The California Insurance Code mandates if a property insurance policy requires actual cash value payment, the payment must be based on the property’s depreciation for two types of claims: (1) a partial loss to a structure, i.e., a home or building and (2) damaged contents, i.e., personal property or business personal property.1 Fortunately, there is guidance on how depreciation is applied. Cal. Ins. Code § 2051 states actual cash value is the amount it would cost the insured to repair, rebuild, or replace the damaged property less a fair and reasonable deduction for physical depreciation based upon the property’s condition at the time of the injury or the policy limit, whichever is less.
The California legislature is currently debating legislation, Assembly Bill 188, that would require an insured be paid in the same manner for the total loss of a building, as an insured is paid for a partial loss of a building, i.e., for the building’s actual cash value.
Cal. Ins. Code § 2051 and Cal. Code Regs. tit. 10, § 2695.9, set forth parameters on depreciation application and require that depreciation reflect damaged property’s actual condition at the time of a loss. Under Cal. Ins. Code § 2051, physical depreciation can only be applied to the components of a structure that are normally subject to repair and replacement during the useful life of that structure. Under this statute, an insurer can only apply depreciation to building components that are expected to actually suffer wear and tear. The threshold question before depreciation can be applied is whether the component is normally replaced by the home or building owner. If it is not a component that is replaced, what is the extent of maintenance necessary to keep the component in a good condition? For example, a building’s foundation, structural elements, walls and piping are usually not replaced and it is therefore improper to apply any depreciation. It is also improper to apply depreciation to any cost in a building repair estimate that does not relate to building property. Thus, an insurer cannot make depreciation deductions for labor, plans, permits, overhead and profit. If a building component requires minimal maintenance, then the amount of depreciation that can be applied should be limited. For example, a brick wall will probably never be replaced, but it could be subject to some maintenance every ten to twenty years.
California also requires that depreciation cannot be applied based solely on a building component’s age. California insurance regulations mandate that any adjustment for depreciation must reflect the measurable difference in market value attributable property’s age and condition.2 Consequently, depreciation must be based on the actual condition of the damaged property. Factors that should be considered include how the insured maintained the property, when was the building component last replaced and what was the quality of the property or component. If you can substantiate the property was in good to excellent condition, then you can substantiate minimal depreciation deductions.
Based on California’s depreciation guidelines, in order to correctly evaluate the proper amount of depreciation to apply, it is very important to asses and evaluate the condition of the property prior to the loss. This includes gathering as much information from an insured whether through photos, the insured’s contractors or detailed oral information. This information will assist in minimizing and correctly assessing depreciation.
1 Cal. Ins. Code § 2051.
2 Cal. Code Regs. tit. 10, § 2695.9.