The Difference Between Replacement Cost and Actual Cash Value

Understanding Claims Payments for Actual Cash Value and Replacement Cost

woman trying to determine price of old items replacement value and actual cash value
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Nearly half of all homeowners don't understand terms like "replacement cost" and what it means for their home insurance coverage, according to a 2018 survey by Insurance.com.

A lot of people think the limits that appear on the DEC page of their insurance policy are a good indicator of how much they'll be paid when they have a claim. But this isn't the reality. The limits on the DEC page are the maximum you could potentially be ​paid, not necessarily how much money you'll actually receive.

How Much Will You Be Paid for Your Claim?

How much you can expect to be paid for your insurance claim depends on three key factors.

First, how accurately can you describe, document, and show the lost value of your property? Keeping a home inventory of items can really help with this. The more details and proof you provide, the less likely you are to be at the mercy of the insurance company's estimates. 

What type of policy do you have? Different insurance policies provide different coverages. You might have a "homeowner policy" or a "condo policy," but the type of homeowner or condo policy you've taken out will dictate the risks covered. It will also cite exclusions and special limits for certain items.

Special limits aren't standard across all insurance companies. Those specializing in attracting consumers with high-value homes might have higher special limits in the areas of jewelry, fine arts, or even wine collections.

The basis of claims settlement is the third critical factor: Will the insurer pay "actual cash value" or "replacement cost?" This is a critical distinction.

You can usually find this basis of claims settlement in the small print of your policy. Very often a homeowner is disappointed by how much she was paid because she didn't understand the meaning of these two terms.

Actual Cash Value (ACV) Definition

Actual cash value is the depreciated value of an item of property at the time of the loss. This type of settlement does not allow you to replace what you've lost. Rather, it compensates you for the value of the item as if it was being sold at a garage sale.

The meaning of the term "actual cash value" has been disputed a few times in the courts, with most courts leaning toward the industry's definition rather than that which is accepted by the Internal Revenue Service: what a buyer would be willing to pay a seller for an item in its current condition if neither the buyer nor the seller was under any duress to complete the sale. In other words, what it might be sold for at a garage sale.

The insurance definition begins with replacement value then subtracts an amount for depreciation.

In either case, actual cash value leaves you in a tough position because you won't be able to go out and buy a similar item new, at least not without coming out of pocket. Rebuilding your personal contents—or even worse, your home—on an actual cash value or depreciated basis leaves you at a loss compared to replacement cost settlements.

Replacement Cost Definition

Replacement cost provides you with a payment equal to that which would be required to replace the lost items. It's superior to ACV because it allows you to put yourself in the same position you were in prior to the loss. It provides you with the necessary money to replace your items.

When Will You Receive Payment?

One common misconception about replacement cost is how it will be paid. You must actually replace the items first before you're able to collect a full settlement.

Depending on the size of the loss and the type of claim, you'll likely be asked to provide a lot of information before receiving the full settlement for your claim. Expect to be asked to provide a list and allow time for the insurance company to review the list and determine how and what it's going to pay you. You should then have an opportunity to review the company's offer.

If your basis of loss settlement was actual cash value, you might be asked to sign off on the amount, agreeing that it's a final payment, before you receive a check. But the process is different for replacement cost.

What Information Might Be Required?

When you're expecting full compensation for the replacement of items or personal contents that were insured in your home, you should expect to provide a list of:

  • The item descriptions with makes and models if applicable
  • When you originally purchased each item
  • The price you paid for each
  • The item's replacement value today
  • Any photos showing the condition of the items
  • The original receipts, if possible

You probably won't have a receipt for every pair of socks you owned, but you might have kept the receipt for your big screen TV or expensive sports equipment. Every insurance company has their own criteria, so be sure to ask the insurance adjuster for a form or guidelines to help you fill out your proof of loss items list.

The Two-Step Process of Replacement Cost Claim

You can expect to receive two checks before being fully compensated when your loss settlement is on a replacement cost basis. The first check will be for the actual cash value of the items.

