Homeowners Insurance: Replacement Cost vs. Actual Cash Value Explained

Concept of couple sitting in a home with illustration of home in front of them

Anyone who owns a home realizes the dwelling represents the heftiest financial commitment they have undertaken and the most sizable asset they will possess. As such, securing homeowners insurance protects the property from substantial loss or even total destruction.

Breaking Down Home Insurance

A home insurance policy consists of a few basic components. Dwelling and other structures coverage insure the physical structures from perils that include fire or storm damage. Likewise, contents or personal property is protected from theft or a ruptured water pipe.

Liability coverage shields the homeowner from financial damages if a guest falls on the premises or gets bitten by the resident canine. Suffice to say that if an epic windstorm completely destroyed the house-- worth $300,000--  and all its contents-- worth $100,000, an insurance carrier would reimburse the insured for $400,000. Or would it?

Actual Cash Value Coverage

A homeowner generally has a few options when choosing coverage for the building and the "stuff" contained within. Actual cash value (ACV) coverage indemnifies the property owner for a covered loss to the house or personal property.

The caveat to this coverage involves depreciation. A 10-year old television, under the ACV umbrella, would be worth the approximate value of a similar set offered for sale on the secondary market. Insuring for cash value means that a total loss to a garage would fetch a claim check for perhaps $10,000-- even if the cost to rebuild the structure board-for-board in today's dollars might be $20,000. Because the structure is insured at ACV, the owner will need to share some cost if electing to rebuild the shelter as it once stood. Homeowners might opt for ACV coverage for budgetary reasons or if they had no plan to identically replace a compromised dwelling or ruined personal property.

Replacement Cost Coverage

Replacement cost coverage works much like it sounds. Lose a $2,000 laptop to theft and expect that coverage to allow the purchase of the same (or thereabouts) computer, whether the price now mirrors or eclipses the original cost.

The reconstruction value of older homes -- determined with estimating software-- often pops a policyholder's eyes when calculated rebuild costs far exceed market value. The rub lies in replacing thick floor joists, plaster walls and ornate woodwork that can't be readily found or ably duplicated. Some insureds might not desire to rebuild to previous specifications and that alternative usually takes shape with homes built prior to 1940.

This physical coverage ensures that a homeowner-- aside from a deductible share-- would not need to supplement the cost of a hail-damaged roof or a waterlogged appliance. Consequently, premiums for replacement cost are higher than those for ACV options.

Choosing the Right Home Insurance Option

Too often a homeowner doesn't discern between these two coverages until it's too late-- essentially after a loss occurs and a claim is filed. It's prudent to self-educate or thoroughly discuss with an insurance professional all facets of a home insurance policy before any unpleasant surprises crop up. The extra cost for replacement cost must be weighed against the potential for a larger hit to the wallet in the event of a fire or burglary. By comparing home insurance quotes on InsuranceHotline.com you can check to see if you have the best rate for your unique home insurance needs.