Let’s imagine (as a worst-case scenario) that your home is destroyed in a storm. A tornado rips through your property while you’re on vacation, and your home is left in ruins. You call your homeowners insurance company to file a claim for the damage—hoping your coverage allows you to rebuild or replace all the property you lost.
One of the biggest areas where homeowners slip up (or misunderstand) when buying insurance is with their personal property coverage. If your carrier agrees to reimburse you for your property’s actual cash value, instead of its replacement cost, you could potentially end up paying A LOT out of pocket if there’s a disaster.
It’s vital to look closely at your insurance coverage before anything happens to ensure you’re well protected. 60% of homeowners are underinsured by an average of 20%, which means you might be, too.
Today, we’ll break down two important terms, actual cash value vs. replacement cost, so you understand exactly how they’re different. Then you can decide if your current coverage is sufficient or if you need to make adjustments.
What is an item’s actual cash value?
Actual cash value (ACV) equals fair market value, which factors in depreciation. ACV is what standard policies typically offer for personal property coverage; however, you should have the option to upgrade to replacement cost if you prefer.
Pretend you bought a dining room table for $2,000 five years ago. Today, it’s worth closer to $1,200. If it’s destroyed in a fire, and your policy states that you’ll be reimbursed for the table’s actual cash value, you’ll only receive the amount the table is worth today: $1,200.
How is replacement cost different?
Replacement cost (or replacement value) is the amount of money it would take to replace something that has been damaged or destroyed with a new version of the same item—or its equivalent. So, instead of being paid $1,200 for your dining room table (in the example above), you’d be paid for the cost of a new $2,000 table.
Pro Tip: Your dwelling coverage—that covers your actual home—should already be equal to your home’s replacement value, but your personal property coverage may not be.
To calculate the replacement cost (RC) of your personal property, take an inventory of all your belongings and determine how much everything is worth. Be as detailed as possible so you have plenty of proof if anything happens to them. Try to include as much of the following information as you can (to present to your insurer if you file a claim):
- Item description, make, and model
- Price paid for each item
- Date you purchased each item
- Your original receipts
- Each item’s replacement value
- Photos of every item (use your cell phone for easy and quick access!)
Adding up all these costs will give you a good estimate of how much personal property coverage you need.
The Payment and Replacement Process
There are usually two phases in the repayment process after you file a claim. Typically, you will be reimbursed for your property’s actual cash value first. Then, if you have replacement cost coverage, you’ll be paid the rest of the amount (up to the limits of your policy) after you’ve purchased new items to replace what you lost. Once you can prove to your insurance company that you’ve bought the items, they will send you another check.
One Exception: Cash Out Loss Settlement
An exception to the rule of having to prove you’ve purchased items to replace what you lost exists in some high-end policies. If you have a high-value home, you may qualify for this type of policy. You may have the option to receive the full replacement value of your property without having to replace the property you lost first.
What if I have items that are irreplaceable or highly valuable?
If you have any rare collectibles, fine jewelry, artwork, antiques, items that are now obsolete, or firearms in your home, talk to your insurance agent about how to protect them. These types of items likely won’t be fully covered under a standard policy.
Extended or Guaranteed Replacement Cost Coverage
These are a couple other (more expensive) options you can add to your policy on top of your ACV or RC coverage. Guaranteed replacement cost will pay for you to rebuild your home, even if the cost to build it today is higher than its original estimated value. This coverage protects you if materials and construction costs in your area rise. Guaranteed replacement cost coverage can also be helpful if you live in an area with severe weather or where natural disasters frequently occur.
An extended replacement cost policy will cover an additional percentage of your home’s replacement value. Again, this type of policy can be useful for homeowners living in areas prone to natural disasters, like tornadoes or hurricanes.
If you can afford it, replacement cost will serve and protect you better than actual cash value. Check with your insurance company to see how much it would cost for you to upgrade your policy. Once you get a quote, you can decide from there whether you think the difference in price is worth it.
There is an exception—where it may be smarter to stick with ACV. If you’re a brand new homeowner and most of what you own is new, your home’s ACV is likely very similar to your home’s RC already.
If you have any questions about what we covered in this article or your homeowners insurance policy in general, we’d love to offer you some answers! Call us at (888) 411-1710, send us an email, or check out our homeowners insurance page on our website. You can request a quote from us any time.