What does 'actual cash value' mean in an insurance policy?

Editor’s note: This column is part of PropertyCasualty360’s Foundations of P&C Insurance series, which aims to bring new insurance professionals up to speed, while keeping industry veterans sharp. On Fridays, PC360 will offer up fresh content covering the nitty-gritty details of P&C insurance, tips for professional development, articles looking at the industry’s more niche concepts, and the history of certain lines and programs.

The purpose of insurance is to help people and organizations recover from the unexpected and to reduce the financial blow when the unexpected does occur. However, not all policies are created equal. Some might establish the value of damaged property based on its actual cash value (ACV), while other policies might settle based on the replacement cost or a predetermined amount.

Put simply, the ACV is the money needed to repair a home damaged by a hurricane, for example, minus the decrease in value due to age or use, according to the North Carolina Department of Insurance.

However, ACV is easier to understand by looking at its counterpart, replacement cost, and how it works, according to Steve Colorundo, director of claims at Plymouth Rock Home Assurance Corp.

“The way I describe replacement cost, especially to new adjusters, is that we want to write an estimate that brings the covered claim to the place it was the second before the loss occurred,” Colorundo explains. “If you were building the home from the ground up, that would be the replacement cost.”

He says an easy way to think about ACV is to consider it as the used value of the property. Although in the case of home insurance, this would not be the market value as the value of the land would not be factored in.

According to IRMI, ACV is typically calculated in one of three ways:

1. The cost to repair or replace the damaged property, minus depreciation.
2. The damaged property’s “fair market value.”
3. Applying the broad evidence rule, which calls for “the selection of that ‘value,’ which, in the event of a total loss, will provide complete indemnification and no more,” according to IRMI. Not every state allows for this. This could be the replacement cost, estimate profits the property would have turned or the tax value.

So which is better to have included on an insurance policy? Colorundo says everyone’s situation is different, and it all comes down to the policyholder and the property being covered.

For policyholders seeking lower premiums or with the means to come out of pocket to cover a portion of a loss, ACV might be the way to go. However, Forbes Advisor found that the average home insurance costs increased by 8% when adding replacement cost coverage to a policy.

Colorundo does note that while depreciation is applied in ACV-based policies, deprecation is recoverable on HO-3 type policies (the most common home insurance policy).

While the difference between ACV and replacement cost might be clearer now, the right decision for a policyholder is more nuanced. This makes the advice of agents and brokers even more vital for policyholders.

“Knowing the loss settlement language in your specific policy is important because you don’t want to be blindsided,” Colorundo says, continuing: “Many people have insurance, and they might not use it for 20 years and think we have a certain type of coverage and realize once we finally need it that we don’t. It is really good to speak with someone as soon as possible to understand the options that you have.”

Related:

• The fundamentals of the insurance adjuster’s code of ethics
• Deciphering the designation: CPCU
• Equipping the next generation of insurance claims professionals