Sometimes when an insured item is lost or damaged by a covered peril, your homeowners insurance pays you actual cash value (ACV) of the item instead of its replacement value. The difference between the item’s ACV and its replacement value is called recoverable depreciation. 

The other type of depreciation you might have heard of is nonrecoverable depreciation. It describes the loss in value an item has that your insurance company can’t reimburse you for.  

Understanding when each type of depreciation comes into play can be useful if you ever have to file a claim. Let’s dig into the details.

How does recoverable depreciation work on an insurance claim?

Let’s say you have a home insurance policy that covers your dwelling for its replacement cost. Unfortunately, your home is a total loss, so you file a claim. Your insurance company determines that your coverage applies and sends you payment for your home’s actual cash value.

Surprising, right? You probably expected your claim payment to be for the full cost of rebuilding your home (up to your coverage limit and minus your deductible, of course). Isn’t that what replacement cost coverage means? Your reimbursement is supposed to be enough so you can return your property to its pre-loss condition using currently available materials that are similar in kind and quality.

Don’t worry – that’s just the first payment you receive, and you can use it to get started on rebuilding your home. 

Once you demonstrate to your insurer that your property has been completely replaced, you’ll receive additional compensation. This payment is for your property’s recoverable depreciation (i.e, the difference between your property’s ACV and replacement cost), which is based on the amount you actually spend on repairs up to your policy’s limit.

How to calculate recoverable depreciation

Here’s an example to show how recoverable depreciation might work in real life. Imagine you bought a couch that cost $2,500. Over time, its value diminishes until six years later it’s only worth $1,500.

Now let’s say your couch was destroyed in a fire. You file a claim with your insurer, pay your $500 deductible, and get busy looking for a replacement couch. In the between, your insurer sends you a check for the couch’s ACV at the time of the fire minus your $500 deductible – or $1,000. 

Great! Now you have money to spend on a new couch. Ultimately, you buy a similar one for $3,000 and send the receipt to your insurance company. Your insurer accepts the receipt and reimburses you $1,000 in recoverable depreciation.

In total, your homeowners insurance covered $2,500 – essentially, the couch’s replacement cost minus your deductible.

What is nonrecoverable depreciation?

Nonrecoverable depreciation is the amount lost from an item’s value over time that insurance doesn’t reimburse. If your homeowners insurance policy only has ACV coverage, then you’ll only be reimbursed for your insured property’s current depreciated value. The depreciated value is typically less than what it would cost to replace your property.

As the policyholder, you want to confirm whether you have ACV or replacement cost coverage so you know if depreciation is recoverable or nonrecoverable. You also need to clarify if there are conditions you must meet in order to recover depreciation. In some cases, depreciation that is initially recoverable may become nonrecoverable if specific policy clauses are not honored, such as a requirement for repair or replacement to be made by a set deadline.

Why do insurance companies use recoverable depreciation?

Insurance companies have several reasons for holding back a portion of your claim settlement when you have replacement cost coverage. Probably the most important one is that it helps them from overpaying on claims.

In this case, let’s consider what happens after hail damages your roof. If you received the entire in one shot, you could conceivably pocket that check but never make repairs. You could even file a second claim for the same unrepaired damage if another hailstorm came through your area. 

Long story short? Your insurance company needs to see that repairs have actually been completed and your roof is restored. This helps it protect the reserves it needs to have on hand to pay all of their claims.

What factors impact recoverable depreciation payment?

Factors that can affect the amount of recoverable depreciation include:

• The type of item being repaired or replaced

• The age of the item

• How long the owner had the item

• The materials used to make the item, and if similar materials are available to replace it.

Remember, too, that recoverable depreciation is only available to you when you insure your property for its replacement value.

How to submit a claim for recoverable depreciation

The first step to receiving the appropriate amount of recoverable depreciation is to submit a claim. Once your insurance company determines that your coverage applies, it will send you a claim payment for your property’s actual cash value. You can use this money to start repairs or replace your property.

When you’ve fixed what is broken or replaced your property, send your insurer proof, like a receipt for the purchase that clearly shows the item and its costs, an itemized invoice for the work performed, images of the completed work, and a certificate of completion from the contractor. Your insurer can likely send you payment once it has evidence of the cost of repairing or replacing your property.

Who keeps the recoverable depreciation check?

The homeowner usually receives the recoverable depreciation check, which they then use to . to pay the contractors or retailers involved. However, the process may vary based on your policy language, your insurance company, and the type of claim you have. For example, recoverable depreciation payments for roof claims often go to the roofer after the repairs have been made in full.