Depreciation, what can and cannot be depreciated on your home policy
The term depreciation, as used by insurance companies, means the spreading of the value of an item during its useful life. Insurers normally pay claim settlements on either a replacement cost or on an actual cash basis.
In general, insurance defines depreciation as the loss of value of an item with time - especially income-producing activity. When an item is used, its value decreases with time, leading to a tax burden. Insurance companies calculate depreciation by evaluating the item's replacement cost and life span.
Normally, some items cannot be depreciated, including property for personal use and assets held for investments. Such assets include land, current assets such as cash in hand, and receivables. Read this article to learn more about depreciable assets.
An insurance policy is a legal contract between the insurance company and the insured person's business or entity.
The reduction in the value of an asset over time due to wear and tear is referred to as depreciation. An insurance policy is a contract between an insurer and the policyholder determining the claims the insurer is legally required to pay.
Insurance contracts have many other types of contracts. Insurance contracts are designed to meet specific needs and thus have many features not found in many contracts.
An insurance policy is a legal contract between the insurance company and the business or the insured entity. However, it is important to understand the insurance policy before purchasing. Here are the basics of an insurance policy.
The declaration page is the first page of an insurance policy, and it identifies who is insured, what risks or property are covered, and the policy period.
The insuring agreement has major promises of the insurance provider and indicates coverage. The insurer agrees to offer certain essential things in the agreement, including paying losses for the covered perils offering certain services. There are two basic forms of an insuring agreement.
Need-perils coverage. Under this policy, those perils specifically listed in the policy are covered. If the peril is not listed, it is not covered.
All-risk coverage, under which all losses are covered except the losses that are covered except those losses specifically excluded.
The exclusions take the coverage away from the insuring agreement. The three major types of Exclusions are;
There are some circumstances in case of a loss not covered by an insurance policy. However, whether a peril can be covered depends on the circumstances of the policy.
Every insurance policy illustrates excluded perils; therefore, policyholders should carefully review it to make informed decisions before purchasing an insurance policy.
Damages and losses not covered by an insurance policy are referred to as excluded losses. Excluded losses are outlined in a policy document for review by the person who wants to be a policyholder.
The two excluded perils under a homeowner’s coverage are earthquake, flood, and nuclear radiation. A good example of such excluded loss under the automobile policy is damage due to wear.
An example of an excluded loss under an automobile coverage is damage occuring due to wear and tear.
The conditions inserted in the policy qualify or limit the insurer's promise to pay or perform.
Insurance Policy and Depreciation
In case of damage or destruction of properties, the insurance policies cover the replacement taking into account the value of the depreciated property.
Depreciation is calculated with item's Replacement Cost Value and life expectancy.
The Replacement Cost Value and its life expectancy represent the current cost of repairing or replacing the item with a similar one. In contrast, life expectancy refers to the item's average expected lifespan.
Submitting A Request for Recoverable Depreciation.
Repair or replace the lost or damaged item.
Save all the invoices and signed contracts and submit them to your claim professional.
At the top of each receipt, specify in writing which items need to be replaced.
Provide legible copies or the original documents to your claim professional.
Include your traveler's claim number in all correspondence.
Once your request for reimbursement is received, your Claim professional will contact you to discuss any additional payments.
The Essential Factors of Computing Depreciation
There are a few factors that lead to depreciation expense, thus a depreciate property. Most are tangible assets and others intangible assets and may return actual cash balance or less after calculating depreciation. Some of the affecting factors include:
Date the Service was First Provided
The date the company first utilizes the asset as part of its operations. Circumstances in which the usage starts immediately after the acquisition are easier to prove.
If an asset has been used and has yet to be recorded as a fixed asset, it can be challenging to ascertain when it was first in service.
Value of Acquisition
The investment cost includes taxable income, shipping, and the initialization costs before including an asset. Before including an asset in a fixed asset, it is important to include it in fixed assets.
If the asset has a high market value, you should get it informally appraised to understand better how much it originally cost.
