Which coverage is better, replacement cost or actual cash value?

Home

Home insurance protects your home and belongings against damage or loss caused by events like natural disasters, theft, or fire. When choosing a home insurance policy, you’ll want to consider your budget and coverage needs equally.

There are two main types of coverage: replacement cost and actual cash value. Understanding the differences is important because whichever you choose will determine how much you’ll receive in case of a loss.

Replacement cost coverage can cost more, but it provides the best protection for your property and pays out more in case of a claim.
Actual cash value coverage is a good choice if you have a limited budget, but it won’t cover the total cost of repairing or replacing your property.

To help you make that decision, let’s look at both options.

Replacement Cost Insurance

What Is Replacement Cost Coverage?

With replacement cost coverage, the insurance company will pay for all the costs to fix or replace your damaged or lost belongings with new ones that are the same quality, no matter how old or used the originals were. This gives you the best protection because you’ll get the full amount you need to fix or replace your belongings — often with no deductible you need to pay.

Remember, replacement cost coverage often comes with higher premiums. But if you’ve got some important, valuable, or rare items that would be tough to replace, replacement cost coverage will give you a little peace of mind.

How Does Replacement Cost Insurance Work?

Here’s what happens when you have replacement cost insurance and have to make a claim:

You let the insurance provider know of the loss event. They’ll send an adjuster to assess your personal belongings and property damage.
The adjuster will determine the cost to repair or replace damaged or destroyed property with new materials of similar quality.
Once replacement costs have been determined, the insurance company will pay you the full amount.

Pros & Cons of Replacement Cost Insurance

Pros:

Higher payouts: This coverage pays the total cost to rebuild or repair your home or personal belongings with no deduction for depreciation.
Avoid underinsurance: You’ll be protected even if the costs of rebuilding, repairing, or replacing what’s lost or damaged have gone up since you took out your policy.

Cons:

Higher premium: This coverage typically has a high premium, as the insurance company assumes more risk.
May not be necessary: If your home or personal belongings are older and have a lower value, this coverage may not be needed, as the cost to repair or replace them may be less than your annual premium.

Actual Cash Value Insurance

What Is Actual Cash Value Coverage?

Also called ACV, actual cash value policies will only cover the current market value of your property, taking into account its age, condition, and replacement cost. Because they’ll include depreciation, the insurance company gives you a lower payout than replacement cost coverage.

On the other hand, it’s also generally less expensive. Going for ACV coverage could save you on your insurance premium if you have older or less valuable items.

How Does Actual Cash Value Insurance Work?

Here’s how actual cash value insurance works in the event of a claim:

Like with replacement cost coverage, an adjuster will visit to assess the damage when you make a claim.
With actual cash value insurance, the adjuster determines the current market value of your damaged or destroyed property, not the cost to replace it with something new.
Your insurance provider then pays you the replacement cost, minus depreciation, based on the value of your property at the time of loss.

Pros & Cons of Actual Cash Value Insurance

Pros:

Accurate value: Because actual cash value policies account for depreciation, you’re not overpaying to insure older, less valuable items.
Lower premium: Because the insurance company assumes less risk, this coverage typically has lower premiums.

Cons:

May not cover total replacement: If the cost of replacing your home or personal belongings has gone up since you purchased your policy, you may end up being underinsured and left with a shortfall if you need to file a claim.
Longer processing: Determining the value of an item based on depreciation can be complicated, leading to disputes and delays in the claims process.

Choosing Between Coverage Options

Choosing between replacement cost and actual cash value coverage for your home insurance can be tricky. Here are 5 tips to help make the best decision about home insurance coverage:

Size up your risk tolerance: Knowing whether or not you’re a risk taker will help you avoid unnecessary expenses or inadequate protection.
Make an inventory: Keep track of your belongings with photos and their original and current values. This will help you choose the best coverage for your items, including separate coverage for high-value pieces like jewelry or art.
Know what’s covered: All insurance plans are different, so you’ll want to make sure you understand what’s covered and what’s not on every policy you consider.
Home rebuilding cost: Calculate the cost of rebuilding your home if it were destroyed, taking into account all costs, like labor, materials, and building code upgrades.
Weigh the costs: What you can comfortably pay for insurance? Compare the premiums of both policies, and check out typical payouts for claims.

Can Home Insurance Have Combined Coverage?

Many home insurance policies give you options for both replacement cost coverage and actual cash value coverage.

A common scenario might be that if your home gets damaged or destroyed, the policy will pay to rebuild or fix it up to what it would cost to replace it with something similar – without deducting for depreciation. That’s the replacement cost part of it.

For things inside the home, the policy would pay based on how much the stuff is worth now, considering depreciation. That’s the AVC part.

By offering both types of coverage — replacement cost and actual cash value — a combination policy can provide a balance of protection for both the physical structure of the home and the contents within it.