“Price is what you pay. Value is what you get.”
That Warren Buffet quote gets thrown around a lot. He wasn’t really taking about insurance claims settlement, of course. Yet this price-value dichotomy is a handy way of understanding the amount you will get when you make a claim.
Price is what you pay for your car, tv, house etc. Value is what you will get based on how your insurance company settles your claim.
The trouble is, there are a few different ways insurance companies will determine value depending on your policy. One key distinction is actual cash value vs replacement cost.
With actual cash value, the difference between the price you pay and the value you get from insurers can be pretty significant. It all comes down to depreciation.
What is ACV?
Actual cash value or ACV relates to the value of an insured item for the purposes of paying a claim.
It is a way for insurance companies to determine how much to pay you if you are claiming for any items that you need to replace.
This is because items you own are not deemed to be worth the same amount as when you first bought them. It’s sort of like if you were to sell your stuff on Craigslist. If you put an old TV up for sale, you likely wouldn’t expect to get back what you paid for it new.
Policies that settle claims according to actual cash value work in a similar way. They take into account the depreciation of items.
How is ACV calculated?
Things can get pretty complicated with ACV calculations. At a very basic level, ACV is the replacement cost of an item, minus depreciation. The level of depreciation is based around an estimate of the useful life of an item then assessing how far through that useful life the items being replaced was.
So a very general actual cash value calculation would be:
Replacement Cost x Percentage of Useful Life Remaining
Say a fire destroyed your laptop and you wanted to claim for it. If replacing the computer new would be $2,000, and the useful life of the laptop was five years, but your machine was two years old – ie it had 60 percent of its useful life remaining, the math would look like this:
$2,000 x 0.6 = $1,200
This is only a rough calculation to highlight the way depreciation works. ACV in actual claims isn’t always going to be this clear cut. Practices for determining ACV will vary by insurance carrier and by location. The ACV can also be determined by a fair market price rather than a depreciation calculation.
ACV can get pretty contentious and can be disputed. People even go to court over the way it is determined in particular situations.
Actual cash value in auto insurance gets even more complicated since it isn’t just the age of the vehicle but mileage, or the price vehicles are selling for that will determine the ACV.
The main point to remember is policies that settle on cash value will pay you a percentage of what it would cost to replace the item new.
Actual cash value vs replacement cost in home insurance
Because of the depreciation factor, policies that settle claims based on ACV aren’t always the best way to go when it comes to homeowners insurance.
If your home was completely destroyed by a fire, replacement cost would enable you to rebuilt it based on today’s labor and material costs.
Consider the situation if fire destroyed your property. Any expensive items of clothing that you lost would cost a lot to replace. Yet the amount you would receive based on actual cash value would be determined on their depreciated worth as used clothes.
This would be significantly less than the cost to buy them new again. You would be paying most of the money to replace them.
For this reason, when it comes to homeowners insurance in particular, Replacement Cost Value, or Extended Replacement Cost Value are better choices to cover damage.
Replacement cost will cover the cost of the repair or replacement of damaged property with materials of similar kind and quality – ie depreciation will not be deducted.
Extended replacement cost provides extra protection – usually a set percentage above your policy’s limits to rebuild your home. This would guard against sudden increases in costs to repairs.
Actual cash value in auto insurance
Claims for property damage on your auto insurance will generally be settled by actual cash value.
So if your car is totaled, and you have collision insurance, your claim would be settled on actual cash value.
Given how the depreciation of your car increases with age, this is why full coverage isn’t worth it for older cars. Essentially the ACV gets so low that it just doesn’t make sense to keep paying the premiums for collision insurance.
New car replacement
One situation where ACV wouldn’t apply is with new car replacement coverage. This is useful if you are paying off a loan used to by the car.
Even within a year a vehicle’s value can depreciate a lot. It can reach the point where the amount outstanding on the loan is higher than the value of the vehicle.
If the vehicle is destroyed or stolen, you owe more in loans than what you will receive from your insurer. On top of that you will still need to get a replacement vehicle.
While gap insurance is one option, new car replacement coverage could be a better option if you are eligible.
If the vehicle is under one year old and under 15,000 miles, this would pay out the full value of replacing the car new.
Ultimately the means of settling a claim is huge when determining the value you get out your insurance whether it’s your home, your car or anything else.
If a carrier offers replacement cost as an option, you will get more back from your insurer. However, you will have to pay higher premiums.
That’s why you decide if the price you pay in premiums is worth the value you’ll get from the claim.
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