Understanding Insurance Claims

Replacement Cost vs. Actual Cash Value Insurance—What to Know

As you shop for homeowners and personal property insurance coverage, one decision that you'll need to make is whether to buy actual cash value coverage or replacement cost coverage. What do these two terms mean? And when should you opt for either? Here's what you need to know.

Actual Cash Value and Its Benefits

Insurance that stipulates actual cash value means the policy will pay you what a covered item is worth today. If a kitchen fire destroys an oven you bought five years ago for $3,000, the policy will determine its value today less depreciation for the time used. That means you may get significantly less than what is needed to buy a new oven of a similar type. You may have to downsize a replacement or even do without. 

Actual cash value policies are less expensive to purchase, so they can be good tools for budget-minded homeowners and renters. Also, if you have plenty of savings to provide financial buffers between the amount that insurance will pay and the cost of replacement items, a cash value policy saves money you can use for other things. 

Replacement Cost Coverage and Its Benefits

In contrast to actual cash value policies, replacement cost insurance figures the amount you would spend to replace an item with a like item today. After the kitchen fire above, your insurance may offer a market rate for new ovens that match the original unit. Or they may offer you the full $3,000 you originally paid, particularly if this would be less than the market rate method. 

The big advantage of a replacement cost-based policy is that you get a check closer to the actual amount needed to replace insured items. Of course, this still doesn't mean that the carrier will pay you to upgrade to a chef-grade oven. But with a check in hand, you may have more options to replace or update your unit. 

This additional protection does cost the insurance company more—which is passed on to customers in the form of higher premiums. However, because it doesn't link payouts to original costs, this coverage automatically keeps better pace with inflation and market changes. 

Where to Learn More

Want to know more about the choice between replacement cost insurance and actual cash value? Start by meeting with a personal insurance agent in your state. With their help, you can find the right balance between cost and coverage so that you don't have to worry about your finances even in the face of the worst emergencies.