As an insurance agent, your role involves assisting clients in making well-informed decisions about their coverage. For someone who is well-versed in insurance terminology, it can be difficult to simplify complex concepts such as Replacement Cost (RC) and Actual Cash Value (ACV). But when your investor clients understand the nuances of each settlement method, they’re able to tailor their coverage to meet their unique needs. Engaging in these conversations with your investor clients can also provide you with insights into their investment goals and strategies, ultimately allowing you to serve them and their portfolio more effectively. Use the outline below to help guide conversations regarding Replacement Cost and Actual Cash Value.
Explaining Depreciation
In discussions with investor clients, it’s essential to highlight that the primary difference between Replacement Cost and Actual Cash Value lies in the ability to recover depreciation. While both account for it, Replacement Cost is the only settlement method that allows for reimbursable depreciation.
It may be difficult for your investor clients to understand that depreciation is extremely difficult to determine until a loss occurs. You’ll want to inform them that depreciation is based on the date of the last updates, not the original year built. Additionally, everything depreciates at a different rate, but the average is about 1% annually. Although roofs deteriorate much quicker due to weather exposure.
Replacement Cost (RC)
When discussing Replacement Cost, emphasize that it is the only settlement method that allows for recoverable depreciation. Additionally, inform your client that Replacement Cost coverage requires their property be insured to a higher valuation per square foot, providing them with more financial protection.
Provide An Example:
Let’s say a kitchen fire at one of your properties caused a partial loss, totaling $30,000 in damage. Your deductible on this property is $3,000, so the insurance carrier will pay you no more than $27,000. An assigned claims adjuster visits the property to determine how much useful life is left in what was damaged. The adjuster determines that the actual cash value of the loss after depreciation is $15,000. You would then receive a payment of $12,000 (actual cash value minus deductible) from the insurance carrier. That $12,000 must be used for any necessary repairs and replacements. If repair or replacement expenses exceed that amount, you would pay out of pocket for the time being.
Let’s say, when it’s all said and done, the cost of repairs totaled $20,000. With your provided receipts, a second check for reimbursable depreciation would be issued for an additional $5,000. This is because Replacement Cost allows you to recoup some or all of the depreciation. The only money that is not recoverable is your deductible.
Actual Cash Value (ACV)
When discussing Actual Cash Value, highlight that ACV policies only pay out the depreciated cost for repairs and replacements. Another major difference is that compared to RC coverage, ACV is typically 20-25 percent cheaper and allows the property to be insured to a lower value per square foot. It is important to emphasize to your investor client that there is no opportunity to recover the depreciated amount with the ACV settlement method.
Inform your investor client that if they have ACV, the money they recover can be used however they choose. In some scenarios, the investor may use the money to fix the damage. Others may want to cut their losses, sell the property as is, and pocket the money.
Provide An Example:
Let’s use the same example from earlier- a kitchen fire caused $30,000 in damage, you have a $3,000 deductible, and the actual cash value of what was damaged is $15,000 after depreciation. With Actual Cash Value, you would be issued a check for $12,000. That $12,000 is all you will recover from this loss.
Important Questions to Ask Your Investor Clients
What would you do in the event of a total loss? Would you rebuild the property? Or would you clean up the land, sell it, and move on to another opportunity?
- If your investor client would not rebuild, there is very little reason for them to have Replacement Cost coverage. They would be paying more to the insurance carrier than they would ever recover in the event of a loss. Remind your investor clients that they must make the necessary repairs to be able to recover any depreciation.
Are you capable of making repairs yourself? Or do you have access to someone who can?
- Some investors are handy enough to complete necessary repairs themselves. And if they can’t, they likely have a friend or business acquaintance who can. If this is the case, it’s possible that your investor client would be able to repair the damage for substantially less money than their insurance carrier estimates.
- We have noticed that 60-65 percent of investor clients who suffer a partial loss and have Replacement Cost coverage never go back to the carrier to recoup any depreciation. Not because they don’t want to, but because the initial payout was enough to make them whole again.
Do you have a loan on the property?
- If your investor client has a loan on the property, most likely their lender will have a set of insurance lending requirements that must be met or exceeded. Oftentimes, lenders will require investors to carry Replacement Cost Coverage.
