Home Insurance Articles for Erie PA.

A Light Refresher on Replacement Cost and Actual Cash Value Settlement Options

When purchasing a policy and making a claim on home insurance, a homeowner needs to understand the differences in settlement options.  Specifically, there is a stark contrast between insurance that is covered by replacement cost coverage versus insurance that is based on the actual cash value of the property insured. A thorough understanding of each is beneficial when purchasing an insurance plan.  How an insurance company evaluates and settles a loss can differ significantly depending on the settlement option provided by the homeowner’s insurance product. 

The valuations of both types of coverage (replacement cost and actual cash value) are based on the value of the property at the time of loss.  The former is based on a “cost new” valuation, as opposed to the latter, which is based on a current, depreciated value.   Because of these significant differences, the decision of how to insure something is all the more important to a homeowner. When reviewing these options, the potential for depreciation that could be applied during a ‘covered cause of loss’ is an important factor to consider when comparing insurance premiums to the benefits of the coverage being offered.  The following is a further explanation of each option.

Homeowner Insurance - Replacement Cost

First, the settlement option provided under many homeowner insurance plans is Replacement Cost. Replacement Cost Coverage is defined as the amount required to replace or rebuild your home or else to repair the damages using materials of similar type and quality without deducting any amount for depreciation.  A quick example to illustrate this would be to imagine that under an insured, covered cause of loss, a homeowner loses the entire roof on their home. The roof is about fifteen years old and would cost approximately $40,000 to install using brand new materials of similar type and quality at the time of the loss. 

With Replacement Cost Homeowner Insurance, the insurer pays to reconstruct the damaged property, without regard to depreciation or age of the original materials. This is significant because it means the insurance pays to fully restore the roof without any monetary contribution from the policyholder.  The only exception would be the insured’s responsibility for the property deductible.  Keep in mind that most insurance policies are going to have “valuation provisions” in the contract that need to be met in order for the insured to receive the full replacement after a loss. These provisions are requirements that address the total amount of insurance purchased.  These requirements vary by product.  The specifics of these provisions should be discussed in detail with the insurance agent representative.

The next settlement option is Actual Cash Value insurance.  Actual Cash Value insurance is based on depreciation and also factors in the age of the materials at the time of the loss. Once the actual cash value of the insured element is calculated, the insurance settlement is reduced by this depreciation. The obligation of the insurance carrier is to reimburse the homeowner for what the materials were worth “used” at the time of the loss.

Going back to the previous example of the roof, let us assume the hypothetical homeowner’s roof is estimated to last 20 years. Since 15 of those 20 years are already used up via wear and tear, the amount of the claim settlement will most certainly be affected by depreciation.  In our example, the claim settlement would probably be around $10,000 once the depreciation was factored in, forcing the homeowner to pay the additional $30,000 out of his/her own pocket to finish restoring their roof.

To which areas in your homeowner’s insurance are Replacement Cost Insurance and Actual Cash Value Insurance applied? It all depends on the specific terms of your home insurance. Contact your insurance provider today to find out, or make sure to explicitly discuss these terms when signing a new insurance contract.  As a general rule, the better homeowner policies carry replacement cost on both the dwelling and the contents coverage.   Also remember that new additions to your home have to be adequately covered by your existing limits.  Therefore, if new additions are added to your dwelling, your current coverage limits for those areas need to be addressed and adjusted accordingly.  If your limits are too low at the time of a loss, your policy can fail to properly reimburse you for the damage to your home.  In addition, certain insurance contracts can apply additional penalties if valuation provisions of the contract are not met.  If you add any new renovations or amenities to your home, contact your insurance provider to determine that you have adequate coverage.

Remain aware of what you’re paying for and understand the differences in coverage before you talk to your insurance company. A little bit of understanding can go a long way in terms of receiving a fair and just settlement at the time of a “loss”.