Home Valuation vs. Replacement Costs: What You Need to Know
April 12, 2024
Your homeowners, renters or condo insurance provides valuable peace of mind should the unexpected come to pass by mitigating the financial implications of covered losses. As we continue to feel the ongoing effects of climate change — resulting in more extreme weather events that can damage our homes and property, such as floods and wildfires — carrying the proper coverage to make yourself whole again is essential.
Market Value vs. Actual Cash Value vs. Replacement Cost Value
When shopping for homeowners or renters insurance, you might use your property’s real estate value, also known as market value, to calculate the coverage you need. Unfortunately, taking this approach can lead you astray. Market value incorporates the intangible value of amenities like your school district, the availability of fire and rescue services and any nearby parks or other attractors. Basing your policy limits on your home's market value can cause you to become overinsured, a costly situation where you pay too much for excess coverage you might not need. Conversely, you could end up underinsured, as your home's market value does not factor in your belongings' values or estimated rebuild cost. Being underinsured results in coverage gaps where your insurance policy isn't enough to cover your total losses.
Instead, most carriers allow you to choose between actual cash value (ACV) or the replacement cost value (RCV) for your personal property coverage. While there might not seem like a significant difference between these two options at first glance, each one influences how much your insurer will reimburse you for your possessions — such as furniture, electronics, appliances and other costly items — and how much you pay in premiums.
What Is ACV and How Is It Calculated?
ACV is the cash value of your property minus depreciation due to wear and tear. You'll often see this term when it concerns the personal property covered under your policy.
For example, let's say your home floods and your mattress — which you purchased new five years ago for $2,000 — is ruined. Your insurance won't reimburse you the original cost but will offer you a fair rate for its current value. If the same flooding event damages your original hardwood floors, your insurance will evaluate the damage and assign them an ACV of $20,000 after depreciation. With a policy limit of only $15,000, you'll have to pay the remainder out of pocket.
ACV coverage usually costs less than RCV coverage, but that's because it offers less protection. If you want peace of mind that your home will be restored to its original condition after a loss — or as close as you can get it — it's worth exploring RCV coverage.
What Is RCV and How Can It Benefit Me?
We feel inflation in every part of our lives, from the prices at the grocery store to the premiums we pay our insurance carriers. If your home is damaged following a covered event, you don't want to be surprised by how much it will cost to return it to normal. That's where RCV coverage can help.
Unlike ACV, an RCV policy considers the costs required to rebuild or repair your home with materials of the same kind or quality. This includes the current value of items such as floors, windows and doors, as well as current labor rates and fees associated with hiring cleaning crews or debris removal services.
For example: Your home is in a region increasingly at risk for wildfires. You evacuate your home when one breaks out in a nearby wooded area. You return days later to find your home unharmed, but your charming backyard gazebo was reduced to cinders. If you carry an ACV policy, your insurance carrier will cut you a check for the value of the gazebo — after considering its age and previous condition. With RCV coverage, you'll be covered for the cost of rebuilding the gazebo using the same or similar quality materials, within the limits of your policy.
RCV is especially beneficial to policyholders due to the ongoing high cost of labor and materials. What initially began because of pandemic-related supply chain interruptions continues through the present day, with high materials costs and labor shortages driving up the cost of rebuilding, according to our 2023 Gallagher Private Client State of the Market Report. Naturally, this leads to higher limits and premiums for policyholders.
While most major insurance companies will estimate your home's ACV or RCV on your behalf, knowing which policy options work best for your situation can be difficult. Don't risk going underinsured by selecting the least expensive policy or paying too much money on your insurance and becoming overinsured. By working with a Gallagher Personal Insurance advisor, they can help you understand your options and secure the best policy to make you whole again in the event of a covered loss.