Replacement Cost vs. Actual Cash Value Coverage
Discover which kind of home insurance works best for you.
Written by
Christine Lacagnina has written thousands of insurance-based articles for TrustedChoice.com by authoring consumable, understandable content.
Reviewed by
Jeff Green has held a variety of sales and management roles at life insurance companies, Wall street firms, and distribution organizations over his 40-year career. He was previously Finra 7,24,66 registered and held life insurance licenses in multiple states. He is a graduate of Stony Brook University.
When you buy homeowners insurance and other types of property insurance, you’re likely to have to make a choice between replacement cost and actual cash value coverage. However, you must first understand what these terms mean and which would work best for you.
An independent insurance agent can help you choose between these two coverage options and get you set up with all the homeowners insurance you need. But first, here's a breakdown of replacement cost vs. actual cash value coverage.
What Is Replacement Cost Coverage?
Replacement cost coverage pays for the cost of replacing something with a brand-new version. If your TV gets fried by a lightning strike, for example, replacement cost coverage would reimburse you for the cost of buying a brand-new, comparable model. When it comes to certain types of personal property like TVs, it’s pretty easy to estimate replacement costs. You can look up the same brand and model online and see what it’s selling for.
But figuring out the replacement cost of your home and other buildings is a little trickier. In these cases, the replacement cost is the cost of the materials and labor needed to rebuild the structure. Some replacement cost policies may also provide reimbursement for you and your family to stay in a hotel while your home is rebuilt.
Don’t confuse a home’s replacement cost with the amount you paid for it when you bought it, though. Replacement cost is a much more stable number based on the price of materials and sometimes labor and design costs, whereas the real estate value of a home can vary wildly based on your neighborhood’s desirability, hot or stagnant housing markets, and many other factors. But a home’s replacement cost is the cost of rebuilding, plain and simple.
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What Is Actual Cash Value Coverage?
Actual cash value policies reimburse claims based on the amount needed to replace or rebuild lost or damaged property, minus any depreciation. Depreciation is determined by the age and condition of the item. If you have an actual cash value homeowners insurance policy, you will be reimbursed for what your items are worth now, not what it would cost to purchase a comparable item at today’s prices.
Actual cash value policies are generally less expensive than replacement cost policies. But in this case, cheaper is not necessarily better. If you suffer a loss and have actual cash value coverage, you may not be able to rebuild your home or replace your belongings sufficiently, with far greater financial consequences for you than saving a few dollars on your monthly premium.
What’s the Difference between Replacement Cost Insurance and Actual Cash Value Insurance?
Replacement cost policies pay claims based on the amount needed to replace or rebuild your property or repair damage using similar materials to what you had before. If you have replacement cost coverage, you should be able to make repairs or rebuild using the same or similar materials at today’s prices.
When you file a homeowners insurance claim, your insurance company will need to determine how much to pay you for your lost or damaged property. The insurer will need to evaluate the cost of replacing your property with new property of the same type and quality if you have replacement cost coverage.
But if you have actual cash value coverage, depreciation will be included in the calculation. The amount you will receive will probably not be enough to repair or replace your lost or damaged possessions at today’s prices, leaving you with expenses you must cover on your own. Inflation is critical to consider when deciding between replacement cost coverage and actual cash value coverage.
Many homeowners make the mistake of purchasing only enough coverage to pay off the mortgage, and others only purchase an insurance amount equal to the market value of their home. But the actual cost of rebuilding your home is likely to be quite different from the market value on a good day, and when labor and supplies are in high demand after a disaster like a tornado or a hurricane, costs can skyrocket overnight and leave you underinsured.
What's More Expensive: Replacement Cost or Actual Cash Value Coverage?
Some insurers offer guaranteed replacement cost coverage, an expensive option that protects you from sudden increases in building costs. Guaranteed replacement cost policies pay whatever it costs to rebuild your home but are often more expensive than either replacement cost or actual cash value coverage.
In terms of replacement cost vs. actual cash value coverage, replacement cost insurance is more expensive since the insurance company needs to pay out more if your home or items get damaged. The carrier passes this cost on to you through higher insurance premiums. Likewise, actual cash value is cheaper for basically the opposite reason. It’s cheaper for the insurance company to provide, so they need to charge you less to break even.
Neither replacement cost insurance nor actual cash value insurance will pay for you to buy more expensive things to replace things that were damaged. If you owned a mid-range HD flatscreen TV, your replacement cost insurance won’t pay for you to upgrade to a top-of-the-line 4K model, and actual cash value insurance will pay for much less. This also applies to building materials for your home, so don’t plan on upgrading to marble countertops from materials like Formica.
Which Is Better, Replacement Cost Insurance or Actual Cash Value Insurance?
Replacement cost insurance is a better choice than actual cash value insurance for most people. That’s because it allows you to replace your home and belongings without needing to dip into your savings or other assets.
The downside is that replacement cost insurance has higher premiums than actual cash value insurance because the insurance company is on the hook for more money if you need to file a claim. So, if you have a lot of savings and assets, you may decide that you’d rather take a chance and save money on premiums. You’ll need to contribute more of your own money in case of fire, theft, or another disaster, but you’ll free up extra money in your monthly or quarterly budget.
