What Is Recoverable Depreciation and How Does It Work?
When buying homeowners insurance, you will have the option of buying an actual cash value (ACV) policy, which is cheaper than a replacement cost value policy (RCV). However, depreciation is calculated into the ACV claim payout. Depreciation is how much the value of that property decreases over time. Depreciation is why your home, computer, television and sofa are not worth as much now as when you first bought them. Only with an RCV policy will you be able to replace your belongings and rebuild your home at today's costs.
For instance, if a storm destroys the structure of your home, an actual cash value policy will only cover what your home's depreciated value is today. A replacement cost policy would cover the value of your home and its depreciation so you can rebuild with the same quality materials and labor at today's rates.
However, in certain cases, a replacement-cost policy may not cover all the costs associated with total restoration, which is why some insurance customers purchase add-on extended or guaranteed replacement-cost insurance.
What Is Recoverable Depreciation?
Recoverable depreciation is the gap between what it would cost to replace an item with a brand new replacement and what your used item is worth today. In the event of a loss, a replacement value cost policy would make two payments, one for the depreciated value of the piece of property and a second check for the recoverable depreciation. An actual cash value policy would only send you the first check.
What Is Non-recoverable Depreciation?
An actual cash value homeowners insurance claim includes non-recoverable depreciation, which means that you do not get a second check in the amount of the recoverable depreciation, as you would with a replacement cost policy.
Actual Cash Value vs. Replacement Cost Value
A standard homeowners insurance policy provides reimbursement when your home and personal property are damaged or destroyed by a named peril. For example, the personal property component of your home insurance policy will pay for your acoustic guitar if it is stolen or destroyed by fire, but it will not pay for your guitar if you smashed it to smithereens in a fit of rock-and-roll exuberance.
When your home or personal belongings have been damaged or destroyed, your home insurance company will determine their worth based on their actual cash value or their replacement value. When you sign up for a homeowners policy, you, as the policyholder, will take part in deciding which valuation method will be used to settle claims. If you are wondering which method your current homeowners insurance employs, take a look at your policy's declarations page, which is the first page of your policy.
Actual Cash Value
The actual cash value of a damaged or destroyed item is determined by its market value just before the loss incident. So, if your 2015 sofa is destroyed by a fire, the value of that sofa will be determined by the current selling price of that same 2015 sofa or a similar sofa. In a home insurance claim, the actual cash value of a damaged or destroyed item is based on its age and how much longer it would have successfully performed its given function.
Some insurance consumers prefer the actual cash value method because their personal belongings can be readily replaced with acceptable substitutes. Also, an actual cash value-based homeowners insurance policy costs less than a replacement-value policy.
Replacement Cost Value
Whereas actual cost value is based on the value of an old, used item, the replacement cost is based on the value of a new item. So, if your 2015 sofa is destroyed by a fire or a natural disaster, the replacement cost of that sofa will be determined by how much a comparable brand-new sofa is currently selling for.
As you can see, the replacement cost method does not subtract the cost of depreciation from an item's value. Because you are replacing your belongings with new items, a replacement-cost homeowners policy costs more than an actual cash value policy.
How to Calculate Recoverable Depreciation
Let's look at how recoverable depreciation works for a personal property claim and a dwelling claim.
Personal Property Claim
Let's say your six-year-old refrigerator is destroyed by fire. Six years ago, the refrigerator cost you $1,000, but the same or similar refrigerator now costs $1,500. If your home insurance carrier determines that a refrigerator's useful life is 10 years, that means your refrigerator lost 60% of its useful life and has 40% of its life left. So, your fridge lost value by $400 in depreciation, which brings you to the ACV of $600. If you wanted to buy the new $1,500 model, you would have to pay for the $900 difference out of your own piggy bank.
On the other hand, a replacement cost policy would pay you the full $1,500 for a brand-new refrigerator of the same or similar make and model. So, replacement cost includes both the recoverable depreciation and the actual cash value of your fridge.
Homeowners Insurance Claims
A home inventory is more than just a list of all your possessions: It should also include receipts, credit-card bills and appraisal documents as well as photos and videos of the items. Having a home inventory will expedite the claims process and help you to get the settlement you deserve. But there are times when you shouldn't file a claim. For example, if your policy deductible is $500, it wouldn't make sense to file a claim for your stolen $350 necklace. Also, filing too many claims may end up in the insurer canceling your policy.
When buying homeowners insurance, you should make sure that your policy's maximum payout limit will cover the cost of rebuilding your home with dwelling coverage. If you have an actual cash value homeowners insurance policy, you would only get paid out for the depreciated value of your home after a loss.
