Have you ever seen the words replacement cost or actual cash value on your property coverage and not understood what they meant? If so, I can assure you that you are not alone! These terms are often associated with the extremely popular property coverage. The purpose of this article is to educate you regarding valuation used in property coverage so that the next time you come across this terminology you are familiar.
To start with, let’s look at defining what property essentially pertains to. Presumably, property is anything that contains value. Property consists of three categories: buildings, business personal property and personal property of others. Comprising the buildings category are items such as additions, outdoor fixtures and permanently installed machinery and equipment. Business personal property includes items located in or on the building such as furniture, fixtures, stock and all other personal property owned by you and used in your business. Lastly, personal property of others covers property that is in your care, custody or control. However, the property must be located in the building described in the declarations or within 100 feet of the building.
Now, what is valuation when it comes to property coverage? This is what we use to properly insure items included in property coverage. While property taxes are based upon the market value of the property in a specific area, insurance is based on replacement cost or actual cash value as this is the promise the insurance company makes to help you rebuild or reconstruct the property. As simple as it sounds, replacement cost is really what is says. It is the estimate of all costs that would reasonably be incurred to repair or replace the property that has been destroyed or damaged. In contrast, actual cash value is the replacement cost of the property less accumulated depreciation. In other words, it is the depreciated values of the property based upon the diminished useful life or the value when the insured does not repair or replace the damage.
Since market values fluctuate time after time, insurance companies often rely upon the replacement cost to make their calculations. Using the actual cash value approach can distort the worth of the property as the item immediately loses value once purchased due to depreciation. Specifically, this means you are unable to receive the same amount it would cost to purchase the identical or nearly equal item employing the actual cash value approach.
To put it simply, you will receive a smaller pay out using the actual cash value approach compared to replacement cost as replacement cost does not consider depreciation. In all reality, insurance relies on the principal of indemnity which means you will be returned to the point before the loss happened with neither a gain nor loss. Therefore, replacement cost is the best option to choose.
References
“Property Insurance Valuation Methods.” Insurance Associates Agency Inc. Insurance Associates Agency Inc., 10 Mar. 2016. Web.
“Valuation Loss Condition in the Building and Personal Property Coverage Form.” Reference Connect. IRMI, 2011. Web.