Another situation where it can make sense to choose actual cash value insurance over replacement cost insurance is for a second home or vacation home. Because you’ll still have your primary residence, it's not likely to be as urgent for you to rebuild that second property. Saving money on premiums might be a higher priority for you in this case.
However, if you don’t have a lot of savings or are in a lot of debt, you'll most likely want to consider getting replacement cost insurance. In fact, a mortgage or other type of loan may require you to carry replacement cost insurance so that they can be certain you’ll keep up on your payments in case the worst happens. In these cases, it’s better to deal with the higher premiums each month than it is to get hit with a disaster scenario in which you can't replace your belongings.
What Is Contents Replacement Cost Coverage?
Contents replacement cost coverage provides reimbursement for the replacement cost of your personal belongings. Even if you have replacement cost coverage for your dwelling, your home’s contents might have actual cash value coverage.
Review your policy in-depth, and don’t assume that both are covered the same way. You may have to specify that you want replacement cost coverage for your personal property when you purchase your policy.
Also, remember that every insurance company is different. Some may have caps on replacement cost coverage, and others may exclude certain items or categories of items from replacement cost coverage.
How Do Insurance Companies Calculate Replacement Costs for Homeowners Insurance?
Your insurance company will probably ask you a series of questions about your home, and your responses will be plugged into a model that determines its replacement cost. In order to estimate your home’s replacement cost, you need to be able to determine the value of all of your home’s interior and exterior finishes, including those in any attached structures, as well as the costs of labor. You'll want to know this figure so you can compare it to the one your insurance company comes up with.
Use these tips to determine your home's replacement cost:
- Talk to homebuilders in your area to determine an average rate per square foot to build a home the same size as yours. Multiply your home’s square footage by the average rate per square foot to develop an initial estimate for the cost of rebuilding your home. Your estimate then must be adjusted to account for unique features of your home, such as luxury finishes, high-end appliances, and any other variations that could increase or decrease the cost of rebuilding your home to its current state.
- Compare your cabinets, appliances, and other fixtures in your kitchen and bathrooms to new items at local retailers. Do the same for flooring, carpeting, and all other interior features.
- Determine the value of your home’s exterior (e.g., vinyl siding, brick, etc.) if it were purchased today. Talk to a roofer to get an estimate for what it would cost to replace your roof.
Putting all of these calculations together can help you get an idea of what it would cost to rebuild your home and how much insurance you should buy. Be sure to listen to your insurance agent’s recommendations as well, and work with them to come up with a figure that is acceptable.
Don’t forget to evaluate your personal property coverage, as well. Personal property coverage in a homeowners insurance policy typically starts at a percentage of your home’s dwelling coverage, but if you feel you need more coverage because of certain valuable items, don’t be afraid to increase your personal property coverage limit or add special riders or endorsements to protect your valuables. Preparing a home inventory is extremely helpful in determining if you have sufficient coverage for the contents of your home.
Once you have settled on a replacement cost figure, remember that it will need to be reevaluated every year to account for changes in building materials and labor as they fluctuate over time.
What Is Extended or Guaranteed Replacement Cost Coverage?
If your home gets totally destroyed, you might end up pushing the limit of your insurance policy in order to replace it, even if you have a replacement cost policy. Insurance companies will not pay more than the limit of your policy, even if it’s going to cost more than the limit to rebuild your home exactly as it was. This extra cost could be because of a labor or materials shortage in your area that’s driving up construction costs or because materials in your original home are now rare or difficult to work with.
In response to this scenario, some insurance companies offer an extended replacement cost or guaranteed replacement cost option. Extended replacement cost policies extend your limit by a certain percentage, like 10% or 20%, if that money is needed to rebuild your home.
Guaranteed replacement cost pays to rebuild your home exactly as it was, with no limit on cost. Both of these options can be significantly more expensive than a regular replacement cost policy.
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How Do I Buy Replacement Cost Insurance or Actual Cash Value Insurance?
To buy replacement cost insurance or actual cash value insurance, you’ll want to work with an independent insurance agent who can help you pick an insurance company and choose the coverage you want.
Independent insurance agents aren’t bound to any one company, so they can shop around for multiple quotes, not just the best quote one company offers. They’ll help answer your questions and weigh the pros and cons of replacement cost vs. actual cash value insurance with you.
Before speaking to an independent insurance agent and getting a quote, you’ll want to make a preliminary list of the items you’d like insured, especially any valuable or appreciating items. Homeowners insurance usually covers your belongings up to a limit, but if you have a lot of expensive items, you may need to raise that limit or buy extra coverage.
Tell your independent insurance agent if you own any of these items:
- Valuable art such as sculptures or paintings
- Precious metals and gems
- Firearms
- Fine jewelry
- Antiques or heirlooms that you think could be valuable
It’s also a good move to make a more general list of your belongings, including furniture, appliances, clothes, media, etc. This can help you buy the right kind and amount of insurance and makes filing a claim much easier if you ever need to later on.
Why Work with an Independent Insurance Agent?
Independent insurance agents are experts in finding you the right kind of replacement cost or actual cash value insurance and any other type of coverage you need. They can shop and compare policies from many different insurance companies for you, then present you with only the best quotes together in one place. Also, they're available down the road to help you file claims if you ever need to.