Replacement Cost Insurance – What You Don’t Know Can Hurt You
By Jeffrey W. O’Connor, SPPA Vice President
Alex N. Sill Company
As an insurance consultant, I often hear that a client expects a claim to be simple or “straight forward” because they have replacement cost insurance. Is this true? Absolutely not. Here’s why:
Contrary to what most policyholders are lead to believe, a replacement cost policy does not mean that the insurance company will promptly pay whatever it may cost to replace the damaged asset. Instead it pays:
The cost to repair the item if that cost is less than the cost of replacing the item.
The replacement cost only after the asset is replaced.
Less than replacement cost if other common policy language exists that limits recovery.
Repair Versus Replacement
Most insurance policy language states that the insurance company owes the insured for costs of repair or replacement, whichever is less. If the insurance company and its experts can justify the cost of repairing the damaged asset rather than replacing it, the insurer will settle on a repair cost basis. The benefit to the insurance company is obvious as the savings could be significant. That is why the insurance company will assign an experienced adjuster to the claim who will investigate all options available to the insurance company. Furthermore, the insurance adjuster will typically employ construction experts, equipment experts, salvors and other consultants to prepare very detailed documentation that supports their position for payment less than full replacement cost or less than full policy limits.
Anyone that has been involved in securing estimates of any kind has experienced large differences between the lowest and the highest estimate. In the insurance industry, it is common knowledge that experts will produce as many different conclusions and amounts as the number of experts involved.
Which opinion is correct? The insured’s best interests are not protected by the “average” of the differing opinions — nor are insured’s interests best protected by the “majority” of the opinions. They are best protected by the most accurate assessment of what they are entitled to given the loss, damage and provisions they are entitled to under policy conditions.
As the insured, you have two courses of action available to you to establish the correct approach and cost of your claim. One is to do nothing and let the insurance company and its experts determine the value of your loss and make you an offer at some point in the future. Without a thorough investigation of your loss accompanied by detailed appraisals, it would be difficult to weigh the accuracy of the insurance company’s offer short of duplicating their efforts to arrive at what your loss value should be.
Your second option, which is most common and preferred, is to supply the insurance company’s adjusters with well-prepared documentation to substantiate the value of your loss. Using this approach, you are in a position to give yourself the benefit of the doubt in those “gray” areas of the claim. A well documented claim will put you, the insured, in the offensive position and make it necessary for the insurance company’s adjuster to analyze or audit your claim presentation.
After you have prepared, presented and negotiated your claim with the insurance company and a replacement cost loss has been determined, the actual cash value of the claim must be established. The measurement of actual cash value is typically replacement cost less a negotiated amount of depreciation that represents the physical condition of the building at the time of loss. Other factors that can affect actual cash value are market value, land value, salvage value before and after the loss, income derived from the property, etc.
Due to the fact that your asset might not be replaced at all or it may be replaced by one at a lesser cost than the agreed replacement value, it is in your best interest to maximize the actual cash value recovery by minimizing the depreciation applied to the agreed replacement value of loss. Since the actual cash value amount may be the extent of your recovery, you need to maximize the actual cash value by supplying the proper documentation and negotiating a favorable recovery with the insurance adjuster.
Once the actual cash value has been agreed upon, the claim will be paid to the insured on that basis first. If and when you repair or replace the property, it will be necessary to submit documentation to support the cost of repairs and recover the appropriate amount of depreciation withheld. Substantiating your claim for the recovery of amounts above actual cash value can be involved and complicated. There may be issues involving the identification of insurable costs, code upgrades, additions and improvements. In addition, variable costs to the original agreed upon figures may need analysis for purposes of determining appropriate replacement cost recovery.
Policy Language and its Effect on Replacement
Despite the fact that the policy provides for recovery on a replacement cost basis, the full replacement cost spent by the insured may still not be paid by the insurance company. Most basic policies exclude costs associated with upgrades due to codes or ordinances. Most policies also limit the costs that may be allowed for debris removal. Today’s insurance policies also limit or completely exclude recoveries for mold damages, asbestos remediation and pollution cleanup.
In addition, many policies contain a coinsurance clause. This is a requirement that you insure the property adequately or suffer a penalty when a claim occurs. The amount of penalty is equal to the amount by which you were underinsured. So if you are underinsured by 30%, your claim will be paid out at the agreed amount less 30%. Hardly the full replacement you expected!
Another consideration is the amount spent (or not spent) to mitigate the damages after the loss. If the adjuster considers your expenses too high, he may not pay them in full. If the adjuster feels that you did not do what was expected to preserve the property, he may not pay for the resulting damages caused by your inactivity.
As mentioned earlier, it is best to have the business owner prepare, present and adjust the claim documentation rather than have the insurance company prepare the claim detail. However, without the detailed knowledge of insurance policy language, the claim adjustment process and extensive adjusting experience, the insured is likely creating additional problems if they attempt to adjust a claim on their own behalf.
In most incidences, a business owner can benefit by being represented by a professional loss consultant. Also known as public adjusters, we represent the insured in the adjustment of insurance claims. Our staff includes personnel qualified in building reconstruction, contents and equipment appraisal, accounting and property insurance claim adjusting. Our services include total claim preparation and adjustment discussions with the insurance company’s representatives.
Our objective is to assist the insured in recovering the maximum dollar amount available under policy conditions, absorb our expense as a result of both a larger and faster settlement and relieve the insured of much of the time consuming details of the claims process. This requires knowledge gained through thousands of adjustments and our thorough understanding of the claims adjustment process, the policy of insurance and the appraisal of loss.
If you are faced with a major property insurance claim, consider discussing the details with a loss consultant. Most firms offer to review your policy and offer advice without commitment or cost. A consultation with an experienced adjuster immediately after the loss can help you make timely and wise decisions that may have a tremendous effect on the ultimate recovery of your claim.