Property Valuation: Replacement Cost vs Actual Cash Value

These two loss settlement options are given on almost every property-covering policy available. What’s the difference between Actual Cash Value and Replacement Cost though? How does it apply to your home or commercial building? How does it apply to your personal property? 

What are Actual Cash Value (ACV) and Replacement Cost (RC) Valuations?

ACV and RC are intertwined, but react vastly different during partial and total losses. Starting with Replacement Cost, this settlement option insures property for the full cost to replace it to the same state it was before the loss. With RC, partial losses will be paid in-full, and total losses will result in an entirely new building being built or the property being replaced with a new version. RC settlement requires insuring the property for the full cost to replace the property, which should account for the current costs of materials, labor, contractor profit, inflation, and other miscellaneous costs of construction.  

Actual Cash Value is commonly defined as the ‘fair market value’ of your property. This common definition is only an estimate, because the true calculation of ACV is: "Replacement Cost minus depreciation of the property." To work ACV, you'll need to know what percent the property has depreciated by, and what the total Replacement Cost is. With those two figures, you simply deduct X% off of the RC value to determine the ACV. Similar to RC, when a total loss happens, you would receive the full ACV amount. However, partial losses aren't paid in-full. Instead, the amount you'd receive is a depreciated value.

RC & ACV personal property example: You have a leather couch that you bought for $3,000 a few years back and a fire completely destroys it. If you had it insured for RC, you would receive a brand new model of the exact same couch (if one could be found), or the modern equivalent of it, even if it costs more. If it were ACV insured, you would get the amount calculated by taking the Replacement Cost minus depreciation.

Let's calculate it: Most couches don't have much resale value, so after a few years, it's probably depreciated 70%. To get a similar couch from the same manufacturer now costs $4000. So the RC value is $4000. For ACV you deduct the depreciation, so the ACV is only $1,200 (4000 x 0.3 = 1200).

RC & ACV real estate example:

You have your home insured for RC and it has suffered a total loss. Let's say the house is worth $100K on the market, however, it would cost $200K to rebuild the same building today. Being insured for RC, you get a new house built, even though it's only worth about $100K on the market. 

Conversely, let’s say we had the same loss on the same house, but this time, it was insured for ACV. The RC value is $200K, but your building is older and has depreciated by 60%. The ACV is  $80K, so that's what you'd receive. You'd now have to spend extra money to find a similar quality home or downsize. 

The difference between ACV and RC is substantial come claim time, but is often overlooked because RC costs more. Make sure to discuss the true value of your home or building with your agent, and have them help you decide what the best option is for your situation!

Note: This article does not account for the Coinsurance Clause, or the option to insure property at Agreed Value