 Personal finance PowerPoint presentation. Actual cash value. Prepare to get financially fit by practicing personal finance. We're breaking the financial decisions into the short-term and long-term decisions. The short-term decisions being those where we're gonna train our gut to trust our gut the long-term decisions such as with the insurance planning being those where we're gonna use the adage of measure twice, cut once, have a more formal process in place which might look something like this. We're gonna set the goals. We're gonna develop a plan to reach the goals. We're gonna put the plan in action and then we're gonna review the results and do it over and over again on a periodic basis in order to check where we stand. Some of the things we might be applying insurance to, we went over these in the past, but just to review would be things like disability, illness, death, retirement, property laws, liability. We're now gonna be focusing in on the term of the actual cash value, which is a term that you might run into when you're thinking about different formats in types of insurance. Most of this information can be found at Investopedia, actual cash value, which you can find online. Take a look at the references, resources, continue your research from there. This is by Julia Kagan, updated July 27th, 2021. What is actual cash value? Actual cash value, ACV, is the amount equal to the replacement cost minus depreciation of a damaged or sold property at the time of the loss. So when you think about this in terms of the insurance policies, the question then would be, well, if you're insuring against something happening in the future, if you're thinking about something like property, if you're insuring some kind of property for example, then if something happens to that property in the future, then how much are you gonna get for the replacement? So clearly what we're trying to do with the insurance is lower or mitigate the risk upfront and hoping that some event doesn't happen that would trigger the insurance because that would generally be a bad thing. But if it does, then how much are we gonna get at the point in time that that event happens and will it be enough to basically suit our needs? That's the general idea, the general questions. So we could see the term of actual cash value instead of say like replacement cost, which is once again, the amount equal to the replacement cost. So we start at the replacement cost, how much it would cost us to replace the piece of property at that point in time. Notice that if you were to replace something like a structure, like a building, then the replacement, even though you might use the same materials, would be worth more you would think due to the fact that when you had the structure, you built it a while ago. It was built in the past and most things deteriorate over time and therefore due to it being older, it would be have a lesser value you would think. So then the cash, the actual cash value is the amount equal to the replacement cost minus depreciation of a damaged or stolen property at the time of the loss. So the actual value for which the property could be sold, which is always less than what it would cost to replace it. So if you see a policy that's basically gonna give you the replacement cost, you would expect that that would be a better situation typically because now you're gonna be able to have enough money to replace the item. And obviously you can't simply replace it at the cost because you can't build a new thing, for example, because you're gonna have to use, it's gonna have to be new, of course. So if you want the policy to then be covering what you can replace it for, then you would think that you would want the cash value as opposed, I mean, you would want the replacement cost as opposed to the cash value. However, of course, if you have more of a payout at the point in time that an event could happen, then it's gonna cost more on the premium side of things typically. If you have the cash value, then you would think they would give you the cash amount, but that might not be enough then to cover the full replacement, but you would think the premiums would possibly be less. So your questioning when you're doing the insurance might be something like, well, if this was to happen, do I need all the money necessary in order to pick this up at that point in time? Or maybe I do some kind of mixture and try to do some self-insurance type of thing where I have some coverage for the cash value, which might be less than the replacement cost, but I'm also gonna save money. I'm gonna have a significant amount of savings, which I'm gonna think about as my self-insurance kind of thing so that I can cover the difference. You might try to do some kind of combination between the two, for example. So how actual cash value works? Sometimes insurance companies use actual cash value to determine the amount to be paid to a policyholder after loss or damage to the insured property or vehicle. So there's a property, the insurance policy was out, the damage has happened, there's been an accident of some kind and now they gotta determine how they're gonna pay it out and some policies might use the cash value. So there isn't a type of insurance called ACV insurance, for example, that's a misconception. So it's not generally gonna be called ACV insurance or actual cash value insurance, but they might use the cash value method for to think about the payout. So in the case of an automobile that is totaled in an accident, for example, the insurance company would typically pay the actual cash value of the vehicle after determining its replacement cost and subtracting factors, such as depreciation and wear and tear. So how are they going to come to this? They're gonna use some kind of estimating system where they might first say, okay, well, what if they had a new car and then we're gonna take away the depreciation, which basically would be, well, if you had the car for so many years, like five years, then we're gonna basically do our calculations of depreciating it over that point in time, which means it's worth less than it would be if you were to replace it with a new car at that point in time. So under replacement cost coverage, the insurer would pay the amount required to replace the covered item with a like kind new car. So if it was replacement costs, as opposed to the cash value, then you would be thinking, and this might be the starting point that they're thinking to get to the cash value, you would be thinking, well, they