Replacement Cost vs. Actual Cash Value Coverage

Homeowners insurance policies offer two types of valuation of your personal property. One is replacement cost and the other is actual cash value. If your property is destroyed, your insurance policy will follow one of these two methods to replace that property.

  1. Replacement cost is what you would pay for the item if you went out to the store and bought it brand new today.
  2. Actual cash value is what you paid for the item when you bought it minus the depreciation.

Depreciation is a decrease in value due to wear and tear, which is the aging process.

Replacement Cost vs. Actual Cash Value

What does it all mean? Let’s say your home and the furnishings inside it were damaged by a fire. You make an insurance claim to your company and then pay the deductible amount associated with your coverage. Now you must replace the damaged furnishings. How much money will you receive from your insurance company to buy new furnishings? This depends on if you have replacement cost coverage or actual cash value coverage.

For example, last year you bought a sofa for your living room for $2,000. This year the same sofa now costs $2,100 at the store.

If you have replacement cost coverage, your insurance company will pay you $2,100 (less your deductible).

However, if you have actual cash value coverage, your insurance company might pay you $1,800 because that is the amount you paid for it ($2,000) minus the depreciation of the sofa over one year.

Calculating the Depreciation Rate

Depreciation is calculated based on the expected life of the item divided into the cost. This comes up with a per year depreciation rate.

In our case, the expected life of your sofa is 10 years.

$2,000 / 10 = $200 per year depreciation rate

Calculating the Actual Cash Value

The amount you paid for the item minus the depreciation rate for however many years you owned the item is the actual cash value.

One year has gone by since you purchased the sofa

$2,000 – $200 = $1,800

The actual cash value of your sofa after one year is $1,800. If you owned the sofa for two years before the fire, you would receive $1,600 actual cash value.

*Please note: For replacement cost coverage, most insurance companies will initially give you the actual cash value of an item and then require a receipt for the new item before paying you the remainder.

Why have Actual Cash Value Coverage?

Generally speaking, you’ll receive less money from the insurance company to replace your furnishings if you have actual cash value coverage. So why have it? Actual cash value coverage is less expensive on an annual basis than replacement cost coverage. It’s a way to save money on your insurance policy.

Record Your Personal Property

Remember, you need to have proof of your belongings for your insurance company. We recommend taking pictures of every room in your home from each angle to record your personal property.  Save the photos in two places so you have a backup copy. Do this every year or after a large purchase or renovation in your home.

For actual cash value coverage, your household financial system will be important (i.e. receipts, tax forms, etc.) because it shows the value of your personal property.

Know Your Coverage

It’s important to know your homeowners insurance coverage before you need to use it. You don’t want to be expecting to receive one amount and end up receiving far less. Know now if you’ll have to pay more out-of-pocket to replace your furnishings if they are damaged or if you’re paying more annually. This can also help you plan your savings for an emergency fund accordingly.

So take a look at your current homeowners insurance policy to see if you have actual cash value or replacement cost coverage for your personal property.

Contact us if you want assistance reviewing your current homeowners insurance policy or if you want to get a comparative quote.

Homeowners Insurance Coverage Types Explained

Let’s talk about homeowners insurance coverage types. When you get a homeowners insurance policy, you have some options. One of them is selecting what coverage type you want for your home. Different coverage types cover your home (protect it) from different perils. It all depends on what kind of insurance coverage you want on your home.

What are Perils?

Perils can be anything from fire to sinkholes to falling objects. They are threats to your home that you can be protected against with insurance. With a homeowners insurance policy, you choose if you want coverage for 2 perils, 9 perils, 17 perils or all risks of physical loss with certain exceptions. These four coverage types are called FL-1 Fire, FL-1 Extended Coverage, FL-2 Broad, and FL-3 Special Form.

Homeowners Insurance Coverage Types

I look at these coverage types like sunscreen. The higher the SPF number, the more you’re protected against the sun’s harmful rays. For home insurance, the higher the number of coverage type, the more perils your home is protected against.

If you want the broadest coverage, like SPF Homeowners Insurance Coverage Perils50+, in insurance that’s FL-3 or “Special Form”. FL-3 covers you for all risks of physical loss with certain exceptions.

If you’re looking for the least amount of coverage, like an SPF 15, FL-1 covers fire or lightning and explosion ONLY. You could also get FL-1 Fire and Extended Coverage. It will cover those 3 perils plus 7 more, including windstorm or hail, riot or civil commotion, aircraft, vehicles, smoke, volcanic action, sinkhole collapse. Vandalism coverage is optional for an additional charge.

FL-2 is like SPF 30. It’s middle-of-the-road, broad coverage. It covers all 9 risks listed above plus burglary damage, falling objects, weight of ice, snow or sleet, accidental tearing apart, burning or bulging, accidental discharge of liquids or steam, freezing of plumbing or heating system, sudden and accidental electrical damage. That’s 17 perils in all

**Please Note: None of these cover flooding! Flood is not covered under your homeowners insurance policy. A flood insurance policy is a completely separate policy type. It’s a specific type of insurance for a specific type of weather. If you’re not protected against flooding with a flood insurance policy, then damage to your home from flooding is NOT covered. Find out more about whether or not you may need flood insurance.

Weighing the Cost of Insurance Coverage

Now at this point your head might be spinning. You may be asking yourself… What type of homeowners insurance coverage do I have? Is it enough? What type of coverage do I want? How much coverage do I need for my home?

Of course, you have to consider price as well. The more coverage you have, the higher the cost. Some companies will offer you a reduced price on your homeowners insurance policy by reducing the coverage to FL-1 or FL-1 Extended Coverage. Sure, your insurance will cost less, but your home will not be as well protected.

