Limited Depreciation

Reviewed by Stefan Tirschler

Noun

lim·it·ed de·pre·ci·a·tion | ˈlɪmətəd dɪˌpriːʃiːˈeɪʃən

Definition: A form of depreciation where assets are not depreciated below a specified percentage of their replacement cost.

The basis of loss payment will be limited depreciation.

What is limited depreciation in home insurance?

Depreciation is a practice where one reduces the value of an item over time. If you’d like the full definition, we’ve got an article for that!

Under normal depreciation, an object can be depreciated all the way down to zero dollars, making it worthless after a time.

Limited depreciation is a modified version of depreciation, where depreciation stops at a certain percentage of the original value, no matter how old the item is. For example, a limited depreciation clause may stop depreciating an item once it’s dropped to 50% of the original value, rather than continuing all the way down to zero.

Limited depreciation is more common in auto insurance than home insurance, but you’ll see “limited depreciation” in home insurance policies sold by Square One!

How does limited depreciation work in home insurance?

In home insurance, depreciation comes up during the claims settlement process.

When someone makes a claim for lost, damaged, or destroyed property, the insurance company doesn’t create the settlement amount out of thin air. The settlement comes from the basis of loss payment, a term found in most every insurance policy.

The basis of loss payment explains how the insurer will pay to settle a claim. A policy usually includes more than one basis of loss payment, depending on the type of claim and other circumstances.

Common bases of loss payment include: replacement cost, guaranteed replacement cost, actual cash value, or agreed value.

Most home insurance policies don’t offer limited depreciation as part of their loss payment bases, but here’s where it factors in with policies sold by Square One:

  • When an insured makes a claim for lost or damaged property, we’ll repair or replace it on a replacement cost basis. That is, we’ll pay whatever the cost would be to replace the damaged property with new property of equal quality.

  • If the property can’t be repaired or replaced, or if the insured would prefer a cash payment, we will pay on an actual cash value basis. Actual cash value is replacement cost minus depreciation, but in many cases, Square One uses limited depreciation. No matter how old the property is, we’ll only depreciate it by a maximum of 50% of it’s replacement cost (in most cases). For property that’s non-functional at the time of the loss (like a 12-year-old cell phone sitting in a drawer), we’d pay actual cash value.

Let’s look at a theoretical example of limited depreciation in action:

Example

Tom, Bob, and Ron are brothers who live in the same apartment building. They all have identical home theatre systems. Tom and Bob both have tenant insurance from Square One, while Ron has tenant insurance from a different provider. All three have $500 deductibles.

A fire in their building destroys all three of their home theatre systems, and each brother makes a claim with their home insurance provider. All three have their claims approved.

Tom, a Square One customer, wants his home theatre system replaced. His adjuster determines it would cost $12,000 to replace his system with a similar, new one. Because he’s replacing his system, his claim is settled on a replacement cost basis: Tom gets $11,500 to replace his home theatre system: the replacement cost minus his deductible ($500).

Bob, the other Square One customer, decides he doesn’t want a new system. He tells his adjuster that he’d rather have cash. His claim is settled on an actual cash value basis. His system was over 10 years old. Based on depreciation guidelines, the adjuster determines that the system’s value has depreciated by 70%. However, Bob’s policy features limited depreciation, so the depreciation calculation won’t go below 50%. Bob receives a cash payment of $5,500: the replacement cost of $12,000, minus 50% limited depreciation ($6,000), then minus the deductible ($500).

Ron, the last brother, has a home insurance policy with no limited depreciation. He also wants a cash payment. Since his system is the same as Bob’s, his adjuster tells him that it’s depreciated by 70%. Ron gets a cash settlement of just $3,100: the $12,000 replacement cost minus 70% depreciation ($8,400), minus his deductible ($500).

The important points

  • Depreciation is the practice of reducing the value of an object over time.
  • Limited depreciation is a cap on how much something’s value can be reduced by depreciation.
  • Square One limits depreciation to 50% of an item’s replacement cost.
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