One concept you'll want to make sure you understand in homeowners insurance is ‘actual cash value’ versus ‘replacement cost’ coverage. It's a key distinction in insurance, and having a grasp of it, and a few other important terms, will help you make the best choices when it comes to your homeowners insurance policy.
Actual cash value is the cost to repair your home or replace your belongings, after a deduction for depreciation has been applied. Actual cash value takes into account the age, normal usage, and obsolescence of the damaged item. In other words, actual cash is the “as is” value of the item at the time of the loss.
Replacement cost is the actual cost to replace or repair your property with new items of like kind and quality at current market value.
Of course, it is more expensive to insure your property at replacement cost than actual cash value as you will be getting new for used items. The difference depends on the current value of your property. If your house and possessions are only a year old, there might not be much of a difference. If you live in an older home with beautiful wood floors and crown molding and your possessions were purchased some years ago, it can be much more. As a homeowner, you should consider what insurance value to place on your home, any separate buildings or structures, and all your personal possessions.
To ensure you have adequate coverage for your dwelling, insurance companies offer a number of choices which vary according to what kind of dwelling you are insuring: a home, a manufactured home, or a condo.
Here are some typical options offered
- Extended replacement coverage – This endorsement provides additional replacement cost, capping the payout at around 125% of your home’s insured value.
- Inflation guard – This option automatically adjusts the dwelling limit when you renew your policy. It is designed to keep up with the pace of inflation.
- Guaranteed replacement cost coverage– With this kind of coverage, the insurer pays to rebuild your home with like, kind and quality materials no matter the cost.
The contents of your home also can be insured for actual cash value or replacement value. Again, cost is the factor here. All of your home's contents can either be covered for what they would cost to replace (replacement cost), or for actual cash value which is their current “second hand” value (actual cash value).
Imagine your living room furniture is ruined by a covered loss. While your couch and love seat cost $2,000 five years ago, their actual current value is much less because they have been used on a regular basis. To replace them today would cost $2500. Depreciation of the items is $900 based on their age and usage. If you only had the items insured for actual cash value, after you have met your deductible on the claim, you would be paid $1,400 (replacement cost minus depreciation=actual cash value) to replace the sofa and loveseat; much less than the actual cost to buy a new set. If the items were insured for replacement cost, you would receive the full $2500 after application of your deductible.
You will have to decide if you want to pay for the higher cost of replacement value coverage for your personal property compared to actual cash value coverage. Your homeowners policy will most likely cover your belongings at up to 50-70 percent of the total coverage on your dwelling. As there may be limits in your policy for certain items, such as jewelry or collectables, you may wish to consider scheduling these valuable items separately. It is highly recommended that you discuss your coverage options and policy limits with your agent to ensure you are comfortable with what you have chosen.
It is wise to keep receipts or other records of purchase, serial and model numbers, make an inventory of your valuable items, or even create a video of your possessions so that when you make a claim there is no dispute as to the items you are presenting as damaged.
The bottom line is that it is important to have adequate coverage for your home, other building and structures on your property and all your personal property. Your homeowners insurance is designed to protect these most valuable assets against unforeseen damage or loss. You will want to work closely with your agent to make sure you have the coverage you need.