Actual Cash Value vs. Replacement Cost Explained

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

What does ‘Replacement Cost’ mean? What does ‘Actual Cash Value’ mean? While you might be familiar with these two terms from your homeowners' insurance, how does it apply to commercial property insurance? Which one is the right choice for your small business?

When you are insuring your building or your business property you will see that you have the choice between 'Actual Cash Value' and 'Replacement Cost.' We are going to talk about those two options and what their differences are so that you can decide which one you should opt for.

What is covered in this article:

  • The definition of Replacement Cost
  • The definition of Actual Cash Value (ACV)
  • The difference between the two insurance options
  • Which option is the best coverage choice

What Does ‘Replacement Cost’ Mean?

Replacement Cost is a coverage that will pay you enough money to replace your property/belongings with “like-kind or quality” up to the limit of the policy you have. This should not be confused with the guaranteed replacement of your exact items. So if you lost a laptop in a fire, the policy is not going to replace it with a next-level replacement. It is going to provide you the cost to replace your computer with a similar computer.

The replacement cost is an easy estimate for items such as clothing, equipment, TV’s, etc. However, the cost to replace a building is going to be a little trickier. Insurance companies have to take into consideration the value of the building, including the cost of materials and labor. Your commercial property insurance may also include business interruption insurance to cover lost wages and profits or the cost of operating out of another location while yours is being repaired. 

NOTE: Did you know that in most cases insurance companies won’t give you money up-front to replace your damaged or stolen items? Some require you to purchase the item first—and then they’ll reimburse you. The cost of replacing the item is something you need to consider upfront when you purchase insurance coverage.

Extended or Guaranteed Replacement Cost

Guaranteed replacement—also referred to as guaranteed cost coverage—isn’t normally found in commercial insurance coverage. But if you are fortunate enough to have replacement cost coverage, the loss will be covered to replace the building to its original state, even if it meansthe value exceeds the policy limit. An extended replacement cost extends the coverage beyond your policy limits by a certain percentage, sometimes 10–20%. 

What is an ‘Agreed Amount Endorsement’?

An Agreed Amount Endorsement is this: “An endorsement to a policy made by the insurance company wherein it waives the coinsurance clause on the specified property. As long as this endorsement is in effect, there would be no coinsurance penalty at the time of a claim.”

What is ‘Actual Cash Value’?

Actual Cash Calue (ACV), on the other hand, is the amount of money that an item is worth, minus depreciation for the wear and tear it has suffered since you’ve had it. It’s often referred to as ‘fair market value’. So an adjuster with your insurance company takes the replacement cost of an item and calculates the depreciation to come up with the ACV. The calculation looks like this:

Replacement Cost x Percentage of Useful Life Remaining

Most items depreciate over time to the point where their value is minimal at best (unless—of course—it’s art, jewelry, antiques, collectibles, etc). Another way it can be calculated is to look at what dollar amount you could obtain for the item in question if it were sold today. 

What is the Difference Between Replacement Cost and Actual Cash Value? 

The largest difference is how a destroyed or damaged item is replaced. Replacement Cost pays for the full value of the item in question, whereas ACV pays for the depreciated cost of the item. 

Secondly, Actual Cash Value usually consists of lower premiums than replacement cost because you’re not being paid the full original value of the items and/or property. Conversely, Replacement Cost will consist of higher premiums and potentially a higher deductible at the time replacement or repair is necessary. The difference in premium can be substantial.

You'll want to take all of these variables into consideration to help you choose the best insurance company for your business.

Actual Cash Value vs Replacement Cost: Which Option is the Best Choice?

Choosing which type of coverage for your business is difficult. Because Actual Cash Value is cheaper and more affordable, it may seem like the easiest choice. However, if you were to lose your property in a fire, you’d only get part of what it costs to repair or rebuild. Is your small business financially prepared to make up the difference in cost? If your business is prospering and you have the means to replace your building if necessary, then perhaps ACV is the best coverage option. 

Full Replacement Cost may be more expensive, but it gives you peace of mind if your property was robbed or damaged. Your mortgage lender (or leaseholder) may require you to pay for full Replacement Cost in your commercial property insurance to protect their investment. Be sure to look at your mortgage and any other business loan agreements carefully.

How Much Will You Be Paid for a Claim?

Regardless of the policy you choose, the items you’re insuring need to be well-documented to receive the proper coverage. If your business keeps detailed inventory records this may be sufficient. If your business contains any valuables—such as antiques—make sure they’re appraised and you’ve kept a record of their worth off the premises. 

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Debating actual cash value vs replacement cost can be tricky (with homeowners insurance or commercial insurance). We encourage you to speak to an insurance agent who is knowledgeable in the area that can help walk you through the different options (even guaranteed cost coverage). Complete the form above to start the process of getting a quick, free quote for your commercial insurance, or call us at 1-877-907-5267 to speak with one of our specialists for guidance in finding a policy that fits your requirements.

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