Replacement Cost vs. Actual Cash Value: What to Know

When you buy homeowner’s insurance, and other types of property insurance, you are likely to have a choice between two coverage options: replacement cost and actual cash value. What do they mean, and which option should you choose? Luckily, these two concepts are simple when you get the terminology out of the way.

What Is Replacement Cost?

Replacement cost means exactly what it sounds like. It’s the cost of replacing something with a brand-new version. If your kitchen refrigerator is fried by a lightning strike, it’s the cost of buying a new comparable model at the store. If a tree falls through the roof, and rainwater destroys your 80-inch flat screen television, it’s the cost of—you guessed it—buying a comparable new television at the store. If your favorite recliner burns to a crisp in a house fire, then it’s—well, we think you get the picture.

When it comes to things like refrigerators, TVs, and recliners, it’s easy to estimate replacement cost. You can look up the same brand and model online (or, if the item is no longer sold, its closest match) and see what it’s selling for at your favorite stores.

Figuring out the replacement cost of your home and other buildings is a little trickier. In that case, the replacement cost is the cost of the materials and labor needed to rebuild the structure. Don’t confuse a home’s replacement cost with the amount you paid for it when you bought it. A home’s replacement cost is the cost of rebuilding, pure and simple.

What Is Actual Cash Value?

Actual cash value also means exactly what it sounds like. It’s the actual cash value of an item, as opposed to what it would cost to replace that item with a brand-new version.

Over time, the value of almost everything declines. Your TV slowly goes on the fritz. Those jeans fray and get holes. That couch soaks up a few too many grape juice stains. Stuff wears out. This loss of value over time (called depreciation) can be estimated using math. Using a few different methods, insurance adjusters figure out an item’s actual cash value based on its replacement value, its age and its salvage value, or the amount an item could theoretically be sold for at the end of its useful life. The older something is, the less it’s worth—most of the time.

Like replacement cost, actual cash value works a little differently for homes and buildings than it does for objects. If you choose actual cash value coverage, the age of your home’s walls, roof, floors, lighting, and more are all taken into consideration, and you will only be paid for their depreciated value, not the money it will cost to replace them. That means you could be on the hook for a lot of money if you need to rebuild. This is a big drawback of actual cash value coverage, and the reason most homeowners’ insurance is based on replacement value by default.

Which Is Better, Replacement Cost Insurance or Actual Cash Value Insurance?

It totally depends on your financial situation, your home, and your personal property. Replacement cost insurance is the better option for most people, since you’ll be able to replace your home and belongings in case of disaster without needing to dip into your own money. In fact, a mortgage or other type of loan may require you to carry replacement cost insurance so they can be certain you’ll keep up on your payments in case the worst happens.

But actual cash value insurance does work for some people. Since the insurance company does not have to guarantee replacement cost in the event of a claim, the cost of insurance can be less expensive compared to replacement cost coverage. If you have lots of savings or other assets, you may decide that you’d rather take the chance of needing to dip into them rather than coughing up the cost of higher premiums.

What Is Extended Replacement Cost?

If your home is destroyed, you might end up pushing the limit of your insurance policy to replace it—even a regular replacement cost policy. This could easily happen due to rising cost of construction costs or labor shortages.

In response to this scenario, some insurance companies offer an extended replacement cost option. Extended replacement cost policies extend your limit by a certain percentage, like 10% or 20%, if that money is needed to rebuild your home.

What are the next steps?

Whether you choose replacement cost insurance or actual cash value insurance, Selby Insurance is here to help guide you through the process every step of the way. As an independent insurance agency, we work with multiple insurance carriers and can offer you multiple different options. If you have questions, we can be reached anytime in Jonesboro at (870) 336-2121 or at tobyselby@selbyinsurance.com.