In business accounting, depreciation is used to allocate the cost of an asset over the course of its useful lifetime. Many insurance policies, particularly policies for homeowners' insurance, include replacement cost coverage. That means that if a claim is filed, some or all of depreciation might be claimed.

This is known as recoverable depreciation.

Insurance, Depreciation and Recoverable Depreciation

When a consumer obtains a homeowners' insurance policy, everything that is covered under the policy gets a dollar value attached to it.

Key Takeaways

  • In insurance, recoverable depreciation accounts for the deterioration in the value of insured property.
  • If depreciation is recoverable in the policy, the owner may claim those costs as well as the cost of replacing the property.
  • It is important to know whether your policy includes recoverable depreciation or cites non-recoverable depreciation.

The house itself and the possessions in it that are listed in the policy may decline in value over time due to normal wear and tear and the passage of time. The amount of value that is lost each year and accounted for is known as the depreciation.

How to Calculate Recoverable Depreciation

As an example, assume that the homeowner purchases a high-end refrigerator for $3,000. The refrigerator is assumed to have a useful life of 10 years. Therefore, 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 people file an insurance claim, they typically 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 a requirement for repairs or replacements by a set deadline.

Recoverable Depreciation With A Deductible

Many policies have a deductible that must be taken into account. This is the point at which the difference between having recoverable depreciation or non-recoverable depreciation makes a large difference on a claim.

Example of Recoverable Depreciation

For example, assume that a home appliance costs $5,000 and has a useful life of five years. The insurance policy's deductible is $1,700. The appliance is destroyed after two years and a claim is filed. This is the calculation:

  • 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 is $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

The claim with recoverable depreciation is more than two and a half times the amount of the claim without recoverable depreciation.

Submitting a Claim

Generally, to recover the cost of depreciation, you must repair or replace the damaged asset, submit the invoices and receipts with the claim, and provide original claim forms and receipts, and contact an insurance professional for further steps. Every insurance company has its own rules for such claims, so a chat with a representative will be needed.

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 cost of the item that was destroyed.