Almost all tangible and non-tangible assets depreciate in value, disregarding circumstances such as regular maintenance and market demand. This is no different for houses or apartments, both of which fall into the category of property. In general, there’s a straightforward formula to calculate property depreciation in Pakistan when you are considering selling an asset, but how do home insurance agencies calculate depreciation before settling your claims? Let’s find about calculating the depreciation of a property below.
Types of Home Insurance Policies
Discussing specifically the different kinds of home insurances in Pakistan, there are two major types of policies that come into play. One takes the replacement value into account while the other takes the actual value into consideration.
Replacement Cash Value (RCV)
This type of property insurance is generally applicable to the house itself, along with all that it encompasses within it. The concept behind the policy is that the insurance company will keep a record of all the belongings covered by the policy, such as your cash, jewellery, furniture, and appliances. In case of damage to the items or to the home itself, you will be paid an equivalent of the full price of the item as of the current market rates so that you can replace it at your convenience.
This kind of insurance is mostly availed in accidental cases where a theft, a fire, a structural collapse, a hurricane, or any other natural or manmade disaster hits an insured home in Pakistan. However, it is important to note that a higher premium is generally paid for this policy.
Let’s take an example to clarify this further:
You bought a laptop for PKR 1 lakh and got it insured under RCV. After about 3 years, the laptop gets stolen. In this case, when you claim for insurance, you will be given PKR 1 lakh in full. What’s more, if the laptop actually costs more than 1 lakh now, you will be given the additional amount as well to ensure that you are able to replace your stolen laptop with a new one of the same make and model. RCV offers a full insurance claim, irrespective of how long you’ve owned an asset.
Actual Cash Value (ACV)
The second type of home insurance in Pakistan comprises reimbursement of the insured loss based on the current value of the property and assets. Since the home itself does not depreciate in value until sold, only the belongings present within the house are insured in this policy. In case of damage or loss of property, home insurance agencies will calculate depreciation on the value of the lost/stolen/damaged goods and pay the actual (current) cash value of the items/assets to the insurer.
But the question remains, how do home insurance agencies calculate depreciation?
Calculating Property Depreciation in Pakistan for ACV
Insurance companies consider a large number of variables in order to determine the ACV of an asset for reimbursement. However, there are two primary methods used in the industry.
ACV = RCV – (% of Depreciation * RCV * Age of the Item)
This is the first formula that is commonly used in insurance circles. While we’ve discussed ACV and RCV above, two more key factors need to be explained. The percentage of depreciation here does not mean the same value that you calculated above when you were selling the house. Most insurance companies have a set list of how much each insured household item depreciates in a year under normal circumstances based on its life expectancy. They use that value to calculate ACV. Another factor determining ACV while calculating property depreciation in Pakistan is the age of the asset.
Let’s explain this with an example:
You bought a flat-screen TV for PKR 50,000 two years back, and it got stolen. Assuming that the insurance company considers its yearly depreciation at 8.5% and that the same TV is now available in the market for PKR 80,000, the above formula would give us:
ACV = 80,000 – (8.5% * 80,000 * 2)
ACV = PKR 66,400
ACV = RCV × (Expected Life of an Item – Age of the Item) / Expected Life of an Item
In the second formula, we only have one to consider one factor, which is the expected life of an asset. Even if an insurance company does not have a yearly rate at hand while calculating depreciation of property, they will always have a certain life span specified for each insured belonging that you own. Thus, it is fairly easy to use this formula as well. Using the numbers from the example we’ve shared above and assuming that the TV was expected to last 8 years:
ACV = 80,000 x (8 – 2) / 8
ACV = PKR 60,000
While both formulae offer different Actual Cash Values, it is important to note that ACV will always be less than RCV, which means that you will not be able to replace your lost belongings until you add some money to the insurance claim from your savings.
This is primarily why many people might prefer RCV over ACV, but with a lower premium, ACV leaves very little for homeowners to complain about.
Calculating property depreciation like the way many home insurance companies in Pakistan do is easy when you know the methods or formulas applied by the insurance agencies. Awareness of how you will be reimbursed for your loss will also help you choose the best policy for your home in Pakistan.