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Replacement Cost vs Actual Cash Value in Insurance Claims

Understand the difference between replacement cost and actual cash value in insurance policies and how it affects claims. Calculate reimbursements for damaged items based on depreciation.

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Replacement Cost vs Actual Cash Value in Insurance Claims

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  1. Marty is using an expensive video recorder near the family pool when he slips and falls in, destroying the camera. Marty bought the camera 3 years ago for $4000, and it depreciates at $500 per year. A new, similar camera costs $5,000 today. Assuming the loss is covered, if Marty had a replacement cost policy, how much would Marty’s insurer indemnify Marty for the destroyed camera? $5000 $4000 $2500 $3500

  2. Replacement vs Actual Cash Valuation • Actual Cash Value calculates the depreciated value of an item at the time the loss occurs. ACV is calculated by taking the item's replacement cost and subtracting its depreciation. • Replacement Cost valuation replaces the damaged item at current prices, without depreciation.

  3. Marty is using an expensive video recorder near the family pool when he slips and falls in, destroying the camera. Marty bought the camera 3 years ago for $4000, and it depreciates at $500 per year. A new, similar camera costs $5,000 today. Assuming the loss is covered, if Marty had a replacement cost policy, how much would Marty’s insurer indemnify Marty for the destroyed camera? $5000 $4000 $2500 $3500

  4. Vivian decides to get a valued insurance policy on her antique car. She and her insurance company agree to a value of $85000. Three years later, the car is destroyed when a tree falls on it in a parking lot. The car depreciates at $2000 a year, and its replacement cost is $100,000. Ignoring any deductible, how much can Vivian expect her insurer to indemnify her? • $83,000 • $94,000 • $85,000 • $79,000

  5. Agreed A valuation method that assigns a set value to each insured item Value is determined prior to the issuance of policy Avoids the confusion of assessing appreciation or depreciation

  6. Vivian decides to get a valued insurance policy on her antique car. She and her insurance company agree to a value of $75000. Two years later, the car is destroyed when a tree falls on it in a parking lot. The car depreciates at $4000 a year, and its replacement cost is $120,000. Ignoring any deductible, how much can Vivian expect her insurer to indemnify her? • $67,000 • $116,000 • $75,000 • $71,000

  7. Darren’s SUV cost him $38,800 when he bought it new four years ago. The vehicle is currently worth $21,000. How much is the annual depreciation on Darren’s SUV? • $17,800 • $4,450 • $21,000 • $5,250

  8. Annual Depreciation: replacement cost divided by the item’s useful life • Accumulated Depreciation: the item’s Annual Depreciation multiplied by its age • Car life expectancy: 10 years • Replace Cost of new car: $30,000 • Calculate Depreciation • Annual depreciation: $3,000 ($3000/10) • Accumulated depreciation: $9000 ($3000 X 3) • 2. Calculate ACV • RC - $30,000 • -Depreciation ($9000) • = $21,000 • Tony will be indemnified for $21K

  9. Darren’s SUV cost him $38,800 when he bought it new four years ago. The vehicle is currently worth $21,000. How much is the annual depreciation on Darren’s SUV? • $17,800 • $4,450 • $21,000 • $5,250 (Original Value – Current Worth)/Years owned $38,000 - $21,000 = $17,000 $17,000/4 = $4,450

  10. What is the formula for actual cash value? • Replacement cost minus annual depreciation • Original cost minus total depreciation • Fair market value minus annual depreciation • Replace cost minus total depreciation

  11. What is the formula for actual cash value? Formula: Replacement Cost minus Total Depreciation Example – a laptop that Tony bought for $1000 was only worth $600 at the time of the claim because of depreciation.

