Actual cash value and replacement cost are two common ways that insurance companies value your property. When you purchase a commercial property insurance policy, you can choose whether to insure your property for actual cash value, replacement cost, or a combination of both. This affects how much money is paid to you if your business property is damaged or destroyed.

What is actual cash value?

Actual cash value (ACV) is a method of valuing insured property that takes depreciation into account. If you have an ACV policy, your insurer would provide funds equal to the current price or value of your damaged property—how much the item would be worth if you had sold it directly before it was damaged or destroyed. 

When calculating the value of an item, your insurer would consider how much the used item is worth, how old it is, its current condition, and how much useful life it would have had left if it had not been damaged. Your insurer would then subtract the calculated amount of depreciation from the original value of your lost item. Many insurance carriers use a fixed depreciation schedule. In this case, the value of your insured property decreases by a specified percentage each year. 

Example:

• Several laptops are stolen from your real estate agency’s office. Although the laptops cost $2,000 each when they were purchased three years ago, the used laptops are now worth only $900 each due to depreciation. A similar brand new model costs $1,700. If you have an actual cash value policy in place, your insurer will pay $900 for each laptop — their value before they were lost. 

With Actual Cash Value coverage, you would not be reimbursed for the amount you purchased the item for. Because the amount insurers would have to pay in the event of a disaster is lower, premiums for actual cash value policies are typically less expensive than replacement cost policies. This type of policy can be cost-effective for companies wishing to save money on insurance. However, if a disaster results in the loss of an expensive item or destroys much of your property, you could find yourself having to pay significant costs out of pocket since there can be a major difference between the claim payment and the actual cost of replacing your property.

What is replacement cost?

Replacement cost (RC) is the amount needed to buy a new item of similar kind and quality to an insured item that is damaged or destroyed. Replacement cost policies do not consider depreciation or the current value of the used item. They provide funds to allow you to replace your property with a new equivalent item. 

Because RC policies provide a higher level of coverage, premiums are typically higher than ACV policies. Replacement cost insurance is important to consider for companies that operate in disaster-prone areas, run businesses with a higher level of physical danger, or rely on expensive, specialized equipment that is difficult to replace or depreciates significantly over time. In the event of a major disaster, ACV coverage may not provide sufficient funds to help your business resume operations easily. If you have critical equipment that you rely on, RC coverage may help you recover more quickly in the event of a disaster. 

Example:

• A faulty refrigerator causes a fire to break out in your IT company’s offices, destroying several servers. Because you have a replacement cost policy, your insurer would pay for new equipment of similar kind and quality. 

Which is better: replacement cost or actual cash value?

	Actual Cash Value	Replacement Cost
Benefits	Lower premiums	Full replacement coverage pays for new items of similar kind and quality
Drawbacks	Less coverage due to depreciation costs	Higher premiums

Whether replacement cost or actual cash value policies are better depends on the needs of your individual business. When you choose which type of property insurance policy to purchase, it’s a good idea to assess your business’s risk level, how much you can afford to pay in premiums, and the value of the property you own.

Actual cash value policies have lower premiums, which will help your business save money. For many companies, this type of policy could provide adequate coverage and fit in their budget. However, these policies will provide less coverage in the event of a disaster, so when you’re choosing insurance policies, it’s important to consider the value of your business property and how difficult it would be to replace. ACV policies may be a good choice for companies who do not rely heavily on business property, own property that is not expensive, or would potentially be able to purchase used items to replace damaged property. 

Replacement cost policies have higher premiums and provide more extensive coverage. For companies that work with expensive, difficult to replace property that depreciates significantly, such as computers and other technology, this type of coverage may make more sense. It’s also important to consider whether your location or type of business is prone to disasters. For example, if you operate a business in an area prone to wildfires, it may be a good idea to purchase an RC policy since there is a higher possibility that you could suffer a catastrophic loss. 

It’s common to purchase property insurance policies that offer replacement cost coverage for what’s known as “real property,” which includes buildings and permanent equipment, machinery, and other fixtures, while offering actual cash value for business personal property, which includes furniture, equipment, computers, office supplies, and other property. Replacement cost coverage for buildings provides funds to repair or rebuild the structure, and these costs can be very different from the market value of the building. 

Is actual cash value the same as fair market value?

Actual cash value and fair market value are two distinct concepts that are used in different situations. Fair market value is the cost that an informed buyer and seller would agree is reasonable for an item, based on their knowledge of the current item price in the market. For example, appraisers determine fair market value for a building by evaluating similar buildings and comparing their sales prices. 

In contrast, actual cash value is determined by insurance companies. Insurers deduct the calculated depreciation from the replacement cost of the property. This amount is not necessarily the same as the fair market value of the item, although some insurers may use fair market value in their calculations. 

What is gap insurance?

Gap insurance, also called guaranteed auto protection, is a coverage option designed to cover the difference between a car’s actual cash value after a loss and the amount you still owe for the vehicle. Commercial auto insurance policies typically provide ACV coverage, which means the insurer will reimburse you for the value of the car at the time it is totaled or stolen. Since cars can depreciate rapidly, the ACV may be less than the amount remaining on your loan. Gap insurance policies, which are typically added by endorsement, can step in to cover the difference.

Final Word

When you select a property insurance policy, it’s important to understand the difference between actual cash value policies and replacement cost policies. Which type of policy is better for your business depends on a number of factors, including the type of work you do, your location, and the cost and depreciation rates of the property you want to insure. For some companies, ACV policies may provide sufficient coverage, while for others, RC policies will provide more complete coverage.