Depreciation

Depreciation is the decline in value of an item over time due to age, wear, and obsolescence. Every physical asset loses value from the moment it is put into use. In insurance, depreciation is the tool adjusters use to calculate actual cash value -- what a used item is worth at the time of loss, as opposed to what a new one costs today.

Each category of property depreciates at a different rate based on its expected useful life. A residential asphalt shingle roof with a rated life of 25 years is roughly 60 percent depreciated after 15 years. A kitchen appliance with a 12-year expected life is substantially depreciated by the end of its useful span. On an actual cash value policy, the adjuster subtracts all that accumulated depreciation from the replacement cost before cutting the check. The result can be surprisingly low on older items.

On a replacement cost policy, depreciation is initially withheld as a holdback -- called recoverable depreciation -- and then released after you complete and document the repairs. You receive the actual cash value payment first, complete the repairs with a licensed contractor, submit receipts to the carrier, and receive the remaining depreciation balance. If you take the initial check without completing the repairs, the withheld depreciation is forfeited. Replacement cost only pays replacement cost if you actually replace the item. This is a contractual obligation, not a loophole, and it is one of the most common misunderstandings about how large homeowners claims are settled.