Choosing a homeowners insurance policy can be a complicated process riddled with a huge number of highly technical details. Since you are choosing a protection plan for what is likely your most valuable possession, it pays to have a solid understanding of the many terms that you will encounter. Of these policy details, one of the most important is the level of protection that your plan provides. This protection level is usually described as "actual cash value" or "replacement cost value." Selecting the best protection level for your needs can have a drastic impact on how much you are paid in the event of a claim.
What is the Difference Between Actual Cash Value and Replacement Cost Value?
The key difference between these two policy types is whether or not depreciation is factored into the value that you receive for your home and its contents. For homeowners insurance policies, depreciation is generally determined by considering the likely lifespan of a particular item or part of your house and comparing this service life to the age of your item.
With actual cash value (ACV) policies, you receive money for your home and its contents based on this depreciation calculation. If the age of a covered item is half of its expected lifespan, for example, your insurance company will only cover up to half of the item's value. Actual cash value policies may apply only to the contents of your home, or they may apply to the home itself. If an ACV policy applies to structure of your home, then the age of features such as the roof and siding will be taken into account when determining your payout.
By contrast, replacement cost (RC) value policies will determine the amount of money required to purchase new replacements for your damaged property. In this case, depreciation is not used to determine the amount that will be paid out on your claim. More importantly, the original cost of the item is not used to determine its replacement cost. Instead, the insurance company will determine the cost necessary to replace the item with one of similar quality, even if that amount is higher than the item's original cost.
Which Is Right for You?
In most cases, replacement cost policies are strictly a better option than actual cash value policies. By choosing a replacement cost policy, you have a much better chance of recovering sufficient money to repair damage to your home and replace your items in the event of a catastrophe. Unfortunately, replacement cost policies do not guarantee that you will receive the full value of everything in your home. In many cases, replacement cost policies will cap the maximum pay out for certain categories of items (such as computers), limiting how much you will actually recover for a claim. If you have particularly valuable items, it may be necessary to attach additional coverage to the policy to ensure that you will receive enough money to replace your belongings.
The one advantage to actual cash value policies is that they often result in lower premiums. This trade-off can severely impact your ability to repair your home in the event of damage, however, so you should be sure that you can cover the amount lost to non-recoverable depreciation. Actual cash value may also make some sense if you anticipate being able to complete repairs yourself and so can save on labor costs. Outside of these edge cases, replacement value policies are usually the better option for most homeowners.