How Do Home Insurance Replacement Cost Policies Pay Out?

You have two choices when it comes to a home insurance policy–Replacement Cost Policies or Actual Cash Value (ACV) policies.

I’m not a big fan of Actual Cash Value policies.

The reason I don’t like those type of homeowners policies is because they don’t meet most people’s expectations.

Sure there’s the occasional person who knows they are really only insuring a portion of their property, but most people expect if their property is damaged their insurance company will pay to replace what was lost.

That’s why for most the Replacement Cost Value (RCV) policies are the best value.

Yes on a whole, they cost slightly more in pure premium payments per year, but let me breakdown how they payout on claims, and I think you’ll agree the little extra is definitely worth it when it comes time to make a claim.

Replacement Cost Policy versus ACV Policy Example Payout

Let me use the same example I used on the Actual Cash Value policy answer, but this time let’s say you’re covered with a RCV policy instead of ACV.

The same storm hits your house.

The same damage occurs to your property: totaled roof, $20,000 in damages, which you replaced in 2006, totaled 55-inch flat screen TV you bought in 2009 for $1200. The dwelling amount on your home is $250,000, and you carry a 1% deductible for clause one (wind & hail) on your homeowners.

This time when the adjuster calculates the payout, he still calculates the depreciated value, but then he throws on top of that the additional cost of what is needed to replace your roof and TV, minus your deductible.

So in total, you would be paid something like $18,300 ($20,000 + 800 – $2,500). Remember, you ALWAYS have to pay your deductible. Your deductible is the first portion of your risk you signed up to retain, so there’s no getting around paying it.

If you’ve read the ACV policy answer article, the payout on the EXACT same event and damage was around $9,700. That’s almost half of what you get with a RCV payout!

Still think cheaper ACV policy might be worth it?

Think about it this way: on average you are going to save $300-$500 a year going with an ACV policy instead of an RCV policy.

So if you take the savings per year, how many years do you think it would take you in cheaper premiums to make up for the difference for one payout of this very common claim? The answer is 17.2 – 28.67 years!

That’s right! You’d have to go at least 17 years straight without a claim to make up the difference in one payout!

Now for those of you who are very detail oriented and noticed that the payout for the TV was $800 instead of $1200, you might be asking yourself, “Why didn’t they get the full $1200?”

First off, remember I’m talking more in principle than in actual numbers. The actual numbers could be closer to $1200, but the reason why is because it doesn’t cost as much to replace what you lost with today’s technology.

The key question is what does it cost TODAY to replace the object lost.

So for TVs, with the increase in technology a close replacement to what you lost is a middle of the road $800 flat screen TV. Yes in 2009 when you bought the TV, it was top of the line. But today’s top of the line TVs are Ultra 4K, 3D smart TVs that cost $2000 or more.

So the payout you get is what’s closest to what you had. The insurance company is going to pay to get you back to where you were before the loss, not pay you to upgrade your TV to the newest greatest model.

Now, you’ll still get some added benefits.

Your new TV will be way slimmer than it was, and it will probably have a lot of the Smart technology already included, so in that sense, you do get an upgrade just not the highest upgrade.
On roof replacement, a lot of times it can work in the opposite way. What cost you $18,000 to replace in 2006 now costs you $20,000, so Replacement Cost Value works both ways.

Why Two Payments for Big Claims?

Most insurance companies today will pay big claims such as roof replacements in two parts. They will first give you the depreciated value of the roof, which if you remember from the ACV blog was $12,000, minus the $2,500 deductible. Therefore, first payout would be something like $9,500.

They expect you to pay this money plus your deductible to a roofer to begin repairs. Once the repairs are completed, you turn in the proof of the finished work provided by your roofer, and then they will release the additional Replacement Cost Value of $8,000.

Why do insurance companies do this?

Because of insurance fraud.

One of the most common forms of insurance fraud lately has been making multiple claims on roofs for the same damage.

Dishonest people get their roofs totaled in a storm and make a claim, but then never actually replace the roof. Then a little time goes by and they turn in a second claim again for the same basic damage.

This costs insurance companies millions of dollars and has also driven up the premiums you have to pay.

So to combat this, the insurance companies pay in two installments.

By paying the claim in two portions, it protects the insurance companies because they can still pay the depreciated value, and then if proof is never received, they can exclude coverage on the roof or even send them a letter of nonrenewal. It’s not a perfect system, but it works.

Keep Your Receipts!

On a final note, I tell all my clients this during our yearly reviews, so I want to tell you this as well — ALWAYS keep the receipts on any big purchases or big projects at your house. Having dated receipts will simplify your life and exponentially increase the claims process should you have a big loss.

Get a safety deposit box at the bank and put all your big receipts in there. I’m talking about TVs, computers, furniture, jewelry, guns, rugs, furs, appliances, etc.

I’m also talking about renovation projects such as adding a patio, a pool, a shed, remodeling the kitchen, adding a bedroom, etc.

Keep all these receipts! We’ll talk more about keeping your additions updated on your insurance policy in a different article.