Actual Cash Value vs Replacement Value Insurance

8 Replies

Are there any kind of formulas typically used when determining if you want your landlord policy to cover replacement cost vs actual cash value?

I am looking at 6 properties right now.  On some of them, my purchase price is significantly lower than the actual cash value.  Also, the cash value on some of them is much lower than what it would cost to replace.  I'm just trying to get a general feel of what most people do.

@James Maher Remember that your value includes the value of the land. I personally think most people have there houses over insured, mainly due to them using the price they paid or the mortgage balance as the basis.

All of my policies are based on a stated value, which the insurance companies then compare with what they think replacement value is.  My insured value is for more than any mortgage that I have on the property.

If you are in a particular situation where the land really has no value (i.e. you could not rebuild a house for less than its market value), then you might consider having a higher insured value than what the property was worth.  But for every dollar of additional coverage, your premiums would be more.

I am sure there are some insurance agents on BP here that will provide some additional insight.

@James Maher For me, which insurance company I use dictates whether I get cash vs replacement value.  The cost of the insurance is directly related to their liability.  So if you have a property that has a cash value of $50K, but a replacement value of $100K, insurance for he former will be less than insurance for the latter, though I don't think it is directly proportional.

One thing you'll have to consider is if your house is basically "totalled," meaning, the cost of repairs exceeds the value, and you have a cash value policy, then what do you do?  Say the kitchen burns  but the rest of the house is good.  But still it would be more than the value of the house to repair.  Do you just board it up?  Do you tear it down?  Who is going to pay for that ?

I'm no expert but I did just listen to podcast #64. Josh Sterling, Brandon Turner and Josh Dorkin seem to all be in agreement that they only use cash value insurance for their properties.

Their reasoning was of course lower premiums to pay but also that a cash value policy was more then enough to cover the capital they had tied up in the property. They all said that they have used replacement value policies when partnered with someone that felt more comfortable with having more insurance.

So I think it's just a matter of what your comfortable with.

Of course having said that I personally have replacement value insurance on my rental, which I'm thinking I should change.   

You want to make sure that when your tenant or property manager calls to let you know the home is no longer there,  your day doesn't get worse after you speak with your insurance agent.   

The problem with this question is it's a risk tolerance question.  There is no right answer.  

Here are the facts.  If you choose replacement cost you will absolutely pay more for coverage.  If you choose replacement cost and IF there is a claim, you will pay less out of pocket.  Now reverse and repeat for Actual Cash Value (less for coverage, paid more out of pocket IF a claim occurs).

So now we're to the proverbial glass and is it half full or half empty.  By nature an investors will weigh more to half full, why?  Because if they didn't have that optimism, they would probably be still on the sidelines.

So it comes down to how well will you sleep knowing you are potentially out of pocket a large sum on a $250,000 house (replacement cost, or to put it more easily a mid-century ranch in middle america that has 2200 square feet).

@Larry T. hit the nail on the head.  So you get that bad call, there was a fire, not bad, but not good.  The property manager says the fire was contained to the kitchen and the contractor says they can repair it for $60,000.

What did that contractor just tell you?  Replacement cost.

What is Actual Cash Value?  Replacement cost minus depreciation.

So now the adjuster comes out and he uses the standard depreciation (I see it all of the time at 40%, they use complex calcs, but it basically always shakes down to a stones throw of 40%).

Now the adjuster is telling you the check he will write on the $60,000 in damages is $35,000 (assuming a $1,000 deductible).  Can you afford the $25,000?  Can you sell the house as-is and break even?  Can you tear it down, walk away and get another house with the $35,000?  

It's risk tolerance, so if you purchase stocks, are you a guy that picks a company and buys into it, or do you buy a mutual fund?  What's the right answer?

@Derek Lacy laid out the most common claim scenario that every investor should be discussing with their agent. 

@James Maher Ask your agent to walk you through how the RC and ACV policy will react to a $50k claim.  They should be able to give you a good ballpark claim payout.  Once you have those #'s, you can make an informed decision.  Until you run the #'s, your just guessing.

@Mike Wood All policies only take the building value into consideration.  The insurance policy does not include the value of the land.  If you have been factoring that in, and you have a RC policy, you may want to go back to your agent and try and negotiate the value down.