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by Brent AllenImage
Allen Financial Insurance Group

Probably two of the most misunderstood coverage terms in property insurance valuation are “Actual Cash Value” and “Replacement Cost”.  Most consumers do not read every word of their insurance policy anymore than I read the product warranty on everything I purchase.  It is very important to at least understand the basic differences between these valuation approaches before you need to file a claim so there will not be any costly surprises.  For example, most homeowners policies today offer replacement cost coverage on your household personal property so end of story… right?  Not necessarily as there are a number of exceptions to that coverage rule.  In the event of a loss, the property in your “living area” will be adjusted on a replacement cost basis but if it is being stored in the garage or an outbuilding you may very well be paid on an actual cash value basis.

There are several different methods by which your insurance company may calculate the amount it will pay you for a loss. Payment based on the replacement cost of damaged or stolen property is usually the most favorable figure from your point of view, because it compensates you for the actual cost of replacing property. If your camera is stolen, a replacement cost policy will reimburse you the full cost of replacing it with a new camera of like kind. The insurer will not take into consideration the fact that you ran three rolls of film through the camera every day for the last two years, causing a considerable amount of wear and tear.

What Does “Replacement Cost” Mean?

The term “replacement cost” is defined or explained in the policy. Simply stated, it means the cost to replace the property on the same premises with other property of comparable material and quality used for the same purpose. This applies unless the limit of insurance or the cost actually spent to repair or replace the damaged property is less. Refer to your policy for the exact definition and explanation of replacement cost.

What is “Actual Cash Value”?

The term “actual cash value” is not as easily defined. Some courts have interpreted the term to mean “fair market value,” which is the amount a buyer would pay a seller if neither were under undue time constraints. Most courts, however, have upheld the insurance industry’s traditional definition: the cost to replace with new property of like kind and quality, less depreciation. Courts have varied in their rulings as to whether or not depreciation includes obsolescence (loss of usefulness as a result of outmoded design, construction, etc.).

So What’s the Difference?

The only difference between replacement cost and actual cash value is a deduction for depreciation. However, both are based on the cost today to replace the damaged property with new property.  

What is an “Agreed Amount Endorsement”?

This endorsement is an agreement 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.   Insurers usually require a statement of property values signed by the insured as a condition of activating or including an agreed value provision in a commercial property policy. 

 What About “Book” or “Market” Value?

Note that accounting or “book” value has no relevance to either of the previous methods of valuation. The depreciation rate reflected in “book” value would yield a terribly inadequate settlement. Another problem with using “book” value is that it may reflect only the items that are “capitalized.” To determine adequate limits, one must add “expensed” items into capitalized items.

The next time you renew your policy is would be wise to spend a couple of extra minutes determining how much you will actually be paid in the event of a loss.  Forewarned is Forearmed.