Actual Cash Value vs. Replacement Cost: What’s the Difference?

When shopping for insurance, it’s common to hear about premiums, deductibles and coverage types. But what about how you’ll be paid after a property loss? Actual cash value and replacement cost are the two most common methods insurance companies use to determine how much you’ll get after a covered loss. 

So, in some ways, the coverage options you select on an insurance policy are even more important than the premium and deductible. Which should you choose? Let’s start with looking at the actual cash value definition and comparing it against replacement cost insurance.First up, your actual cash value definition. If your insurance quote or policy is based on actual cash value, that means that if a claim is filed, the insurance company will pay out the actual value of the property. This is the cost of the property brand-new, minus depreciation.

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      But what about homeowners insurance replacement cost coverage? If your insurance quote or policy is based on replacement cost, the coverage amount will equal the amount it will cost to replace the damaged asset new with like materials and quality. In other words, you’ll generally get more from your claim if you have replacement cost insurance.

      How does actual cash value work?

      When a claim is made against an actual cash value policy, the insurance company will most often assess what the insured asset would cost to replace new and then deduct depreciation to determine the coverage amount.

      Some insurance companies will instead determine the fair market value of the property in its damaged state. The fair market value will be the coverage amount.

      Actual cash value coverage considerations

      Just knowing the actual cash value definition isn’t enough. You also need to know the details of your coverage. Specifically, under this type of policy, there are some things you should keep in mind. If you file a claim on a car, for example, the insurance company will determine the replacement value of that car and deduct somewhere around 10% of the car cost each year.

      Using this example, if the replacement value of your car is $20,000 and you have driven the car for 2 years, the actual cash value will be around $16,200. This means you will not be covered enough to replace the car with the same value and quality you had.

      The same applies for your homeowners or renter’s insurance. If your couch is five years old, don’t expect your insurer to pay the full cost to buy a brand new one. With depreciation factored in, you’ll probably get enough money to cover a Craigslist purchase, or maybe a little more.

      How does replacement cost work?

      When comparing actual cash value vs. replacement cost, the big distinction is that replacement cost ensures you will be covered for the full replacement value of the property at today’s cost.

      Replacement cost insurance helps you make sure you can replace the item without worrying about depreciation or other price changes. With homeowners insurance replacement cost coverage, you can start your life over after a disaster with less of a financial struggle.

      [ Read: What Is Home Insurance Replacement Cost? ]

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      How will replacement costs be paid?

      It’s a common misconception that with homeowners insurance replacement cost coverage your insurer will issue you a fat check to cover any insured losses in one fell swoop. But the process isn’t usually that streamlined. 

      Instead, getting the full amount paid to replace any insured losses is generally a two-step process if you have replacement cost insurance. 

      First, your insurer will most likely cut you a check for any lost items’ current market value. Then, when you buy the item new, you can submit your expenses to your insurer. With replacement cost insurance in place, it should issue you a second check to make up for any difference. 

      Replacement cost coverage considerations

      Although we consider the extra amount you’ll pay minimal for the value you get in return, there’s a major factor to consider with replacement cost insurance. This coverage often costs more than actual cash value coverage.

      We consulted with a State Farm Insurance representative to get an example of the difference in premium costs on an actual cash value vs. replacement cost policy. In our example, we considered a small dwelling and its contents with a replacement value of $96,000. Under a replacement cost policy, the premium was $924.34. Under an actual cash value policy, the premium was $799.13 with coverage up to $83,900. These numbers will vary based on your location and the property you are insuring.

      Extended and guaranteed replacement cost coverage

      Replacement cost policies typically offer two coverage options to help you get even more protection from your policy. We recommend checking with your insurance agent to find out they offer extended replacement coverage or guaranteed replacement coverage.

      If you add extended replacement coverage to your policy, the insurance company will pay anywhere from 25% to 50% over the insured amount. If you are insuring the $96,000 dwelling and it’s destroyed and will cost you $120,000 to rebuild, the additional $24,000 will be covered by your insurance.

      If you add guaranteed replacement cost coverage, the insurance company will cover the amount it costs to fully replace your property. So, if you experience a total loss on your $96,000 dwelling but find out it will cost you $200,000 in today’s dollars to fully rebuild that same dwelling, the guaranteed replacement cost coverage will cover the replacement entirely.

