A major concept in accounting is known as depreciation, which is a method of allocating the cost of an asset over the course of its useful lifetime. Many insurance policies, such as those for homeowners' insurance, include replacement cost coverage, which means that if a claim is filed, some or all of certain depreciation can be claimed as well. This is known as recoverable depreciation.

Insurance, Depreciation and Recoverable Depreciation

When a person obtains a homeowners' insurance policy, everything that is covered under the policy gets a value attached to it. It is natural that the home itself and the items assigned value under the policy may decline in value over time, due to normal wear and tear usage and passing time. The amount of value that is lost each year and accounted for is known as the depreciation. As an example of depreciation, assume that the homeowner purchases a high-end refrigerator for $3,000. The refrigerator is assumed to have a useful life of 10 years. Considering this, the annual depreciation allowed per year is the total cost divided by the expected lifespan. In this case:

Depreciation = $3,000 / 10 = $300 per year.

When most people file an insurance claim, they are reimbursed for the actual cash value (ACV) of the property that is damaged or destroyed. This is a measure of the value of the asset. The ACV is calculated by taking the replacement cost of the asset, which is the cost to replace the asset at its pre-loss condition, and subtracting the depreciation. Assume the above homeowner's refrigerator is destroyed after four years. The ACV of the refrigerator in this case is:

Refrigerator ACV = $3,000 - ($300 x 4) = $1,800

If the insurance policy has a recoverable depreciation clause, then the homeowner is able to claim the depreciation of the refrigerator. In this case, the recoverable depreciation is $1,200. It is important for a policy owner to confirm whether depreciation is recoverable or non-recoverable. In some cases, depreciation that is initially recoverable may become non-recoverable if certain policy clauses are not met or honored, such as repairs or replacements not being done by a certain deadline, for example.

Recoverable Depreciation With A Deductible

Many policies have a deductible that must be taken into account. It is at this point when the difference between having recoverable depreciation or non-recoverable depreciation makes a large difference on a claim. For example, assume that a home appliance costs $5,000 and has a useful life of five years. Furthermore, assume that the insurance policy's deductible is $1,700. The appliance is destroyed after two years and a claim is filed.

  • Allowable depreciation = $5,000 / 5 = $1,000 per year
  • Appliance ACV = $5,000 - ($1,000 x 2) = $3,000
  • Net claim = ACV less deductible = $3,000 - $1,700 = $1,300

Without recoverable depreciation, the total claim on this item can only be $1,300. With recoverable depreciation, the claim is adjusted upwards to include the depreciation amount:

Net claim with recoverable depreciation = $1,300 + depreciation = $1,300 + $2,000 = $3,300

As can be seen, the claim with recoverable depreciation is over two and a half times the amount of the claim without recoverable depreciation.

Submitting a Claim

Every insurance company has its own policies for submitting a claim, but generally, to recover the cost of depreciation, you must repair or replace the damaged asset, save all invoices and receipts so you can submit them with the claim, provide original claim forms and receipts, and contact an insurance professional for further steps.

Keep in mind that if you replace the original asset with one that is less expensive, the insurance company is likely to base the payment amount on the replacement cost of the new item, not the destroyed item.