A few scenarios are below to better your understandings...
How it Works
Homeowners insurance policies offer actual cash value or replacement cost coverage to replace your damaged, stolen, or destroyed personal property.
• Replacement cost is what you would pay for the item at today’s cost.
• Actual cash value is what you would pay for a similar item at today’s cost minus depreciation (replacement cost minus depreciation).
• Depreciation is a decrease in value due to wear and tear or age.
Your home and some furnishings were damaged during a recent wildfire. You made a claim to your insurance company and have met your deductible. Now you are looking at replacing the damaged furnishings. Last year, you bought a sofa for your living room for $2,000. The amount of money you will receive to replace your sofa depends on the type of coverage you have.
• If you have actual cash value coverage, the company might pay you $1,500 because that is the actual cash value of the sofa today (replacement cost minus depreciation).
• If you have replacement cost coverage, the company will pay $2,100 because that is what it would cost to buy a similar sofa today.
Note: If you have replacement cost coverage, most insurance companies will give you the actual cash value of an item and require you to submit a receipt for the new item before paying you the remainder.
• With actual cash value coverage, you will receive a payment from the insurance company for $1,500.
• With replacement cost coverage, you will first receive a payment from the insurance company for $1,500. When you submit your receipt for the sofa, the company will pay for the difference between $1,500 and the amount you paid to replace the sofa up to $2,100.
$2,100 = Amount of the receipt for your new sofa
$1,500 = Actual cash value of the sofa and amount sent to you by the company after you filed a claim $600 = Amount the company will send you after you submit a receipt for $2,100
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.
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.