4.5 Insurance Deductible

An earthquake destroys Company R’s corporate headquarters. At the time of the earthquake, the net book value of the corporate headquarters is $350,000. Company R’s insurance policy covers the fair market value of the property, and R has a $50,000 deductible. In accordance with the insurance policy, the fair market value of the corporate headquarters is based on a third-party appraisal before the earthquake. Company R carefully analyzes the provisions of the insurance policy regarding the deductible. Using an external expert, R determines that the fair value of the corporate headquarters before the earthquake was $500,000.

In the same period as the earthquake, the insurance adjuster communicates to R that once the fair value is determined, an amount equal to the fair market value of the property, reduced by the deductible, will be paid to R, and the amount will not be subject to refund. Because this is a determinable mix of a loss recovery and a gain contingency, in the current period in which the earthquake occurs, R recognizes a loss of $350,000 for the net book value of the destroyed corporate headquarters and a corresponding insurance recovery receivable of $350,000. The loss recovery receivable is recognized because R concludes that it is probable that the insurance recovery will be realized.

Because it is probable that the insurance recovery will be realized and the fair value of the facility was determined to be well above the net book value of the corporate headquarters, it would be appropriate for R to recognize the entire $350,000 loss recovery in the period in which the loss on the property is recognized. In a scenario in which there is sufficient evidence that the insurance payment (in this case, $450,000, which represents the $500,000 fair market value of the property reduced by the $50,000 deductible) will exceed the amount of recognized loss (in this case, $350,000), it would be appropriate for R to recognize an insurance recovery receivable in an amount of $350,000 and apply the deductible to the deferred gain, which represents the excess amount of the fair market value over the net book value of the property.

The deferred gain is the $100,000 difference between the expected insurance proceeds of $450,000 less the $350,000 recognized recovery receivable. Such a gain contingency should not be recognized until all contingencies are resolved and the insurance proceeds are realized. In this example, R may conclude that the $100,000 is realized once the adjuster pays or confirms the related covered amount (the fair value of the corporate headquarters) and the amount is no longer contested or subject to refund (see Chapter 3 for additional considerations related to the determination of the appropriate period in which to recognize the gain contingency).

To recognize the $350,000 recovery receivable, R considered whether it had sufficient evidence to support recognition of the full amount of the loss recovery receivable. If, for example, the external expert had determined the fair value of the corporate headquarters to be $400,000 rather than $500,000, it may have been more difficult for R to conclude that the full $350,000 loss recovery asset would have been received because there would have been no excess (i.e., cushion) of fair value over the net book value of the property. In these situations, an entity could consider consulting with its accounting advisers.