There are two methods of calculating the value of loss items in insurance: Replacement Cost Value (or RCV), and Actual Cash Value (or ACV). Depreciation is used to calculate ACV. With RCV, you are only concerned with the replacement cost of the loss items. For example, if I purchased a 32 inch flat screen TV 5 years ago, I might have paid $900 for the TV. But to buy that exact same TV now might only cost $200. So, I would get RPV of $200, because that is the cost to replace my loss item. (This could also work the other way. If that exact same TV now is $1,200, I would get that amount instead).
With ACV, we use depreciation to determine the actual cash value of the loss item. So with my $900 TV that I bought 5 years ago, each year that I've owned the item its' value will be less. Eventually, my TV will only be worth the amount I could get to scrap it. After 5 years, that TV is only worth $50, because the actual value of that TV has depreciated.
Always ask about Replacement Cost. If your policy pays Replacement cost, it will replace an item without a deduction for depreciation (the cost to buy a similar item brand new). If you do not have Replacement cost, then the insurance company will pay you the fair market value at the time of a loss (Replacement cost - deprection). Depreciation is a deduction in value for every year that the item is used, which lowers it's value.
Business Development Officer, T.D. McNeil Insurance Services, Fresno, California
Depreciation isn’t the word used in most insurance policies. The phrase is “actual cash value.” It means that if you have a loss the company will pay the cost to repair or replace property with “like materials” but never more than the limit in the policy. This is stated in the policy but is further limited to the value of the property at the time of the loss. The key elements are “repair or replace” and “value at the time of the loss.”
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With ACV, we use depreciation to determine the actual cash value of the loss item. So with my $900 TV that I bought 5 years ago, each year that I've owned the item its' value will be less. Eventually, my TV will only be worth the amount I could get to scrap it. After 5 years, that TV is only worth $50, because the actual value of that TV has depreciated.