How do RCV and ACV insurance policies work in this situation?

[Tyler D.]

I'm In the process of insuring my first property. I found a company that is willing to do ACV (Actual Cash Value) or RCV (Replacement Cost Value) insurance and will give me quotes based on a calculator where I can input the numbers. Help me figure this out.

First and foremost, I want liability coverage, which they offer $1Million of for $80 per year. Easy. Done.

Secondly, I want coverage for the house. The purchase price was $43k. However, another company quote the rebuild cost to be around $140k.

I don't care or need to have $140k to rebuild my house, but I do want my investment back if something catastrophic happens. In this case, if I went for a $43k RCV plan, would I get my $43k back if the house is destroyed? What about a $43k ACV plan?

To protect myself completely, do I need to raise the coverage to a certain level? If so, what should I raise it to? My end goal is to get my money back in case of disaster. 

[Ryan Ingram]

Hey @Tyler D., great question and good work on diving deeper into the topic to try and figure out which option is best on the front end, rather than after a claim. It’s generally too late, then. I’d like to take a moment to explain your options in detail, in hopes to help. 

Replacement cost and actual cash value are loss settlement options on both the property and personal contents inside the building.

As you’ve already figured, replacement cost on the building is determined by a calculator that takes into consideration all of the materials needed and the labor to rebuild the building exactly as it stands. If you were to look at a detailed calculator, you’d see drywall, the level of quality of the kitchens and bathrooms, the floor coverings, type of roof, and even the types of mechanicals in the building. Replacement cost will also generally include debris removal, in the event of a total loss.

For older buildings, there is an option called functional replacement cost. Insurance companies generally like to put this on any property built prior to 1940. An example of this would be putting drywall back in, instead of plaster. The underlying promise in insurance is to restore your property to the exact condition prior to the loss. So, unless the policy specifically states otherwise, if you have plaster, the policy promises to rebuild the plaster.

Actual cash value is tricky wording. It has nothing to do with the actual cash value of the property as it pertains to how much was paid, or what it could sell for.

Actually cash value=replacement cost-depreciation.

The general rule of thumb for calculating depreciation is 1% per year (from the date of construction) up to 50% or 50 years.

For example, let’s say a kitchen fire occurred and it would cost 15k to repair the kitchen. 

The replacement cost policy would provide 15k less your deductible.

If the house is older than 50 years, the ACV policy would most likely provide $7,500 less the deductible for that same kitchen fire.

However, there are some good things to note. If the property has recently been completely rehabbed, the insurance company may use the rehab year to calculate the depreciation.

The tornados recently came through Dayton, so I have some good examples of this.

One of my client replaced a roof 3 years ago before the tornado rudely ripped it off. He had an ACV Policy.

The insurance company used 1.5% per year for 3 years to determine the depreciation. So, my client received the replacement cost of the roof less 4.5% for depreciation, less his deductible. 

All this to say, an ACV Policy May not be too terrible if the property was recently built or rehabbed. I have around 40 properties, I personally have some ACV policies and some RC policies.

The amount the property is insured for (Coverage A) has nothing to do with the loss settlement options (ACV or RC). Some companies are very flexible and allow you to place whatever number you’d like on the value of the property. I have several policies that I’ve written for clients that have a 50,000 Coverage A limit and are settled at replacement cost. Similarly, I also have ACV policies in force that have a 150k Coverage a limit. This is common on properties that are built in the 1800s. Insurance companies don’t like to provide replacement cost on such old buildings.

So, in the kitchen fire example, my client would receive the full 15k to fix the kitchen. If the damage on the building exceeds 50k the building will be a total loss and my client would receive the full 50k. 

However, I would caution you heavily on only asking for a coverage amount equal to what you’ve paid for the home. 

Let’s say a loss occurs that exceeds the amount the building is insured. The chances of the loss leaving a completely clean lot are slim to none. Since the tornado recently came through, I’m picturing tons of debris and random walls still standing where a home or commercial building used to be.

As investors, we are all good humans trying to help and improve our respective communities. We will not leave blight or partially erect buildings as eye sores for all to see. We will pay for the debris to be removed and the remaining structures to be demolished.

If you insure the property for exactly what you paid for it, in the event of a total loss, you will have to pay for the debris removal and demo. So, you’d actually lose money and not recover your initial investment. 

I highly recommend that my clients add around 25k to the amount of their investment. I didn’t use a formula or anything to come up with that figure, I just think that would be sufficient to demo and clean up the debris of about any 1-4 unit building. 

Let me know if this helps, or if you have any other questions or concerns. I’d be happy to help clarify any insurance issues...or simply talk real estate!

Also, here are the main coverages in a policy:

Coverage A- Dwelling or Home

Coverage B- Other structures (detached garages, sheds, fences, pools, patios, etc)

Coverage C- Personal property

Coverage D- Loss of Use/Loss of Rents

Coverage E- Liability

Coverage F- Medical Payments