Replacement Cost vs. Actual Cash Value

12 Replies

I heard Brandon on on the BP Podcast mention that he uses cash value policy vs replacement cost policy.  I've read that cash value can be messy. Thoughts?

Personally, my lenders will only do replacement cost. So I am forced to do that. 

But in my markets cash value policy is cheaper than the replacement cost. It really depends on your market and if the cash value is higher than replacement cost or not...

It’s not that ACV coverage is messy as much as the average person does not understand how claims are handled on an ACV policy and/or what the minimum amount of coverage is required by the carrier on an ACV policy. They just look at cost.
First: What is covered?
ACV polices will list 8 or so types of loss that will be covered by the policy and if it’s not named...it’s NOT covered.
RCV polices are an “all risk” type of policy so it will only list the exceptions that are not covered - as long as the loss isn’t listed as an exception than it will be covered.
It’s complicated and is why some people hate the concept of insurance because they end up learning this stuff as part of filing their first claim.
Next - how would a claim be handled?
Ex: A house with a 15 year old roof sustains enough storm damage requiring it to be replaced and the roof damage is estimated at $20,000 and assume a $1000 Policy deductible.
Replacement Cost - will pay out $20k for the roof minus deductible. Payout = $19,000
ACV - will pay out $20k minus a depreciation factor (probably 50% depreciation on a 15 year old roof) then subtract the deductible.
Payout = $9000
Leaving the property owner paying out of pocket $11,000 to fix the roof.
Big difference right?
Replacement Cost is obviously better but...
On a Replacement Cost Policy you’ll be required to carry the Dwelling Coverage amount something close to the full estimated cost to rebuild the home.
Diff states have vastly different rebuild cost.
In my state it averages around $150 per square foot to rebuild x 1000sqft = $150,000 A replacement Cost Policy would require you to carry $150,000 dwelling coverage.
But it’s Cleveland Ohio and you bought the house for $35,000. It was built in 1910 and may be a little rough around the edges, tougher part of town, etc.
There’s more to it than that but hopefully that helps.
An agent who understands investment properties and what your goals are could break it down a lot more than what I just gave.

@Aram Velazquez It can be messy,  just like hiring a handyman off of craigslist.  If managed properly, it can work.

It's dependent on so many variables, that you cant make a blanket statement on it.

it up to the investor, their resources, the type of property they are insuring and what other insurance options are available for that property.

In FL, if you have a $50,000 1960 frame building, that has an ACV (Cash Value) premium at $500 and the Replacement Cost premium @$4000, you may go with the ACV and save $3500, but take on the additional risk.

We always do replacement cost, but I have a friend who only does ACV. His average all in is 42k in a more rural area so he figures if he loses one someday his losses are somewhat capped.

We prefer higher grade assets, so we go with replacement coverage.

Originally posted by @Jason Bott :

@Aram Velazquez It can be messy,  just like hiring a handyman off of craigslist.  If managed properly, it can work.

It's dependent on so many variables, that you cant make a blanket statement on it.

it up to the investor, their resources, the type of property they are insuring and what other insurance options are available for that property.

In FL, if you have a $50,000 1960 frame building, that has an ACV (Cash Value) premium at $500 and the Replacement Cost premium @$4000, you may go with the ACV and save $3500, but take on the additional risk.

Thank you Jason,

I think I'm getting a better idea on what the differences are and the many variables that are involved.

Originally posted by @Ryan Arth :

We always do replacement cost, but I have a friend who only does ACV. His average all in is 42k in a more rural area so he figures if he loses one someday his losses are somewhat capped.

We prefer higher grade assets, so we go with replacement coverage.

Ryan,

Like you I have replacement costs on my properties , but like your friend, my 2 properties are in more rural areas; valued at about 50k for one , and 60k for the other. Would the savings be worth the extra risk? not to mention the co-insurance penalty, that has my head spinning, lol. Thoughts? 

It really depends on your market. I can set my replacement cost value and pay insurance accordingly. I insure for what I owe and my equity but not the full replacement. If my place burned to the ground then I would get my loan paid off, have my equity, and sell the lot. The cost to rebuild would be too high to rebuild what is there now. Of course, that could change depending on values in the market but I can adjust my policy whenever I want.

@Aram Velazquez I would guess you would save a couple of hundred a year per property If you dropped down to ACV. You can decide from there.

@Michael Norris I am not an agent, you may try Your policy will be different depending on the area. Insurance companies are designed not to loose money, LOL.  With that said, if you do it correctly, you can do VERY well on a claim. I had a house catch fire. It was a 4 unit. (2 doubles on 1 lot.) One unit burned. I had the claim up to around 70k, fixed it myself for about 13k and paid the property off with the difference. From that point forward, I encourage my tenants to smoke in bed. LOL! 

Point is, in the unfortunate event of a disaster, I would highly recommend being your own General Contractor and not using a "storm/fire chaser". 

@Rob Gillespie brings up, what I consider, the main factor to insuring your Properties with high values/Replacement Cost or low values/ACV.

That is, will you be the GC fixing the property when there’s a claim?

If so, you can make a strong argument to go with lower values/ACV.  You can fix your own property for $0.50 on the dollar compared to going through a restoration contractor that the insurance carrier will use.

But, if your looking to the insurance company to handle and pay for everything, an ACV policy and Coinsurance penalty will leave you with a big out of pocket expense.

@Aram Velazquez there are some insurance companies out there that can give you an Agreed Value policy. That eliminates the Coinsurnace penalty you would incur for insuring the property below Replacement Cost.

These products are available in the Midwest, not sure about FL.

Aram,

First, I need to correct something that Michael Norris Posted, Replacement Cost and Actual Cash Value are methods of valuing the the loss.   They do not have anything to do with coverage.  However, you often find Replacement Cost Coverage and Special Form (aka All Risk) coverage paired together and ACV and Named Perils paired.  That is not required however.  You could have Actual Cash Value and Special Form together on a policy.  Its not common but I do have a few that way.  

The reason ACV is used vs. Replacment is strictly a pricing issue.   I insure some properties that would cost $300,000 to rebuild but, because of the rental income they command, they have ACV limits of under $100,000.  The savings on these policies is significant.  The big downside is in a partial loss' the company will deduct for depreciation.   I the case I just mentioned, the deduction for depreciation would be 50% or more.  

Depending on the difference in cost, you can also look at Replacement Cost with a High deductible ($2500, $5000, etc) as a way to bring the costs down.

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