By Michael Perlmuter, JD, President & General Counsel
and Jeffrey O’Connor, SPPA, Vice President
Insureds seem to take great comfort believing their replacement cost insurance will fully cover losses to their business or home when in fact they should not be sleeping so peacefully.
It is painfully clear during our initial conversations with clients experiencing a loss that they believe their claim to be “simple” or “straight forward” because they have “replacement cost insurance.” The insureds are adamant in the assumption that their replacement cost coverage obligates the insured to pay the “cost of replacement.”
Is this true? Absolutely not . . . and on several levels.
Here is where we as public insurance claims adjusters help the insured awaken to the reality.
Contrary to what most policyholders are led to believe, a replacement cost policy does not mean the insurance company will promptly pay whatever it may cost to replace the damaged asset. Instead, the insurance company pays according to one of these three scenarios:
- The cost to repair the item if that cost is less than the cost of replacing the item;
- The replacement cost only if and when the asset is replaced. (If the asset is not replaced, then the carrier is only obligated to pay the “actual cash value” (ACV) of the damaged asset, which raises further significant issues. But, we will deal with those issues briefly below (and in further detail in a future BLOG); and / or
- Less than replacement cost, if other common policy language exists that limits recovery.
Repair versus replacement
Standard insurance policy language grants an insured replacement cost coverage in an endorsement stating that the insurance company “shall not be liable under this [replacement cost coverage] endorsement for any loss unless and until the damaged property is actually repaired or replaced by the insured using materials of like kind and quality with due diligence and dispatch.”
This endorsement means the insurance company will owe the insured for the cost of repair or replacement, whichever is less, so long as the insured replaces or repairs the property in the period of time required under the policy. If the insurance company and its experts can establish that the cost of repairing the damaged asset is less than replacing it, the loss may be settled on a repair cost basis. The benefit to the insurance company is obvious as the savings could be significant.
How does the insurance company establish the cost of repair or replacement?
First, the insurance company assigns an adjuster—its own adjuster—to the claim to investigate all options available to the insurance company under the policy conditions. The insurance company’s adjuster will typically employ construction experts, equipment experts, salvors and other consultants who are compensated by the insurance company to prepare detailed documentation supporting the carrier’s position, which may justify payment that is less than full replacement cost or less than full policy limits, as the case may be.
Anyone previously involved in securing estimates or bids of any kind has experienced large differences between the lowest and the highest estimates. It is no different in the construction and insurance arenas.
So, what estimate will the carrier use? The estimate or formula prepared by its own representative adjuster and other selected resources fulfilling its own greatest benefit.
It is undisputable that an insured’s best interests are not protected by the carrier, especially when the insurer 1) assigns its own adjuster and 2) upon completion of a final report “cherry-picks” its estimate “of choice” or even when averaging the differing estimates. This certainly is contrary to the best interests of the insured—the business or homeowner who thought the insurer was on his or her side providing the safety blanket to be used in the event of damages.
Clearly, an insured is best represented by its own advocate, one who is expert at both preparing an accurate assessment of damages and then fighting for the amount entitled to given the coverages under the policy.
We often draw the analogy to filing a tax return. If an insured allows the insurance company and its team of experts to assess the damages and propose a settlement amount based solely on its calculations, is that not similar to allowing the IRS to prepare your tax return and assess your tax bill as it sees fit? That is why all businesses and many individuals hire accountants to assess their tax liability.
Similarly, it is essential for an insured who wants a fair assessment of its damages to employ its own professional advocate who is experienced in preparing its own estimate of damages. Without a thorough investigation of a loss accompanied by detailed loss appraisals, it is practically impossible to weigh the accuracy or fairness of the insurance company’s offer (an offer which may be self-serving).
More importantly, an insured working with its own public adjuster to complete a thoroughly prepared and documented claim puts the insured in the offensive position and makes it necessary for the insurance company’s adjuster to react to the insured’s claim presentation.
Settlement procedures—another reason why taking the offensive is vital to a fair recovery
After an insured has “settled” its claim on a “replacement cost” (RC) basis, (and remembering that an insured only gets paid RC if and when it replaces the damaged asset), the carrier then calculates the ACV of the damaged estimate. (Different jurisdictions utilize different tests or definitions of ACV which, again, we will discuss in a subsequent BLOG). However, it is not unusual for a carrier to calculate the depreciation of the damaged asset (from its original value) and subtract that number from the RC to determine the ACV.
There is no scientific method for determining or calculating depreciation. Most often, in the absence of the insured hiring a professional skilled and experienced at valuing depreciation, the depreciation is what the insurance company says it is.
In the event that the damaged asset is not repaired or replaced, then the insurance company only is required to pay ACV. Thus, it easily can be understood why establishing as fair and maximum RC is so important to an insured’s recovery whether or not the damaged asset is replaced!
Until that entire process unwinds and a carrier agrees to an RC and then an ACV, it is likely the carrier may not pay a dime to the insured. Thus, the need for a supportive third party public adjuster expert at assessing and valuing the RC, the depreciation and ACV is vital to obtaining a fair initial payment as quickly as possible. Then, if and when an insured replaces the damaged asset (assuming the carrier agrees that the replacement is of “like kind and quality” and also has been done in a timely period as required under the policy), it will be necessary to submit documentation to the carrier to support the cost of repairs/replacement and recover the appropriate amount of depreciation withheld. Substantiating an insured’s claim for the recovery of amounts above ACV is anything but a walk in the park and not for the faint of heart and inexperienced! There are likely to be issues concerning the identification of insurable costs, code upgrades, additions and improvements, and “like kind and quality.” 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 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. Current codes and ordinances will require an insured to re-build or repair in accordance with the then existing codes and ordinances. However, most basic policies exclude coverage for 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 (again one of the most confusing topics in the world of insurance and one which we will address in a subsequent BLOG). It is a requirement that an insured insure the property adequately or suffer a penalty when a claim occurs. The percentage of the penalty is equal to the percentage by which the insured is underinsured to the current and true replacement cost. So, if the insured are underinsured by 30%, its covered claim will be paid out at the agreed amount, less 30%. Hardly the full replacement an insured expected!
Another consideration is the amount spent (or not spent) to mitigate the damages after the loss. While policies require an insured to act promptly to mitigate its damages, if the adjuster considers an insured’s mitigation expenses too high or unnecessary, in part, the amount may not be paid in full. On the other hand, if the adjuster feels an insured did not act promptly or do what was expected to preserve the property, approval may not be granted for payment of the resulting damages caused by the insured’s inactivity.
Thus, in order to manage the entire claim process successfully with the goal of achieving a fair recovery, it is essential that an insured not rely on the insurer’s own adjuster, but retain a professional public adjuster experienced with understanding and evaluating policy language and preparing, presenting and adjusting a property insurance claim.
Alex N. Sill Company is North America’s leading public adjuster and loss consultant exclusively representing insureds across the United States, Canada, the Bahamas, Bermuda and the Caribbean. 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 and doing so in the least possible timeframe while concurrently relieving the insured of much of the time-consuming details of the claims process.
If you are faced with a major property insurance claim, consider discussing the details with us. We are pleased to review your policy and offer advice without commitment or cost. A consultation with an experienced public adjuster immediately after the loss can help you make timely and wise decisions which may have a tremendous effect on the ultimate recovery of your claim.