To choose the better insurance policy option between “Actual Cash Value” (ACV) and “Replacement Cost Value” (RCV), a household owner has to know how the two policies differ from each other. Only after understanding the difference should you buy the one which suits you.
Depreciation or the “wear and tear” due to usage is the main reason in calculating the “Actual Cash Value” of the article at the time of loss. This depreciation value gets deducted from the first cost of the article when payment gets cleared by the insurance company for its loss.
For example, the depreciation value for a sofa bought 10 years ago for a price of $700 gets considered by the insurance company as $30 per year. The payment made to you for its loss now would be the first cost minus the depreciation value for 10 years, i.e. $700 minus $300 equal to $400.
All other deductible amounts would also be considered when the payment gets cleared for the recovery of the loss of the sofa. The last amount you can recover from an “Actual Cash Value” insurance policy on your sofa may be even less than the $400 where effectively and essentially you are the “co -insurer”.
Conversely, a “Replacement Cost Value” insurance policy means that you get paid the present cost price of a similar sofa even after you have used the old one for some time. No depreciation value gets considered here and the insurance company pays you the full $700 when you want to replace it with a brand new one.
Which the best option between the two insurance policies to choose from? The most important factor is the amount you can recover from taking out the insurance policy. With the RCV option you can buy a similar sofa straight away with the money you get but with an ACV option you have to add some money over and above the money you get from the insurance company to buy a similar new sofa.
The example of an old house which has almost completed its life-span along with its furnishings and fittings can highlight the advantage of a RCV insurance policy more. If this house gets valued at $200,000 due to the upgraded fittings at the time of a fire and is completely damaged, then the house owner is able to recover more than what he had invested initially in the house. In this case you gain more if the fire does take place instead of having no fire at all.
To make sure that the house owner does not gain financially by taking out a RCV policy on the house the insurer may pay him the ACV amount to repair all the items damaged by the fire before paying him the rest of the money which is the difference between the RCV amount and ACV amount.
However, there is limitation of the RCV type of insurance policy. Due to the continuous fluctuation of the market dealing with real estate, the RCV value is sometimes less than the ACV value if the market is going through a rough patch. In this case the other premium paid for the RCV type of insurance policy for your house is not always a correct option. It’s always recommended that before buying any insurance policy you should always take your agent’s advice before opting for one.