The reason you’ll likely be disappointed with your claims payout
There’s a valuable disclaimer on your insurance policy you probably ignored, but it’ll likely be the reason you’re disappointed with your insurance claim payout. You’re not alone. According to a survey, nearly half of respondents don’t understand replacement cost vs. actual cash value and what it means for their insurance coverage.
Many of us review our policies and declaration pages only to instantly file them away. Did you understand what it said on the page? The numbers show how much you’ll receive in the event of a claim, but they represent the maximums, and there are limits. These numbers tell you how much you could potentially be paid, but not how much you’ll receive.
To understand the differences, let’s look at replacement cost vs. actual cash value (ACV).
The actual cash value is equal to the replacement cost of the lost or damaged item, but it includes depreciation. ACV is how much you could sell your car for at current market value, not how much it costs to replace. Homeowners insurance might repair your roof, but ACV will call into question the current age of the roof.
Note that this is different then the book value accountants use to calculate depreciation on something like a business laptop. The book value is when an accountant takes the purchase price of the computer and deducts the accumulated depreciation to show its current value on a balance sheet.
ACV is how much the purchased item is worth in today’s value. To better understand depreciation, insurance companies use standard depreciation tables to help them determine ACV. Often they’ll also hire a professional appraiser to help them get an accurate estimate of the item’s value.
So, let’s say, your laptop is stolen. Your insurance company tells you laptops have a useful life of 10 years. The original laptop you bought was worth $1,500, and a similar one to what you have today costs $2,000 due to factors like inflation. Your stolen 5-year-old laptop, according to deduction tables, had 50% (5 years) of its life remaining. The actual cash value equals $2,000 (replacement cost) multiplied by 50% (5 years of useful life left), so you’ll be compensated $1,000. You’ll have to pay a deductible before money is released to you, say $500. That means ACV gives you about $500 towards buying a new laptop.
So, how does replacement cost insurance work?
Replacement cost insurance will help you restore your life much faster and with less financial stress but will cost you more in your monthly premiums. Replacement cost insurance gives you money to replace the lost or damaged items equal to the amount you’d need to replace that item with a new or similar product.
Examples of how this works with claims
In any claims process, an insurance adjuster will evaluate the value, be it with your car or your home. Depending on whether you have ACV or replacement on your policy, here are the different ways it might work. Note: with car insurance, a lot will depend on who is at fault and whether or not you have collision and comprehensive on your insurance policy.
Home insurance claims – comparing replacement cost vs. actual cash value
A pipe bursts under your kitchen sink, destroying your hardwood floors, the drywalled ceiling in the basement below, and the entertainment system underneath. First, you need to shut off the water supply, clean up the mess, call a plumber to fix the pipe, and then – call your insurance provider.
Your insurance provider will review the list of items you wish to claim – your hardwood floors, drywall repair, and the HD TV and sound system. The claims process is much easier if you have a detailed home inventory of what you own and ideally, the accompanying receipts. The level of contents insurance you have will affect your payout, so, without going into details, know that there are limits on items unless you have special endorsements.
Actual cash value
Insurance companies will often use depreciation tables to help determine the amount of money you will receive after you submit your claim.
Here’s a table of the offer to you for the property damage. This is only an estimate. If you want to do your own estimate, check out this depreciation tool.
|Hardwood||$3,000 – (5%*$3,500*5 years)||$2,125|
|Drywall||$1,000 – (2%*$1,200*10 years)||$760|
|HD TV||$1,500 – (10%*$1,600*5 years)||$700|
|Sound system||$800 – (5%*$1,000*5 years)||$550|
ACV = RCV – (DPR * RCV * AGE)
ACV = Actual Cash Value (Depreciated Value)
AGE = Age of Item (Years)
RCV = Replacement Cash Value (Cost to Purchase Now)
DPR = Depreciation Rate (% per year)
So, your original cost for all the items is $6,300. Once we take depreciation into account, your total payout is $4,135. That is derived from the replacement cost to buy those items new at $7,300. Meaning that even though you have insurance coverage, you still have to pay $3,165 out of pocket to get yourself back to where you were. You also have to pay your insurance company the deductible ($500-$1,000) to release the money. Unless you have a replacement cost policy on your insurance, which some providers offer, but for a significantly higher premium.
Replacement cost does not have a depreciation formula. Instead, the payout is focused on getting back to where you were – no more, no less. The only limits are based on your contents insurance within your home insurance policy. The new market value of these items was $7,300. While you still have to pay the deductible (the amount you pay before the insurance company pays out the rest), it still reimburses you much more than ACV.
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Car insurance claims example – ACV vs. replacement cost
If ever you’re in an accident, call your insurance company to guide you through the process. There may be a preferred collision centre or tow company, and you’ll want to make sure you use them to avoid any disputes. It also helps to prevent insurance fraud. When you report the crash, the insurance company will call upon their adjuster, who decides the severity of the damage and whether or not the car is a write-off. Know that even if it can be fixed, but the cost is getting close to a full replacement (70-80% of its determined value), your insurer may opt not to repair it.
To continue this example, let’s assume your car is totalled. The insurance adjuster will appraise it and give it a value based on what your car could be sold for on the open market before the crash. They’ll also double-check their work and hire a third-party to estimate the pre-crash value. Then, they make you an offer.
Actual cash value
Let’s say the totalled car is only a year old and is worth $20,000. Your ACV will be significantly lower than what you paid for it. The adjuster will use the odometer reading and take into account any stains on the car seats, sure. But, the big one is when they factor in the depreciation, which immediately removes at least 20%, but could go as high as 40% of the value. Let’s say they offer you a cheque for $12,000 after all the depreciation is factored in.
Buying an equivalent car will be frustrating and difficult with less money. You’ll likely have to settle for a lesser vehicle or fork over more money to afford the difference. Then, when your premiums increase, you’ll go shopping around for new car insurance quotes, but they’ll be more expensive too due to the collision.
What’s worse, if you financed your vehicle, without gap insurance, that money would only go to pay off a portion of the loan. Let’s say that $20,000 car still had $15,000 owing on it. You are given $12,000 of insurance money for a new car, but all that money needs to go to the loan company who, knowing the car is totalled, will strong-arm you to repay the loan. You still owe $3,000 on the loan and you have no car to show for it.
Gap insurance adds to your insurance premium, but well worth it if you financed your car.
With a replacement cost policy, there is no depreciation factored in. While it uses the same methodology with adjusters and third-party estimators, with replacement cost, they pay the price of the same class and year of the automobile. If they write off a year old car, they give you money to replace that year old car.
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The Bottom Line
A free call to your home insurance broker or provider will help you understand if you have an actual cash value or replacement cost policy. Only you can decide if the extra premium is worth it. Take into account your current financial state and make the best choice that fits your needs and budget. If you need to switch, you can compare car insurance and home insurance quotes online.