Few subjects are understood less by homeowners than the role depreciation plays in compensating for property damage and loss. Depreciation is usually defined as the decrease in the value of your property because of use, age and obsolescence. You will save yourself a lot of frustration and money by knowing how insurers use depreciation in computing claims damages. Depreciation is relevant whether you have replacement cost or actual cost coverage of your insured possessions.
You usually have two options when purchasing homeowners insurance to protect your residence and your possessions: replacement cost coverage and actual cash value coverage. Replacement coverage is the cost to replace your damaged property with new property of equivalent materials and quality. Actual cash value coverage is the replacement cost value minus depreciation. Replacement cost policies are more expensive but provide better coverage. Actual cash value should not to be confused with "fair market" value, which is what a willing buyer would pay a willing seller. Recoverable depreciation is the amount of your refund after you complete and submit the required paper work to your insurer. Recoverable depreciation applies only to replacement cost insurance coverage.
Insurance companies use a two-step payment process to compensate you for your loss in the event of a disaster under replacement cost coverage. Depreciation is used to determine the amount of the initial check the adjuster issues to start your repairs. Your first check will be for the actual cash value of the property. To recover the second payment -- the recoverable depreciation -- you must submit your receipts and paperwork in a timely manner after the work is completed to your satisfaction. Insurers also have non-recoverable depreciation items. These items have no value. For example, your Nehru jacket and your cherished collection of 8-track tapes probably have no value for insurance purposes.
Calculating Insurance Depreciation
Using estimating software based on Internal Revenue Service depreciation rules and data from other reliable sources, the insurance industry has a depreciation rate for practically every item of property imaginable. These items typically have useful lives ranging from three to 20 years. You can usually get your insurer's depreciation schedules upon request. You need to know the age of your property and the purchase price to do the calculations. For example, your microwave oven has a useful life of 10 years according to the insurance industry. If you purchased the unit five years ago for $100, the unit has an actual cash value today of $50. It might have a replacement cost value of, say, $75, in which case the recoverable depreciation is $25.
Calculate and Research
You have access to many of the same depreciation rates and tools as your insurer. To avoid unwanted surprises when filing a claim, it would be prudent to develop a depreciation schedule for your major household possessions, including your vehicles, beforehand. This will help you challenge future claims disagreements. Structural damage to your residence frequently presents challenges because building experts do the replacement cost estimating. This is also the area where disgruntled policyholders typically have grievances about claim adjuster errors. You can learn what disgruntled policyholders have to say about insurers from your state's insurance department before taking out a homeowner's policy and make your purchase decision accordingly.
- The Insurance Coach: Replacement Cost vs. Actual Cash Value
- IRMI.com: What Exactly Is Actual Cash Value? Better Yet, How Do You Calculate It?
- USA Coverage: Let's Talk Depreciation
- IRS.gov: Publication 946 (2011); How to Depreciate Property
- The Claims Pages: The Insurance Claims Resource for Adjusters; Depreciation Guide
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