Are you covered by home insurance if disaster hits? Don't count on it

Are you shopping around for home insurance? Make sure you understand the difference between replacement cost and actual cash value coverage - or it could cost you.

When it comes to paying for damage to the possessions in your home, you basically have two home insurance choices: a policy based on either replacement cost coverage or actual cash value coverage.

So, which one is best for you? Looking at the value of your items should help you decide what's best, says Jonathan Peele, president and CEO of the independent insurance agency Coastline Insurance Associates of North Carolina.

To insure your possessions are properly insured, keep reading to see which coverage is right for you…

Replacement Cost Coverage vs. Actual Cash Value Coverage

What's the difference between the two?

When a policy has replacement cost coverage, the insurance company will pay to replace the item for a like-item using today's market price.

On the other hand, "If the policy covers the property based on its actual cash value, the insurance company will subtract depreciation from the replacement cost of the property," explains Peele.

[Is your home adequately covered? Click to find the right home insurance coverage for you.]

What's Cheaper?

Actual cash value coverage is a bit cheaper than replacement cost coverage because the insurance company doesn't have to pay out as much if a claim occurs, says Kirk Ball, a certified insurance counselor and the president of Wren Insurance Agency in Florida.

In fact, while Ball says prices can vary in different parts of the country, actual cash value coverage will generally cost about 10 percent to 15 percent less than replacement cost coverage.

Peele agrees, adding that in most cases, replacement cost coverage is going to cost more, but it's usually a very small cost.

"Pricing will depend on several factors like location, property type, and use, but replacement cost coverage is sometimes as little as $50 to $200 more per year," Peele explains.

[Click to shop around and find the right home insurance coverage for you.]

When to Choose Replacement Cost Coverage

Replacement cost policies provide more adequate coverage for homeowners who possess items that will depreciate in value.

Dan Weedin, an independent insurance and crisis management expert, adds that the "better" coverage for most household items is replacement cost because this option will replace your property with a new, similar-quality item.

"This guarantees you get the best possible return on your property, as you receive the 'new' value, rather than the depreciated value," Weedin adds.

For example, suppose you have a fire loss and your 10-year-old couch is destroyed.

"If you have a replacement cost policy, you'll receive a settlement for the current value of a new, similar couch," Peele explains. "So if a new, similar couch will cost $800, you'll receive $800. But if the policy pays the claim based on actual cash value, you will receive $800 minus the depreciation value. As you can imagine, a 10-year-old couch probably isn't worth very much."

[Make sure your possessions are covered. Click to find the right home insurance coverage for you.]

When to Choose Actual Cash Value Coverage

Based on the previous couch example, it might seem like replacement cost insurance is always the best choice - but the truth, of course, is slightly more complicated than that, says Kristofer R. Kirchen, president of Florida-based Advanced Insurance Managers, LLC.

That's because some insurable items, like, jewelry, firearms, fine arts, and silverware, don't depreciate.

For example, Kirchen says a diamond ring bought now is going to be worth the same as a similar ring purchased 50 years ago. In some cases, the older ring's value may even be bolstered by being an antique, Kirchen says.

So, actual cash value coverage may actually be a smarter choice if your possessions are mostly valuable items like jewelry and antiques.

Other than that, however, Weedin says actual cash value is very rarely the better choice.

In fact, Peele says "Actual cash value coverage is typically only used on homes that don't qualify for replacement cost coverage because of factors like their age or lack of updates," Peele explains.

Another time actual cash value coverage makes sense? If you are solely looking for the lowest premium possible and you do not care about insuring your personal property, says Ball.

"This may be the case if you have a mortgage and the mortgage company requires replacement cost, and you want to comply, but do not want your contents covered," adds Ball.

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