What’s the difference between actual cash value and replacement cost?

What happens when your vehicle is totaled due to a collision? Insurance companies follow different procedures to calculate the amount of a loss. While nobody wants to be in a situation like this, knowing what to expect in the weeks following an accident is important for vehicle owners. In this article we share what the difference is between cash value and replacement cost.

What is replacement cost?

If you had replacement cost coverage, this is the amount of money the insurance company could reimburse you to replace your totaled vehicle with another car of comparable material, style, and quality. The definition and limits vary by insurance company, so it’s always important to refer to your policy to see what your insurer covers.

What is actual cash value?

Some insurance companies also refer to this as fair market value and is the more common coverage, which simply means how much the insurance company is going to reimburse based on the current market value of your insured vehicle.

What’s the difference?

The main difference between these two concepts in that the latter one takes depreciation into consideration. Your car starts losing value the moment you drive out of the dealership. If you sell your vehicle four years after you bought it, you probably wouldn’t expect to receive the same amount of money you paid for it.

The same happens with the reimbursement you receive for your totaled car. Insurance companies prefer this approach rather than reimbursing the vehicle’s replacement cost.

How is the actual cash value calculated?

Each insurance company follows its own process, but the basic formula to determine the actual cash value is:

Replacement cost – Depreciation = Actual Cash Value

Exactly how each insurance company calculates depreciation varies, but in general they take the vehicle’s mileage, model, and original price into consideration to determine depreciation.

For example, if your vehicle was worth $20,000 at the time of purchase and your insurance company determines that the depreciation after two years is $5,000, you would receive $15,000 to recover the costs associated with the collision. However, if you had replacement cost coverage, your insurance company might pay $20,000.

With replacement cost coverage there may be a higher deductible in place, so before signing any agreement it’s important to know whether you are able to pay the deductible if you’re involved in a collision.

Each type of coverage comes with its advantages and disadvantages, and that’s why you should speak to your agent first before agreeing to any policy.

Infinity Insurance Agency can help you to better understand the difference between replacement cost and actual cash value. Call one of our friendly agents at 1-855-478-3705 to receive information on our auto insurance plans.

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