We all understand on some level that the things we buy don’t keep 100% of their value as the years pass, but how this affects our insurance isn’t always as well known. Referred to in the industry as depreciation, this loss of value and how your policy takes it into account can play a key role in how much you’re able to claim on your insurance.

What Exactly is Depreciation?

Although those in the insurance and accounting professions may use more technical definitions, a simple and straightforward explanation will suffice for homeowners just looking to understand what coverage their policy offers.

In simple terms, depreciation is the loss in monetary value that your property undergoes over time. This loss in value primarily arises due to regular wear and tear and is entirely independent of specific incidents that may also damage your property and thereby reduce its value.

How is Depreciation Calculated?

The way in which depreciation is calculated can vary between insurance providers and policies, so you can always consult with them if you need to. That being said, most policies handle depreciation largely the same way, by reducing the value of the item to nothing over the course of its expected life.

For example, if you paid $2,000 for a TV and your insurer expected it to last for four years, its value would be depreciated by $500 per year, giving a value of $1,500 after the first year. After four years the TV would be fully depreciated and assigned a nil value as a result of this.

Of course, not all assets depreciate at the same rate and some do not depreciate at all. Antiques are perhaps the most obvious example of items that don’t depreciate, and your home itself likely won’t depreciate but is in fact more likely to increase in value over time.

How Could Depreciation Affect Your Insurance Claim?

The impact of depreciation on the value of your insurance claim depends on the type of policy you have. Homeowners insurance can be broadly split into two types, those that insure your property based on their replacement cost value (RCV) and those that insure it based on their actual cash value (ACV).

Actual Cash Value Policies

Actual cash value policies take depreciation into account, with the amount that you’re paid being reduced by the amount that the assets you’re claiming for have already depreciated. This increases the chance that you’ll need to dip into your own money to repair or replace any damaged, destroyed, or stolen items. These policies can be notably cheaper, however, meaning that they’re a good option for many despite the lower coverage.

Replacement Cost Value Policies

Unlike ACV policies, replacement cost value policies will pay the full amount needed to repair or replace your assets should you ever need to make a claim. This ensures that you won’t be left out of pocket but can push the price of the insurance itself up significantly.

Which Type of Policy is Right for Me?

Despite their differences, both ACV and RCV insurance policies are effective ways to protect your home and the things in it, with either ensuring that you’ll receive financial compensation and support when you most need it.

However, it is still worth considering their relative advantages to determine which best suits your individual needs and preferences. With RCV policies providing more coverage at the cost of higher premiums, it’s important to consider how much you value knowing you’ll not be out of pocket at all and how the different options would fit into your budget.

If you’re uncertain about which option is best for you, you should consider speaking with an insurance agent or other advisor before moving forward.