4 Min Read | July 5, 2023

What Is Actual Cash Value?

Actual cash value is a method used to calculate the value of insured property. Here’s how it works and how it differs from replacement cost value.

At-A-Glance

Actual cash value is a method of valuing insured property to determine the amount the insurer will reimburse you in the event of a loss.

It’s calculated by subtracting depreciation from replacement cost.

When you buy homeowners insurance or other types of property insurance, you may have to choose between actual cash value and replacement cost value coverage.

When you dive into the world of insurance, be it home, car, life, or health insurance, you’re bound to come across a slew of new terms. Actual cash value is one of those terms. Understanding actual cash value – and how it differs from replacement cost value – can help you determine which option works best for you.

Actual Cash Value Defined

Actual cash value is one method of establishing the value of insured property to determine how much an insurer will pay the policyholder in the event the property is lost or damaged. Actual cash value is typically calculated by subtracting depreciation from replacement cost at the time of the loss. In other words, actual cash value accounts for age and wear and tear when the insured, damaged property needs to be replaced.

How Insurance Companies Calculate ACV

Insurers use depreciation to calculate actual cash value (ACV). Depreciation is an accounting concept that spreads the value of an item over its expected useful lifetime. Insurance companies use a similar concept, but they approach the calculation differently from accountants. Insurance companies calculate depreciation based on the property’s condition when it was lost or damaged, what a new item would cost, and how long it would typically last.

For example, if your home floods and you lose three laptops, your insurer would consider the cost of similar laptops at the time of the loss. They would also consider the expected life of the laptops to determine depreciation. If the expected life of each laptop was three years, and your laptops were two years old, and the replacement cost value is $1,000, the actual cash value formula would look like this:

$1,000, the actual cash value formula would look like this: $1,000 – depreciation (67% of $1,000) = $330 actual cash value per laptop

Actual Cash Value vs Replacement Cost Value

Replacement cost value means your insurance policy will pay the cost to repair or replace your damaged property without deducting for depreciation. In other words, it’s the cost of replacing something with a new version, at today’s market prices, or the current price at which an asset can be bought or sold.

Determining replacement cost for belongings is simple – it’s estimated by figuring out what the same or similar item costs to buy today. Figuring out the replacement cost of your home is a little more challenging, since it factors in the cost of the materials and labor required to rebuild the structure, and maybe even to bring the dwelling up to current building codes, depending on the policy.

It’s important to note that the replacement cost for a home is just the cost of rebuilding it and replacing damaged belongings that were inside of it, not what you paid for the house. Therefore, replacement cost doesn’t consider things like a neighborhood’s desirability or the value of the land, both of which may drive home prices higher. Nor does it factor in the state of the housing market, which could also inflate the cost of buying a home. Replacement cost value is simply the cost of materials and labor.

Comparing Actual Cost Value and Replacement Cost Value

When you buy homeowners insurance and other types of property insurance, you might have to choose between actual cash value and replacement cost value coverage. Before you do so, it is important to consider the pros and cons of each and to fully understand how your policy will pay.

Many home insurance policies cover your home at replacement cost value by default. For example, if a covered event demolishes your home and your policy’s dwelling coverage is $450,000, you may receive up to that amount to rebuild or repair your home.

Your belongings, meanwhile, are covered under personal property coverage within your homeowners insurance policy. When you insure the things you own inside your home, you may be able to choose between actual cash value and replacement cost value. Many insurance policies provide coverage for personal belongings on an actual cash value basis.

For some people, replacement cost might be the preferred option because it restores your situation to what it was before your covered loss occurred and doesn’t subtract depreciation. That also means you are protected against material and labor cost increases, which is especially important in times of high inflation. However, replacement cost value policies often cost more.

Actual cash value coverage may be less expensive, but it may not offer financially sufficient coverage if you suffer a loss. With actual cash value, you would need to make up the difference between the depreciated value and replacement value if you want to replace your belongings.

The Takeaway

Insurers use actual cash value to determine the cost to replace an item minus depreciation. It’s typically calculated by subtracting depreciation from the insured property’s replacement cost at the time of the loss. On the other hand, if you insure your home or belongings with replacement cost value coverage, you’d be reimbursed for the market price of materials and labor – or that of the covered belongings – without accounting for depreciation.

Justine Brown is a writer based in California who focuses on technology, business, and finance.

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.