In both personal insurance, like homeowner’s insurance, and in business insurance, such as Commercial Property Insurance, there are often two ways you can insure your property: Actual Cash Value (ACV) or Replacement Cost. Many policyholders aren’t fully aware of the distinction and it’s always best to understand your coverage before you have a claim so you can make adjustments to your policy if needed.
Here’s a quick example: If you bought a computer for your business three years ago and it was stolen when someone smashed the front window of your business, the amount your insurer would pay for the computer would differ depending on the type of property coverage you have.
Computer price when new: $2,000 Actual Cash Value coverage: $1,000. The computer has depreciated due to age. Replacement Cost coverage: You’ll get the amount needed to replace the computer with another computer of like kind and quality. In other words, you’ll get enough to purchase a comparable replacement.
If you’re curious, the smashed window is usually covered for replacement cost value, meaning the insurer will pay enough to repair or replace the window without a deduction for depreciation — assuming you or your landlord have the window insured. Commercial leases often pass the responsibility for plate glass windows to the tenant.
Actual Cash Value is a common way to provide coverage for business property and is usually less expensive than Replacement Cost Value coverage. The difference in rates is due to how the expected cost when a claim arises. With both types of coverage, you choose your total coverage limit — however, the coverage limit refers to the maximum amount the insurer will pay for a damaged property claim. Specific items are covered for a value that depends on which type of coverage you choose (ACV or RCV), which governs the maximum coverage amount for a given item.
One way to understand actual cash value is that it insures the unused value for your property. ACV is how most vehicles are insured and how many other types of property are covered. Here’s the logic used by insurers: If you have an item for five years, it’s no longer worth as much and your financial loss is lower than if you’d had a loss for a new item. You’ve received some of the value already by owning the item and accessing whatever utility it brought to your business. Your insurer isn’t picking on you if your policy has Actual Cash Value coverage. ACV coverage is very common and helps keep premiums more affordable.
Insurers use various methods to determine the actual cash value of an item, with one common method being for insurers to use a fixed depreciation schedule. In this case, the insured value of your property goes down by a fixed percentage each year, during which time you had use of the item and derived value from it. While actual cash value is an equitable way to provide coverage, if a covered claim results in the loss of an expensive item or of several items, the difference between your claim payment and the cost of replacement can be significant.
For many policies, you’ll have the option to add Replacement Cost coverage to your policy if you don’t have it already. The cost of your policy premiums may increase but you’ll have the benefit of knowing you have full coverage. Imagine a fire at your business destroying all your furniture and equipment. With Actual Cash Value coverage, you might only get enough money from your claim to replace some of the items, but not all. Replacement Cost coverage avoids this problem by paying to replace your lost furniture and equipment with items of like kind and quality.
Insurance policies can provide different types of coverage depending on what type of property is being insured. “Real property” refers to buildings and fixtures and is usually insured for replacement cost value. In this case, replacement cost value means how much it would cost to rebuild or repair the building, again using like kind and quality for materials. Because insurance for real property is insuring for rebuild cost, the market value of real property isn’t relevant to the insured value calculation. In some areas, there can be a large difference between the market value and the cost to rebuild. Insuring for rebuild cost provides much better coverage if the market value is lower than the cost of rebuilding.
Another reason to insure for rebuild cost is what’s called a “coinsurance clause”. Many commercial property insurance policies require that the building(s) be insured for at least 80% of the rebuild cost. Buildings insured for a lower amount get a lower claim payout even for smaller claims due to the coinsurance clause. A building insured for 50% of rebuild cost, for example, might only get 50% of the claim payout. The “co” in “coinsurance” is your business, which has to pay the other 50% of the claim.
Roofs are one area where real property is often covered at actual cash value. The reason is simple: roofs wear out. Fortunately, you may also have the option to change your roof coverage to Replacement Cost coverage so you don’t have financial exposure due to a lower claim payout on an older roof.
The types of property owned vary by business or industry. An accounting office might have mostly furniture and computers — and calculators, of course. A machine shop may have significant financial exposure for its specialized portable equipment. A trucking company makes a large investment in its fleet of trucks. The insurance coverage for these types of property is usually provided as actual cash value. If your business can’t afford to pay the difference between the claim payout and the cost of replacement, which can be significant, ask your agent about an endorsement to add Replacement Cost coverage.
Real property refers to the land (which isn't insured) and buildings (which are) as well as permanent fixtures. Flooring and attached cabinetry are considered to be part of the building. Most real property is usually covered for replacement cost value, meaning that if you have a covered claim, your insurer will pay for the cost of repair or replacement, subject to your coverage limits and deductible.