What’s the Difference?
When you consider your most valuable assets, your home is probably at the top. Did you know that insurance companies provide coverage for your home in more than one way? The two most common ways that homes are insured are on the basis of Replacement Cost or Actual Cash Value. But what do these terms mean and what’s the difference when it comes to protecting my home?
Replacement Cost
Replacement Cost is typically defined in insurance policies as the cost to repair or replace the home with “material of like kind and quality.” It does not deduct anything for depreciation. The insurance company will pay the cost to repair or replace the home, up to the Dwelling Limit indicated in your policy, minus your deductible.
For example, we have Bob Smith whose home is insured on a Replacement Cost basis. He has a $1,000 deductible on his home. Suppose there is a hailstorm that causes $7,000 in damages to Bob’s roof. Here’s how his insurance policy might respond:
Cost to Repair the Roof: $7,000
Minus the $1,000 Deductible
Insurance Pays: $6,000
So, the insurance company pays the cost to repair the damaged portion of the roof minus the $1,000 deductible.
Actual Cash Value
As it relates to homeowners insurance, Actual Cash Value is typically calculated as the cost to repair or replace minus depreciation. Travelers Insurance defines depreciation as the decrease in “value over time due to factors such as age and wear and tear.”
Let’s take our same example with Bob Smith. But, now let’s assume his home is insured on an Actual Cash Value basis and his roof is 10 years old.
Cost to Repair the Roof: $7,000
Minus the $1,000 Deductible
Minus $2,000 in Depreciation Due to the Age/Wear & Tear of the Roof
Insurance Pays: $4,000
So, the insurance company pays the cost to repair the roof, minus the deductible, minus the calculated depreciation.
Conclusion
From our example with Bob Smith, we can see that when your home is insured on a Replacement Cost basis, the insurance policy will typically pay out more than if the home was insured on an Actual Cash Value basis. In truth, having Replacement Cost is usually a bit more expensive, but you can easily see the value during a claims situation.
Don’t wait until you have a claim to find out how your home is insured. Reach out to your agent and discuss whether your home is insured the way you would want it to be.