When purchasing commercial property insurance for your small business, should you choose actual cash value (ACV) or replacement value (RV) coverage? And what’s the difference anyway?

Essentially, ACV and RV are two different methods used to determine the compensation you’d receive from your insurance provider after filing a claim in the event of a covered loss, such as a fire that damages your business property and inventory. 

The difference between them is in how depreciation factors into the equation. Furthermore, whichever option you choose will affect your annual premium and a property claim if you must file one for damage or loss. 

Let’s explore the difference between ACV and RV and how each affects commercial property insurance:

commercial property insurance: actual cash value or replacement value

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What Is Actual Cash Value in a Commercial Property Insurance Policy?

Actual cash value in commercial property insurance refers to the property’s current market value and represents its replacement cost. Actual cash value is calculated by subtracting the depreciation of the property due to its age and condition from its original price. 

Depreciation can be defined as a reduction in the value of an asset with time. For example, if you purchase a new car, its value is at its highest, known as the “initial” value. That is the amount you paid to buy the car when it was new. As soon as you start driving the vehicle, its value decreases because its condition is affected by wear and tear and general use. The same applies to machinery or equipment you buy for your company.

Therefore, if you have commercial property insurance based on actual cash value coverage and suffer an insurable loss like a fire, your policy would only reimburse you for the property’s value just before the fire occurred because depreciation reduced the value of the property over time. 

In other words, your insurer will base your property claim payment on the cost of buying an item or property in similar condition up to your policy’s coverage limit to what was damaged after depreciation is factored into the payment.

Choosing property coverage with actual cash value may help keep your premium lower. The potential downside is if you buy a new item or property to replace the damaged or destroyed one, you’ll have to pay the difference between what your insurer will cover and the cost of the new item or property.

What Is Replacement Value in a Commercial Property Insurance Policy?

Unlike commercial property policies based on actual cash value coverage, replacement value coverage replaces or repairs the damaged property with new items of similar kind and quality without deducting for depreciation.

For example, if your business property’s roof is damaged in a windstorm, the replacement value would cover the cost of replacing the damaged roof with a new one of similar quality, regardless of the age of the original roof.

The premium for buying property insurance with replacement value coverage is typically higher than those based on actual cash value. The benefit lies in receiving the payment of a claim that allows you to replace damaged or destroyed items or property without the depreciation of those assets being considered.

How to Determine Your Business Property’s Value

Whether you own a business property or are renting or leasing one, it helps to understand that commercial property insurance covers two types of property:

1. The physical building, commercial space, structure, and anything permanently attached, like counters, flooring, light fixtures, or an exterior fence.

2. Your business contents, including furniture, inventory, electronics, and equipment. Essentially, any item you can pick up and move to another location. 

The comparable value of your contents, inventory, and equipment can usually be found by searching for those items online. As for the value of the building, that’s more difficult to ascertain and involves several factors, including:

  • The location
  • The building’s overall condition and age
  • The size and layout of the commercial space
  • The municipal zoning regulations outlining how the land where the building sits can be used
  • The property’s income potential
  • The cost of labour and materials to repair or replace damaged or destroyed property
  • Current real estate market conditions, interest rates, inflation, and economic trends that affect property values
  • A property’s improvement potential
  • Accessibility to and visibility from high-traffic roads and areas

What Type of Commercial Property Insurance Should You Choose?

Choosing to go with actual cash value or replacement value for your commercial property coverage is a big decision, and it can be tricky. 

While actual cash value policies tend to have lower premiums, they also might provide less coverage in the event of a loss. Replacement value policies, on the other hand, offer more comprehensive coverage but may come at a higher price.

To make an informed decision, evaluate your property’s insurance needs, your business’s tolerance for risk and budget, and, if you own the property, the impact of depreciation of the property when selecting your coverage.  

Fill out our online application for a free quote, and talk with one of our knowledgeable brokers about your business property coverage needs. 

Not only can we get you the low-cost protection your small business needs, but we’ll also help ensure your questions are answered, and you’re adequately covered for the risks you face.

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About the Author: Alexandria Anthony

Alexandria Anthony is the Team Lead, Property & Hospitality, at Zensurance.