  12. What is the formula for actual cash value? • Replacement cost minus annual depreciation • Original cost minus total depreciation • Fair market value minus annual depreciation • Replacement cost minus total depreciation

  13. Which of the following statements regarding actual cash value is FALSE? • The actual cash value generally reflects the market value of an item • Actual cash value includes the depreciation on an item • Actual cash value is always most beneficial to a policyholder • A replacement cost valuation will generally be more than the ACV valuation

  14. A valuation method that takes into account an item’s depreciation • ACV offers lower premiums for less coverage • Formula: Replacement Cost minus Depreciation • Valuation: the process of estimating what an item is worth • Depreciation: an item’s loss of value due to wear, tear, age, or obsolescence

  15. Which of the following statements regarding actual cash value is FALSE? • The actual cash value generally reflects the market value of an item • Actual cash value includes the depreciation on an item • Actual cash value is always most beneficial to a policyholder • A replacement cost valuation will generally be more than the ACV valuation

  16. Angie’s house is struck by lightning during a thunderstorm, which results in $10,000 in covered damage to the structure and $2,800 in covered damage to her personal property. Angie’s homeowners policy has a fixed deductible of $1,200. How much can she expect to receive in her settlement from her insurer for this claim? • $12,800 • $1,200 • $8,800 • $11,600

  17. Angie’s house is struck by lightning during a thunderstorm, which results in $10,000 in covered damage to the structure and $2,800 in covered damage to her personal property. Angie’s homeowners policy has a fixed deductible of $1,200. How much can she expect to receive in her settlement from her insurer for this claim? • Total Damages – Deductible = Insurance Settlement (Payout) • $10,000 + $2,800 = $12,800 • Deductible $1,200 • $12,800 - $1,200 = $11,600

  18. Angie’s house is struck by lightning during a thunderstorm, which results in $10,000 in covered damage to the structure and $2,800 in covered damage to her personal property. Angie’s homeowners policy has a fixed deductible of $1,200. How much can she expect to receive in her settlement from her insurer for this claim? • $12,800 • $1,200 • $8,800 • $11,600

  19. DJ has a homeowners policy with replacement cost valuation and a coverage limit of $90,000 for his personal property. 3 years ago, DJ purchased a sofa and love seat for $1000 & $500 respectively. Both pieces of furniture depreciate at $100 per year. A house fire damaged many of DJ’s belongings, including the sofa and love seat, which now cost $1,200 and $700 to purchase today. Ignoring any deductibles, how much will DJ’s insurer give him from the damaged sofa and love seat? • $1500 • $1900 • $1300 • $900

  20. Unlike ACV policies which do subtract depreciation, replacement cost policies do not. For this reason, many policyholders prefer replacement cost policies even though the premiums are higher. For example, if Sally's $10,000 roof is destroyed in a storm after three years, an ACV policy would only indemnify her at the roof's depreciated value. Instead, her RC policy would cover her for the complete cost of a new roof of the same quality at today's prices Characteristics of Replacement Cost • No depreciation • Based on the replacement cost at the time of loss • Higher premiums

  21. DJ has a homeowners policy with replacement cost valuation and a coverage limit of $90,000 for his personal property. 3 years ago, DJ purchased a sofa and love seat for $1000 & $500 respectively. Both pieces of furniture depreciate at $100 per year. A house fire damaged many of DJ’s belongings, including the sofa and love seat, which now cost $1,200 and $700 to purchase today. Ignoring any deductibles, how much will DJ’s insurer give him from the damaged sofa and love seat? • $1500 • $1900 • $1300 • $900 • $1200 + $700 = $1900

  22. In order to be considered fully insured, Maggie must have at least a $480,000 limit on her homeowners policy. Assuming her insurer imposes the standard coinsurance requirement, what is the value of Nikki’s home? • $600,000 • $480,000 • $520,000 • $384,000

  23. Coinsurance Formula Coinsurance is a property insurance provision that penalizes the insured’s loss recovery if the limit of insurance purchased by the insured is not at least equal to a specified percentage (commonly 80 percent) of the value of the insured property. • Applying the coinsurance penalty: • Value of Tracy’s home: $160,000 • Minimum coinsurance amount: $128,000 • Tracy’s actual coverage: $100,000 • Calculate coinsurance penalty • $100,000 (actual coverage) • ------------------------------------- = 62.5% (coinsurance penalty) • $128,000 (coinsurance requirement) • 2. Apply penalty to partial losses • The home suffers a partial loss of $20,000 • Coinsurance penalty: 62.5% • Insurer will only pay $12,500 (62.5% of $20,000) (Had) ---------------------- = coinsurance penalty (Should have had)

