If you’ve purchased homeowner’s insurance in the past—or plan to now—you’re probably aware of the ongoing debate:
Is it smarter to buy an “Actual Cash Value” policy . . . or a “Replacement Cost” one?
Like many things pertaining to insurance—and maybe to life in general!—the best answer is “it depends.” It depends on your needs, and on the key benefits you wish to derive from your policy. To help you understand this more clearly, let’s start by defining the two types of policies.
“Actual Cash Value” Coverage
If you decide to purchase an Actual Cash Value policy—and your property is then damaged—you’ll be reimbursed based on the market value or the initial cost of your property, minus depreciation.
Some people like this type of policy, because it generally offers lower premiums. That’s the “upside” of an ACV policy. But for every upside there’s a downside, and the downside of an ACV policy is that you’ll receive lower payouts down the road, if you ever have to file a claim. (Which nearly all homeowners eventually do.)
You may be wondering, How do insurers calculate depreciation? It varies, but a common method takes into account the item’s expected lifetime, then subtracts a percentage of value for each year since the item’s purchase.
“Replacement Cost” Coverage
If you opt for a “Replacement Cost” policy on your home, you’ll be reimbursed by your insurance company based on the money it would take to replace your damaged home with the exact same or a similar home in today’s market.
The Replacement Cost is generally calculated by using the price you actually paid for your home, regardless of any potential depreciation. (Some home insurance policies also cover the Replacement Cost of personal property.)
So What’s Smarter?
Although you’ll pay a lower premium for an Actual Cash Value policy, it’s important to remember why: If you have to file a claim, you’ll receive less of a payout—perhaps much less—with this kind of plan . . . again, because it factors in depreciation of your property.
The opposite is true of a Replacement Cost policy. You’ll pay higher premiums with this kind of coverage. But you’ll enjoy much greater peace of mind, as a result. Why? Because you’ll typically receive a much higher payout from your insurance company, should you need to file a claim.
So remember that each option offers different protection values, and affects your premium differently. And also remember that a Replacement Cost policy nearly always protects you, your loved ones, and your wallet more effectively in the long-run.
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