The difference between the actual cash value and replacement cost
Setting a limit on your insurance coverage is simple, but choosing between actual cash value and replacement cost reimbursement is not always as straightforward.
If you have insurance, replacement cost coverage is the best option if you need to file a significant claim.
This coverage, however, comes at a cost — one that may not be worth it for every situation. We’ll explain the distinctions between actual cash worth and replacement cost so you can consider the pros and cons for yourself.
Actual Cash Value vs Replacement Cost
These are the two approaches of evaluating a specific property, and they are drastically different from one another. Insurance firms may use these words in their policy declarations to indicate how your property will be appraised if an insurance claim is submitted.
Actual Cash Value
Actual Cash Worth (ACV) is a method of determining the value of a specific property in order to settle an insurance claim. Actual Cash Value is most commonly used by insurance companies to assess how much compensation to pay you in the event of a claim.
Actual Cash Value is computed as Replacement Cost minus cumulative Depreciation. Depreciation is normally calculated using the useful life of the asset or product as one of the two separate elements at work.
In an example, if a perfectly functioning, ten year old printer was lost in a fire, the insurance company might say the useful life was five years. Even though the printer was functioning perfectly before the fire, the Actual Cash Value is zero, since the equipment was fully depreciated at five years. The insurance company would not give you any money for the lost printer, and you would have to buy a new one to replace it.
Pro: When you calculate items at their true cash value, you will most likely be charged a reduced premium.
Con: If you buy new products to replace the ones you’ve lost, you’ll be responsible for the difference between the insurance reimbursement and the cost of a brand new item. Alternatively, if you opt to replace it with an older or used item, you may have difficulty finding something suitable.
The cost of constructing replacing the same property or equipment to its same condition before an incident is referred to as replacement cost.
In a commercial setting, machinery or equipment is required for the business to function on a daily basis. In the event of a fire or other catastrophe, a business owner needs the equipment replaced and functioning as soon as possible. In this situation, replacement cost insurance is appropriate.
The amount a person would have to spend to replace an item is known as the replacement cost or replacement value. It is the cost of replacing an item or asset in its pre-loss state. While the replacement cost may not be as high as the asset’s “new market value,” it may also not be as low as the Actual Cash Value, which includes depreciation.
In our example above with a ten year old printer, a replacement cost policy would pay for a new printer, even though the older one had lived much longer than expected.
Pro: The money you get in a claims payout from a replacement cost policy will allow you to effectively replace your lost belongings.
Con: Replacement cost insurance typically has higher premiums than real cash value policies.
How Do I Purchase Replacement Cost or Actual Cash Value Insurance?
To purchase replacement cost insurance or actual cash value insurance, you must first consult with your insurance broker, who will assist you in selecting the coverage you require.
Because independent insurance brokers are not tied to a single insurance carrier, they can shop around for several estimates, not just the best quote one company has to offer. They will assist you in answering your questions and weighing the benefits and drawbacks of replacement cost vs. actual cash value insurance.
Business insurance typically covers your equipment and other property up to a certain amount, but if you have a lot of high value items, you may need to increase that limit or purchase additional coverage.
Which is better, replacement cost insurance or actual cash value insurance?
It all depends on your financial status and the property you want to insure.
Replacement cost insurance is the best option for equipment that is essential for operating your business. Actual cash value might be a good option for property that has long depreciation cycles or when it is not as essential to the business. After an incident, you need your company back on its feet as quickly as possible and with the minimum amount of cash spent to recover, but you do need to balance the higher premium costs of actual cash value policies.