  24. In order to be considered fully insured, Maggie must have at least a $480,000 limit on her homeowners policy. Assuming her insurer imposes the standard coinsurance requirement, what is the value of Nikki’s home? • $600,000 • $480,000 • $520,000 • $384,000 Coinsurance = (.8) x home value. $480,000 = (.80 x home value). Divide $480,000 by .8 = $600,000

  25. Which of the following is NOT a benefit of a co-insurance clause? • The insurer receives ample premium to cover the risks of providing an insurance policy • Co-insurance reduces the risk of damage to a home • Partial losses to insured property will be covered at 100% • The policyholder gets sufficient coverage https://www.youtube.com/watch?v=UM7LG4g1rBo

  26. Underinsured: when a home is insured for less than 80% of its value Coinsurance penalty: if a property is underinsured, the insurer will only cover a percentage of partial losses. If the insured fails to fully insure his home, he is exposing himself to a penalty called a coinsurance penalty. When properties are underinsured, premiums are inadequate. Ideally, policyholders do not expect to experience a total loss, and they assume that any partial losses they may suffer are fully covered because they fall under the policy limit. However, even in the event of a partial loss, the inadequate premiums may result in an inadequate payout by means of a co-insurance penalty. Consequently, the insurance company will only pay a percentage of partial damages. By means of the coinsurance clause, the proper relationship between premiums and payouts is achieved. Coinsurance maintains both the insurer's financial health and the insured's financial obligation.

  27. Which of the following is NOT a benefit of a co-insurance clause? • The insurer receives ample premium to cover the risks of providing an insurance policy • Co-insurance reduces the risk of damage to a home • Partial losses to insured property will be covered at 100% • The policyholder gets sufficient coverage

  28. Jake owns a home and property valued at $600,000. In order to be considered “fully insured’, Jake would have to unsure the home for at least: • $480,000 • $300,000 • $700,000 • $600,000

  29. More plainly, let’s assume we have a building valued at $100,000. Under an 80% coinsurance clause, an insured would be expected to insure 80% of these values, or $80,000. • Now, let’s consider two scenarios, the amount of the loss in each case is $30,000: • First, the policyholder only carries $50,000 in coverage: • ($50,000/$80,000) x $30,000 = $18,750 (less deductible). The policyholder is forced to pay, or self-insure, the shortfall of $11,250. • Second, the policyholder carries the full $80,000 required under his policy: • ($80,000/$80,000) x $30,000 = $30,000 (less deductible). In this example, the policyholder would receive full benefits.

  30. Jake owns a home and property valued at $600,000. In order to be considered “fully insured’, Jake would have to unsure the home for at least: • $480,000 • $300,000 • $700,000 • $600,000

  31. Cynthia swerves to avoid a deer in the road and crashes into a guardrail. She causes $2400 in damages to her car. How much might Cynthia expect to receive from her insurance company if she has a fixed deductible of $500 on her auto insurance? • $1900 • $500 • $1400 • $2400

  32. Deductible Predetermined amount of money that a policyholder must pay before the insurance company will pay the remaining cost. • fixed: a set amount • percentage: a percentage of the property’s value • franchise: insurer pays 100% of damages if losses exceed a certain set amount

  33. Cynthia swerves to avoid a deer in the road and crashes into a guardrail. She causes $2400 in damages to her car. How much might Cynthia expect to receive from her insurance company if she has a fixed deductible of $500 on her auto insurance? • $1900 • $500 • $1400 • $2400 • Example – • Coinsurance requirements: $128,000 • Tracy’s policy limit: $100,000 • Deductible $1,000 • Covered loss:$20,000 • Deductible first: • $20,000 - $1,000 = $19,000

  34. Matt owns a shipping company that transports goods all over the world. While sailing across the Atlantic, a mighty storm gathers and his vessel sustains $700,000 worth of damage. Assuming the ship had a $550,000 franchise deductible, how much of the damages would Matt’s policy cover? • $550,000 • $0 • $150,000 • $700,000

