event of a claim, adding actual cash value coverage to your plan might be the best move. For help determining whether actual cash value or replacement cost insurance is right for you, contact BrokerLink. A BrokerLink insurance advisor can also help you with renewing car insurance, offering advice on whether switching from actual cash value to replacement cost coverage might be worthwhile. They can also answer questions like, “how much is car insurance per month in Ontario?” to give you a better idea of how much swapping actual cash value for replacement cost value would increase your rates.
Deciding between actual cash value and replacement cost
Are you struggling to decide whether actual cash value or replacement cost is right for your insurance policy? You are not alone. There are many factors to consider when deciding between these two types of insurance valuations. One such factor is your budget. If you are on a tight budget, then actual cash value might be the way to go as it usually comes with lower insurance premiums. Thus, if you believe you are at a higher risk of experiencing a loss or damage, replacement cost could be the better choice. For a professional opinion on which type of coverage is right for you, contact BrokerLink today. One of our licensed experts would be pleased to discuss each option with you, and even provide you with a free insurance quote based on both options.
The pros and cons of actual cash value coverage
- Pro: Reduced premiums: Insurance rates for actual cash value insurance policies tend to be lower than for replacement cost insurance policies.
- Con: Smaller payouts: The payouts for actual cash value policies are usually much smaller than replacement cost policies. Therefore, if you needed to file a claim, you would likely receive a smaller amount of money from your insurance company, which might mean having to pay more money out of pocket to cover the cost of replacing or repairing the damaged item.
The pros and cons of replacement cost coverage
- Pro: Larger payouts: The main benefit of replacement cost coverage is that, if you need to file a claim, your insurance company is likely to give you a larger payout than with actual cash value coverage. This is because replacement cost does not take into account depreciation, meaning you will be given an amount of money that is close to the cost of replacing the item today.
- Con: Higher premiums: Replacement value coverage comes at a cost. Since the payouts are larger, the premiums are higher. Therefore, by adding replacement cost coverage to your home or auto insurance policy, you must be prepared to pay a higher monthly or yearly premium.
How to find out if my insurance policy uses actual cash value or replacement cost
Policyholders should be able to ascertain the type of valuation system on their policy by reviewing the terms and conditions. Typically, the default method for most policies is actual cash value. If you are having trouble determining whether an existing insurance policy uses actual cash value or replacement cost, contact your insurance agent or an insurance broker at BrokerLink. One of our friendly and knowledgeable insurance advisors would be pleased to review your policy and inform you of your valuation method. At this time, they can also answer any questions you may have about actual cash value or replacement cost.
Get in touch with BrokerLink for more information on actual cash value and replacement cost for insurance
If you need help understanding how actual cash value works, contact BrokerLink today. Any member of our team would be pleased to walk you through actual cash value vs. replacement cost and explain how each can impact your insurance rates. We can also provide valuable insight into which method is right for you. Beyond helping our customers grasp important insurance terms like actual cash value and replacement, we can also provide them with a wide array of other insurance services. For example, a BrokerLink insurance advisor can help you find the right insurance policy for your business, car, vehicle, or pet. We can also help you understand how other types of insurance coverage works, like third party liability insurance explained. To learn more about what BrokerLink can do for you, get in touch today. We can be reached by phone, email, or in person at any of our 200+ branches across Canada. However you prefer to get in touch, one of our insurance experts will be pleased to assist you. Alternatively, if you’re looking for a free quote, use our online quote tool to receive a complimentary estimate in minutes.
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