Georgia Property & Casualty Practice Exam

Why might an insurance company use actual cash value to settle a claim?

1. To reflect current market prices

2. To account for the replacement cost plus depreciation

3. To account for physical depreciation alone

4. To ensure a policyholder receives full replacement value

The correct answer is: To account for the replacement cost plus depreciation

Using actual cash value (ACV) to settle a claim allows an insurance company to provide compensation based on the replacement cost of the damaged property, minus depreciation. This method reflects the property's current value, which takes into account factors such as wear and tear, age, and market conditions. When an insurance policy specifies that claims will be settled on an ACV basis, it means that the insurer will assess what it would cost to replace the property with a new item of similar kind and quality, and then reduce that amount by depreciation. This ensures that the policyholder does not receive more than the item is currently worth, which is a key reason insurers might opt for this valuation method. This approach balances the need for fair compensation while preventing overpayment, as new items can often hold a higher value than more worn assets. Considering the other options, simply reflecting current market prices alone may not account for depreciation, leading to potential overvaluation. Relying solely on physical depreciation also fails to consider replacement costs, which must be included when establishing an ACV. Ensuring that a policyholder receives full replacement value represents a different valuation method known as "replacement cost" coverage, which does not deduct for depreciation, and is thus distinct from actual cash value settlements.