These days, most of us ensure that we have the proper insurance policy for almost all items we buy. From a smartphone to a car, or a home, everything needs to be insured, to limit our losses. The knowledge of concepts such as actual cash value is necessary for all those who wish to buy a new insurance plan.
Actual Cash Value Defined
Actual cash value computation is done by considering the price of an item, when it was new, and then deducting depreciation from it. The insurance company pays this amount to the customer who has had insurance and has claimed for the same.
The depreciation is decided by the insurance company, by being just, and taking into account some fundamental factors that affect its value over time. More the number of years of purchase of the commodity, lesser would be the amount of money which the customer might get from the insurance company. This concept can be grasped well by considering this simple example.
Let us assume that a customer buys a bike and has an auto insurance policy for the same. If he crashes the bike immediately after the purchase, then the actual cost will not be too less than the cost of the bike at the time of the purchase, because of the minimum depreciation quotient. However, if the same bike is crashed after, say, six years from the purchase date, then the actual cash value received by the customer would be much less, compared to the earlier case.
Now, it is the time to know why many people prefer these policies. The answer to this question is that they are cheap and quite affordable for most buyers. Actual cash value, in other words, is the fair amount which is received by asset owners to make up for the loss suffered by them. In absence of insurance companies offering such facilities, the losses made by people on their valuable assets would be huge.
Actual cash value = Replacement cost – Depreciation
Apart from actual cost value, there is another technique of valuing insurance payment and it is known as replacement cost. In the replacement cost technique, there is no depreciation of any kind. So, as the name suggests, it is the amount of money spent to replace the damaged or lost product of the customer. Many financial experts, mostly from the insurance sector, are of the opinion that the total cost of the policy is substantially increased due to replacement costs. The difference between actual cash value and replacement cost is clear and easy to understand from the above content.