Home Actual Cash Value vs. Replacement Cost

WRITTEN BY: Mark Romero


The next time you find yourself examining the declarations page of a home insurance policy, be sure to read the fine print to learn about 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 a personal item or 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 home and not! 

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

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 Condominium for $250,000 brand new in 2010 that’s now only worth $225,000 in 2020 due to wear and outstanding projects. In 2020 Bob’s home is involved in a flood that leaves his 10-year-old condo with plenty of life destroyed!   

If Bob’s homeowners insurance policy states that his replacement coverage is based on Actual Cash Value, Bob will get a check for $225,000 to replace his condominium. 

While $225,000 accurately represents what Mr. Johnson’s condo was worth when it was flooded, the check will not allow him to purchase a new home of equal quality to the one he bought in 2010.

In contrast, if Bob’s homeowners insurance policy stated that his coverage was Replacement Cost based, he would get a check closer to $250,000, allowing him to purchase a new home of similar size and build quality to the one that had been flooded. 

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.

Understanding ACV helps to understand depreciation.

The Actual Cash Value of your item 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 house or personal item’s salvaged value. 

For example, if you purchase a hot tub for $5,000 brand new that’s expected to be worth $1,000 after ten years of wear and tear, you can calculate the monthly or yearly depreciation by dividing the 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 property insurance policy states that replacement is calculated off of Actual Cash Value, each year 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 an 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 product, this may not be the end of the world, but for daily essentials such as functional plumbing 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, bathroom, or structure.

In the example I used above, Replacement Cost insurance would cover purchasing a brand new $5,000 hot tub 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’re 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 overprotected.

Actual Cash Value Concerns & Considerations

In most cases, a general homeowners insurance policy will contain language that covers personal property such as furniture, light fixtures, appliances, and electronics inside your home under Actual Cash Value settlement terms. 

Depending on the value of the electronics and furniture in your home, it may be worth asking your insurance agent about the cost of upgrading from Actual Cash Value to Replacement Cost settlement terms.

In some cases, especially with renter’s insurance, the price difference can be a few hundred dollars a year, which may be worth considering if you’re in natural disaster territory.

Consider this one final example of a larger loss:

Bob Johnson owns a house with an older shingled roof, originally purchased 25 years ago for $15,000. If a large windstorm comes through Bob’s small town and destroys his roof, which has deteriorated by 25 years of wear and tear. Bob will be relying on his homeowners insurance for replacement. 

Under an Actual Cash Value insurance policy, Bob may not get any insurance payouts for his roof 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 home elements outside of your “useful life” as defined by your insurance policy? (Ex. Bob Johnson’s Roof)
  • Do you have a lot of expensive replaced, depreciated electronics?
  • Do you possess collectible items 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 Property or Homeowners Insurance Policy. 

But understanding these terms and making the right decision for your unique application is where the difficult decisions begin. 

If you’re looking to compare home insurance policies, give us a call or complete our quote form now to see the policies available to you.