It’s always important to check your current homeowners insurance policy. Again, Special Form FL-3 offers the most coverage for you home. Your coverage is reduced from there to FL-2, FL-1 Extended, and finally, with FL-1 being the simplest coverage.

With all that said, there are a couple other factors that play into your annual premium. The duration of your policy, whether it’s 1 year or 6 months, and the amount of coverage (i.e. property value).

Request A Quote

It doesn’t hurt to ask. If you want to change the type of coverage you have on your homeowners insurance policy, talk to your insurance agent to get a quote. You may even want to shop around. Ask for quotes from a couple different insurance agencies to see if changing companies would give you the right coverage at the right price.

You have options, but we don’t want you to think you’re covered for something you’re not.

Contact us at Bruce Gardner Insurance Agency for a free, no obligation homeowners insurance quote.

Homeowners Insurance Tips for Home Buyers

Buying a home is often a chaotic period of time, but you want to make sure you have the appropriate homeowners insurance coverage. Whether it’s a mistake on your policy or you’re trying to save money, you don’t want to end up with partial coverage.

Homeowners Insurance Mishaps

Mistakes can happen, so please double check the numbers on your insurance policy after you close on your home. Especially check the insurance value of your home and your personal property.

A lot of times, people reduce the insurance coverage on their house to get it in line with their other credit card payments and monthly expenses in order to qualify for a home loan. But it is possible to reduce your insurance coverage to the point that it only covers the mortgage and not the true replacement cost of the house.

Remember, replacement cost is a future value to rebuild the existing house. You need to know how much will it cost to rebuild your house, and who’s going to pay for it.

For First-Time Home Buyers

If you’re a first-time home buyer, the closing process can seem a little confusing. You know you’ll need to have homeowners insurance to cover the house or mortgage. Don’t forget about the value of your personal property inside the house.

We recommend you get a competitive insurance quote a few months after closing. Make sure your competitive quote compares the same home values and personal property values. Make sure you have an insurance company that provides good value coverage.

Get a Competitive Insurance Quote & Know Your Coverage

Getting competitive insurance quotes and knowing your coverage are important. We recommend getting competitive insurance quotes every 5 years or so. And when you compare, make sure you’re comparing the true value of your house and your coverages are the same, otherwise, it’s not a true comparison.

We have heard of people thinking they’re saving a tremendous amount of money on their insurance policy only to realize that their 12 month policy was compared to a 6 month policy. That’s not a true comparison.

If you do decide to change insurance companies, don’t worry! It happens every day. It’s understood by insurance companies that people will shop around, get competitive quotes, and look to save money on their coverages. Here are a couple things to remember…

You Could Get a Refund

Recently, we had a new client ask, “Will I get my insurance premium back if I change insurance companies?”

Yes! One of the laws in the state of Virginia requires insurance companies to refund unearned premium when a client leaves.

If you decide to switch insurance providers, the date your new homeowners insurance coverage takes effect is the end date of your previous policy. Any monies that you have already paid for future coverage (after the end date) will be refunded back to you.

What If Your Escrow Account Pays For Your Insurance?

If you’re paying your homeowners insurance through your mortgage escrow account, you need to deposit your refunded money back into your escrow account.

Usually, the insurance refund checks are made out to you, the client, and not the original source of the payment (i.e. the mortgage company). So you need to put the refunded money back to where it first came from. This will help to keep your mortgage escrow account in balance because the mortgage company recalculates all the costs that need to be paid on an annual basis.

We at Bruce Gardner Insurance Agency are happy to work with home buyers or to give a competitive quote a few months after you’ve closed on your home. We explain our policies, explain how the coverage is determined, and answer your questions about your homeowners insurance.

Contact us to get started with a free homeowners insurance quote.

How is Replacement Cost Calculated for Home Insurance?

Although your homeowners insurance is being written today, the coverage you’re purchasing is for tomorrow and beyond. When we determine replacement cost for insurance purposes, we’re looking at the cost of rebuilding your home with new materials at that current labor cost at that point in time, which is in the future.

How is Replacement Cost Determined?

When we go to insure a home, we’re looking at the structures only. To be fair to all parties, we use an evaluation software called E2Value, which is used by insurance companies across the nation. This software takes the size, shape, and main characteristics of the home, or building, and assigns a cost to rebuild it using “future” values (of materials, labor, etc.).

Comparing Assessed Value, Purchase Price, and Replacement Cost

Comparing different values on the same structure is like comparing apples, oranges, and bananas. The apple is the assessed value, the orange is the purchase price, and the banana is the replacement cost. All three are values of the same property at different points in time.

Assessed Value: For the apple, your assessment is determined by the local government and is updated on a periodic basis (approximately every 5 years). Most people would like a low assessment for reduced taxes.

Purchase Price: For the orange, your purchase price is negotiated between the buyer and seller. It factors in a current property appraisal and real estate market.

Replacement Cost: For the banana, your insurance replacement cost, or rebuilding cost, is used when there has been damage to the property by a covered event, such as a fire. If the building is destroyed, then it would need to be completely rebuilt at the construction costs at that point in time. Again, you have to remember we’re looking into the future. Your replacement cost is what it would take to completely rebuild the home in the future.

Hopefully this comparison helps you to understand why these three property values of a home are all different, and why the insurance replacement cost value for your home can be more than the purchase price.

Is your current homeowner insurance replacement cost up-to-date?
Let’s make sure you have accurate coverage for your home.
Contact us to get a quote from Bruce Gardner Insurance Agency.