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Understanding The Difference Between Cash Value and Replacement Cost of Insurance


As you’ll see in any insurance guide, there are many choices when it comes to choosing the best insurance policy and the features associated with those policies. When you are insuring something like property or real estate, one of the biggest decisions that you have to make is whether you want the insurance company to reimburse you for your potential loss based on its current cash value (Cash Value Insurance) or the amount it would cost to replace the asset (Replacement Cost Insurance). The replacement cost option may be more expensive, but sometimes it can be well worth the added expense.

Cash Value Insurance Can Cost You

When you buy a home, for example, and insure it for cash value only, the insurance company will only reimburse you for a loss up to the value of your home. So, if you bought a $150,000 home and it was destroyed in a fire, the insurance company will only pay you the $150,000 original minus your deductible and depreciation as well. On this depreciation aspect, the insurance company will deduct an amount for the wear and tear you have caused on an asset before they pay out the claim. This can significantly reduce your payment and potentially leave you in debt.

With cash value, you may end up receiving a significantly less amount of money than your house was worth and insured for, especially if you’ve lived in it for a long time. With cash value insurance, the insurance company will pay whatever it believes your property was worth at the time of the loss.

Replacement Cost Clause Insurance Is Worth The Price

Replacement cost insurance is a great clause to have as part of your homeowner’s insurance coverage to ensure that you are completely covered for the entire cost of rebuilding should you have an insurance claim. With a replacement cost term in your insurance contract, depreciation is not deducted from your claim payout. The only thing you are responsible for is your deductible. So, for example, if you have a sixty inch plasma television that you have had for over five years that was stolen from you home, your insurance company would have to pay your claim in the amount of what it costs to replace your television with another comparable sixty inch television minus your deductible.

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Replacement Cost Insurance: Better Off Than When You Started?

One of the best features of having a replacement cost insurance policy is that you could potentially make a profit on a total loss. Let’s take your home for an example. If you bought your home ten years ago for $150,000 and it appreciated to a value of $250,000 when it burned down, you would receive the current amount it would cost you to rebuild the exact same house in today’s dollars, which could very well be that $250,000 amount because you had the total replacement cost clause in your insurance policy. Some insurers are now requiring policyholders to rebuild their homes with this money instead of pocketing the cash, which used to be an option. The reason for this is that insurers are trying to prevent things like fraud or excessive profiting on this type of insurance. If you still choose not to rebuild you home, many insurance policies may only pay you an amount equal to your home’s original home value. Figure this stuff out ahead of time before you sign up for a replacement cost insurance clause.

If you have cash value insurance, you will not receive the total amount of money your asset is insured for. You will be charged for depreciation and the wear and tear you created on the asset, such as your home. This can be a significant amount if you lived there for a long time. Opting for total replacement cost insurance can save you thousands of dollars and ensures that you are completely covered through rising inflation and other costs should you have a total loss. The most important thing is to understand the choices that you have when you establish your insurance policy. It’s not the right solution for everyone, but it’s something that each person should consider when evaluating insurance options.

What kind of insurance do you prefer?

Hank is a freelance writer, entrepreneur, and professional in the government sector. He is also a personal finance writer who is currently studying for his Certified Financial Planning (CFP) credentials. He has a Bachelor's Degree in Business Administration and a Master's in Finance.