How Does Recoverable Depreciation Impact My Home Insurance Claim?
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In home insurance, recoverable depreciation refers to the dollar amount difference between your property's actual cash value and its replacement value.
Home insurance companies usually pay replacement cost claims in two parts — actual cash value, then recoverable depreciation — to dissuade fraud and to limit excessive payouts. After you've repaired or replaced the damaged property, your insurer will write you a check for the recoverable depreciation amount.
What is Recoverable Depreciation?
Depreciation is the amount by which the value your home or personal property has decreased in value since you bought it. Depreciation is caused by a combination of:
- Age: how long ago something was purchased
- Condition: the amount of wear and tear or other damage
- Obsolescence: whether newer models have been released
Example:
Four years ago, you bought a new oven for $1,000. If used versions of similar age and quality currently sell for $600, then your oven has depreciated by $400.
Based on this definition, recoverable depreciation is the portion of the depreciated amount that you can get back or "recover" from your insurance company when you make a claim on a policy with replacement cost coverage.
Such claims will generally be paid by the insurer in two parts.
- The first check will cover the actual cash value (ACV) or depreciated value of the item.
- Once you have repaired or replaced the item, your insurance company will send a check for the recoverable depreciation amount.
Insurance companies split their payments this way for a few reasons: most importantly, it discourages fraud and gives you an incentive to spend the money on actually repairing your home as intended. Using the first part of the claim payment for irrelevant purposes means forfeiting the recoverable depreciation.
How is recoverable depreciation calculated?
The exact formula for calculating recoverable depreciation is unique to each policy and the nature of the damaged item, but the most common method begins by estimating the item's useful lifetime and reducing its value by a fraction of that lifetime each year down to zero.
How does depreciation affect a roof over twenty years?
Imagine that you pay $10,000 for a new roof that's expected to last twenty years. Each year, it would depreciate by one twentieth of its purchase value, or $500. If it's completely destroyed in a storm in year five, its actual cash value would be $7,500 and the recoverable depreciation would be $2,500.
| Year | Actual cash value | Recoverable depreciation |
|---|---|---|
| 1 | $10,000 | $0 |
| 2 | $9,500 | $500 |
| 5 | $7,500 | $2,500 |
| 10 | $5,000 | $5,000 |
| 20 | $0 | $10,000 |
Nonrecoverable depreciation
It's possible that you'll also have some amount of nonrecoverable depreciation when you're making your insurance claim. This is most likely when you have an actual cash value policy, which only reimburses you for the depreciated value of damaged or stolen property. In this case, nonrecoverable depreciation is equal to total depreciation.
Even if you have a replacement cost policy, there may be exceptions on some items, or causes of damage. Fragile items like carpets or awnings may only be covered up to their actual cash value. If both your deck and the awning over it are damaged in a storm, the deck may be covered up to its full replacement cost while the awning is only covered to its actual cash value.
Some things are paid out differently depending on what the source of damage is. For example, an insurer might pay out RCV for damage to a roof if a tree falls on it, but only pay ACV if the damage is caused directly by wind or hail.
The potential mixture of ACV and RCV coverage makes it important for you to verify the details of your policy. In many cases, you will find certain categories of property that are subject to nonrecoverable depreciation.
How to claim recoverable depreciation
Claiming recoverable depreciation from your insurance company begins with filing a claim. An insurance adjuster will calculate the RCV, ACV and depreciation of the property that was lost or damaged. Then the company will send you a check for the ACV amount, minus your insurance deductible.
Next, you pay to replace or repair the item in question. Whether you buy a replacement or take bids for repair work, make sure to keep all of your receipts to show your insurer that you've used the money from the first check as intended. It's also possible that your insurer will pay your repairperson directly.
| How recoverable depreciation is paid on a damaged roof | |
|---|---|
| Replacement cost | $10,000 |
| Subtract depreciation (8 years old / 20 year lifespan = 40%) | -$4,000 |
| Actual cash value | $6,000 |
| Subtract deductible | -$500 |
| Net claim (first payment) | $5,500 |
| Add recoverable depreciation (second payment) | +$4,000 |
| Total claim amount | $9,500 |
Note that if you happen to come in under-budget for your claim, it's very difficult to keep the extra money. Your insurance company will ask to see how much the repair cost, and you'll only receive enough to pay for the item or repairs you actually received.
In other words, if you find and buy a new oven for $200 less than your replacement cost coverage limit, your insurance company gets to keep the money — not you.
Once you've submitted the paperwork to your insurer proving the work or purchase has been completed, your insurance company will issue you a check reimbursing you for the recoverable depreciation.
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