Actual Cash Value vs. Replacement Cost

WRITTEN BY: Julia Matseikovich


The next time you examine the declarations page of an auto insurance policy, be sure to read the fine print to learn how you would be reimbursed in the future for property loss. 

Generally, on the declarations page of an insurance policy, it will explain whether your specific policy covers the Replacement Cost of your car or simply its Actual Cash Value. 

This minor distinction may not seem like a big deal now, but the disparity in cash reimbursement may be the difference between being able to replace your vehicle or not! 

If you’re not cautious, it’s easy to end up with an insurance policy that won’t replace your car, truck, or SUV at the cost you would have personally valued.

After reading this article, you’ll have learned about:

  • How Actual Cash Value is Calculated
  • Depreciation and its Relationship to Actual Cash Value
  • How Replacement Value is Calculated
  • Actual Cash Value Concerns & Considerations

Actual Cash Value & Replacement Cost: An Example

For example, let’s consider Bob Johnson, a fictional character who purchased a $25,000 brand new car in 2015 that is now worth $16,000 in 2020 due to depreciation, age, and mileage. 

In 2020 Bob was involved in a car accident that left his 5-year-old car with plenty of life totaled!    

If Bob’s auto-insurance policy states that his auto replacement coverage is based on Actual Cash Value, Bob will get a check for $16,000 to replace his car. 

While $16,000 accurately represents what Mr. Johnson’s car was worth when it crashed, the check will not allow him to purchase a brand new car of equal quality as he did in 2015.

In contrast, if Bob’s auto-insurance policy stated that his auto replacement coverage was Replacement Cost based, he would get a check closer to $25,000, allowing him to purchase a new replacement vehicle of similar make and model to the one that had been crashed. 

After considering this example, you may ask: “Why would anyone choose Actual Cash Value over Replacement Cost?”  The answer always comes down to recurring monthly costs, budget and value of the insured property. 

Typically, a policy based on Replacement Cost will have steeper premiums, which can turn many buyers away who don’t fully understand the repercussions in the case of an expensive loss. 

Actual Cash Value and How It’s Calculated

Actual Cash Value (ACV) of a lost item is typically calculated by subtracting depreciation due to wear and tear combined with age from that item’s full original value.  Therefore, by definition, the Actual Cash Value of any personal item will be less than the initial purchase cost.

Does that mean that to understand ACV, you have to comprehend depreciation?  Yes!

Actual Cash Value can also be considered Depreciated Value at the Time of Loss.

It’s easy to understand depreciation yearly or monthly once you have established a vehicle’s salvaged value. 

For example, suppose you purchase a used Honda Civic for $5,000 that is expected to be worth $1,000 after ten years of wear and tear. In that case, you can calculate the monthly or yearly depreciation by dividing the value’s value by time.  In this example, you would divide $4,000 (the loss in value over time) by ten years or 120 months, giving you an approximate depreciation rate of $400/year or $33.33/month. 

In this example, if your auto insurance policy states that replacement is calculated off of Actual Cash Value, each year that you have owned the hot tub before the loss would subtract $400 from the final check you could receive. 

Because of the impactful depreciation element, Actual Cash Value will often leave a vehicle owner short on cash to purchase a similar product brand new. 

If you don’t mind putting up a bit of your cash to purchase a replacement car, this may not be the end of the world, but for daily essentials such as vehicles or kitchen appliances, this may not be a risk worth taking.

Replacement Cost and How It’s Calculated

In contrast with Actual Cash Value, Replacement Cost (RC) is a simple calculation.  Replacement Cost is the payment you would be required to make to replace the item lost with a similar make or model brand new, whether that be a hot tub, piece of furniture, vehicle, or structure.

In the example that I used above, Replacement Cost insurance would cover purchasing a $5,000 used car similar to the one you had lost.  Replacement Cost takes the element of depreciation completely off of the table!

While Replacement Cost is considered superior in almost all insurance applications, the premiums can be a bit higher, as previously discussed, depending on the value of the items you are looking to insure. 

If the combination of premium-related expenses surpasses the value of the item insured, you’ll know that the personal belonging is over-protected.

Actual Cash Value Concerns & Considerations

In most cases, a general auto insurance policy will contain language that covers personal property within the vehicle, such as aftermarket speakers, electronics, golf clubs, and more, under Actual Cash Value settlement terms. 

Depending on the value of the electronics and other aftermarket parts, it may be worth asking your insurance agent about the upgrade cost from Actual Cash Value to Replacement Cost settlement terms. 

In some cases, especially with cheaper auto insurance policies, the price difference can be merely a hundred dollars a year which may be worth considering depending on your situation. 

Consider this one final example of a larger loss:

Bob Johnson owns an old collectible car purchased 25 years ago for $15,000.  If a large windstorm comes through Bob’s small town and destroys his garage containing the car, which has deteriorated by 25 years of wear and tears, Bob will be relying on his auto insurance for replacement. 

Under an Actual Cash Value insurance policy, Bob may not get any insurance payouts for rare, aged vehicles due to the exorbitant depreciation and would therefore be responsible for the entire replacement cost.

Below you can find a few important questions to ask yourself before making your final decision on Actual Cash Value vs. Replacement Cost:

  • Are there elements of your vehicle outside their “useful life” defined by your insurance policy? (Ex. Bob Johnson’s Collectible Car)
  • Do you have a lot of expensive replacements, depreciated electronics or speakers?
  • Do you possess a collectible vehicle that would be difficult to replace or not properly valued in an ACV scenario?
  • Do you have funds to supplement the difference in replacement value?

In Conclusion

In conclusion, understanding Actual Cash Value (ACV) and Replacement Cost (RC) is essential to reading through any Auto Insurance Policy.  But understanding these terms and making the right decision for your unique application is where the difficult decisions begin.  Consider the examples we discussed above and try to imagine yourself in a position of loss to establish your precise insurance needs.