What Is Recoverable Depreciation in an Insurance Policy?

When you file a homeowners insurance claim for a covered loss, the amount your insurance company pays out will typically depend on two factors, namely:

• Your coverage limits, and
• The type of coverage you have – replacement cost or actual cash value.

Recoverable depreciation is the difference between the replacement cost and the actual cash value of your property.

Read on to learn more about recoverable depreciation and how it affects the settlement amount of your insurance claim.

A standard homeowners insurance policy, such as an HO-3 policy, offers replacement cost coverage for your home and other structures. But some insurance policies only provide actual cash value coverage for your personal property. However, you will usually have the option to get an endorsement to your policy for replacement cost coverage.

An HO-3 policy will typically include the following (or similar wording) under “Loss Settlement” in Section I – Conditions.

“Covered property losses are settled as follows:

Personal property – at actual cash value at the time of loss but not more than the amount required to repair or replace.”

Note: An HO-3 policy is the most common home insurance policy and is required by most mortgage lenders.

What Is Actual Cash Value (ACV)?

Actual cash value covers the replacement cost of property minus deductions for depreciation or wear and tear. So your property is insured for its depreciated value.

How Is Actual Cash Value Calculated?

To determine an item’s actual cash value, insurance companies use the following calculation:

Step 1. The cost to replace a damaged or stolen item with the same or similar one. It’s known as the replacement cost of an item.

Step 2. Subtract depreciation from the item’s replacement cost.

The amount an insurance company will deduct for depreciation is determined based on an item’s theoretical lifespan.

Example 1

Laptops typically have a five-year life expectancy for insurance purposes. Assume the laptop you bought three years ago for $1,200 is stolen and the replacement cost of a similar one is $1,000. Your insurance company will deduct $600 (60% of $1,000) for depreciation.

The actual cash value calculation will be as follows:

$1,000 (replacement cost) – $600 (depreciation) = $400 (actual cash value)

Note that you typically won’t receive $400 as you have to take your deductible into account. So if your deductible is $200, you will only receive a check for $200.

Example 2

The television you bought five years ago for $2,000 is destroyed in a fire and you buy a similar one for $2,500. Your insurance company determines that televisions have a 10-year lifespan so your old television had 50% (five years) of its lifespan left. Your insurance company will deduct $1,250 (50% of $2,500) for depreciation.

The actual cash value calculation will be as follows:

$2,500 (replacement cost) – $1,250 (depreciation) = $1,250 (actual cash value)

Note that if your deductible is $200, you will only receive a check for $1,050 from your insurer.

As pointed out by Investopedia, the method to calculate actual cash value for insurance purposes is different from the way accountants calculate book value in financial statements or for tax purposes:

“Accountants use the purchase price and subtract the accumulated depreciation in order to value the item on a balance sheet. ACV uses the current replacement cost of a new item.”

In addition, your accountant may have a different opinion from your insurance company on the lifespan of an item.

For example, the IRS generally allows for a residential roof to be depreciated over 27.5 years. However, insurance companies typically give a residential roof a lifespan of only 20 years.

What Is Replacement Cost Value (RCV)?

Replacement cost value covers the replacement cost of property, without subtracting anything for depreciation or wear and tear. So your property is insured based on its replacement value.

If the laptop you bought three years ago for $1,200 is stolen and the replacement cost of a similar one is $1,000, your insurance company will pay you $1,000 less your deductible. They will not deduct $600 (60% of $1,000) for depreciation based on a typical five-year life expectancy for laptops.

However, it’s unlikely you will receive one check for $1,000 minus your deductible.

You will typically receive two checks, as follows:

Check 1 is for the actual cash value of your laptop.

The actual cash value calculation will be as follows:

$1,000 (replacement cost) – $600 (depreciation) = $400 (actual cash value)

If you have a $200 deductible, your check will be for $200.

Check 2 is for recoverable depreciation.

You will only receive your second check once you buy your new laptop. And you have to send proof of the amount you paid to your insurance company.

Assuming you paid $1,000, your insurance company will send you a check for $600.

Calculation: $1,000 replacement cost minus $400 for actual cash value.

Note that if you can find the laptop on special for $900, your second check will be $500. You cannot pocket the difference if you pay less for an item than what your insurance company agreed to pay you.

What is Recoverable Depreciation?

Recoverable depreciation is the difference between the replacement cost and the actual cash value of your property.

Recoverable depreciation is only applicable if you have replacement cost value coverage. As previously mentioned, your insurance company will typically issue two separate checks. The first check is for the actual cash value of your property and the second one is for recoverable depreciation.

If you can’t prove you have replaced the insured property, you will only be reimbursed for the actual cash value of your property.

If you have an actual cash value policy, the depreciated value over time is non-recoverable.

Conclusion

Recoverable depreciation is the difference between the replacement cost and the actual cash value of your property.

Homeowners insurance can be confusing. Making sure you have the right coverage is the first step. By understanding the difference between actual cash value and replacement cash value, you can avoid unpleasant surprises.

However, that doesn’t necessarily mean that if you file a claim for a covered event that you’ll receive a fair settlement offer.

If you have a large or complex claim, hiring a licensed public adjuster to act in your best interests is a wise course of action. A public adjuster can help you overcome the challenges of managing your claim and can assist you in getting the best possible settlement offer you’re entitled to.

Avner Gat, Inc. has 17+ years of experience as a public adjuster in Los Angeles, covering Southern California. We protect homeowners from the games and fine print that insurance companies are known for.

Call us at (818) 917-5256 to find out how we can assist you.