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Actual Cash Value Policies Cost Less, Protect Less

By Mike Heuer

There essentially are two types of homeowners insurance protection when it comes to indemnifying policyholders for their financial losses – actual cash value and replacement cost. Actual cash value is the more affordable alternative to replacement cost as it costs insurers less to pay claims. But actual cash value also can leave homeowners vulnerable to financial loss beyond what insurance claims might pay.

Actual cash value takes into account several factors, the primary factor being depreciation. Depreciation is defined as the cost to repair or replace a damaged or destroyed home minus depreciation costs due to wear and tear and other factors. Among those factors are numerous court judgments that essentially break down depreciation and actual cash value among three key elements.

The first of those three elements is the replacement cost minus depreciation. As stated, depreciation takes into account wear and tear of a home or structure. But it also takes into account the demand for something of value. Because new homes can be built, the older a home is, the lower its value generally becomes over time due to depreciation. But the land on which that home is built typically will appreciate in value due to the fact land is a finite source that cannot be added aside from land reclamation along waterways and coasts.

So when a home is built, over time, the structure will lose its value while the land on which it is built likely will appreciate. But for insurance purposes, only the value of the home determines the amount to be paid if a claim is filed due to a loss caused by a covered peril. Most insurers will use the replacement cost minus depreciation formula to determine the actual cash value, and many court cases have upheld that measure of actual cash value.

Actual cash value also can be determined by the fair market value of a home. Insurers can assess the fair market value by the amount for which similar homes are sold and base claims accordingly. The price of homes can vary based on several factors, such as location in a neighborhood, quality of local schools and future development. Depending on the type of development, the value of a home or the land on which it is built might appreciate or depreciate.

The third element sometimes used for determining the actual cash value of a home is the “broad evidence” rule that takes into account the fair market value of a home as well as its replacement cost minus depreciation. Some jurisdictions will favor one definition over the other, but both essentially are used to determine the actual cash value of a home. Both also have several court decisions in their favor, so the primary method used might vary by state.

If unsure of the actual cash value of a home or other structure, it can pay to do legal research or hire someone to do legal research to learn how the state in which it is located bases actual cash value determinations.