Actual Cash Value vs. Replacement Cost Value
While some policies will include replacement cost, some might be insuring a home based on actual cash value ( ACV ). The main difference between the two is that one takes a property’s depreciation into account, while the other does not.
Policies that operate under the actual cash value framework will invariably factor in depreciation when calculating your payout for a given claim. This means that you will likely receive lower payouts the older your home is. So if you have roofing that is nine years into its 10-year lifespan, you’ll likely be getting much less money to replace it. Each insurance company is likely to have its own formula for calculating the impact of depreciation on a given payout, but the majority function under the premise that a claim’s payout will reduce based on how old the item is.
On the other hand, policies that operate under the replacement cost framework do not take depreciation into account when calculating a payout. Instead of the payout decreasing due to depreciation, it is influenced by the current market prices, ignoring the rise of building costs.
As mentioned previously, you will need to make sure that your homeowners insurance plan has enough coverage to meet at least 80 percent of the home’s replacement cost. This is what’s known as the “80/20 rule” and can determine whether your insurance company will cover the full cost of your home.
When it comes to standard home insurance policies, dwelling coverage tends to use replacement cost, while contents coverage tends to use actual cash value. In some cases, insurers might initially pay you the actual cash value of the dwelling, followed by later reimbursements for repair or construction costs.
Generally speaking, fewer and fewer insurance companies are using the actual cash value model, given how many policyholders prefer replacement cost valuation.