Question

Explain 1) what it means if something is insured on a replacement cost basis; 2) what it means if something is insured on an actual cash value (ACV) basis; and 3) why replacement cost insurance is a violation of the principle of indemnity.

Answer 1

1. if something is insured on a replacement cost basis means, it refers to the amount that an entity would have to pay to replace an asset at the present time, according to its current worth. Replacement cost is the actual cost to replace an item or structure at its pre-loss condition. It is different from actual cash value method. In actual cash value method, the insurance firm will deduct the depreciation amount from replacement cost. In replacement cost coverage the policy holder will not have to spend more money to get a similar new item. There is no replacement cost coverage for intangibles.

2. if something is insured on an actual cash value (ACV) basis which means, Actual Cash Value is computed by subtracting depreciation from replacement cost. It is the amount equal to the replacement cost minus depreciation of a damaged property at the time of the loss. In actual cash value method, the insurance firm will deduct the depreciation amount from replacement cost.

3. The principle of indemnity says that an insurance policy should not confer a benefit that is greater in value than the loss suffered by the insured. In replacement cost method, the policy holder will get a benefit that is higher in value than the loss suffered by holder. the reason is replacement cost method will not deduct depreciation.That why the replacement cost insurance is a violation of the principle of indemnity.