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

Suppose a new water heater costs a certain amount, and it has an expected useful life of, say, ten years. If a covered loss destroys it after five years, roughly half its useful life is gone, so about half its value has depreciated. On an ACV settlement, the insurer pays the new cost minus that depreciation—roughly the value of a half-worn-out water heater.

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.