Meaning of Depreciation in Insurance & How to Calculate It?
Everything eventually loses its value over time, be it your most valuable asset, such is the nature of life. We all buy new things and get used to using them in a couple of days and then they are no longer new to us.
The monetary value of items is also calculated based on their age, condition, and usage. The more an item is used, the lesser monetary value it will hold.
Continue reading to know more details about depreciation in insurance.
What is Depreciation in Insurance?
Depreciation in insurance is the loss of value of a car with time, as each part of the car wears out with time, the value of your car also diminishes. And this is not only with a car, but the same also goes for your mobile, motor vehicle, bike and any other assets. Depreciation is the decrease in value due to decay or regular wear and tear of your vehicle.
Think about this! You bought the latest iPhone XS in approx. Rs. 90,000 today, do you think if you go to the market after two years you would be able to sell it for Rs. 90, 000 only? Of course not. It is a universal fact!
Used items will have less value. The price of your iPhone will decrease because of obvious reasons, after two years it will not be as good as new.
Depreciation Rate for Vehicles
Depreciation of a motor vehicle depends on the number of years it has been in use. The following depreciation chart will help you understand the concept better:
How Fast Does Your Car Value Decrease?
Same as your iPhone, your car’s value too decreases very fast. When you buy the car it is new and after a few minutes, it is already used. The value of your car decreases to 91% of the initial market value the minute you purchase it. Its value drops quickly once it is used.
The car value continues to drop year after year. Car depreciation calculator uses the following values:
| After 1 year | Your Car's Value Decreases to 81% of the Initial Value |
| After 2 years | Your Car's Value Decreases to 69% of the Initial Value |
| After 3 years | Your car's Value Decreases to 58% of the Initial Value |
| After 4 years | Your Car's Value Decreases to 49% of the Initial Value |
| After 5 years | Your Car's Value Decreases to 40% of the Initial Value |
How to Calculate Depreciation in Insurance?
Follow the steps below to know how to calculate depreciation in insurance:
Step 1
Determine Replacement Cost Value (RCV)
As much as it is, determine the present value that can be used to replace the item with its similar one. For instance, your motor vehicle cost is ₹16,79,320. This is will be its RCV.
Step 2
Assess Life Expectancy
Set up a well-defined period in terms of years that the product takes before it degrades. For example, if a motor vehicle has ten years of expected life, it will be 10% (100%/10 years) consigned to becoming obsolete each year.
Step 3
Calculate Depreciation
Multiply the annual depreciation by the number of years the item has been in use. For example, if the motor vehicle is two years old, it may have depreciated by 20% (2x10%).
Step 4
Determine Actual Cash Value (ACV)
The value obtained is obtained by deducting the total depreciation from the RCV. In this case, the motor vehicle's ACV would be ₹13,43,456 (₹16,79,320-₹3,35,864).
Step 5
Submit Documentation
Always ensure that you procure receipts for the replacement or receipts for repairs of your claim from the insurance claim professional to gain back additional depreciation.
Generally, depreciation is calculated by evaluating an item’s Replacement Cost Value and its life span. RCV represents the current cost of repairing the item or replacing it with a similar item, while life expectancy is the item’s average expected lifespan.
Understanding these procedures enables the accurate evaluation of claims while the procedures are being processed.
Depreciation Deductions
The depreciation deductions listed below are designed by The Insurance Regulatory and Development Authority of India (IRDA):
| On Rubber, Nylon, Plastic Parts and Batteries | 50% Depreciation is deducted |
| On Fiberglass components | 30% Depreciation is deducted |
| On Wooden parts | Depreciation is deducted as per the age of the car |
| On parts made of glass | NIL |
How Does Depreciation Impact Insurance?
When a claim is presented, insurance service providers tend to determine the Actual Cash Value (ACV) of the affected item balanced by depreciation. This calculation leads to a lesser amount being paid compared to the amount paid for the commodity/stock in the first instance.
For instance, when a car worth ₹16,79,071 is damaged and its value slips to, say, ₹10,07,443 in two years following the depreciation factor, the cash paid to the claimant is ₹10,07,442.
Moreover, the policyholder may opt for additional coverages such as Zero Depreciation cover, which ensures that you get fully reimbursed without any depreciation deduction, hence reducing the loss due to depreciation. This choice substantially improves the financial protection of an insurance policy.
We at Digit believe in providing the best car insurance add-ons and benefits to our customers so that they can make the most of their policies. One such very beneficial add-on cover is Zero Depreciation cover, now if you have this add-on cover with your comprehensive car insurance policy, you have a jackpot!
This add-on cover gives you 100% coverage, covers every inch of your car leaving a certain engine damage, tyres, batteries, and glass. It is zero depreciation or Nil depreciation car cover that leaves out the depreciation from the insurance cover, thus ensuring complete coverage.
Explain it like I'm five
We're making insurance so simple, now even 5-year-olds can understand it.
Imagine you've just bought yourself a delicious ice cream cone.