  35. Percentage deductibles require the insured party to pay a deductible equal to the percentage of the value of the insured risk. • For instance, if Georgia insures her home for $500,000, and the deductible on the homeowners' policy is set at 3%, her deductible is $15,000. This means that Georgia is responsible for paying the first $15,000 of a damage claim before the insurance company will pay the rest. • If the total damage on Georgia’s home is less than $15,000, she is responsible for 100% of the damages. • Some policies will use a combination of fixed and percentage deductibles. An insurer may allow a $500 fixed deductible for fire and hail damage but charge a percentage for wind and tornado damage.

  36. Matt owns a shipping company that transports goods all over the world. While sailing across the Atlantic, a mighty storm gathers and his vessel sustains $700,000 worth of damage. Assuming the ship had a $550,000 franchise deductible, how much of the damages would Matt’s policy cover? • $550,000 • $0 • $150,000 • $700,000

  37. Abe has purchased a homeowners insurance policy with a percentage deductible based on the total limit of insurance for his home. John insures his home for $600,000 and the policy includes a 3% deductible. A huge thunderstorm passes through one night and blows the roof off his house. The insurance company estimates that covered damage totals $80,000. How much indemnification should Abe expect for the losses to his roof? • $18,000 • $77,600 • $80,000 • $62,000

  38. A fixed deductible is one specific, predetermined amount that a policyholder must pay out-of-pocket before he can be indemnified. • For example, Tom's car suffers $3,500 worth of damage and he has a $500 fixed deductible on his auto insurance policy. Tom will receive $3,000 from the insurance company because of his fixed deductible of $500.

  39. Abe has purchased a homeowners insurance policy with a percentage deductible based on the total limit of insurance for his home. John insures his home for $600,000 and the policy includes a 3% deductible. A huge thunderstorm passes through one night and blows the roof off his house. The insurance company estimates that covered damage totals $80,000. How much indemnification should Abe expect for the losses to his roof? • $18,000 • $77,600 • $80,000 • $62,000 • Abe’s deductible is 3% of $600,000. This equals $18,000. Then subtract the deductible from the covered damages to get Abe’s indemnification. $80,000 - $18,000 equals $62,000

  40. David’s home is worth $199,000 and he has a homeowners policy with a $150,000 limit. After burglars broke in, stole several items of his personal property, and broke his glass patio door, David is left with a total of $5300 in damages. Assuming the insurer decides to invoke the standard coinsurance penalty, approximately how much can David hope to receive in indemnification? • $5300 • $4240 • $4992 • $3923

  41. David’s home is worth $199,000 and he has a homeowners policy with a $150,000 limit. After burglars broke in, stole several items of his personal property, and broke his glass patio door, David is left with a total of $5300 in damages. Assuming the insurer decides to invoke the standard coinsurance penalty, approximately how much can David hope to receive in indemnification? Formula • (HAD/Should have had) X Loss = what insurer will pay • Had – means how much insurance the insured had at the time of the loss • Should – means how much the insured should have had • Applying the coinsurance penalty: • Value of David’s home: $199,000 • Actual coverage: $150,000 • How Much They He Should Have Had: $199,000*.8 • Calculate coinsurance penalty • $150,000 (actual coverage) • ------------------------------------- = .942 (coinsurance) • $159,200 (coinsurance requirement) • 2. Apply penalty to partial losses • The home suffers a partial loss of $5300 • Coinsurance: 94.2% • Insurer will only pay $4992 (94.2% of $5,300) (Had) ---------------------- = coinsurance penalty (Should have had)

  42. David’s home is worth $199,000 and he has a homeowners policy with a $150,000 limit. After burglars broke in, stole several items of his personal property, and broke his glass patio door, David is left with a total of $5300 in damages. Assuming the insurer decides to invoke the standard coinsurance penalty, approximately how much can David hope to receive in indemnification? • $5300 • $4240 • $4992 • $3923 (Had) ---------------------- = coinsurance penalty (Should have had)

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