Which is a Better Choice for Homeowners Insurance - “Actual Cash Val

The goal of any investor is to protect their financial interests and where real estate is concerned that means protecting your property. Your rental properties may very well be the most valuable asset that you own. Choosing the best homeowner insurance policy is one way to help protect your investment.

Property insurance policies are written based on two basic insurance categories: Actual Cash Value (ACV) and Replacement Cost Value (RCV). It is important for a property owner to know the difference along with the pros and cons of each choice.

What is an Actual Cash Value (ACV) Policy?

An actual cash value policy insures the “AS IS” value of the property improvements. It is the cost to reconstruct the building less all depreciation. As the building ages and depreciates, your coverage is reduced.

How Does Actual Cash Value Work?

Assume that you have a 3 BR rental property that is 50 years old. It would cost $160,000 to rebuild it using available materials and current construction methods. The depreciation is estimated at 45%. The insurance policy is written for coverage totaling $88,000 ($160,000 – ($160,000 x .45). In the event of a total fire loss, the insurance company would provide you with a check for $88,000. If you decide to rebuild, you will come up $72,000 short.

Why Choose an ACV Policy?

An actual cash value policy is around 10 to 20% cheaper than the replacement cost value one. If you are willing to accept the risk, this can reduce operating expenses.

Another reason to choose and actual cash value policy depends on whether you would decide to rebuild if the damage made the property unlivable. If you would not rebuild, an ACV policy would be a good choice.

What is a Replacement Cost Value Policy?

A replacement cost value policy will reimburse you for the total cost to reconstruct the property in the event of a loss regardless of the amount of depreciation. The policy is based on current construction costs using the same quality of materials but modern construction methods. This means that if you have a turn-of-the-century Victorian home, the policy will take into consideration the extensive decorative trim work and ornate detailing but will not pay for a lathe-and-plaster interior finish since this method of construction is no longer utilized.

How Does Replacement Cost Value Work?

Using the previous property as an example, if the home was insured under a 100% RCV policy, then the owner would receive a check in the amount of $160,000. If several years have passed since the property was evaluated and construction costs increased, the insured amount would be adjusted to current rates.

Why Choose an RCV Policy?

Because the total construction cost of replacing the improvements is covered, this is the most comprehensive insurance policy and is the most frequently chosen one. Many policies will include a guarantee that covers replacement costs up to 125% of the insured value. This can be a great protection against rising construction costs.

Actual Cost Value versus Replacement Cost Value – Which Policy is Better?

To determine which policy is a better choice, you must first answer two questions. First, if your rental property was completely destroyed, would you rebuild or simply sell the lot and look for a new investment? If you have decided that you would not rebuild your investment property, then the Actual Cost Value policy is a better choice. This is especially true if you own an older run down rental. As it turns out, if you pay the higher premiums for the RCV policy and the insurance company finds out that you will not rebuild, they will only pay you the actual cost value anyway.

The second question is this: If you did rebuild, would you construct a similar home? If you are renting out an ornate Victorian home, are you able to charge rent that is commensurate with its value? Probably not. If the property was destroyed, you may decide to build a more basic investment property that would cost less to build yet demand market rent. In that case, choosing the Actual Cost Value policy may save you insurance premiums while still covering any future construction costs.

On the other hand, if you have a newer well-constructed rental property with average depreciation, then the Replacement Cost Value Policy will no doubt provide the coverage you need to protect your financial interests. Regardless of your choice, now that you know the difference between an ACV and a RCV insurance policy, you will be in a better position to secure your most valuable possession.