There are two methods of determining the amount you will be paid on an insurance claim: replacement cost and actual cash value. In the United States, replacement cost is becoming more the norm, but there are a number of situations under which claims are still settled on an actual cash value basis.
Replacement cost is exactly what it sounds like: you are paid today’s price for the same item of comparable size and quality. Say, for example, your 22.6 cubit-foot side-by-side refrigerator was destroyed by a kitchen fire. You go to your local home improvement store and find the same brand and size with roughly the same features as your old one and it costs $1,800. You would be paid $1,800 (less your deductible).
Actual cash value (ACV) is not quite as straight forward. The amount you are paid is based on a calculation of replacement cost minus depreciation. Let’s use the refrigerator in the above example. We’ll assume the average refrigerator lasts for 10 years, and yours was 5 years old when it was destroyed in the fire. A comparable new refrigerator has a replacement cost of $1,800. A refrigerator has a life of 10 years old, but yours was 5 years old. So it had already been used for one-half, or 50%, of its life expectancy the depreciated value. Therefore, you would be entitled to 50% of $1,800 or $900.
Some insurance companies apply the deductible prior to figuring the ACV and others after the fact. Does that affect your claim? It might. Say you have a $500 deductible. If the deductible is applied first, then your claim would be $1,800 (replacement cost) – $500 (deductible) = $1,300 times 50% = $650 going to you. But if your deductible is applied after ACV is figured, then you would have $1,800 times 50% (depreciation) = $900 – $500 (deductible) = $400 going to you.
Sometimes both methods are used, even if you have replacement cost coverage. Under some circumstances (like replacing a roof or major fire damage), you will initially receive the actual cash value for the damaged property. Once the item(s) has/have been replaced or repaired, you will then receive the difference between the ACV you were originally paid, and the actual cost.
It’s generally wise to have replacement cost coverage unless everything you own is quite new. Although replacement cost coverage may cost a little more upfront, you stand to save a great deal in the long run in the event of a loss and isn’t that why you have insurance in the first place?