You may have never heard the terms ‘replacement cost’ or ‘actual cash value’ before, but in the event of a loss, they can be significantly disparate in the coverage they provide.
But just what is replacement cost? How does it work? And how can you choose which coverage option works best for you?
Here, I’ll spell out the meaningful differences for you, using real-world language that you can implement to make a more informed buying decision.
What are the Basics About Replacement Cost?
When it comes to homeowner’s insurance, ‘replacement cost’ isn’t an ambiguous term: it references the cost to replace items damaged by a covered peril with other items of like kind, quality, and value. In other words, what it costs to replace.
For example, if your high-end dining room table is damaged beyond repair by a kitchen fire, your homeowner’s insurance would reimburse you so that you could purchase a similar replacement. Or, they’d help you buy a new leather sectional sofa if yours is water-damaged after a portion of your roof rips off during a strong windstorm.
What would happen if your home was damaged beyond repair by this same storm? If you have replacement cost coverage in place, your homeowner’s insurance will pay rebuilding expenses.
IHS Pro Tip: Keep in mind, however, that replacement cost (total rebuilding expenses) and market value (your home’s worth if sold on the open market) can be very different.
What’s the Deal with Extended Replacement Cost?
Extended replacement cost coverage is also precisely what it sounds like: if your home suffers a total loss caused by a covered peril, your insurance company will pay a certain amount over—typically, 25 or 50 percent—your policy’s dwelling limit.
For example, let’s say that the coverage A on your homeowner’s policy is $500,000. Your home is blown down in a windstorm, and you have a 50% extended replacement cost endorsement in place. Here, your carrier would pay up to $750,000 to rebuild your property as closely as possible.
How Does Actual Cash Value Work?
Compared to replacement cost, which references the amount it costs to purchase a new substitute, actual cash value (ACV) takes depreciation into account (cost new, less depreciation).
Continuing with the examples above, if you paid $10,000 for your custom dining room table but five years old at the time of the kitchen fire, the insurance adjuster will take this depreciation into account. Therefore, instead of receiving $10,000 to purchase an equivalent replacement, you might only receive $6,000.
The bottom line is that when it comes to actual cash value coverage, the older an item is, the less it’s worth in the event of a covered loss. Because of this, most homeowner’s policies include replacement cost coverage for your dwelling and personal property, although ACV is usually an option (more in a moment).
3 Questions to Help You Decide Between Replacement Cost & ACV
With this said, how can you decide if you need replacement cost or ACV?
In my experience, you can get a great handle on the situation by answering the following three questions:
1. What types of property do I own?
Is your personal property (e.g., clothing, furnishings, etc.) meaningful enough that you’d want to replace it with similar items if they were damaged beyond repair? If so, will you be able to make up the difference between what you’ll receive from insurance, and what the items would cost to replace currently?
If your answer is ‘yes’ to both of these questions, you might get away with actual cash value on your personal property.
When it comes to your dwelling, is it a newer, basic tract home? Or, is it older with custom features that might be more labor-intensive (and costly) to replace, such as intricate woodwork? If it’s the latter, extended replacement cost could help cover unexpected costs if your home’s a total loss.
What’s my budget?
In most instances and all things being equal, replacement cost coverage will result in higher homeowner’s insurance rates than actual cash value coverage. And as you might imagine, extended replacement cost is even more expensive.
Do I have significant savings and assets?
However, it’s crucial to balance higher premium costs with the much higher (relatively speaking) difference in your out-of-pocket expenses in the event of a loss.
With this said, if you have significant savings or other assets, ACV might make a greater financial sense.
How Can You Learn More About Replacement Cost Coverage?
In most instances, adding replacement cost coverage to your homeowner’s policy results in a relatively minor premium increase—especially when compared to potential out-of-pocket expenses if a loss occurs. As such, I often recommend that IHS clients maintain it on their policies.
However, as outlined above, there are certainly exceptions. Not sure whether or not you need replacement cost coverage? Give us a call today, and we’ll be happy to discuss and help you find solutions!
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