What’s the Difference between Actual Cash Value and Replacement Cost?

Reader Question: Can you explain cash value and replacement cost, and also tell me if it’s on renters insurance for my belongings?

If you live in a rental property, it’s important first, that you carry renter’s insurance, and secondly, that you understand fully the difference between cash value insurance and replacement cost insurance. Some renters imagine that their possessions will be covered by the building owner’s insurance. This is not the case and to leave yourself uncovered would be a serious mistake.

If you doubt that your material goods have sufficient value to warrant paying premiums on them, take a walk down the aisles of even a discount department store. You probably own at least two sets of sheets for each bed in your house. Price them. Each queen-size set will cost you about $40. When you add pillows, pillow cases, a bedspread, or comforter, you will easily spend $200 per bed. That doesn’t even include the cost of the bed.

Most often, you see these kinds of insurance policies in conjunction with homeowners’ insurance. But the same theory applies to renter’s insurance. In the event of fire or other disaster, this coverage is well worth the expense to buy replacement cost renter’s coverage to protect your belongings and their value.

Cash Value Renter’s Insurance: A policy such as this one will cover your possessions at their actual value. This means that the original cost or value of these items will be reduced to account for depreciation. Just like when you buy a brand new car, the minute you drive it off the lot it loses value. So it is with furniture, appliances, and other personal items, including expensive electronic equipment like flat-screen televisions, audio equipment, and computers. If there were a fire, you might lose up to 40% of the value of those items, which would leave you with far less than you need to replace the item. With cash value renter’s insurance, if you had a standard $100,000 and suffered a total loss, you would probably only receive $60,000, which is far, far less than you would need to replace your belongings.

Replacement Cost Renter’s Insurance: This kind of policy costs a little more, but is worth infinitely more to the renter in the case of a catastrophic loss. Usually, these premiums cost about 10% more each year, but will pay, as the name implies, whatever it takes (up to the full value of the policy) to replace your items with ones just like them. For the same $100,000 coverage we mentioned above, you will have an additional $40,000 worth of coverage for what amounts to about $3 per month in premium costs.

Naturally, your insurance carrier has procedures in place to protect the company from those people who would abuse the policy and attempt to profit from a terrible loss. Insurance policies are not get-rich-quick schemes. They are merely a way of protecting oneself from loss and should never be viewed as a way to make money.

Of course, with replacement cost renter’s insurance, the insurance company will expect you to use the money to actually replace your items. Usually this is accomplished by giving you only the depreciated value of your items until you produce receipts which delineate your actual replacement cost for which they will then pay. When you’re purchasing renter’s insurance, also ask about items such as jewelry and expensive musical instruments. Sometimes these items need to be listed separately.

Don’t make the mistake of waiting until you have a disaster to learn about renter’s insurance. In fact, don’t even wait until you’ve moved in if at all possible — secure coverage before you move into your new home or apartment. Additionally, if you wait until there’s a forecast about severe weather, insurers are likely going to put a moratorium on selling any kind of insurance, so have it in place as soon as you know the address and date you’re moving.

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