Insurance is designed to help replace damaged, stolen, or destroyed property. While its purpose is pretty straightforward, how that works in reality is a little more complex. The fact that you bought that limited edition, ultra-high-tech camera for $10,000 does not mean your insurer will automatically hand you a $10,000 cheque if the camera is stolen or damaged. Instead, the payout you will receive depends on the loss settlement option you choose. “What’s that?” you might ask.
Put simply, loss settlement refers to how insurance companies determine the amount of money you will receive after you suffer a loss to an insured item.
As with most aspects of insurance, loss settlement is dependent on certain factors. Insurance companies have different methods of calculating the value of something, and hence, the amount to be paid out. Differences in coverage and the method of calculation used means the amount paid for the same items will vary, depending on the loss settlement option you choose.
This probably raises the question in your mind: “which loss settlement option is best for me?” To answer that question, let’s first take a look at the types of settlement options available to you.
Typically, loss settlement is decided in one of two ways: replacement cost or actual cash value. With these two options, you could either be reimbursed for the cost to replace the lost or damaged item or for its actual cash value, depending on what your policy says.
Replacement Cost (RC)
The replacement cost takes into account the cost of replacing a damaged asset at today’s cost, i.e the insurance company pays you the same amount you would pay to buy that same item today. This option does not factor in depreciation, which is the decrease in the value of an item due to age or wear and tear.
Replacement cost is like new for old – you have a 40 inch Sony TV that you bought 5 years ago, with replacement cost, you get to go and buy a new 40 inch Sony TV replacement, of the same kind and quality.
Actual Cash Value (ACV)
The actual cash value (also known as the ‘Market Value’) loss settlement option is determined by the current value (worth) of your property, not how much it would cost to replace it with a brand new one. This option factors in depreciation, which means the insurance company would pay you the amount you would pay for a similar item at today’s cost minus depreciation.
An example would probably make it easier to understand. So, let’s say that $10,000 camera we mentioned earlier was bought in 2010. You insured it at replacement cost, and now it’s stolen or damaged. You check online and discover that the same camera now sells for $11,200. This is the amount you can expect to receive from your insurance payout with the replacement cost settlement option.
On the other hand, if you insured it for actual cash value, your payout will be less. Why? Because you’ve had the camera for eight years, and due to age, wear and tear it has depreciated in value by $4,000. It is no longer worth the $10,000 you paid when it was new, and certainly not worth the $11,200 it now costs to replace it. Your insurer will calculate your payout by subtracting the amount of depreciation from the cost today, and so your payout will be $11,200 – $4,000 = $7,200
Here’s another way of looking at it: The valuation looks at what could you buy that same 8 year old camera today (if you could find it). You could buy the exact 8 year old camera today for $7200. “What’s my 8 year old camera worth today if I were going to sell it to someone” is a good way to look at actual cash value loss settlement clause.
What does this mean for me?
It means you need to consider which loss settlement option is best for you when you’re initiating your policy. The advantages of the replacement cost option are obvious: by paying you whatever is required to replace your damaged item with the exact same item (up to your policy limits), you can quickly get back on your feet after a loss. While the replacement cost option is an excellent choice, remember that your policy is likely to be more expensive than if you insured for actual cash value.
While the ACV option is typically cheaper than RC coverage, be very careful if you select this type of loss settlement option. The lower premiums they offer is offset by the fact that they often don’t offer enough coverage to replace your property with a brand new one – a match for a match – in the event of a total loss. We don’t generally recommend this type of coverage as it is very basic – going with RC coverage is a much better place to start.
Can I change my loss settlement option?
Yes, absolutely. The good thing about insurance policies is that you can (and should) review them regularly to check, not only that the entire policy is still right for you, but that the loss settlement option you currently have is appropriate for your situation. Your insurance broker is available to help you compare the options so you can make the best choice for your needs.
Either way, it’s always recommended to review your insurance policy options every year to make sure your coverage options are still the best choice for your current circumstances. Don’t forget to contact your broker when anything changes!