Salvage value refers to the asset's value when it has reached the end of its useful life. The asset’s cost invariably decreases due to usage, wear and tear, and innovations.
If the asset is no longer useful to the company, it can be sold at a lower price than it is usually worth.
Useful Life Estimation
The useful life estimation during which the asset is expected to generate profits for the company is usually called the useful life estimation. This period is usually estimated regarding the length the asset will continue to serve its intended purpose.
After the useful life estimation, there is the possibility that the asset will no longer function cost-effectively.
Depreciation refers to how the asset’s cost are deducted from the business’s profits over its life. Depreciable property can be calculated through the use of different approaches.
Reasons Why Depreciation Matter for Insurance Policy
Depreciation is an essential concept for business owners. It involves the process of allocating the cost over its useful life.
Depreciation is important in the insurance policy because it matches the accounting principle. The principle states that expenses should match the revenue that they generate.
Depreciation enables insurance company helps in depreciating an asset over its useful life.
Depreciation is a critical component in cost accounting, and companies use depreciation to record the declining value of an asset used during claim payment.
Assets that Cannot be depreciated - Non-Depreciable Assets
As mentioned, properties for personal uses, inventories, or assets that are retained for investment cannot be depreciated. Assets that do not lose value over time or assets you are not using to generate income right now cannot be depreciated. Here is a list of items that insurance companies cannot depreciate.
Land is one of the items that an insurance policy cannot depreciate - not a depreciable asset. A land, unlike other structures, does not wear or become absolute. The value of the land remains constant over time and does not need to be depreciated.
Over time, the value of artwork may appreciate, and therefore it can be inappropriate to reduce the value of the land. Instead of using depreciation, it is better to determine the feature of artwork through appraisal or other means.
Certain types of machinery are exempted from depreciation by an insurance policy. Specialized machinery is custom-built for a certain purpose is exempted from depreciation because it may retain its value over time.
Bonds and stock as investments
Bonds and stocks are subjected to a different level of risk. And are debt securities issued by companies or governments to raise funds, and they typically pay interest to bondholders until the bond reaches security.
On the other hand, stocks represent ownership in a company and may provide dividends to the shareholders. Bonds and stocks are different types of investments and are subject to different risks. If a bond or stock is damaged or destroyed due to an insured event, the policy may provide coverage for the loss, subject to the terms and conditions of the policy.
It is important to note that the value of bonds and stocks is affected by other factors, including the exchange rates, economic conditions, and the company performance, factors that may cause the value of the investment to fluctuate but are not typically covered by insurance.
Personal belongings include furniture, clothing, and electronics which depreciate over time. Regarding insurance policies, the items are considered personal property and are not subject to depreciation.
Since insurance policies typically aim to reimburse the current person to their current value or the item of loss rather than their original purchase price. Therefore, even if the personal items may have depreciated during your purchase, the insurance policy will help you recover them at their current worth.
Income Producing Structures
For a business, income-producing structures are essential in the operation of the business because they generate revenue, thus contributing to the overall profitability of an enterprise.
However, before purchasing an insurance policy for an income-producing structure, it would be important to ensure that it protects a wide range of potential risks. The damages may include the coverage caused by natural disasters and other hazards that impact the structure's integrity.
Properties that have not been in service for less than a year.
Although the time a property has been in service does not necessarily determine whether it is depreciable, depreciation is calculated based on the useful life of the asset, which may be less than a year in some cases. Assets such as computers or heavy machinery may have a useful life of only a few months.
However, insurance policy depreciation depends on certain terms and conditions, excluding certain types of properties from coverage or even the amount that should be claimed in case of a loss.
When insuring items that cannot depreciate by an insurance policy, it is important to do an accurate valuation. Items that cannot depreciate over time do not typically experience a decline in value over time and therefore the insurance company requires the policyholder to be accurate when giving the actual value of the asset.
Before making insurance decisions for an asset that can not depreciate, working with an experienced appraiser is important to ensure the assets are insured for full replacement costs.