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Following an auto accident, your insurance company has to determine if your vehicle is repairable or a total loss. If your vehicle is a total loss, your insurance company offers you a settlement for the value of your car; but how does your insurance company determine that value?
Most vehicle owners naturally assume that the vehicle value is the replacement cost of the vehicle. In actuality, insurance companies dictate that actual cash value (ACV) represents the value of your vehicle. Unfortunately, ACV can be a significantly lower value compared to the vehicle’s replacement cost. So, what is ACV, and how does it relate to your vehicle’s replacement cost?
Actual Cash Value
ACV is the replacement cost of your vehicle, less depreciation. Depreciation is the loss of value that occurs to your vehicle over time due to the vehicle’s mechanical decline, wear and tear, mileage, appearance, and the general overall condition.
The damaged caused in the accident does not minimize ACV; rather, ACV encompasses the value of your vehicle prior to acquiring the damage caused by the accident.
Determining Actual Cash Value
While each insurance company follows its own procedures, the process behind determining ACV is generally the same for reputable insurance carriers. The insurance company gathers recent vehicle sale information for vehicles of the same year, make, model, specifications, and condition, in the same zip code as the vehicle owner. This information provides a realistic understanding of how much buyers pay for the same vehicle with equal or similar specifications, in the same location.
When comparable data is not readily available, the insurance company has to exercise judgement in establishing an appropriate ACV. This is likely to occur with brand new, rare, custom, or collectible vehicles.
How is ACV used?
Determining how much money you receive for a total loss settlement, if your vehicle is not repairable, is one use of ACV. However, before evaluating a total loss settlement, ACV helps to determine if the vehicle is a total loss in the first place.
Following a loss, your insurance company has to assess your vehicle’s damage. The insurance company compares the cost of the repair estimate to the ACV to determine what percentage of the value of the vehicle represents the repair cost.
Each state has its own total loss guidelines. For example, your state’s guidelines may indicate that your vehicle is a total loss when the repair costs equal or exceed a 70% threshold of your vehicle’s value.
Note that if your vehicle cannot be safely repaired, your insurance company might total your vehicle even if the total loss threshold has not been met.
ACV and Your Auto Loan
If you have an auto loan and your vehicle is totaled, the total loss settlement has to be paid first to your lien holder to satisfy your loan, and then to you for any remaining equity. If the total loss settlement does not fully satisfy your auto loan due to a low ACV, you are responsible for paying the remaining balance. The lien holder will pursue you directly to ensure that you pay that balance.
This issue often occurs with brand new vehicle loans, or loans that do not require down payments, because the owner has not had a significant amount of time to pay the loan and establish equity.
An effective way to protect yourself when purchasing a new or used vehicle is to acquire gap insurance. If your total loss settlement does not satisfy the full value of your car loan, gap insurance pays for the difference between the loan balance and the settlement value, so that you do not have to assume that cost.
Gap insurance is offered through the lender (but may also be available through auto insurance carriers), and has to be purchased at the same time that the vehicle is purchased. You can pay for gap insurance up-front at time of purchase, or monthly, as part of the loan payments.
Replacement Cost Coverage
Many insurance carriers offer replacement cost coverage and other similar options, in case of a total loss. This coverage provides you with a total loss settlement that aligns with the replacement cost of your vehicle. Some carriers are providing broader coverage options that allow reimbursement for a newer version of your vehicle.
These types of coverage have to be added as an additional feature to the policy. They come with a more costly premium because the resulting payout is greater.
Tying It All Together
Now that you understand the premise behind ACV, you can evaluate your needs: gap insurance and replacement cost coverage are two great ways to create a financial cushion in addressing lien holder obligations and personal needs. Gap insurance has to be purchased at the time of vehicle purchase and is valuable if you have a loan with minimal.
Replacement cost coverage can be added to your auto policy any time before a loss for an additional cost. Ask your insurance carrier about your coverage options to ensure adequate protection following a loss.