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One decision you need to make when you purchase homeowners insurance is whether you want an actual cash value (ACV) policy, which takes depreciation into account when you file a claim, or a replacement cost value (RCV) policy, which, as the name suggests, provides enough money in your payout to replace your lost or damaged items at today’s prices.
Almost everything depreciates over time: your kitchen appliances, living room furniture and technology, for example. The gap between what you paid for an item when it was new and what it’s worth now is called the depreciation. Whether or not you can recoup that depreciated amount is the difference between ACV and RCV policies, with the latter having recoverable depreciation, while the former only pays you what the item is worth now, in its depreciated state.
Although RCV policies generally cost more, they also make it easier to replace your belongings after a covered event without having out-of-pocket expense, because the recoverable depreciation gives you more money in your pocket to purchase new items.
What is recoverable depreciation?
Generally, you will hear the term recoverable depreciation if you have a home insurance policy with RCV coverage. With an ACV policy, depreciation is not recoverable. But if you have RCV coverage, you may be able to recoup the value by which any destroyed or damaged items have depreciated in the years since you purchased them.
In most cases, depreciation is based on:
- The age of the item
- How well it has held up over the years
- How obsolete it is based on newer versions
Consider a TV as an example. You would not be able to sell the TV that you bought in 2015 for the purchase price you paid. Instead, its years of use and the multiple newer TV models released over the years drive down its price or depreciates the value over time. If it developed a crack in the corner, for example, the value drops even further. Say the replacement cost for the TV you purchased in 2015 is $600, your insurance provider may decide that its actual cost value is only worth $250 today after subtracting depreciation.
If you have an ACV policy, you would then expect a $250 claim check (minus your deductible) for that TV, if it gets destroyed by a peril covered by your policy or stolen (since theft is covered by home insurance policies).
If you have an RCV policy, on the other hand, you would still likely get an initial claim payout of $250 (minus your deductible). However, the total recoverable depreciation amount of $350 is the amount you may receive after following the necessary steps. Usually, this involves buying your new TV and submitting a receipt showing your insurer that you paid $600 as the replacement cost for a comparable TV. This would then result in your insurer releasing the depreciation, meaning you would get a second claim check in the $350 amount.
If you have an ACV policy, you will most likely not receive enough money in your insurance claim settlement to purchase items of the same quality as those you lost. You will either need to purchase cheaper items, or use your own money on top of the settlement to purchase items of similar quality.
There is one caveat: read your policy documents carefully if you have an RCV policy. In some, for example, damage to a roof is only included with recoverable depreciation if the roof is damaged in a fire, but not if it is destroyed in a windstorm. Or you may find that there are other exceptions to your recoverable depreciation that are specific for certain items, or particular covered perils. If you have questions, be sure to ask an agent before you sign any policy documents.
How recoverable depreciation is calculated
Because depreciation largely hinges on an item’s value and value can be subjective, you might be wondering how insurance providers arrive at the total recoverable depreciation amount for any given claim. In most cases, they turn to an item’s useful life.
Say you buy a refrigerator in 2016 with a useful life of 14 years for $1,500. By dividing its lifespan (14 years) by that total ($1,500), companies can arrive at a data-based insurance recoverable depreciation estimate. In this example, for each year of the fridge’s life, it would depreciate by roughly $107. This calculation may vary by provider and circumstances, as well as your specific policy details.
How recoverable depreciation affects a home insurance claim
With both ACV and RCV policies, the first part of the home insurance claim process is the same: a covered peril causes the loss of or damage to your personal belongings or the property; you call your agent or file your claim online, and a claims adjuster assesses the depreciated value of the item or property.
If you have an ACV policy, once the adjuster’s assessment has been accepted by the company, you will receive a check for that depreciated value. If you have valuable personal property that depreciates rapidly, such as many computers, for example, you may face out-of-pocket costs to replace them after a loss.
If you have RCV insurance, however, recoverable depreciation will likely be calculated for nearly every item you own after a covered loss—as it was with ACV policy items. But then there’s a further step. Pay special attention here, as recovering that amount usually requires you to submit receipts or invoices to your insurance provider by a specific time—after you have purchased the replacements for the items you lost.
As a quick recap, here are the steps you can expect with an RCV policy:
- The covered loss occurs: Following a house fire, water damage or burglary, for example, the first step (typically after emergency services have become involved) is to call your insurance provider and start your claim process.
- Your insurance provider calculates ACV: A claims adjuster will usually visit the premises and assess damages and the ACV of the compromised belongings, even if you have an RCV policy. You will then receive a claims check for the RCV of any destroyed or stolen items, minus the amount of your deductible.
- You replace the items: Using the ACV check you received, purchasing new items of similar make and quality is your next step, even if your check doesn’t cover the full cost. In that case, you’d need to add your own money for the purchase. To recover the depreciation, you will then usually need to prove you have replaced the item within a certain timeframe and with specific documents (e.g., receipts). Confirm with your agent what is required under your policy.
- Your insurance provider pays out the recoverable depreciation: Once you have proven that you replaced the destroyed or stolen items with new items and show your insurance provider how much you paid for them, you are then typically issued a second check for the recoverable depreciation amount.
How to claim depreciation
Most insurance providers have very specific steps about how to claim the second recoverable depreciation check. If a deadline applies, be sure to submit any required documentation in time.
One important thing to note here: if you find a great deal on an item on sale, you should not expect to pocket the savings. Circling back to our refrigerator example, say you find a comparable replacement model on sale for $1,200 rather than the original price of $1,500. When you submit the receipt to your insurer, they will pay you enough to cover the $1,200 purchase amount, not the full $1,500 original value of the fridge.
Expanding on the fridge example further, here’s how the numbers could play out:
|Fridge value at the time of purchase in 2016 (i.e., its replacement cost)||$1,500|
|Useful life||14 years|
|Depreciation per year||$107 ($1,500 ÷ 14)|
|The fridge gets destroyed in a covered loss in 2021|
|Total recoverable depreciation||$535 ($107 x five years of use)|
|Actual cash value at the time of the covered loss||$965 ($1,500 – $535)|
|First claim check amount||$465 ($965 ACV – $500 deductible)|
|New fridge purchase cost||$1,500|
|Second claim check (recoverable depreciation) amount||$535|
|Total claim amount||$1,000 (fridge total, minus $500 deductible)|
Why do insurance companies use recoverable depreciation in claims?
Why do insurers make you go through all of these extra steps rather than cutting you a single check minus your deductible? It would seem at first that this would make it easier for both the insurer and the policyholder. There are a couple of reasons they don’t do it that way, however:
- It helps prevent insurance fraud. For example, you would not be able to pocket the $1,000 check (which would be the full amount you’d get for a $1,500 fridge minus the $500 deductible) for the damaged or destroyed fridge, while at the same time getting a free one from your in-laws who happened to be getting rid of theirs.
- It helps insurers avoid paying more than is necessary. If you found your new replacement fridge for a lesser amount, your second claim check will only bring your total claim amount up to the cost of that amount (minus your deductible). Insurance companies do not want to pay for more than the actual cost you paid to replace your property.
- It ensures you do actually replace the items that were destroyed. For example, if you decided you no longer need a fridge, you would just receive the value of the depreciated item and not the second amount because you did not actually replace it.
Ultimately, recoverable depreciation requires some extra steps, but can be worth it for items that may lose value quickly over time. To get your second claim check, you will likely need to do some diligent recordkeeping to prove to your insurance company the amount you paid for your replacement items. Review your policy and your insurance provider’s processes for recoverable depreciation so you can be ready after a covered loss.