Depreciation is the loss in value that property suffers over time due to age, wear and tear, and obsolescence. In insurance, it's the amount subtracted from an item's replacement cost to arrive at its actual cash value (ACV). Understanding depreciation explains why an older item's claim payment is often smaller than the price of buying it new.

Why it matters

Depreciation is the hinge between the two main ways property losses are settled. On an ACV policy, depreciation is deducted, so you receive less. On a replacement cost policy, depreciation is not permanently deducted (though it may be held back until you actually replace the item). Knowing this helps you set realistic client expectations.

A simple example

A roof that would cost $12,000 to replace has a 20-year useful life and is 10 years old: half its life is used, so depreciation is $6,000 and ACV is $6,000. Under replacement cost coverage, the insurer typically pays ACV first and releases the withheld (recoverable) depreciation once the roof is actually replaced. The ISO homeowners form pays only ACV until repair is complete unless the loss is under 5% of the limit and under $2,500.

Don't confuse it with…

• Actual Cash Value is the result after depreciation is subtracted; depreciation is the amount subtracted.
• Replacement cost ignores depreciation in the final settlement (or releases it after repair).
• Insurance depreciation is about lost value to wear and age—not the formal accounting schedules a business uses for tax purposes, even though the idea is related.

On the exam

Lock in the relationship: Replacement Cost − Depreciation = ACV. Expect a math question giving you a new-replacement price and a percentage or age-based depreciation, asking you to compute ACV. Remember depreciation reduces ACV settlements but is not permanently deducted under replacement cost coverage.