What Is Actual Cash Value?
Actual cash value is the amount equal to the replacement cost minus depreciation of a damaged or stolen property at the time of the loss. It is the actual value for which the property could be sold, which is always less than what it would cost to replace it.
Actual Cash Value Explained
Sometimes, insurance companies use actual cash value to determine the amount to be paid to a policyholder after loss or damage to the insured property. In the case of an automobile that is totaled in an accident, for example, the insurance company would typically pay the actual cash value of the vehicle after determining its replacement cost and subtracting factors such as depreciation and wear and tear. Under replacement-cost coverage, the insurer would pay the amount required to replace the covered item with a like-kind new one.
Actual cash value is used in valuing insured property in the property and casualty insurance industry. Actual cash value is not the same as replacement cost value. Actual cash value is computed by subtracting depreciation from replacement cost while depreciation is figured by establishing an expected lifetime of an item and determining what percentage of that life remains. This percentage, multiplied by the replacement cost, provides the actual cash value.
As an example: a man purchased a television set for $3,000 five years ago and it was destroyed in a hurricane. His insurance company says that all televisions have a useful life of 10 years. A similar television today costs $3,500. The destroyed television had 50 percent (5 years) of its life remaining. The actual cash value equals $2,500 (replacement cost) times 50 percent (useful life remaining) or $1,750.
This concept is different from the book value used by accountants in financial statements or for tax purposes. Accountants use the purchase price and subtract the accumulated depreciation in order to value the item on a balance sheet. ACV uses the current replacement cost of a new item.
Actual Cash Value vs. Replacement Cost
Property insurance policyholders will usually prefer payment based on the replacement cost of damaged or stolen property because it compensates a policyholder for the actual cost of replacing property. For instance, if a camera is stolen, a replacement cost policy will reimburse you the full cost of replacing it with a new camera of like kind. The insurer will not take into consideration that the lost camera had a shutter count of 25,000 because you used the camera every day for the last two years, causing a considerable amount of wear and tear.