How Does the Insurance Company Calculate the Insurance Value of My Building or Home? Coinsurance

In our last blog entry we discussed types of valuations for insuring your building. One of the last subjects we covered was something called coinsurance. What is coinsurance and how does it affect my property insurance?

 

All valuation methods have coinsurance clauses in their contracts. Why this is important is the insurance carrier wants to make certain that the building or item they are insuring is insured to full value. If this wasn’t a consideration no one would insure a property item to full value but would expect to be reimbursed in the event of a loss at full value. In another words, a replacement cost valuation indicates that your building is valued at $500,000. You only insure the building to $100,000 but expect that in the event of a loss to be reimbursed for the full cost of $500,000. I know what you are thinking, that doesn’t even make sense! Why would someone insure their property for less than the value and expect to get a settlement at the full value? The truth is this happens all the time. In fact, most lawsuits are over valuation. There are a lot of reasons that owners may not select the full insurance value for their building and property and often it is simply a misunderstanding of valuation. Just like we discussed last week an owner who is convinced that the building isn’t worth any more than the tax assessed value or decides that the building isn’t worth anymore than a value a realtor told them could be shocked to find out that the actual cost to replace the building is far more. And, what happens over time? If you guessed that costs go up you would be right. So if it cost you to $400,000 to build your building twenty years ago does it make sense that it would still cost $400,000 to build it today? Of course not, but in many cases I find when working with clients that they haven’t checked their valuation in years and the coverage that they had stopped being adequate a long time ago. Unless you have inflation guard included in your insurance plan your valuation is static and will remain that way until your request the coverage changed.

 

Coinsurance applies when a building or property item is underinsured. Most insurance companies will require you to insure your building to 80%, 90% or 100% of replacement cost. If the actual cost to replace the building is more than the insurance that you carry by contract the insurance carrier can levee a coinsurance penalty. In the event of a total loss your inability to collect the full amount of replacement for the building can change what type of building that you end up with. However, in the event of a partial loss I believe that the coinsurance penalty is even more meaningful. Say that you had a partial fire loss to your $500,000 building. The damage was $150,000. Unfortunately, you have been insured for $350,000 which is only 70% of the true replacement cost of the building. Your insurance contract requires that you maintain a replacement cost value of at least 90%. Your claim will be subject to a 20% coinsurance penalty and you will not receive the full cost of the insurance settlement for the repairs. So, based on your $150,000 claim the carrier will use a coinsurance penalty of 20% which is $30,000. You will need to cover that plus you’re deductible.

 

This gets even more complicated when you have multiple buildings and values. The best way to make certain that you are adequately insured is to have a replacement cost valuation completed by your agent and company at least every two years. Ultimately, you the owner are responsible for selecting the correct insurance coverage however there are tools available to help you and your insurance agent can be a great resource in helping you to properly insure your building and its contents.

How Does the Insurance Company Calculate the Insurance Value of My Building or Home? Part II

The 2004 Cedar and Pine Ridge fires in California led to numerous homes lost to forest and brush fire. After the cleanup many of the homeowners were shocked to receive claim settlements of only a portion of the total loss to rebuild. The homeowners were under the impression that replacement cost of their home meant that they would get replacement cost at the time the home was destroyed by fire. Unfortunately, this just wasn’t the case. Many of the homeowners had insurance policies for their homes that went back 15, 20 and in some cases more than 30 years and had not made any changes to the replacement value of their homes. If you recall from last week’s blog I indicated that “Replacement Cost Value is a static value that represents the replacement value of the structure at one moment in time.”Over time the cost to rebuild or replace these structures increases however the insurance value did not. In the end there were lawsuits and the process lasted years. What is important to remember from this case is that in the end most of the suits were denied because the responsibility for making sure the structure is fully insured lays with the owner.

 

Insurance carriers use coinsurance clauses in their policy contracts to require the owner of the structure to insure to full replacement cost value. You can avoid a costly mistake in valuation by having your buildings replacement cost value updated at least every two years. You can also elect to have inflation guard set up on your policy to increase the replacement cost value of your building at a set inflationary value each year. And, you should have Extended Replacement Cost or Guaranteed Replacement Cost coverage added to your policy to ensure that spikes in the cost of materials and labor in the event of a national or regional catastrophe don’t increase the cost of rebuilding your building beyond the valuation set by your insurance contract.

 

In the next several blogs I will explain in more detail what coinsurance is and what it does. I will also cover how to get a replacement cost valuation and what the purpose of tools like inflation guard, extended and guaranteed replacement cost is.

How Does the Insurance Company Calculate the Insurance Value of My Building or Home?

I was working with a client this week on setting the replacement cost value for his home. We had an interesting discussion which led me to an idea for a series of blogs on valuation. The information is definitely not exciting but is critical for making sure that you are insured accurately and I will explain what can happen when you are not insured correctly!

 

Case law has developed over the past one hundred years to determine valuation of property such as your home, rental property and commercial buildings. It even extends beyond structures to the value of your diamond ring, your collection of antiques and other personal property. The laws regarding valuation are set by the insurance code of each state. In most states the responsibility for setting the correct valuation for insurance rests with the owner. However, if you don’t know how valuation is calculated how can you make certain you are insuring your property correctly?

 

Most building values are calculated today with Replacement Cost. There are other values available and we will discuss later in the series but we will focus on replacement cost as it is the valuation that is most widely used. Replacement Cost Value (also known as RCV) is simply what it would take to rebuild or replace a structure today with current labor costs and modern building materials. (RCV never includes the value of land).

 

Replacement Cost Value (RCV) is rarely the same as the retail value of the structure (example: the value your home could sell for). Replacement Cost Value is a static value that represents the replacement value of the structure at one moment in time. If a structure falls out of replacement cost value it will be subject to coinsurance penalties that would diminish what the insurance would provide to rebuild the structure or replace in the event of a total loss.

 

A good insurance agent will carefully consider the building characteristics of your structure and will use a replacement cost value formula to arrive at a replacement cost for your structure. This value should always be considered a recommendation as the final decision on value will always lay with the owner of the structure. In next week’s blog I will discuss more on how the insurance carrier calculates replacement cost and introduce a couple of important insurance terms such as coinsurance which can greatly affect the final insurance settlement.

Creating a Wildfire Defensible Space for Your Home

We have seen so many tragedies this past year due to wildfire’s particularly in the western portion of the United States. Taking steps now to protect your home from fire risk is a great way to lower the chance of loss when wildfire threatens the next time. I found an excellent article on the web provided by CalFire. I thought it was so well written and so important that I wanted to share with you. Visit the site at: http://www.readyforwildfire.org/defensible_space

Everyone should consider their wildfire risk regardless if they have faced wildfires in the past. In so many instances, fires have occurred in the past three years where wildfires traditionally had not been a problem. We have noted wildfires in the southeast, Texas, southwest and most all of the western states. In this case, an ounce of fire prevention is worth far more than a pound of cure!