What is Recoverable Depreciation

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Your house suffered heavy damage during a storm in your area.  The insurance company adjuster showed up and you worked with him to file a claim.   To your delight, the insurance company agreed with the adjuster and processed the claim speedily.   You got the check, but when you opened the envelope and looked at it, the amount was less than the claim.  On the attached explanations, you see that the difference is listed as recoverable depreciation.

What is recoverable depreciation? Recoverable depreciation is the difference between the actual cash value of your home and the replacement value. If your insurance policy is for replacement cost, the insurance company will pay you this difference when the repairs are completed successfully.

Insurance claims can get complicated and involved.  Understanding what goes into an insurance claim, the terminology and language of the insurance industry, and how the calculations that lead up to your eventual settlement are made is critical.  Before you purchase your homeowner's insurance policy, you should consider how these things might affect you in the event of a calamitous loss.

The Key Difference

Many people are under the impression that homeowner’s insurance will replace or repair any loss that they suffer.  Unfortunately, this isn’t always true. How much you can recover from your insurance coverage after a loss depends on how the homeowner's insurance policy was written and the options you elected to add to the policy at the time you agreed to the contract.

Let’s look at what you can expect from a standard actual cash value homeowner's policy in the event the home is damaged.  

The Claim – You filled out all the paperwork, and the adjuster looked at your loss and calculated his estimate of what your claim is worth.  You agreed, and the claim was filed. In our example, let's say the adjuster estimated that the loss to your home was $10,000.

• What you can expect to get – When you get your settlement check, it will be made out for less than the actual claim.  Here’s why
  
  
  • Depreciation - Everything has a life expectancy, even your home.  Our claim on our damaged roof is calculated on the life expectancy of the roof.  Roofs are typically depreciated at a rate of 4% per year. If our roof was ten years old, the depreciation would be 40%.  Our claim would be reduced by that 40% to $6,000, which is the actual cash value of the roof.
    
    
  • The deductible – Your insurance policy has a deductible.  This is the amount that you are responsible for paying as part of the contract.  Let’s assume your insurance policy has a $1,000 deductible. The amount that the insurance company pays you is reduced by that $1,000.  Your settlement check is reduced by that $1,000 dollars as well to $5,000.
    
    
  •  The Final Payment – This $5,000 constitutes the final and full payment that we will receive on our $10,000 dollar loss.  If the roofing company replaces the roof for $10,000, as was estimated, the difference must be made up of our personal money.

Seeing those kinds of numbers can be shocking.  Most people think that insurance on their home is going to repair, replace, or rebuild their homes.  Unfortunately, any homeowner's insurance policy that has only actual cash value coverage is going to leave the homeowner financially crippled in the case of a major loss.  This is where recoverable depreciation is key.

Figuring Recoverable Depreciation into the Picture

If the homeowner's policy had a replacement cost add-on with the policy, the scenario changes drastically.  Taking the same set of circumstances and the same $10,000 claim against an insurance policy that pays replacement costs, allows us to capture that depreciation, which is now termed recoverable depreciation.

• After the Initial Claim Payment – We should receive our claim check from the insurance company for the $5,000.  However, since we have a replacement cost homeowner's insurance policy, we can expect to get additional payments from the insurance company when the work is finished.
• Interim Payments – If the expected recoverable depreciation is large, the insurance company may agree to pay out that amount in smaller settlements as the work progresses.  On most smaller claims, the recoverable depreciation is paid when the work is finished. In our example, when the roof work is completed, we will receive a check for $4,000 dollars. 

This makes a huge difference.  Instead of having to foot a $6,000 cost to replace our $10.000 roof, with recoverable depreciation, we are only responsible for the $1,000 deductible.  You can see how having a homeowner's policy with replacement value coverage can be a lifesaver.

Disadvantages and Advantages

There are advantages and disadvantages to both kinds of homeowners' insurance policies.   You should consider your options, consult with a professional financial advisor or your insurance agent, and get their advice before deciding.  Some things to consider as you explore your options are:

• Sometimes homes appreciate faster than the market value and are worth more than the cost of rebuilding them.  If you are insured for actual cash value, and your home has increased in value over time because of location or some other extenuating circumstance, you may recover more In the event of a loose than you would with replacement value coverage.
• Other factors can change the value of your home overnight.  Your home can suddenly depreciate because of a change in zoning rules, changes in the area in which the home is located, and other environmental factors.  If you chose to insure your home at actual cash value, you must re-evaluate your decision at least every year when the policy renews.
• Ensuring your home at replacement value protects you financially.  You need never worry about an insured loss, leaving you crippled financially because of depreciation or decreased market value.
• Replace costs estimates vary over time.  You should re-evaluate the replacement cost that is written into your homeowner's insurance policy each year at renewal time.

