Depreciation is the decrease in the value of property over a period of time, usually as result of age, wear and tear from use, or economic obsolescence.
Most home insurance policies, such as HO-2, HO-3, HO-5, and HO-7, will pay to fix your humble abode based on what it costs right now. That’s called Replacement Cost (RC) coverage.
Replacement cost coverage = pays to repair or rebuild your home based on current costs.
But wait! Some homeowner policies, HO-1 and HO-8, cough up less cash ‘cause they factor in how old and worn a house is. That’s called Actual Cash Value (ACV) coverage. It’s cheaper up front, but when disaster strikes, out-of-pocket costs rack up fast.
Actual Cash Value coverage = pays less based on the age and condition of your home (depreciation).
Picture this: your roof gets hit by a storm. Your house is insured for $200,000. You’ve got a 2% deductible, which means you’re coughing up $4,000 before the insurance company cracks open their wallet. The storm said, “Hasta la vista, shingles,” so your entire roof’s toast.
Now here’s the insurance policy kicker—your payout changes depending on your policy type.
- Replacement cost? You’re golden.
- Actual cash value? You may be faced with large out-of-pocket costs.
Oh, and don’t forget: your house value and deductible might be different from this example.
Right-o! Let's break down the Actual Cash Value infographic.
First up: notice that the value of the roof is being depreciated over time. A five year-old roof has more value than a 20 year-old roof.
Actual Cash Value of Roof column: This column records the value of the roof if it was sold in cash at the depreciated price based on how old the materials are. The more that time has passed or the more wear and tear, the less your home components will score in actual cash value.
Minus deductible payment column: This column records the deductible payment that you as the homeowner (i.e. policyholder) would pay to your insurance company. The deductible payment details are shown on the Declarations page of a policy, which is generally the first page of your insurance policy.
Policy would pay column: This column records what the insurance carrier will pay out based on the insurance policy agreed upon terms. Remember that your insurance policy is a legal contract and all the fine print does carry weight.
Cost to replace roof column: This column records an example price of replacing the entire roof. And yeah, it’s kind of on the low end.
Out-of-pocket costs column: This column records the money that you as the homeowner would have to pay out of your own funds to replace the roof.
EXAMPLE ACTUAL CASH VALUE CALCULATION:
$8,500 Actual Cash Value of Roof of a 5 year-old roof
$4,000 - Minus deductible payment
$4,500 TOTAL: Amount the Policy would pay out to replace the roof
$10,000 Cost to replace the roof
$4,500 - Minus Policy pay out
$5,500 TOTAL: Out-of-pocket costs to replace the roof
Clearly, the Actual Cash Value homeowner policy will not fully cover the cost to replace a five year-old roof. Even worse is the projected 20 year-old roof replacement. In that scenario, as the homeowner you would have to pay out-of-pocket for the entire cost of the roof replacement! Heck, it’s not even worth submitting an insurance claim since there is no policy payout.
Moving on, let’s review the Replacement Cost infographic.
A simplified Replacement Cost table looks like this:
$10,000 Cost to replace the roof
$4,000 - Minus deductible payment
$6,000 TOTAL: Amount the Policy would pay out to replace the roof
$10,000 Cost to replace the roof
$ 6,000 - Policy pay out
$ 4,000 TOTAL: Out-of-pocket costs to replace the roof
You would think our table illustration would have less math since depreciation should be not calculated in replacement cost valuation…right? But no! The insurance carriers have made policy payouts complicated!
Our infographic illustration reveals the real situation. Insurance carriers make their initial damage report and policy payout based on depreciated value! Say, what?!
And worse, you only get the “recoverable depreciation” AFTER your general contractor – the guy who replaces your roof – submits a Certificate of Completion telling the insurance company that yes, the roof really is replaced.
Notice that the “Policy would pay” column added with the “Recoverable Deprecation” column all add up to $6,000 in our example (5 year: $4,500+ $1,500 = $6,000; 10 year: $3,000 + $3,000 = $6,000; 20 year: $0+ $6,000 = $6,000;)? That math lines up with our simplified example above.
If things were handled simply by the insurance carriers, as a homeowner you would not have to prove the damage was fixed and wait for a second “recoverable depreciation” check. Instead, you would have had the total policy payout funds in one check.
But reality must intervene. You can expect a minimum of TWO checks. One for the initial policy payout based on depreciated value, and a second for recoverable depreciation AFTER your general contractor has fixed the issue and submitted a Certificate of Completion.
To make things even more complicated, sometimes you might get several recoverable depreciation checks since different types of damage might fall under different parts of your policy coverage.
Oi! Good thing you have a Public Adjuster to help you through the claims process!
Insurance carriers typically source their depreciation charts from a combination of industry-standard resources, internal data, and third-party providers.
The most common sources are:
