A depreciation clause in a building insurance policy is a provision that accounts for the decrease in value of a property or its components over time due to age, wear and tear. This clause plays a significant role in determining the payout you receive when you file a claim for damage or loss. Knowing how this clause works can help investors and landlords manage their insurance expectations and ensure they have adequate coverage.
Under a typical building insurance policy, the depreciation clause applies to claims involving repairs or replacements. When you make a claim, the insurer calculates the payout based on the current value of the damaged asset, not its original purchase price. This means the older or more worn out an item is, the less you might receive to repair or replace it. For example, if a roof with a 20-year lifespan is 15 years old when damaged, the insurer may only cover a portion of the replacement cost, reflecting the roof's depreciated value.
To see how this plays out, consider a scenario involving a 2010-built apartment in Sydney valued at $900,000. Suppose a storm causes significant roof damage, and the replacement cost is estimated at $30,000. Given the roof's 20-year lifespan and its current age of 13 years, the insurer applies depreciation. Roughly 65% of the roof's life has been used, so the insurer might only cover 35% of the replacement cost, equating to $10,500. The remaining $19,500 would need to be covered by the owner.
In our experience reviewing thousands of properties across Australia, we find that many investors overlook the implications of depreciation clauses until they make a claim. Often, they are surprised by out-of-pocket costs due to underestimated depreciation. Another common oversight is failing to update insurance policies after renovations, leading to underinsurance. Investors frequently miss out on the opportunity to negotiate terms that better fit their property's needs or fail to compare policies for more favourable depreciation terms.
The answer can differ depending on your situation. Policies differ substantially between insurers, and the age and condition of your property can significantly affect depreciation calculations. For properties purchased post-9 May 2017, if the building is new, depreciation might be less of an issue initially, but it becomes more pertinent as the property ages. In contrast, older properties may have more significant depreciation impacts from the start. If you own a commercial property, note that commercial insurance policies may have different terms and benefits concerning depreciation.
Understanding the specifics of your insurance policy, including any depreciation clauses, is crucial. A Chartered Quantity Surveyor can provide a detailed understanding of how depreciation affects your property and insurance cover, while an accountant can help align this with your financial strategy. Together, they ensure you are not underinsured and help optimise your insurance and tax positions.