You may have heard it’s important to insure your rental property for its full value. This is good advice that can ensure you have sufficient coverage if you ever need to file a claim. However, property owners often neglect to check whether their landlord insurance policy provides actual cash value vs replacement value coverage. 

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What’s the difference between replacement cost vs actual cash value?

The value of an asset often depends on the method of valuation you use. 

For example, if you have a car, its value could be based on what you paid for it, how much it would cost to replace it or the price you could sell it for. These three numbers would probably be quite different.

These same general principles apply to the value of your rental property, how much property insurance is needed and how much your insurer will pay in the event of a claim. 

As the following examples illustrate, your claim payout can vary greatly depending on which property valuation method is used. Insurance policies generally use one of two methods: actual cash value or replacement cost value.

Here’s how these two values differ:

  • Actual cash value is the amount that your property is worth today, considering any loss in value due to depreciation. Actual cash value is sometimes called depreciated cash value. 
  • Replacement cost value is how much you would need to replace your property with similar items at today’s prices.

For example, let’s say you’re a landlord who rents out a furnished apartment. You purchased new furniture three years ago and paid $20,000 for everything. Now, a fire has occurred in one of the units, causing extensive damage to all the furniture. You decide to replace the furniture and file a claim with your insurance to cover the cost. Three values are identified:

  • Original furniture cost: $20,000
  • Actual, depreciated furniture value: $15,000
  • Replacement furniture value: $22,000

How much will your insurance policy pay in this claim scenario?

The amount covered by insurance will depend on whether the policy covers replacement value or actual cash value. Using this furniture example, let’s look at the insurance payouts:

  • If the policy provides replacement cost coverage: You will receive the $22,000 replacement cost, less the deductible.
  • If the policy provides cash value coverage: You will receive the $15,000 depreciated value, less the deductible.

Obviously, the first scenario with replacement cost coverage is preferable. The second scenario pays $7,000 less than the first, leaving the landlord to either cover the difference out-of-pocket or find less expensive furnishings, which could ultimately decrease the rental value of the unit. 

This valuation discrepancy isn’t restricted to furniture, and the differences in payout can be much more than $7,000 in other, more complex loss scenarios. 

Policyholders are often surprised by the impact of actual cash value vs replacement cost valuation as it pertains to roof damage claims. The average lifespan of a roof is typically 20 to 30 years, allowing a lot of time for depreciation. 

Roof valuation numbers can be vastly different:  

  • Original cost of roof: $56,000
  • Depreciated value of roof 17 years later: $8,400
  • Replacement cost of roof: $78,400

Different insurers may have different formulas to calculate depreciation and determine how much they would pay for your roof in a claim scenario, but one thing is constant: You will receive a much a higher payout with a replacement cost policy, especially if your roof is older.

If your roof is damaged and your insurance provides coverage using actual cash value instead of replacement cost, your payment might not be enough to cover the cost of a new roof. 

Which is better: insurance with replacement cost vs. actual cash value?

Buying insurance coverage that uses actual cash value can be less expensive, but that’s because you’re receiving less coverage. If you ever experience sizeable property damage, you will be glad that you selected a replacement value insurance policy. 

Think about what you would do if a storm severely damaged your property: you can’t rent out the property until you finish the repairs, but you can’t finish the repairs unless you have enough money to pay for the costs. If your insurance policy only provides actual cash value and you don’t have savings to cover the difference, you may be in a difficult situation because you have underinsured your property.

If you want enough insurance to be able to rebuild after a loss, you need replacement cost value insurance. If you have an older building and would need to rebuild with modern materials, you may also need ordinance or law coverage.

Pay attention to your policy terms

Insurance terms can be confusing, but it’s important to read and understand the fine print. If you ever experience a loss, the decision to buy actual cash value versus replacement cost can impact your payout and your ability to recover. 

In addition to making sure you have replacement cost coverage, check that your limits are high enough. The insurer will calculate your building’s replacement cost, but it’s smart to have a basic understanding of how these calculations work and how they will impact your payout in the event of a claim. Don’t assume that your agent has properly valued your property. Verify the numbers. If you’re comparing options from multiple insurers, check to be sure limits and terms are the same on all quotes.