When we insure something, we do so in case it someday gets damaged, lost or stolen. We insure things that are valuable to us, such as homes, cars or boats, because their damage or loss would create financial difficulty. When you purchase homeowners insurance, a major decision will be how you choose to be compensated for a loss. Insurance carriers reimburse their policyholders for losses by two major methods. One is based upon replacement cost and the other is based upon actual cash value. The difference between the two is how they account for the difference in the original cost of the item and its value after depreciation.
Actual Cash Value Coverage
Actual cash value coverage provides compensation for all the items in a home minus depreciation. With this type of insurance your insurance company may reimburse you a fraction of the $800 you spent on a television two years ago. Some insurance providers use a depreciation scale that reduces the value of an item by as much as 50% within one year of its purchase, which could be a nasty surprise if you aren’t aware of the type of coverage you have. Unfortunately there’s no good way to tell what the actual cash value of an item is, so insurance companies will either compare the price of the item to a new product that it considers an equivalent, or it goes by the used price.
This is a beneficial arrangement for a home insurance company because it doesn’t have to pay out as much in claims. The tradeoff is that actual cash value coverage is cheaper to purchase, but you’re taking more of the risk of loss onto your shoulders. Ask your insurance provider which type of coverage you have, as it could make a huge difference in how much you’re reimbursed for after a loss.
Replacement Cost Coverage
Replacement cost coverage, on the other hand, doesn’t take depreciation into account at all. With this type of insurance you’re reimbursed for the cost you paid for the item, not its current value. Therefore, you’d get the $800 you spent on that television two years ago back, which you could use to replace it with something new. When you file a claim you can help expedite the reimbursement process by providing receipts, or bills of sale, for the items that need to be replaced. If you don’t have the receipts the insurance company may determine the original value of the item on their own, which could mean you’re reimbursed for less than what you paid. If the structure of your home is damaged, your insurance carrier’s adjustor would compare prices on contractor sites indicating how much it would cost to replace these things, ultimately giving you that amount.
This type of coverage is the more desirable of the two since it can save you a lot of money in replacing lost items. However, replacement cost coverage is more expensive than actual cash value coverage. Yet the difference in the cost of the two types of coverages is offset by the amount you may have to pay if you experience damages to your home or property loss.
Which Type of Coverage Should I Have?
That depends on how much you are willing to pay in premiums. The fact that replacement cost coverage is more desirable to have is a “no-brainer.” However, you should consider if you’re willing to pay higher premiums to obtain a superior level of coverage. An actual cash value coverage plan is best-suited for a person who only has a few items or valuables and who lives on a budget, while a replacement cost policy is ideal for those who have electronics, musical instruments, jewels, or any other type of high-value property.
In making an intelligent decision about which of the two types of coverage to purchase, you should weigh the difference in premiums, the level of “wear and tear” you will inflict upon your goods and the depreciation of such goods in the marketplace. Additionally, you shouldn’t overlook another element of control you have over your premiums in terms of selecting a high deductible or low deductible. You will be able to choose the right reimbursement plan for yourself as long as you consider all the proper things upon purchase of the policy.