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. Over time, the home itself and the items under the policy may decline in value, due to normal wear and tear usage. The amount of value that is lost each year is known as the depreciation. For example, assume that the homeowner purchases a high-end refrigerator for $3,000. If the refrigerator is considered to have a useful life of 10 years, 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. 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, such as repairs or replacements not being done by a certain deadline, for example.
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