Then you must prove that you've replaced the items. Only then will you typically receive final payment. You can usually submit your expenses along the way if you replace items over time, and you can talk to your adjuster about when you can expect payments. This depends greatly on the size of the loss. 

Keeping open communication with the adjuster on your claim will help you understand exactly what to expect, and it will help you get paid for your actual loss

Cash Out Loss Settlements vs. Replacement Cost

Some high-end policies might offer you the option to receive full replacement value without an obligation to replace. These types of policies are generally more expensive than standard insurance policies. You can ask your insurance representative if you qualify for one. They're often based on higher home values, or condo or tenant policies with higher contents limit requirements, as well as other criteria.

This is very different from replacement cost where you might only be offered the depreciated ACV as a settlement option if you choose not to replace the item or to rebuild your home.

Can an Insurance Company Repair Items?

The insurance company often retains the right to repair or replace the items. The adjuster will review your list and let you know. You might be offered a repair instead if an item can be reasonably restored to its condition prior to the claim. Otherwise, the company will offer you replacement cost.

Is There Room for Negotiation?

There might be some room for negotiation of replacement cost values. For example, the item might have been replaced by a better model since the time when you first purchased it. You might have had a 3-year-old computer that can't be replaced by the same make and model today. In this case, you might find an equivalent product and list that as the "replacement equivalent" with the associated value. Always try your best to find the most similar replacement item possible.

If you give a fair replacement cost price and do your research, you'll likely get what you're asking for. If you don't do the extra work, the adjuster will come up with his best solution or evaluation and you might lose out.

Some insurance companies are more lenient than others. It can depend on case-by-case circumstances and the company's own requirements. 

What About Items That Are Obsolete?

You might find yourself in a situation where you'll only be offered ACV if an item is determined to be obsolete or by its "inherent nature cannot be replaced." A similar clause can apply to sets or pairs of items when only one part of a set or pair is lost and the other is undamaged. 

Items That Can't Be Replaced

Specialty items that cannot be replaced, such as collectibles, antiques, and fine arts, should always be discussed with your insurance representative before a claim occurs. This will allow you to get the proper advice regarding how to protect the value with the right type of insurance.

It will also give you the opportunity to get appraisals, and possibly schedule the items on a separate floater or rider to ensure a settlement to value. You might be very disappointed in what you receive if items of this nature are lost in a claim and the proper insurance was not obtained.

Does Replacement Cost Include By-Law or Ordinance Coverage?

Beware of increased costs of reconstruction when it comes to ordinance coverage. Your home might be insured for replacement cost, but it can impact the actual cost of replacement, increasing it, if by-laws came into play after your original home was built. Some policies include exclusions that don't cover the increased cost of construction due to by-laws or city ordinances.

Endorsements are available to add by-law coverage to your policy, however, and some more comprehensive high-end insurance policies will include by-law coverage as a matter of course. But it could be a major problem in the interpretation of what the actual cost of rebuilding will be if your policy does not include this coverage.

What If Your Building Was Underinsured?

Many policies include a "guaranteed replacement cost clause" that allows some wiggle room around the total insured value of the home when it's been determined that the cost was a little off. This can depend on your specific policy wording and the type of policy that you have. 

For example, some policies might state that you'll still be eligible for replacement cost if you were insured to at least 80 percent of the value of the actual reconstruction cost.

Will the Insurance Company Ever Pay the Full Limit?

Some insurance companies might pay out the full value to limit for the home and its contents in disaster claim situations when a home and its contents are a total loss. This might be the case after a major natural disaster or a fire—but the situation must make sense to the adjuster. It's up to the discretion of the insurance company.

An insurance company always has a right to ask for a proof of loss, but the adjuster might come to a settlement without making you list every single item up to your policy limits in these types of major claims and total losses. Ask your insurance representative how your insurance company generally settles a total loss to get an idea of how things would work.

The best course of action is to always be prepared with copies of larger purchases stored in a cloud or a safe deposit box off premises. Regularly document your home with photos. They could come in handy in a total loss situation.