Depreciation is the loss in value most property undergoes as it ages or experiences normal wear and tear. Methods for calculating depreciation can vary by insurance provider.
One way to determine depreciation is to divide the cost of an asset, minus its salvage value, over its useful life.
When you buy home insurance, you need to decide if you want to insure your property for its replacement cost value (RCV) or its actual cash value (ACV). Choosing a replacement cost policy means your insurance provider reimburses you the amount it would cost to replace your damaged items with new, similar items. An actual cash value policy only pays the depreciated value.
Each insurance provider has its own way of determining depreciation, some even use the IRS depreciation guidelines. However, most consider an item’s replacement cost value and its life expectancy, or how long the owner should expect to get use out of the property. Each year that passes, the item loses a percentage of its value.
Here’s an example that may make this clearer: Let’s say you buy a laptop for $1,000, and you have actual cash value coverage for it. It is assumed to have a life expectancy of five years. That means every year, the laptop loses 20 percent of its value. If it’s stolen after only a year, your laptop’s depreciated value is $800.
Remember, certain items don’t depreciate, like fine art, jewelry, and antiques. Some, like cars and computers, depreciate faster than others.
Depreciation is also important to understand when it’s time to file a claim. Even if your home insurance is written on a replacement cost basis, under most policies you initially receive the actual cash value of the damaged item. To get the rest of the payout, you typically need to:
Keep in mind your insurance company usually pays the difference between the actual cash value and what it cost you to replace the item. For example, let’s say you spend $900 to replace the stolen laptop. Your insurer has already covered the actual cash value of $800, so the recoverable depreciation is the remaining $100.