Have you compared your home insurance policy (or any property insurance policy) and see some insurance policy state they cover on replacement cost basis and others state they cover actual cash value basis? What is the difference?
The reality is that in some cases it is night and day difference. In case of a claim, actual cash value bases will take into account depreciation. The theory is that in case of a claim, the property must be depreciated because it has been used (no longer brand new), so why should new prices be paid to replace this property. Insurance is in place to indemnify, NOT for insured’s to be better off (or benefit) after a claim, so ACV is a generally accepted insurance principle.
ACV Example: you have a 20 year roof on your 2000 year build home. In 2015 (you still have the same roof from year 2000), a hail storm hits Austin and it tears down all your shingles, you now need a new roof. Actual cash value basis will depreciate your roof by 75% (15 years roof has been in place / 20 years roof expected life), minus the deductible. If we assume your deductible is $1,000 and the cost to replace your roof is $10,000, the estimate pay out on this claim is $1,500 ($10,000 – $7,500 (75% of$1,00) – $1,000 (deductible))
Many insured complained at the ACV arrangement, so insurance companies came up with replacement cost payout basis. There is no depreciation taken into account in replacement cost. Let’s use the same examples we used above, but apply replacement cost instead.
Replacement Cost Example: on the same 20 year roof which cost $10,000 to replace after 15 years, the payout would be $9,000. The logic used here is that in case of a claim, the insured would have to buy new wood, paint, shingles, etc. Therefore, the insured sustained no true gain the insurance company paid for the claim. So the concept of “indemnity” still stands.
The reality is that purchasing a replacement cost policy is much more expensive and more difficult to qualify. Generally, only property in very good condition will qualify.