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What’s the difference between actual cash value and replacement cost?

No one wants to think about something terrible happening to their property. Still, in the event that something does happen, it’s essential to have the right insurance coverage to repair or replace an item if it’s lost or damaged.
When you purchase an insurance policy, you may be given the option of insuring your property at actual cash value or replacement cost. These are two of the most common calculations used to determine how much you’ll receive if you make a home or car insurance claim. Both methods have their pros and cons. But what’s the difference between the two? And which is best for you? Let’s take a look.
Actual Cash Value
If your policy is set up to cover the actual cash value of a lost or damaged item, the dollar amount you’ll be paid is equal to how much that exact item would be worth today. This considers the original price you paid for the item, depreciation (the decrease of an item’s value over time, commonly due to wear and tear), and the condition the item was in on the day it was lost or damaged. Most insurance companies use standard guidelines (known as “depreciation tables” in the insurance world) to calculate an item’s actual cash value, or they contact a professional appraiser to determine what a similar item would cost to buy.
For example, suppose a fire breaks out in your basement and damages the washer and dryer set you bought six years ago for $1,500. After consulting an experienced technician, your insurance company says the machines aren’t salvageable. How much will you be reimbursed? With actual cash value, you’ll be reimbursed for a similar set in the same condition as the ones destroyed in the fire. In this case, you may receive $600.
While the premiums for actual cash value policies tend to be lower than replacement cost policies, the reimbursement you would receive in the event of a claim is typically smaller, so you may have to pay more out of pocket to cover the difference between that and the cost of a new item.
Replacement Cost
If your policy is set up to cover the replacement cost of a lost or damaged item, the dollar amount you’ll be paid is equal to the price you would need to replace that item with a new item of similar kind and quality. Since insurance is designed to get you back to where you were before a loss, your insurer will research how much it would cost to replace the item with a new one that’s as similar as possible.
For example, suppose your home is burglarized, and the thieves make off with the TV you bought four years ago for $500. How much will you be reimbursed? With replacement cost, you’ll be reimbursed for the value of a new TV of similar kind and quality to the stolen one. In this case, you may be able to buy a new TV for $800.
Therefore, on the flip side, while the premiums for replacement cost policies tend to be higher than actual cash value policies, the reimbursement you would receive in the event of a claim should allow you to replace your lost or damaged item sufficiently.
Regarding car insurance, this only applies if you add a limited waiver of depreciation to your policy. Suppose you have a limited waiver of depreciation. In that case, your insurer will reimburse you for the original price you paid for the vehicle, the manufacturer’s retail price of the vehicle, or the cost to replace the vehicle with something similar, depending on which is lowest. However, conditions and terms can vary.
Actual cash value vs. replacement cost insurance claims
If you have an actual cash value policy, your insurance company will review the lost or damaged items, calculate their value, and provide you with an offer. The more proof you can give, the easier it will be to determine their value. That’s why keeping an updated home inventory list is always wise.
If you have a replacement cost policy, you may receive two payments:

  1. An initial payment for the actual cash value of the lost or damaged items.

  2. A second payment for the remaining value once you prove that you replaced the items within a reasonable time. If you don’t replace the items, you won’t be entitled to the second payment (and you will only receive the actual cash value for the items).

Remember that the amount you receive also depends on the deductibles and the limits outlined in your policy.
If you're a current OTIP policyholder, contact us at 1-833-494-0089 to review your existing home insurance policy and discuss additional coverage. If you’re not insured with OTIP and are shopping for home insurance, call us at 1-833-615-9326 to get a quote and receive a $20 gift card of your choice!

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