But an ice cream is only ice cream if it's frozen, right? And even though it is perfectly frozen when you buy it, it doesn't stay that way. The forces of nature act upon it the moment you take it out of the freezer. It starts to melt.
Now suppose you want to sell your ice cream to your friend. You bought it for Rs. 100, and if you offer it to your buddy RIGHT after you bought it, it's still worth Rs. 100. But if you try to sell it 5 minutes later? It's melting! Your friend will offer you a lesser price for a melted ice cream, because its value has decreased. And the value decreases with every minute that the ice cream is out of the freezer, and the more it melts. That's depreciation!
FAQs about Depreciation in Insurance
How is depreciation calculated for mobiles?
1) In most cases for mobile insurance, a surveyor assesses the depreciation – and the verdict is based on their opinion! This means that your depreciation isn’t set in stone, and it’s based on the assessor’s judgement.
2) There is a pre-defined ‘fixed slab’ of depreciation based on the age of your product (that’s how we do things at Digit!) Since your depreciation doesn’t depend on a surveyor’s assessment, there’s less to-and-fro, making the process simple, clear and fast.
What is depreciation cover?
Depreciation cover, also known as zero depreciation, extends auto or motorcycle insurance. It ensures the insured gets the full cash value for replacements or repairs. There will be no deduction for depreciation. Cars from recent years enjoy this coverage, preserving their value.
What does depreciation mean in insurance?
Salvaging a reduction in the worth of an asset is what they call this situation in insurance terms. This can happen due to age, usage, or advancements in technology. If you file a claim and want to make a new one, the insurance company usually deducts the item's depreciated value when calculating the payout.
What parts does depreciation protect?
Depreciation cover ensures that likely depreciated parts are well covered. This includes body kits and engines. If a policyholder makes a claim, the insurance company will replace these parts at their new, not depreciated, value.
What is the rule of depreciation in insurance?
In insurance, the rule of depreciation states that the claim amount will depend on the item's depreciated value. This implies that over time, assets lose value. So, subscribing to a zero depreciation cover lowers the chances of receiving high compensation.
Can I get recoverable depreciation?
You can recover depreciation through insurance policies, including those with zero-depreciation coverage. This lets policyholders recover the actual cost without depreciation deductions. They are fully compensated.
What is a depreciation example?
An example of the simplest depreciation is a car that costs ₹25,18,606. If, for example, the initial value was ₹12,59,303, others may devalue it after three years; it could be worth ₹15,11,164. When we file a claim for loss, the coverage falls short. This is unless a zero depreciation policy is in place.
How is depreciation calculated?
It depends on the car's age and condition. Insurance regulators set a standard scale to estimate depreciation. For example, a car that is less than 6 months old may decrease in value by 5% while a car that is between 4 and 5 years may also decrease in value by 50%.
How can I claim depreciation?
To claim depreciation, policyholders must file a damage claim with their insurer for their car's current value. Because they have no depreciation coverage, they can claim full repair costs without having to allow for depreciation.
What is the cost of depreciation?
Asset valuation varies with age, condition, and market prices in mind. Depreciation reduces a product's value, especially in vehicles, impacting resale and insurance claims.
What are the benefits of depreciation?
Depreciation has two advantages. First, firms can deduct it from taxes. Second, it accounts for declines in asset value on balance sheets. In insurance, some zero-depreciation products can increase claims. This, in turn, raises repair costs.
What affects a car's depreciation?
When it comes to depreciation of cars, age, miles covered, state and model contribute. Its market demand also affects its value. Well-maintained, low-mileage used cars depreciate slower than most older, high-mileage cars.
What is depreciation allowance in insurance?
Diminishing value allowance in insurance means a reduction in a claim due to the age and use of the car or its parts. When submitting a claim, this allowance determines the payment amount.
What is the difference between depreciation and actual cash value in insurance?
The concept in insurance is a difference in paying claims. It's between depreciation and actual cash value (ACV). Asset depreciation is merely the reduction in a property’s worth. ACV is the replacement cost minus depreciation. ACV often comes with lower payouts without coverage for zero depreciation.
What is the impact of age on vehicle depreciation?
As a vehicle’s age lowers, it impacts its value. It seems sensible since older cars tend to suffer more wear and tear. The slippage rate rises with age. It affects compensation when filing an insurance claim.
How do market trends influence depreciation rates?
Among the factors affecting it, one can single out changes in preferences about specific types of vehicles, the economic climate, and the appearance of new models. This means that the higher demand for a certain model, say electric vehicles, draws down the rate of depreciation compared with conventional internal combustion engine-governed models.
What role does vehicle maintenance play in depreciation?
Maintenance is also an essential factor in corrosion. Well-maintained vehicles will generally cost less than those with varying signs of corrosion. Regular maintenance and prompt repairs help slow depreciation, boosting resale value.
How can I minimise the impact of depreciation on my vehicle’s value?
Cut automobile value loss by scheduling regular maintenance, driving fewer miles, and buying vehicles that keep value. Furthermore, choosing zero depreciation insurance can help prevent financial losses while filing claims.