Actual Cash Value
Actual cash value is another popular property insurance valuation option. This method functions in a similar way to replacement cost in that it considers the cost to replace or repair a property. However, a deduction is made to the valuation to account for depreciation to the original property. Think of actual cash value as being replacement cost minus depreciation.
An actual cash value property insurance policy will still rebuilt or repair the property using modern construction techniques and materials. But since the building value is reduced by depreciation, it allows a client to insure their property for less. The client will receive less for their claim as well.
We typically see the actual cash value property insurance valuation option work better with businesses that do not need their building to be rebuilt as-is. Building owners of older buildings with expensive building methods may benefit from actual cash value if they would prefer rebuilding using less expensive methods. Actual cash value policies generally have lower premiums than replacement cost plans.
Suppose you are a manufacturing business that occupies an old car dealership downtown. The building is solid masonry, much of the first floor is covered in marble, and the roof is slate. Should your building be destroyed by fire, it would cost $1,000,000 to replace it with the same building materials and methods.
- Total Loss Scenario: Suppose a fire destroys the building. If you insured the structure for $1,000,000 replacement cost, you would receive $1,000,000. If you insured it for $700,000 actual cash value, you would receive $700,000. Although you receive less with the actual cash value property insurance valuation option, you also pay less for insurance premiums.
- Partial Loss Scenario: Suppose the fire only damages the roof and that repairs will cost $50,000. If insured at replacement cost, you will receive $50,000 to repair or replace your roof. However, if insured at actual cash value, the amount you are paid depends upon how old the roof was since depreciation is a factor. If the roof was 50 years old, at the end of its life cycle and in need of replacement already, you would receive very little for the claim. However if the roof was brand new when damaged, you would receive full value.