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:

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.

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.

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.

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.

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.