An actual cash value policy won't take into account the increased cost of building materials or labor. If you are unable to pay out of pocket to make up the difference, you insurance payout may not be enough to rebuild your new house. On the other hand, a replacement-cost policy will pay for your house to be rebuilt just as it was before, by paying for most if not all increased costs.
Extended Replacement Cost Coverage
Of course, all homeowners policies have a maximum payout limit, and even a replacement-cost policy may not end up covering the total cost of rebuilding. For the highest level of protection, some consumers prefer to purchase extended replacement-cost coverage or guaranteed replacement-cost coverage, which is the highest level of protection.
If you have made improvements or renovations to your house, tell your insurer. For example, if you pay for a new roof out of your own pocket, a new roof could dramatically reduce your premium. On the other hand, adding an extension to your house may raise your insurance rate but it will be protected.
Extended vs. Guaranteed Replacement Cost
An extended replacement-cost policy pays out a certain percentage over and above the homeowners policy limit. If that percentage is, for example, 20% on a $200,000 homeowners policy, the policyholder would receive an extra $40,000 in coverage for rebuilding costs.
A homeowners policy that stipulates a guaranteed replacement cost is the absolute best way to not lose your recoverable depreciation. This type of coverage is especially beneficial when construction costs (materials, labor) suddenly increase after a widespread disaster hits your area.
Not every home insurer offers extended or guaranteed replacement-cost coverage. Further, while neither extended nor guaranteed typically pay to upgrade your home to comply with current building codes, you can purchase extra coverage, or an "endorsement," to cover those costs.
Finally, if you want to insure your jewelry, artwork or other big-ticket items, you can purchase an endorsement, often called "scheduled personal property" coverage, to protect those special items.
Recoverable Depreciation: Roof Tips
The dwelling component of your insurance policy protects the structure of your house, including the roof. If fire, hail, the weight of snow or another named peril should damage or destroy your roof, replacement-cost coverage will not subtract the roof's recoverable depreciation. Insurance will not replace that roof if it was in disrepair prior to the loss.
ACV and the Claims Process
After a fire, let's say it will cost $13,000 to replace your entire five-year-old roof. Assuming your home insurer determines that a roof should last for 20 years, that means your five-year-old roof has lost 25%. Therefore, your roof's depreciation is $3,250 and an ACV homeowners insurance policy would pay out $9,750 towards replacing the roof, minus your deductible.
Recoverable Depreciation and the Claims Process
If you have replacement cost coverage, you will first pay your homeowner policy's deductible. Afterwards, your insurer will first pay for the roof's ACV ($9,750). When the work is completed, you will receive another payment for the roof's recoverable depreciation ($3,250). Together, these two amounts make up the $13,000 cost of your new roof. Some home insurers offer a policy discount for having a new roof, so ask your insurance agent about this money-saving option.
Roof Value Brand New in 2017
Useful Life of Roof
Age of Roof in 2021
Depreciation per year
$650 ($13,000 ÷ 20)
Depreciation after 5 years
$3,250 ($650 x 5)
ACV Pay Out
$9,750 ($650 x 15) minus deductible
RCV Pay Out
$13,000 ($650 x 15 + $3,250) minus deductible
How To Claim Recoverable Depreciation
If you have an RCV policy, you will work with an insurance adjuster who will determine how much you will be paid. You'll submit receipts for any renovations and for belongings along with an inventory or photographs of everything you need to replace. List the prices for what your possessions would cost to replace today. As for rebuilding your home, that means researching the current construction materials' prices and labor costs.
With an ACV policy, you will only get one check that reflects the depreciated value of the home and your belongings. When claiming recoverable depreciation with an RCV policy, you also get a check for the depreciated value for your losses but later receive a second check, which recovers depreciation so you can rebuild and replace at today's prices without paying out-of-pocket.
Home Insurance Is the Investment of a Lifetime
If you have an actual cash value home insurance policy, you'll only receive coverage for your home and personal belongings at the current market price of your assets, which may have lost value due to age, wear and tear or, say, technological obsolescence.
A replacement-cost homeowners insurance policy allows you to recoup the recoverable depreciation of your property so that you can rebuild your home to its former standards. You will also be able to replace your damaged belongings with brand new items. Many insurance companies offer further protection against depreciation, including extended replacement-cost coverage and guaranteed replacement-cost coverage, which is the highest level of protection.
SmartFinancial uses AI-enhanced algorithms to sort through all the homeowners insurance policies in your area to find the policy from the home insurer that best fits your needs and budget. If you're looking for home insurance that's cheaper than what you pay for your current policy, or you want to upgrade to a replacement cost policy without paying too much, enter your zip code below or call 855-214-2291 for a free quote and consultation.