Replacement Cost Coverage v Actual Cash Value

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Many insurance policy terms can be confusing, and even more so when you are dealing with a substantial insurance loss to your home or business.  Replacement cost means the cost, today, to replace your home with a new one, or the cost to repair parts of your home with new components.  For example, the replacement cost of a damaged roof if the amount of money it would take to put on a brand new roof today.  So, if a qualified roofing contractor provides a bid of $10,000 to replace a roof, that amount is the replacement cost.  Actual cash value, on the other hand, means the depreciated value of a building just prior to the loss.  Using that same roof as an example, if it is 5 years old and 25% into its useful life, the depreciated value might be $7,500 instead of the full replacement cost.  The difference between the the replacement cost and the actual cash value is called depreciation.  In this example, the depreciation would be $2,500.

The standard HO-B and HO-C forms used in Texas will cover replacement cost of the dwelling, though the HO-A policy form will only cover actual cash value. For personal property, the policies will typically cover only actual cash value unless the homeowner has purchased an endorsement to cover replacement cost. If your policy only covers actual cash value, the insurance company will not pay the cost to replace the damaged areas of your home. Instead, they will only pay the current, depreciated value of the damage. For example, if your five year old roof is damaged and needs to be replaced, an actual cash value policy will not cover the full cost of replacement and will only pay for the value of a five year old roof.

Where the insurance policy provides for replacement cost coverage, the insurance company is obligated to pay the full cost to replace the damaged structures. The way this typically works is the insurance company will estimate the damage and pay up front the actual cash value of the damage. They will, however, withhold what they call depreciation, or the difference between the replacement cost and the actual cash value. Once repairs are undertaken, the insurance company is then obligated to pay the depreciation and bring their full payment up to the replacement cost value.  Most insurance policies place a time limit on how quickly repairs must be completed in order for depreciation to be reimbursed.  These limits range from as low as 90 days to 2 years, so it’s best to check your insurance policy to determine how much time you have to complete repairs.

Problems can arise when an insurance company misstates the actual cash value of property.  Sometimes, they will “over depreciate” property, which means they will depreciate the property 50%, for example, instead of a more appropriate 25%.  By doing this, they hold onto a larger amount of depreciation money than they should, and force a policyholder to spend more money than they should out of their own pocket to complete repairs.  Other times, insurance companies impose short time limitations in which to complete repairs, and after a natural disaster, it can be difficult if not impossible to complete the repairs within the time imposed.