While homeowners may anticipate that their property values will rise over time, the structure itself and many of the items within it decline in value as they age. That's known as depreciation, and it affects your insurance costs and benefits. A replacement cost value homeowner's insurance policy pays the full cost of replacing a damaged item even if it's at the end of its useful life. However, the company may withhold some of the funds associated with depreciation until you can prove you repaired or replaced the items.
Reoverable Depreciation Basics
Insurance companies use recoverable depreciation to ensure that the covered property has been repaired or replaced, as the policy intended. Because the policies replace even older items, there's a chance that a homeowner might otherwise elect to pocket the money and not make the repair, or to replace the item with a cheaper alternative and keep the difference.
In a replacement cost value policy, the initial payment might be for the actual cash value of the item, which adjusts for age, use, deterioration and obsolescence when determining the coverage amount. Once the owner provides receipts and other proof that the items have been fixed or replaced, the insurance company releases the rest of the amount. For instance, a replacement for your computer is available today for $2,000; this is the replacement cost value. Because your computer is five years old and has depreciated, its actual cash value is $1,000. This is the amount the insurance company will send you in the event of a loss -- the replacement cost ($2,000) less the recoverable depreciation ($1,000). If you then purchase a new computer for $1,800, the insurance company will send you the $800 difference between the actual cash value of your previous computer and the cost of your new one.