As Natural Disaster Season Ramps Up, Here’s How to Decide Between Replacement and Cash Value Homeowners Insurance

Firefighters in a fire protection suit wearing firefighter helmet with breathing device and holding fire hose is extinguishing a burning house fire that is putting off excessive heat and smoke.
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Home insurance protects what’s typically the biggest investment you’ll ever make: your house. In the event of a fire or natural disaster, this investment can disappear in a matter of minutes. You need to have a cash value or replacement cost value home insurance plan in place to recover or rebuild.

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Homeowners insurance provides financial relief if a covered event damages your home, property or personal belongings. It can also pay out when you’re held responsible for an accident or injury.

But what events are covered? Some disasters, like lightning strikes, home fires and windstorms can occur anywhere. Others, like earthquakes and hurricanes, are more common in certain regions. Many homeowners insurance policies cover damage due to fire, wind or snow, but won’t cover floods or earthquakes. These would require separate plans, which some insurers do offer in relevant areas.

Actual Cash Value Versus Replacement Cost Value Homeowners Insurance

Actual cash value coverage is calculated by determining the market value of your home by taking its initial cost, adding personal property, then subtracting depreciation. An insurance policy with coverage based on cash value is less expensive to buy since depreciation is factored in the value of your home. Payments from a filed claim will be less, but the cheaper premiums might be the only option available to a homeowner.

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Replacement cost value (RCV) is the most recommended insurance coverage option, since it can help policyholders secure a living situation that closely resembles their previous home and possessions in the event of a disaster. Replacement cost policies give you more protection than actual cash value coverage but have pricier premium payments. Replacement cost insurance is recommended at the best of times, as it takes doesn’t take depreciation of a house or its contents into account. If you factor in damages from potential natural disasters, RCV can literally save you from financial ruin.

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There are also variations of replacement cost insurance policies, but not all insurers — or circumstances — allow for their purchase:

Guaranteed replacement cost value insurance is essentially an enhanced version of RCV coverage, but it also pays the cost to rebuild your home exactly as it was before any pitfall, even if the cost exceeds the estimated value of the home.

Extended replacement cost insurance policies cover you for an additional percentage — normally 20% to 25% — above the replacement value of your home, to account for price inflation.

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Which Type of Home Insurance Policy Should I Go With?

To understand what type of coverage makes the most sense for your location and financial situation, consider the following three things before deciding whether a cash value or RCV home insurance policy is best for you.

  • Policy cost: The most important factor to consider when shopping for home insurance is deciding what you can afford to pay in premiums. Ashley Kilroy and Jason Metz of Forbes Advisor point out that cash value coverage is generally cheaper than replacement cost value policies because claims are typically of lower value.
  • Tolerance for risk: Speaking of what you really need, being thrifty and missing out on some essential coverage can come back to bite you. Are you prepared to pay out of your own pocket to buy new items in the event of theft, damage or disaster? Do you live in a region that requires extra home insurance coverage in an event of a disaster? These questions and more will need to be answered. The analysts at Forbes Advisor indicate that, despite being more expensive, RCV plans offer greater piece of mind as they expose you to less risk in the event of a claim.
  • Age of Home: The expense of repairing an older home with original materials can be extremely expensive, to the point that some insurance companies do not offer standard RCV coverage for older homes, Kilroy and Metz write. You might need to consider a modified insurance policy that will provide you with high-quality and equivalent building materials should replacement be required.

Your home is more than just a roof over your head. It is most likely your most valuable physical asset and one you likely can’t afford to replace out-of-pocket if disaster strikes. Protecting your investment with the proper insurance is an essential part of being a homeowner.

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About the Author

David Nadelle is a freelance editor and writer based in Ottawa, Canada. After working in the energy industry for 18 years, he decided to change careers in 2016 and concentrate full-time on all aspects of writing. He recently completed a technical communication diploma and holds previous university degrees in journalism, sociology and criminology. David has covered a wide variety of financial and lifestyle topics for numerous publications and has experience copywriting for the retail industry.
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