      Keep in mind that if you add extended replacement coverage or guaranteed replacement cost coverage, your premium will generally be higher than if you just carry standard homeowners insurance replacement cost coverage.

      How much will I be paid for my claim? 

      After a disaster, you want to know how much money you can expect to start your recovery process. It all depends on your policy, the coverage you chose, your ability to document your loss and the incident that caused the loss in the first place.

      Basically, to get the most from your claim — whether you have replacement cost or actual cash value coverage — you need to prove your loss to your insurer. That means showing them how much those losses are worth. 

      Your best bet here is to gather as many receipts as possible. Look over past credit card and bank statements and highlight any purchases you made that were lost or damaged during your covered event. Or, if you’re dealing with a car insurance claim, make sure you’re up to date on your car’s current market value. 

      If you have actual cash value coverage, your insurer will deduct depreciation when it issues your claim check. Stay involved in the process and don’t be afraid to ask questions. Working closely with your insurance adjuster can help you get more from your claim.

      If you have replacement cost insurance, your process will be a bit easier. You just need to prove what was lost and show receipts for replacing the item. But keep in mind that your coverage pays for replacing lost or damaged items with ones of a similar quality. If you had an old 24” TV but you spring for a 75” 4K TV now, don’t expect your insurer to pay for the difference. 

      What information do I need to submit a claim? 

      The information you’ll need to provide depends on the type of claim you’re submitting.

      If it’s an auto insurance claim, you’ll usually need to submit the following to your insurer:

      • Your insurer’s “proof of claim” or “proof of loss” form.
      • A copy of the police report.
      • Pictures from the scene of the accident or loss.
      • Details about the loss, such as the time it occurred and the circumstances surrounding it.
      • Information about any other drivers involved, including their insurance details.

      If you’re submitting a home or renter’s insurance claim, you’ll generally need:

      • Your insurer’s “proof of claim” or “proof of loss” form.
      • A copy of the police report, if applicable.
      • A list of damaged or stolen items (if you can back that up with receipts or statements showing how much the items are worth, your claim process will go more smoothly).
      • Pictures of the loss.
      • Details about the loss.

      Your insurance provider might ask for additional details and it may assign an adjuster to your case. It’s the adjuster’s job to determine the value of your losses so you can get properly reimbursed. Work with them and provide any information it requests. 

      [ Read: How To File a Home Insurance Claim ]

      Cash value vs. replacement cost, which one is cheaper? 

      As we’ve mentioned before, actual cash value coverage is cheaper than replacement cost coverage. The very actual cash value definition gives you a clue. You’re only getting reimbursed for how much your losses are worth now; that is, their actual cash value. That means your insurer gets to deduct depreciation when it writes you a check to cover your older car or well-used appliance.

      Replacement cost insurance costs more, but it also gives you significantly more coverage. With this type of coverage, you can easily restart your life after a covered loss. Generally, you’ll get much more in value than you’ll actually pay in premiums. 

      It can be helpful to compare actual cash value and replacement cost policies to get a clear understanding of how much more you’ll pay to get this significantly more robust coverage.

      [ Read: How to Find Cheap Homeowners Insurance in 2020 ]

      Which is better?

      Replacement cost policies offer more coverage levels than actual cash value policies. While it’s important to assess your individual needs before determining which policy to choose, it’s almost always a safer option to go with a replacement cost policy if your budget allows for the extra premium.

      It may cost you a bit more on the premium but it’s important to remember why we have insurance to begin with. The purpose of insurance is to protect our property and financial well-being in times of damage and loss. You may not really be saving money in the long run if you don’t have adequate coverage in the case of property damage or loss. Replacement cost policies offer greater protection in times of property damage and loss.

      However, some insurance is better than none. If all you can afford is an actual cash value policy, that may be the right option for you. Similarly, if you have the money to replace your items without as much help from the insurance company, you might feel comfortable paying for an actual cash value option. Consider your needs, budget, savings account and the replacement costs you would need to pay to determine which is right for you.

      We welcome your feedback on this article. Contact us at inquiries@thesimpledollar.com with comments or questions.

      Reviewed by

      • Nashalie Addarich
        Nashalie Addarich
        Insurance Editor

        Nasha Addarich is an editor at The Simple Dollar and a former attorney who specializes in home insurance, auto insurance, life insurance, and savings. She is a former contributing editor to Reviews.com.