What Is Replacement Cost vs. Actual Cash Value?

When your house or personal property is damaged, how much your policy will pay is an important consideration. Property claims can be paid in two ways: Replacement Cost or Actual Cash Value (ACV).

Damage that is paid on a replacement cost basis is pretty simple to understand. Replacement cost means that the items are repaired or replaced based on today’s prices. For example: suppose you have an eight-year-old air conditioning compressor that is damaged by lightning and needs to be replaced. Eight years ago you paid $4,000, but now it will cost $6,000. If your policy has a replacement cost provision, then your insurance company will base the claim payment on the $6,000 cost.

ACV is defined as the cost to replace the item at today’s cost minus the item’s depreciation. In other words, the amount paid will be based on the item’s life expectancy. To use the same example, suppose the average life span of an air conditioning compressor is 16 years. Since the compressor is eight years old, it has 50 percent of its life left. Since the ACV of the compressor is the replacement cost minus the depreciation, the company would pay 50 percent of the $6,000—or $3,000.

The typical homeowner’s (HO) policy pays building losses based on replacement cost. Personal property items, however, are paid based on ACV. The good news is that you can add replacement cost coverage for your personal property for a small additional cost.