Actual Cash Value vs Replacement Value Insurance

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Commercial Property Insurance & Replacement Value

Buying commercial property insurance is a major step in building a sustainable business. Commercial property insurance protects your business in the event your building or property suffers from damage. Having the right insurance policy in place is key to paying for repairs or replacing damaged property.

Even though most business owners understand the importance of commercial property coverage, plenty focus on the insurance cost instead of the coverage offered. Some insurance companies let you choose between actual cash value and replacement value policies. Before you decide to go with actual cash value to save a few pennies, it is important to understand why replacement value may be the better choice.

What is Replacement Value?

Replacement value (RV) is the amount it costs to replace your damaged building or property in the event of a loss. It does not factor in any depreciation expenses. The estimated replacement cost is typically used to determine the limits of coverage on the policy. If a loss occurs, the insurance company will pay the cost to replace the property. In some cases, the amount paid can be less than the policy limits.

What is the Difference between Replacement Value and Actual Cash Value?

There are two main differences between the types of valuation. Where replacement value doesn’t factor in depreciation, actual cash value (ACV) does.

Let’s say your business has three laptops that get stolen and you originally paid $2,000 for them. Each year they decrease in value by $400 as they are expected to last five years. If those laptops are three years old and you have an actual cash value policy, the value of each is now $800.

$2,000 (Initial purchase price) - $1,200 (3 years depreciation: 3x $400) = $800 (Actual Cash Value)

If you purchased a replacement value policy, the insurance company would pay the cost to buy three new laptop computers.

The second difference is premium costs. Actual cash value is less expensive than replacement value because the insurance carrier pays you less in the event of a loss.

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Are There Any Special Requirements for Replacement Value Coverage?

Replacement value policies generally include a clause that requires you to insure your property for at least 80% of the replacement value. If you fail to comply, the insurer can pay less in the event of a loss.

For example, if the cost to replace your building is $100,000 and you insure it for $80,000 (80%) after which a fire causes $50,000 in damages. The insurance company would pay $50,000. If you only have it insured for $70,000, the insurance company may only pay for a portion of the loss.