What is the difference between actual cash value and replacement cost?

• A. Actual cash value equals replacement cost minus depreciation; replacement cost pays to replace with new (without deduction for depreciation), subject to policy terms.
• B. Replacement cost includes depreciation as part of payout.
• C. Actual cash value is always higher than replacement cost.
• D. Replacement cost is never subject to policy limits.

Answer: (A)

The main idea is whether depreciation is taken into account when paying a claim. Actual cash value subtracts depreciation from the cost to replace, so you’re paid the replacement cost minus how much the item has aged or worn. Replacement cost, on the other hand, pays enough to replace the item with a brand-new one of like kind and quality, without subtracting depreciation—though the payout is still subject to policy terms, deductibles, and limits.

For example, if it would cost $1,000 to replace an item now, but it’s 20% depreciated due to age, the actual cash value would be $800. If you have replacement-cost coverage, you’d typically receive about $1,000 to replace with a new item (minus the deductible and subject to any limits). This is why the statement that actual cash value equals replacement cost minus depreciation and replacement cost pays to replace with new fits best.