Commercial Lines Question of the Month - August 2009

Q. When obtaining an insurance policy with property coverage, what is the difference between “Replacement Cost” and “Actual Cash Value”?

A. There are several different methods by which an insurance carrier may calculate the amount they will pay you for a loss. Payment based on the “replacement cost” of damaged or stolen property is usually the most favorable basis to be insured by from the insured’s standpoint, because replacement cost compensates the insured for the actual cost of replacing your property. If an insured’s computer is stolen, a “replacement cost” policy will reimburse you the full cost of replacing it with a computer of like kind. The insurer will not take into consideration the fact that you have been using the computer every day for the last two years, causing a considerable amount of wear and tear. Essentially, having a policy that is covering an insured on “replacement cost” may be more expensive than a policy based on “actual cash value” but the coverage is more advantageous to the insured should a loss occur.

In contrast, “actual cash value” or ACV, also known as market value, is the standard that insurance companies arguably prefer when reimbursing policyholders for their losses. Actual cash value is equal to the replacement cost minus any depreciation (ACV = replacement cost - depreciation). This type of policy will more than likely be less expensive than a policy on a “replacement cost” basis. ACV represents the dollar amount you could expect to receive for the item if you sold it in the marketplace. The insurance company determines the depreciation based on a combination of objective criteria (using a formula that takes into account the category and age of the property) and subjective assessment (the insurance adjuster's visual observations of the property or a photograph of it). In the case of the stolen computer, the insurance company would deduct from its replacement cost an amount for all the wear and tear it endured prior to the time it was stolen.

Please note that this is subject to “Co-insurance percentages” and “deductibles being applied” at the time of loss.

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"?

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 About "Book" 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.

Other Kinds of Valuation

Certain property may be subject to a special valuation basis other than replacement cost or actual cash value. The value reported should match the applicable valuation basis. For example, if the property policy is endorsed with a selling price endorsement for finished goods, the proper value to insure for finished goods is the cash selling price, less any customary discounts and expenses that otherwise would be incurred.

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For more information, contact Anthony Miller, Vice President, at (650) 237-3003 or amiller@lawson-hawks.com.