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Insurance is a way to protect your most valuable possessions against loss. If any of these items are damaged, you can use your insurance policy to help cover the cost of repair and/or replacement.

However, your coverage may not reimburse you for all out-of-pocket expenses after you file a claim for a covered loss. Depending on whether your home insurance coverage includes replacement cost value (RCV) or actual cash value (ACV), you may actually be responsible for some of these expenses.

Here’s what actual cash value and replacement value include, and how to determine which coverage is right for you:

What is replacement cost?

Replacement cost is the full cost of replacing or repairing a covered item. This can include rebuilding your home after a fire, repairing your roof after a hailstorm, or even replacing stolen belongings.

Replacement cost coverage takes into account the current cost of these items or repairs, not necessarily when they were first purchased. The purpose of this coverage is to make you, the insured, whole again following an eligible loss, even if the cost to replace or repair your covered items is higher than when you purchased them.

Since the replacement cost value does not take depreciation into account, it usually results in a higher payment than the actual cash value.

What is the actual cash value?

The actual cash value of a home insurance policy represents the value of your assets at the time of loss. The payment – also called the settlement amount – takes into account both depreciation and, in many cases, market adjustments, so it may or may not pay for a full repair or replacement of the item. Depreciation reduces the value of the property because it takes into account the age and use of the item.

More often than not, the actual cash value is less than what you originally paid for, as most items lose value over time. It may also be less than the current cost of replacing or repairing the asset. How much less depends on the type of asset it is and the depreciation formula; some items depreciate much faster than others, so they will lose more value in less time.

Learn more: What does home insurance cover?

Replacement cost versus actual cash value

When it comes to filing an insurance claim, there is often a big difference between the replacement cost and the actual cash value of your personal property or assets.

Replacement cost policies are usually the default option, especially when it comes to home insurance coverage. In many cases, you can opt for actual cash value, which can lower your home insurance premiums.

Your insurer will usually ask you to replace a damaged or lost item before giving you the replacement cost value of the item. When you file a claim, the insurer will often provide a settlement check for the actual cash value of the item. After you replace the covered item, the insurance company will usually issue another check to reimburse you for the depreciation, if any. This is also called recoverable depreciation.

Example of Replacement Cost vs Actual Cash Value

Here’s a quick look at how replacement cost value and actual cash value compare:

For example, suppose you just replaced the roof of your house eight years ago at a total cost of $18,000. The value of the roof depreciates by 5% each year. In this scenario, your depreciation from installation until today would be approximately $6,060. This means that if you had an ACV policy and a hailstorm destroyed your roof today, your insurance company would write you a check for about $11,940.

However, you probably wouldn’t be able to replace your roof for anywhere near that amount. After all, you paid $18,000 to replace it nearly ten years ago, and the costs have gone up. You call around for roofing quotes, only to find that a comparable roof today will cost you almost $20,000, forcing you to pay 40% of the cost of that new roof out of pocket.

If you had replacement value coverage instead, your insurance company would likely write you a check for the actual cash value ($11,940) and then another check for recoverable depreciation ($8,060) – covering the cost. total replacement cost of $20,000.

Replacement Cost vs Actual Cash Value: Which Costs More?

Opting for a policy that offers more coverage is usually more expensive than buying a policy that won’t pay as much following a covered loss. Although many different variables are at play, such as what is insured, the deductible you have chosen and the age of the property, you can expect to pay around 10% more for replacement value coverage. compared to a policy with actual cash value coverage.

Remember: your home insurance premiums are based on a variety of personal factors and property characteristics, all of which come down to risk. The more risk you pose to an insurance company, or how much you could possibly cost them, the more likely you are to pay for this coverage.

Should you insure your home at replacement cost or actual cash value?

Both RCV and ACV policies have their share of pros and cons, but the final decision comes down to personal preference, budget, and available savings. Ideally, you should insure your home for 100% of its replacement cost.

Replacement cost insurance policies can save you money if you suffer a qualifying loss because they cover the full replacement cost of your property, no matter how old or worn out the item is.

On the other hand, policies with actual cash value often come with a lower premium, saving you money each year.

Also see: How much home insurance do I need?

Other types of coverage to consider

Beyond your policy’s actual cash value and replacement value coverage options, many insurers offer a few other types of home insurance coverage. Some may be worth considering, especially if you have high-value or rapidly depreciating items, which would lead to higher expenses following a claim.

Not all types of coverage are available in all states or from all insurers. However, the difference in the cost of coverage may be negligible in some cases. Purchasing extended (or even guaranteed) replacement coverage may only cost you a few dollars more per year, giving you peace of mind that your home is protected.

Disclaimer: All insurance related services are provided by Young Alfred.

About the Author

Stephanie Colestock

Stephanie Colestock is a Washington, DC-based writer with over 11 years of experience writing about investing, business, and personal finance. She has contributed to outlets such as Yahoo! Finance, MSN, Investopedia, Credit Karma, Credible, etc. She holds a bachelor’s degree from Baylor University and is in the process of obtaining her CFP® certification.

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