Difference Between Actual Cash Value vs Replacement Cost
The following article provides an outline for Actual Cash Value vs Replacement Cost.
Value of a Product:
Since we humans have decided to formalize exchange values, we have created currencies to measure the worth of a product. This is labeled as the Value of the Product. Remember this basic term as it may be of use ahead.
Actual Cash Value vs Replacement Cost:
These are the two methods of valuing a particular property, and the two heavily differ from each other. Insurance companies may use these terms in their policy statements to clarify how your property may be valued in case an insurance claim is filed.
Actual Cash Value
Actual Cash Value (ACV) is a way to measure the value of a particular property to settle an insurance claim. Insurance companies mainly use Actual Cash Value to determine how much reimbursement to shell out to the insured in case of a claim. Items valued at Actual Cash Value are definitely valued lower than their actual buying price. The valuation is done in a manner just like when you decide to sell off your laptop or furniture on OLX, Quikr, etc.
At a very basic explanatory level, Actual Cash Value is calculated as Replacement cost minus the accumulated depreciation. Out of these two distinct factors in play, depreciation is usually estimated based on the useful life of the asset or product. Actual Cash Value is never clear, as someone might claim a laptop’s useful life to be 8 years, while some might claim it to be 5 years. This affects the depreciation value, and thus the book value of the asset. In the case of vehicles, the value determination becomes a lot trickier as along with the age of the vehicle, its fuel type, mileage covered, maintenance record, damages, if any, the number of previous vehicle owners, etc. are all key factors in determining the Actual Cash Value of a vehicle.
Replacement Cost
Replacement Cost or Replacement Value is the amount a person would have to pay to replace an asset. It’s the actual cost to replace an item or asset at its pre-loss condition. While replacement cost may not exactly be as high as a “new market value” of the asset, it may also not be as low as the Actual Cash Value, which excludes depreciation.
In cases of an insurance company paying out the Replacement Cost of an asset, in an insurance claim, the insured will have actually to replace the asset in the first place. After replacing the asset, the insurance company may ask for a lot of information to finalize a full settlement offer for the customer.
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In some cases, the insurance company may disburse insurance claims via 2 cheques. The first cheque is given immediately to the customer, and it is worth the Actual Cash Value of the damaged or lost asset. The other cheque that includes the balance of the replacement cost may be sent after verification of the fact that the customer has actually replaced the item.
Replacement cost valuation may have a standard deductible for each kind of product, and this may be reduced from the current market value to arrive upon the Replacement Cost finally.
Example 1: Let’s assume a user has an iPhone XS that costs $1,000 and insures it in full replacement insurance with a deductible of $100. Now, if the phone is stolen and an insurance claim is filed, the user can claim $900 from the insurance company after buying a new iPhone XS worth $1,000.
Example 2: A user purchased a new car worth $8,000 and insured it in full replacement insurance with a deductible of $1,000. Now, if the buyer makes a valid insurance claim after 2 years, the insurance company is liable to offer the user that exact car model’s market price minus the deductible. Let us assume that since 2 years have passed, the same model of the car is now worth $6,500.In that case, the user receives;
Market Value of the insured asset – Deductible = $6,500 – $1,000 = $5,500.
Head to Head Comparison between Actual Cash Value vs Replacement Cost (Infographics)
Below is the top 4 difference between Actual Cash Value vs Replacement Cost
Key Differences Between Actual Cash Value vs Replacement Cost
Both Actual Cash Value vs Replacement Cost methods is mainly based on today’s cost to replace a damaged asset with a new one.
Let us discuss some of the major differences:
- However, Actual Cash Value indicates the Book Value of the asset or item in the insurance company’s books. This particular issue is always heavily contested as depreciation is heavily subjective. On the other hand, the Replacement Cost is comparatively simple. The only factor affecting the cost there is the age of the replacement asset.
- The calculation involved deducting Depreciation in the calculation of Actual Cash Value, whereas Replacement Cost involves the reduction of only a standard and mostly pre-determined deductible.
- Insurance policies using Actual Cash Value are mainly undertaken in case of items that can easily be replaced by the user, versus Replacement Cost method insurance is bought in case of assets that are fairly costly and tough to replace.
Actual Cash Value vs Replacement Cost Comparison Table
Let’s look at the top 4 comparisons between Actual Cash Value vs Replacement Cost:
|
Actual Cash Value |
Replacement Cost |
| Definition | |
| An actual value of the asset as calculated in the books of the insurer. | Usually denotes the Market Value of the asset, given certain conditions are fulfilled. |
| Mathematical Calculation | |
| Replacement Cost – Accumulated Depreciation. | Current Market Value – Deductible. |
| When To Choose Which | |
| Actual Cash Value is chosen for items that the insured can choose to buy from his/her savings. This is also important for items that may not suffer any damage during their useful life. | Replacement Cost is the method opted for in case of expensive products, and the insured may not be able to replace them from his/her pocket. |
| Affordability | |
| Actual Cash Value is much more affordable in terms of the premium payments and allows peace of mind that the items are insured. | Replacement cost premiums are fairly heavy on the pocket and hence needed to be chosen wisely only for requisite assets. |
Conclusion
While both methods assure a user the ease of replacing the item or asset in case of damage, the user has to appropriately select the method of valuation, where he/she can balance both the risks and the affordability of the replacement of the product.
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This has been a guide to Actual Cash Value vs Replacement Cost. Here we also discuss the Actual Cash Value vs Replacement Cost key differences with infographics and a comparison table. You may also have a look at the following articles to learn more –
