Insurance companies exist to help protect our financial assets in the event of a covered peril. However, the amount of money you get as reimbursement will vary depending on what method the company uses to calculate the value of your possessions.
What Is Actual Cash Value?
Also known as market value, actual cash value is a common method insurance companies use to assess the current value of the item you need to replace. It works under the following formula:
Replacement cost - Depreciation = Actual Cash Value
The insurance company would research the current price of similar items to the one that you need to replace. Then, they would subtract the depreciation—the value that your item has lost due to things like wear and tear (remember that almost no item is worth the same after some years of use). The remaining amount would be the actual cash value.
As you might have been able to figure out, this means that you would be paying a difference to replace your item since depreciation costs keep the reimbursement amount below the market value.
Example of Actual Cash Value
Let’s say that you have a fridge that breaks down during a storm. Similar fridges are currently worth $1,000, but you’ve had it for five years now when the average lifetime is 10 years. The formula would then look like this:
$1,000 - $500 = $500
In this example, 1,000 divided by 10 years = $100 of depreciation per year times 5 years = $500. This is the amount that your insurance company would be able to reimburse you for the fridge.
How Does Actual Cash Value Coverage Compare to Replacement Costs Coverage
While actual cash value coverage is one of the most commonly known methods, it is also not the only one. The replacement cost method tends to be the most favorable and the one that most people prefer. That’s because this method, unlike actual cash value, does not take into account depreciation costs. Instead, the company would pay you for the cost to replace the item. Referring back to the fridge example, this would mean that the company would pay you $1,000 for the fridge.
Which Method Does My Insurance Company Use?
If you’re not sure which of these methods would apply to you, you can always check your insurance policy declaration. In it, you should be able to find the information you need.
Actual cash value is a method that insurance companies use to assess the current value of the item you’re looking to replace. Unlike replacement cost, actual cash value takes into account depreciation costs; this is why most people prefer the replacement cost method.