When you file a property claim under your homeowner's insurance policy, an insurance adjuster will come out and take a look at the damage. As he looks at the damage, he'll make notes about what he sees to come up with an estimate on what it will cost to repair or replace the damaged items.
Insurance Policy Valuation
No matter what figure the adjuster comes up with, you can rest assured that the insurance company will not pay more than the maximum limit on your insurance policy. Additionally, you will be responsible for the deductible amount as indicated on your insurance policy. After establishing those two facts, the next item that helps adjusters to determine the amount an insurance company will pay for a claim is the policy's valuation clause.
The valuation clause spells out how the insurance company should calculate the claim amount. The valuation is either on actual cash value (ACV) or replacement cost.
Replacement Cost Valuation
Replacement cost valuation is just what it sounds like. The adjuster determines how much it will cost to repair or replace the damaged items, and the insurance company will send you a check for that amount minus the deductible. The replacement cost is the actual cost to repair or replace. There is no deduction for depreciation.
Actual Cash Value Valuation
The other type of valuation clause is called actual cash value. To determine the actual cash value, the adjuster starts with the cost to repair or replace the damaged items and then deducts depreciation from the replacement value. In other words, if you had a fire in your home and the building was burned to the ground, the adjuster would determine how much it would cost to repair or replace your home, and then deduct depreciation to account for the age of your home.
If your home was 10 years old, the adjuster would use the depreciation formula to determine how much your house depreciated in those 10 years. The depreciation will be deducted from the replacement cost and you will be issued a check for the depreciated value of your home. That insurance check will not be enough to repair or replace your home in today's economy.
Replacement vs. Actual Cash Value Insurance Policies
Although it costs slightly more to purchase a policy issued with replacement cost valuation, you will more than make up for the additional costs if you have one loss. There is nothing worse than finding out at the time of a loss that you will not be able to adequately repair or replace your loss due to depreciation.
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