Choosing the Best Settlement Method: Replacement Cost vs Actual Cash Value

When it comes to settlement methods, you have two options to choose from Replacement Cost (RC) and Actual Cash Value, (ACV). These two options determine how your claims payout is settled in the event of a loss. So, what’s the difference? Depreciation. Regarding property insurance, depreciation represents the estimated reduction in value based on how much useful life is determined to be left in the damaged property. This is calculated by an adjuster, factoring in criteria such as age and general wear and tear.??

Both RC and ACV account for depreciation. However, one settlement method allows for reimbursable depreciation whereas the other does not.?

Replacement Cost (RC)

This settlement method allows claims to be settled with reimbursable depreciation. Replacement Cost coverage requires you to be insured to a higher valuation per square foot but provides you with more financial protection.??

For example, a kitchen fire at your property causes a partial loss, totaling $30,000 in damage. The deductible on this property is $3,000, so the insurance carrier will pay no more than $27,000. An assigned claims adjuster visits the property to determine how much useful life was left in what was damaged. The actual cash value of the loss after depreciation is determined to be $15,000. You will receive a payment of $12,000 (the actual cash value minus the deductible). That $12,000 will go towards the necessary repairs and replacements. If expenses exceed that amount, you will pay out of pocket. ?

Let’s say the cost of repairs totaled $20,000. With provided receipts, a second check for reimbursable depreciation will be issued for an additional $5,000. Replacement Cost allows you to recoup some or all of the depreciation that was taken from you. The only part that is not recoverable is your deductible. ?

Actual Cash Value (ACV)

Actual Cash Value policies pay the depreciated cost to repair or replace your damaged property and/or its contents. ACV coverage pays you for what the property and/or its contents are worth at the time of loss. Coverage with this settlement method is typically 20-25 percent cheaper than an RC policy and allows you to be insured to a lower value per square foot. However, ACV does not allow you to recover any depreciation. ?

For example, the same $30,000 kitchen fire occurred at a property with an ACV settlement method and a $3,000 deductible. The adjuster depreciates $15,000 from the loss. You will be issued a check for $12,000 (actual cash value minus the deductible). With an ACV policy, $12,000 is all you can recover from this $30,000 fire loss.??

What you may not know is you can do whatever you want with that money- fix the damage or cut your losses, sell the property as is, and use the money to buy a car.??

As a side note, depreciation is extremely difficult to determine until the loss occurs. It is based on the date of the last updates, not the original year built. Everything depreciates at a different rate, but the average is about 1% annually. Although roofs deteriorate much quicker due to weather exposure. ?

Consider the following when choosing your loss settlement method:

1. At NREIG, we always recommend that you consider what you would do in the event of a total loss. Would you rebuild the property? Or would you clean up the land, sell it, and move on to another opportunity??

• If you would not rebuild, there is very little reason for you to have RC coverage. You would be paying more to the insurance carrier than you would ever recover in the event of a loss. Remember, you must make the necessary repairs to be able to recover the depreciation.??

2. You may be wondering why we are speaking in terms of a total loss and not a partial loss. There are a couple of reasons:?

• You most likely can make the repairs (or have access to someone who can) for substantially less than what your insurance carrier thinks you can.??
• We have noticed that 60-65 percent of our investors who suffer a partial loss and have Replacement Cost coverage never go back to the carrier to recoup any depreciation. Not because investors don’t want to, but because the initial payout was enough to make them whole again. ?

3. If you have a loan on the property, most likely your lender will have a set of insurance lending requirements that you will have to meet or exceed. Oftentimes, lenders will require you to carry Replacement Cost coverage. ?