What does the term 'depreciation' refer to in insurance?

In insurance, 'depreciation' specifically refers to the reduction in value of an asset over time due to factors such as wear and tear, age, or obsolescence. This concept is essential in helping to determine the actual cash value of a property when a claim is made. When an insurance policy assesses a claim for damages, the insurer will often apply depreciation to provide a fair payout, reflecting the current value of the asset rather than its original purchase price.

By understanding depreciation, policyholders can grasp how the value assigned to their property may decrease over time and how this impacts their potential claims. This knowledge aids in managing expectations regarding insurance payouts, as depreciation will often mean that the amount received for a loss may be less than the original cost of the item.