When an individual or company purchases insurance, they understand the coverage received. This means they know they’ll get reimbursed for lost items due to fire, theft, or some other loss. What they might not know is the type of payment they’ll get. The two most common are actual cash value and replacement value.
Replacement Value Definition
Replacement value is the full cost of the lost product. It doesn’t matter what it’s currently assessed for or its existing market value. Whatever the policyholder paid for the item will be reimbursed once their claim is processed.
Replacement vs. Actual Cash Value
There’s a large difference between replacement and actual cash value. The latter looks at the cost of the lost item minus depreciation. The former is what it might cost to replace the item.
Let’s say a business files a claim regarding a stolen laptop. If they signed on to receive an actual cash value, they would receive an amount equal to the original cost minus the number of years it was owned. Conversely, a company that purchases a replacement value option would receive a reimbursement for a similar laptop currently available.
While the replacement value option seems like the best course, there’s the matter of premiums. Since the insurer will pay out more for replacement, the premiums will be much higher. This is especially true if the insured wants to cover expensive items like computers, electronics, and heavy equipment.
When Replacement Value Is Most Useful
Replacement value isn’t always needed. There are some situations when the actual cash value provides sufficient reimbursement to replace items in the home or business. The former often comes into play with larger items.
A home is a good example. If a policyholder selects cash value, then they may not be able to completely cover costs related to replacement or reconstruction. Conversely, when an option is chosen to cover 100% of the replacement costs, what’s needed is fully reimbursed.
The same situation applies to auto insurance. An actual cash value might get the insured a car, but it won’t be as nice as what they once owned. Replacement value allows them to receive a full payment. As a result, the policyholder can pay off the remainder of their loan and still have money left for a new vehicle of the same quality as their old one.