UPDATED: Mar 13, 2020
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Actual cash value (ACV) plays a crucial role in the insurance industry. Insurance companies use actual cash value to ensure policyholders receive fair compensation for damaged or destroyed property.
If your car has been in a serious accident, for example, then your insurance company might send you a check for the actual cash value of the vehicle. This is the value of the vehicle the moment before the accident occurred.
Insurance companies calculate actual cash value by deducting depreciation from the replacement cost of an item. If your 2012 Honda Civic with 100,000 miles was destroyed in an accident, then your insurance company will send you a check to cover the cost of getting a 2012 Honda Civic with 100,000 miles, minus any depreciation. It’s the value of your vehicle the moment before the accident based on its current value.
How Does Actual Cash Value Work?
Insurance companies use different metrics to determine actual cash value. However, all of these metrics boil down to one simple principle:
Actual cash value is calculated by subtracting depreciation from replacement cost.
First, insurance companies will calculate depreciation by establishing a useful life of the item by determining what percentage of that life remains. Then, this percentage is multiplied by the replacement cost to get the ACV.
Let’s say you purchased a new car for $20,000 six years ago. That car was destroyed in a house fire. Your insurance company states that the average vehicle has a useful life of 12 years. A similar car today costs $5,000. The destroyed car had 50% (6 years) of its life remaining. The ACV equals $5,000 (replacement cost) times 50% (useful life remaining), giving you a total of $2,500 for your car.
Replacement Cost Versus Actual Cash Value
When buying insurance, some insurance companies give you the option of choosing replacement cost or actual cash value. What’s the difference?
Replacement Cost: If you have replacement cost insurance, your claim will either cover the cost of restoring items to their original condition or buying new items of similar kind and quality to the ones lost (whichever option is cheaper). There are no deductions for depreciation. Let’s say your four-year-old car is stolen. Your insurance company will send you enough money to buy a car with features as similar as possible to the stolen model. The payment is generally less than what you originally paid for the vehicle because prices of similar models are now cheaper.
Actual Cash Value (ACV): If you have an actual cash value policy, your claims payment will be based on the cost of buying items in similar conditions to the ones you lost, with depreciation factored into your payment. If your ten-year-old car is stolen, then your insurance company will calculate the actual cash value of your vehicle based on its used condition, then send you a payment for that amount.
With actual cash value policies, payments tend to be lower. Your premiums are also cheaper. Upon receiving payment, you can buy a vehicle similar to the one you lost. Or, you can buy a newer vehicle and cover the difference yourself.
Actual cash value (ACV) is a common way for insurers to compensate policyholders after an accident. it covers the value of your vehicle after an accident, calculated by subtracting depreciation from replacement value.