What is Replacement Cost vs ACV?

You have probably come across the terms "replacement cost" and "actual cash value" while looking over your home insurance policy. Like many others, you are probably wondering exactly what the difference between the two is.

It's definitely preferable to have a "replacement cost" policy versus an "actual cash value" policy, and here is why.

"Replacement cost" is the cost of replacing a damaged or stolen item of "like kind and quality". With "replacement cost", depreciation (the reduction in value of something over time due to wear and tear) isn't taken into account.

So - let's say that you have a stereo system that cost you $1,000 to buy. You arrive home from work one day, and your stereo system is stolen. You owned the stereo system for two years before it was stolen.

With a "replacement cost" policy, the insurance company will cut you a check for the amount of money that it will cost to replace your stereo system with one of a like kind and quality. So, if the same (new) stereo system costs $950, that is the amount that you will receive from the insurance company.

The key words to remember when thinking about replacement cost - replaced with one "of a like kind and quality". So, if your Sony 42 inch plasma TV is stolen, then the insurance company will replace it (or cut you a check for the amount) with a Sony 42 inch plasma TV, and depreciation WILL NOT be taken into account.

Now, let's look at an "Actual Cash Value" policy in the same situation.

You have an "Actual Cash Value" homeowner's policy and your $1,000 stereo is stolen. You had owned the stereo for two years.

"Actual Cash Value" is the value of an item MINUS depreciation.

So, let's say that the insurance company figures that the expected lifetime of the $1,000 stereo is 5 years. By the end of this five year period, the stereo would be worthless.

This would mean that the stereo, in the eyes of the insurance company, would depreciate by $200 every year.

So, after a two year period, your $1,000 stereo might have an actual cash value of just $600. Another way to think about "actual cash value" - how much could you sell the stereo for after two years?

--

You might want to ask your insurance agent if you have "replacement cost" or "actual cash value" on your homeowner's policy. As you can see from the examples posted above, the difference in the two policies would be massive, especially in the case of a catastrophic loss.