Broadly speaking, there are two types of home insurance policies, actual cash value policies and replacement cost policies. There are multiple forms (we’ll look at those next week), options and perils, but they all end up in one of these two broad types.
Actual Cash Value Policies
This is a very basic policy in what it covers and what it pays. Actual cash value or ACV policies typically have these attributes;
- They are usually named peril policies – they cover only those perils (causes of loss) that are listed in the policy such as;
- Fire & smoke
- Vandalism & malicious mischief
- Wind & hail
- They can cover more such as water leaks, but they have to be added as optional coverage (this is referred to as endorsing the policy)
- Claims are paid on a depreciated basis
- As an example of paying a claim in a depreciated basis, let’s assume we have a home with a 20 year composition shingle roof
- The roof’s been there for 8 years and there’s a hail storm that damages the roof and it needs to be replaced.
- The cost to replace the roof is $8,000. Since the roof is a 20 year roof, the roof is depreciated by $400 a year ($8,000 / 20 years) or in this case $3,200.
- The remaining “value” of the roof is $4,800 which is further reduced by the amount of the deductible and the claim is paid.
- While this policy type will save the homeowner money in the short term, it will potentially cost more in the long term in the event of a claim.
Replacement Cost Policies
Replacement cost policies provide the homeowner a more complete level of protection in the event of a loss / claim.
- A replacement cost policy can cover only named perils or they can cover everything unless it’s excluded such as earth movement (more on that next week)
- Claims are paid on the basis of what it would cost to replace a specific loss
- In the example of the hail claim above,
- The age of the roof does not matter
- The only thing factored is the cost to replace the roof (materials & labor) less the wind/hail deductible
- Most policies sold today are either replacement cost to begin with or endorsed to make them that way (always check though!)
- Replacement cost coverage should be on the home (dwelling) as well as your contents (some policies come with the home protected at replacement cost but the contents are covered as ACV – make sure both are set up as replacement cost)
- The amount of replacement cost is limited to the amount of coverage on the home and the amount of coverage on the contents or personal property (make sure it’s enough for both)
Some policies originally came as guaranteed replacement cost. With this type of policy, the home would be replaced regardless of the amount of coverage on the home in the event of a total loss. Most insurance carriers have moved away from this policy type, however there are a few that still offer this as an option.
Actual cash value and replacement cost policies have their place depending on the coverage that is wanted and needed. Also, remember your mortgage company may require you to have a replacement cost policy. The bottom line is to know what you’re buying and what coverage you need to have. No one wants to find out what’s covered and what’s not when a claim is filed.
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