gotta, obviously if they need a new car, they're gonna have to replace it with a car of a similar nature. How much would that cost? And so actual cash value is used in valuing insurance property in the property and casualty insurance company. Actual cash value is computed by subtracting depreciation from replacement cost while depreciation is figured by establishing and expected lifetime of an item and determining what percentage of that life remains. So the standard method you would use then is you're saying, okay, I'm gonna use these depreciation methods. The straight line method is the first starting point that you might think about depreciation and then use accelerated methods. You'd say, well, what's the useful life of the car? And then how long would the car last and how old was the car so that you can get the cost of the car and then subtract out basically the depreciation. That would be the general format to think about how much the payout would be, which would mean that you would not get enough money in that case, you would think to get a similar car for replacement because they would be giving you that cash value. So this percentage multiplied by the replacement cost provides the actual cash value. Example of actual cash value as an example and then purchase a television set for $3,000 five years ago and it was destroyed in a hurricane. So his insurance company says that all televisions have a useful life of 10 years. So that's again, it's just kind of an assumption. Notice you might be saying, hey, look, if you're doing a car, why don't you use mileage, for example, as the calculation and they could, it might be more accurate in some cases, but the default method is to use the years, which means if they're just using years, they're not really taken into consideration how much care you put into it and whatnot and that kind of stuff too. They're just basically taking an average kind of calculation oftentimes or at least that's the starting point that they can vary it from there, you would think. So as an example, a man purchased a television set for $3,000 five years ago and it was destroyed in a hurricane. His insurance company says that all televisions have a useful life of 10 years. Well, how do they know that? That's just, that's the number they use. So a similar television today costs 3,500. So if he was to buy a similar television today, he bought it for 3,000. There's been inflation and just changes in the price of TVs. You could buy a similar one, but it costs you 3,500 because it's five years later now. The destroyed television had 50% of five years of its life remaining. So meaning it was living for five years and they say it only lives for 10 years. So the actual cash value equals 3,500 replacement costs times 50% or 1,750, which often might look something more like this. You might say, okay, we've got 3,500 to replace it and they said that they last 10 years divided by 10. So that's gonna be the $350 per year and this thing is five years old, so times five. So that means that we took it down by 1,750. 1,750 minus the 3,500 is the 50% or 1,750. So they give you the 1,750 and you could be like, well no way, televisions are valued differently either years are different or something like that. And you could try to argue with them, but that's a general idea. This concept is different from the book value used by accountants in financial statements or for tax purposes. Accountants use the purchase price and subtract the accumulated depreciation in order to value the item on a balance sheet. So if you were doing this from an accountant standpoint, you wouldn't be taking the replacement cost but it would be similar. You would be taking the 3,000 up top, how much you purchased it for because in accounting, what you're trying to do is allocate the cost over the useful life. So you're not gonna increase it based on the fair market value or the replacement cost. You're gonna take the, this would be generally accepted accounting principles. You'll take the 3,000 divided by the five years which means it would be 600 per year times the five years. You would be, I'm sorry, you would take the 3,000 divided by 10 years. That would be 300 times five years have passed 1,500. So we would be at the 1,500 minus the 3,000 would be 1,500. So 50% of the 3,000 instead of the 3,000 five would be the general difference if you're using a straight line kind of method. So accountants use the purchase price and subtract the accumulated depreciation in order to value the item on a balance sheet. See, ACV uses the current replacement cost. So that's current replacement cost. That's the difference. So the actual cash value versus the replacement cost property insurance policy holders will usually prefer payment based on the replacement cost of damaged or stolen property because it compensates the policy holder for the actual cost of replacing the property. So if you have a choice and you're saying, okay, we've got the actual cost or I mean, we've got the replacement cost or we've got the actual cash value. Well, I would like to get the replacement cost. I would, whatever it is that I'm ensuring that broke down I'd like to replace it with a similar one today rather than just get the cash amount which is going to be less than that. So clearly that would be generally the better way to go but obviously too it's going to cost more on the premiums you would think on the insurance side of things and the company's side of things they're going to want to be feeling more comfortable giving the actual cash value because that would be less in the event of an accident. And if they're going to give you more at the event of an accident then you might have an increase in the cost of the insurance in the premiums. So for instance, if a camera is stolen every replacement cost policy will reimburse you for the full cost of replacing it with a new camera of like kind. So clearly you would like to say I want a new camera that I can buy not just like a little bit of money that's not going to pay for my new camera that I want to have at this point in time. So the insurer will not take into consideration that the loss camera had a shutter count of 25,000 because you use the camera every day for the last two years using a considerable amount of wear and tear. So those are the kind of the pros and cons when you're thinking of the insurance policy you want to take into consideration actual cash value replacement costs measuring and balancing that out with the cost of the policy, the premiums.