[Akshay]

Before buying home insurance, you’ll have a choice: insuring property for "actual cash value" or for "replacement cost". Both offer the same kind of liability, but they differ in the amount and type of property protection coverage. This difference often results in very different dollar amounts in the event of a loss.

Actual cash value: "Actual cash value" refers to how the value of the property is determined in the event of a loss. Actual cash value takes into account depreciation -- that an item purchased new is worth less after having been "in-service" for a number of years. For example, you bought a sofa three years ago for $2,000. Fire destroys the sofa and you put in a claim with the insurance company. The insurer determines that the actual cash value of a sofa that is three years old is currently $500, and that is what they would pay you. If your policy has a $1,000 deductible, you’ll collect nothing.

Replacement cost: "Replacement cost" likewise refers to how the value of the property is determined in the event of the loss. But the fundamental difference is that the value is set at how much it will cost you today to go out and buy a new item to replace the one that has been lost. In the example above, that $2,000 sofa may cost $3,000 if it were bought new today. With replacement cost coverage, when that sofa is destroyed today, after you have paid your deductible, the insurer pays you $3,000 to go out and buy that same new sofa replace the one which has been destroyed. Replacement cost policies are more expensive than actual cash value policies.