Replacement Cost vs Actual Cash Value

When selecting property insurance coverage with NREIG, consider a choice of two loss settlement methods: Replacement Cost and Actual Cash Value.

Actual Cash Value is typically 20%-25% cheaper than a Replacement Cost policy, and allows you to be insured to a lower value per square foot, but does figure depreciation into the settlement of your claim. Replacement Cost requires you to be insured to a higher valuation per square foot but provides you with the opportunity to recover the depreciation that was initially levied against you. Let’s run through a claims example (all companies settle claims the same way) and then touch on some things to consider when deciding between RC and ACV.

EXAMPLE –You suffer a partial loss at your property, a kitchen fire that causes $30,000 of damage. The assigned claims adjuster will visit the property and determine how much useful life was left in what was damaged (to figure in the depreciation of the loss). They depreciate the loss at 40% due to the age of the item(s), meaning $12,000 will be depreciated from the $30,000 loss. Leaving you with a payout of $18,000.

REPLACEMENT COST (RC)

Replacement Cost coverage allows claims to be settled with reimbursable depreciation.

  • The value of the loss is determined to be $30,000.
  • The deductible is $3,000.
  • The insurance company will pay no more than $27,000.
  • The Actual Cash Value of the loss is determined to be $15,000.
  • The first check will be issued for $12,000 (Actual Cash Value minus deductible).
  • Upon completion of the repairs (paid out of pocket) above the $15,000 ACV, with provided receipts, the second check for “reimbursable depreciation” will be issued for up to, but not exceeding an additional $15,000.

ACTUAL CASH VALUE (ACV)

Actual Cash Value settles claims with depreciation.

  • The value of the loss is determined to be $30,000.
  • The adjuster depreciates $12,000 from the loss, leaving a payout of $18,000
  • The deductible is $3,000.
  • The check will be issued for $15,000 (Actual Cash Value minus deductible).

If you are on an ACV policy, $15,000 is all you can recover on your $30,000 fire loss (and by the way, that money is yours to do with what you want – sell the property with the damage existing and use the money to go on vacation, buy a car, you get the point). If you are on Replacement Cost, you can go back to the carrier and recoup some or all of the depreciation that was taken from you.  The only part that is not recoverable to you on an RC policy is your deductible.

As a side note, depreciation is extremely difficult to determine until the loss occurs. It is taken off of the date of the last updates, not the original year built. Everything depreciates at a different rate, but the average is about 1% per year. Other than the roof that deteriorates much quicker due to the exposure to the weather.

Things to consider when deciding on an ACV or RC policy:
  • I always recommend that you consider what your plan would be in the event of a total loss. Would you rebuild the property or would you clean the land up, sell it and move on to another property? If you would not rebuild the property, then there is little reason as to why you would pay for Replacement Cost coverage because you are paying more to the insurance company than you will ever recover in the event of a loss. Remember, you have to actually make the repairs at the property to be able to recover your depreciation.
  • The reason I say concern yourself with what your plan would be in the event of a total loss and not so much a partial loss is for a couple of reasons:
    1. You most likely can make the repairs (or have access to someone who can) for substantially less than what your insurance carrier thinks you can.
    2. 60%-65% of the investors insured with us that suffer a partial loss and are on Replacement Cost, never come back and recoup any depreciation. Not because they don’t want to, but because the ACV settlement was more than enough to make them whole again.
  • If you have a loan on the property, most likely your lender is going to have a set of insurance lending requirements you will have to meet or exceed. Often times, they require Replacement Cost coverage.

 

Please keep in mind, NREIG is willing to provide you with a full policy/coverage comparison of what you currently carry and what NREIG can provide.


About the Author

Shawn Woedl is the President of National Real Estate Insurance Group. He is an industry-recognized speaker and educator with an emphasis on Commercial Property and Premises Liability. He brings over 12 years of professional and personal experience in real estate, business, and insurance to NREIG’s unique, investor-oriented brand.

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Coverage Options, Insurance Education