That big TV you bought a couple years ago; how much would you say it's worth now? Not what you paid for it, that's for sure. But how much would it cost to replace it if it was stolen? Maybe a little more than you originally paid.
That, in a nutshell, is the big difference between two ways you can insure the things you own -- your home, your personal property, your commercial property if you're in business, and more.
The first type, known as actual cash value or market value, would give you what that TV was worth when it was stolen (less any deductible) or what you might get if you sold it online or in a yard sale.
The second, replacement cost, would give you the money you need to buy the same TV brand new (again, less any deductible).
A lot of people don’t realize this when they're buying insurance. They end up being bitterly disappointed when they discover they're only insured for actual cash value and can’t afford to replace items that have been lost, damaged or stolen.
Of course, it's not always as straightforward as that. So, let's take a closer look.
Understanding Actual Cash Value
When you insure something for its actual cash value, unfortunately you don’t get to decide what that value is. The insurance company does that. Usually, their calculations are based on the current replacement cost, less a certain amount -- depreciation as it's called -- for each year of the item's age.
So, let's say your TV cost $2,500 and you've had it five years. Maybe a replacement would cost $3,000 (unlikely these days but stick with us). The insurance company uses depreciation tables for various items, so let's say it reduces cash value by 10% a year, or 50% over the five years of ownership. In this case, you would get 50% of $3,000, which is $1,500 (less deductible).
Of course, there are some things that actually increase in value over time. These are generally valuables and collectible items that usually require additional, separate insurance coverage. Actual cash value by itself may not be considered appropriate.
Understanding Replacement Cost
Using the same example, a replacement cost policy would pay out the full $3,000 (less deductible), regardless of how well used and what condition the TV was in when you lost it.
The basis of this type of policy is to enable you to replace an item with one that is exactly the same. Obviously, that's not always possible. TVs are a prime example. So, you will need to agree with the insurer on which item is approximately the same.
Insurance companies are used to this problem so it's not as much of a challenge as you might think. However, it's a good idea to check the wording of your policy for any definitions or limitations the insurer uses concerning replacement.
Replacement cost coverage is crucial (and normal) in the case of structural insurance. The cash value of your home may bear little relationship to the cost of replacing it if its damaged or destroyed by an insured peril.
For example, your house may be worth $500,000 but it could cost $700,000 to rebuild. It's the replacement cost not the market value that matters. In fact, because of this, some mortgage lenders may insist you have replacement cost coverage.
Some replacement policies will also pay for the cost of temporary lodging and meals if you have to move out while your home is repaired/rebuilt.
There's a further type of coverage in this category known as guaranteed replacement cost, which does what it says; it guarantees to pay up to 20% above policy limits for replacement if necessary.
A Word About Deductibles
We've mentioned a few times that any payment received from an insurance company under either the actual cash value or replacement cost terms would be subject to a deductible.
This is the co-payment a policyholder must make when a claim is settled. Typically, this might be around $200 for personal property, much more for structural coverage. The insurance company will deduct this from a settlement sum.
However, it is possible but rare to have an endorsement written into your policy which eliminates this co-payment. Naturally, there is a cost for this.
Differences in Premium
It stands to reason that a replacement cost policy is going to cost you more than an actual cash value. But the difference in premium is not so great that it should affect your decision.
Importance of an Inventory and Records
Your decision on actual cash value or replacement cost will be built into your homeowners or renters insurance policy. But, for your coverage to be effective, in either case, your policy must cover the value of everything in your household. Your policy will specify the maximum amounts it will pay.
If there's an underestimate, it's possible that, even with a replacement cost policy, the insurer might reduce the payment on a large claim. That's why it's important to have an accurate inventory of your home's contents.
Furthermore, keeping receipts and other records about the items you own will considerably simplify and speed up settlement of a claim.
This is particularly important because if you have a replacement cost policy, your insurer will probably initially only issue a check for actual cash value. You will need to provide proof that you replaced the item before you'll get a check for the balance.
A few policies stipulate that you don’t actually need to replace an item -- whether it's a TV or your entire home. They pay out regardless, but this is an exception rather than the rule.
It's also crucial that your structural insurance coverage accurately reflects rebuilding costs. That's not something that's always easy to establish without help. Which is why you should rely on…
The Importance of Expertise
Insuring the things you own is one of the most important things you can do for your financial security and your peace of mind. As we've suggested, making the wrong decision with regard to cash value and replacement cost can be an expensive mistake.
A good agent will also be able to help and advocate for you if there's a dispute with the insurer over cash value or replacement cost.
This underlines the importance of working with an expert, an agent like Equity Insurance, to secure the right coverage for your needs and your budget. If we can help, please get in touch.