Whichever type of homeowner’s policy you elect to purchase, it is your responsibility to know and understand the contents of that policy.  The insurance policy is a contract between you and the insurance company. As with any contract, you should read and understand the provisions of the contract.  Knowing the limits of your coverage, the values that are set on your home and its contents, and the way the insurance company will handle any claims is vital to protecting your interests.

Why is my Mortgage Company on my Claims Check?

Your lender has a vested security interest in your house.  They, in effect, are your partner in your home purchase until you pay back the money they loaned you to purchase the house plus any interest that is owed.  It is in their interest to see that the insurance settlement is used for the purposes of rebuilding or repairing the damage to the home to maintain its value.  Several things can happen at this point.

• The lender may instruct you to endorse the check and send it to their office.  The lender has several options at this point.
  
  
  • The lender may endorse the check and send it back.  This is usually the case on small claims of less than $500 or for losses on personal property such as clothing or furniture.
    
    
  • If the claims are larger or include a settlement for damage to your home as well as for personal property, the lender will usually send you the amount of your personal property loss first.
    
    
  • Larger claims or the portion of the claim for repair or replacement of your home will probably be held by the mortgage company and paid out in smaller checks as work is performed.  In some instances, the lender may send the checks directly to the contractor performing the work once they are satisfied the work is completed satisfactorily.

What is Additional Living Expense?

If your home is badly damaged and you cannot live in it while it is undergoing repairs, your insurance policy may pay for certain expenses that you incur while you can’t live in your home.   Some of these additional living expenses are:

• Rent or hotel fees
• Pet Boarding if your temporary lodging won’t accept your pets.
• Gas and Mileage if you must travel further to work than normal.
• Food if your temporary lodging has no cooking facilities, and you must eat out consistently.

Some insurance policies contain provisions for advance additional living expenses.  These quick sums of money allow you to plan for you and your family without stressing your personal finance.

There are some critical things to know about additional living expenses.

• ALE reimbursements are usually capped.  Your policy probably sets a maximum amount the insurance company will pay toward ALE.
• Some policies set a time limit for ALE reimbursements.  Claims for ALE must be submitted within this time frame to be considered.
• Ask for a list of items that are reimbursable under your policy.  This is probably not listed in the policy document, but the insurance company should provide you with a written list of what is eligible and what is not.

Don’t get confused about what constitutes ALE and what should be covered under the personal property provisions of your insurance policy.  If you are displaced from your home, there will be lots of needs as an example.

• Having to move into a hotel or rent an apartment to live in is covered under the ALE provisions of your insurance policy and should be claimed as such.
• If you and your family lost all your clothing and need to purchase new clothing, these expenses should be claimed as a personal property loss and filed under that portion of the policy.

My Contractor Started Repairs and Found Additional Damage.  What do I do?

All too often, insurance adjustors miss or can’t see all the damage that needs to be addressed.  This is particularly true where damage to a home is severe, and the adjuster can’t see portions of the structure still covered by the finishes.  When the contractor begins demolition before the rebuilding or repairing process, it is common to find structural damage that must be addressed.

You will be required to file a supplemental claim in this case.  Many contractors are familiar with this process and can handle filing your supplemental claim on your behalf.  If not, the process is simple and straightforward. If your contractor can’t or won’t file the supplemental claim, there are some steps you should follow.

• File the supplemental claim before any further work is started. 
• Contact the original adjuster or your insurance agent to get the exact steps you should follow to file the supplemental claim.
• Generally, the supplemental claim will be sent to a company adjuster for approval.  The insurance company has the right to do a follow-up inspection.
• Document your supplemental claim with pictures, videos, and further estimates of the additional work and materials that will be required.

Disclaimer

This article does not constitute legal advice and is intended for educational and informational purposes only.  Before entering any contract, you should consult an attorney for legal advice.  

The Bottom Line

In the end, the goal of buying homeowners' insurance is to accomplish several things.

• To protect you and your family against the loss of your home and personal belongings.
• To protect your financial security.
• In the case of a loss, to return your home and family to the same as it was before the loss occurred.

Whether you choose actual cash value or replacement value homeowners, insurance coverage is a decision you must make based on your evaluation of the best set of options.  You should do your due diligence in making that decision by consulting your insurance agent or a public insurance adjuster and educating yourself about the options available in the homeowner's insurance market.

I hope that this article has helped you understand a bit more about how actual cash value and replacement value can affect you in the event of a loss.  Recoverable depreciation is certainly a large factor in making decisions about what kind of homeowner’s insurance coverage to purchase.

 It is our aim to give you a clearer understanding of how these things work and how they can affect you if you must file a claim with your homeowner's insurance company.