S P O N S O R E D B Y
SELECTING PROPERTY
INSURANCE LIMITS
Selecting Property
Insurance Limits
Robin Federici, CPCU, AAI, ARM, AINS, AIS, CPIW
PO BOX 781
NORTH KINGSTOWN, RI 02852
Phone: 401-294-3557 Fax: 401-294-3557
Robin’s Cell-401-529-9617 Fred’s Cell-401-524-4567 E-mail: ROBINF@IETA.BIZ EFEDERICI@IETA.BIZ
This material has been designed for use in training programs for insurance industry personnel. It is not intended to be used as a complete reference resource on the programs and coverages outlined herein.
The programs use “standard” policy forms and endorsements for the purposes of discussing the exposures to loss that may exist, some of the coverage options available to treat them, and to provide a framework for discussions with carriers you represent concerning the programs they have available.
Coverages, rules and materials presented during this program may differ from those used by individual insurance companies. Contact individual carriers for details about interpretations of their eligibility requirements, particular insurance contracts and rates.
Copyright 2013 by Insurance Education & Training Associates, LLC. All rights reserved. This document or any part thereof may not be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information retrieval system, without the express written consent of Insurance Education & Training Associates, LLC. Inquires should be addressed to: PO Box 781, North Kingstown, RI 02852 E-Mail:robinf@ieta.biz.
Selecting Property Insurance Limits
STEP #1
Valuation
x Selecting direct damage property insurance limits, first requires, a determination of the value of the property to be insured, using the valuation basis that applies to the coverage in question
x Valuation basis is usually either:
o Replacement o Actual Cash Value
VALUATION BASIS – REPLACEMENT COST:
Property policies generally provide a definition of the term “replacement cost”
ISO 2013 Building & Personal Property Coverage form:
Replacement cost is an “Optional Coverage” and the form describes it as follows:
3. Replacement Cost a. Replacement Cost (without deduction for depreciation) replaces Actual Cash Value in the Valuation Loss Condition of this Coverage Form.
ISO 2013 Businessowners Policy (BOP):
5. Loss Payment
d. Except as provided in Paragraphs (2) through (7) below, we will determine the value of Covered Property as follows:
(1) At replacement cost without deduction for depreciation, subject to the following . . .
Selecting Property Insurance Limits
STEP #1
Valuation
ISO 2011 EQUIPMENT BREAKDOWN: l. Valuation
(1) We will determine the value of "Covered Property" in the event of loss or damage as follows:
(a) The cost to repair, rebuild or replace the damaged property with property of the same kind, capacity, size or quality on the same site or another site, whichever is the less costly; or (b) The cost actually and necessarily expended in repairing, rebuilding or replacing on the same site or another site, whichever is the less costly
. . .
ISO 2013 CRIME (LOSS SUSTAINED & DISCOVERY BASIS) – VALUATION-SETTLEMENT PROVISION:
(3) Property Other Than Money And Securities
(a) Loss of or damage to "other property" or loss from damage to the
"premises" or its exterior for the replacement cost of the property without deduction for depreciation . . .
Selecting Property Insurance Limits
STEP #1
VALUATION BASIS – REPLACEMENT COST (continued): Regardless of policy form replacement cost coverages promise to pay:
x If the property is actually repaired/replaced
x If the repair/replacement is made as soon a reasonably possible
x The cost to replace the lost or damaged property with other property ofcomparable material and quality
x The property must be used for the same purpose
x Premises coverage allows the insured to replace the
building/structure at another location but for no more than what it would have cost to replace at the current location
x Replacement cost applies unless the limit of insurance or the amount actually spent to repair or replace the damaged property is less
)
Note that, since there is no deduction for depreciation, replacement cost means the cost to replace the damaged property withnew property of like kind and quality.)
Aclaim may be made on an actual cash value basis instead of on a replacement cost basis. If the insured elects to have loss or damage settled on an actual cash value basis, they may still make a claim for replacement cost if they notify the carrier of their intent to do so within 180 days after the loss or damageSelecting Property Insurance Limits
STEP #1
VALUATION BASIS – ACTUAL CASH VALUE (ACV): Property policiesRARELY defineor explain the term “actual cash
value”
ISO Building & Personal Property Coverage form:
Under the unendorsed ISO coverage form the valuation clause for all covered property is ACV:
7. Valuation
We will determine the value of Covered Property in the event of loss or damage as follows:
a.At actual cash value as of the time of loss or damage, except as provided in b., c., d., e. and f. below.
Sometimes the courts have been called on to determine its meaning.
Essentially, the courts have defined the term "actual cash value" inthree (3) ways:
1. Replacement cost minus depreciation 2. Fair market value
Selecting Property Insurance Limits
STEP #1
VALUATION BASIS – ACTUAL CASH VALUE (ACV):
COURT DEFINITIONS:
1. The cost to replace the property less a deduction for any physical depreciation
This definition is the traditional insurance industry used for most property in most situations
There are numerous court cases that have applied and upheld this definition
With this traditional definition both ACV and replacement cost begin with cost today to replace damaged or lost property
The only difference between these two valuations is the deduction for any applicable physical depreciation
Accounting or “book” value is not a good indicator of the “insurance” value of insured property. “Book” value uses an accelerated depreciation that makes this value lower than ACV or its replacement cost
)
NOTE: There are certain property that is subject to special valuation other than ACV(i.e. Stock sold but not delivered is valued based on selling price)
Selecting Property Insurance Limits
STEP #1
VALUATION BASIS – ACTUAL CASH VALUE (ACV): Courts that have found the traditional definition too limiting in a given situation haveused either the fair market value definition or the broad evidence rule to determine actual cash value.
COURT DEFINITIONS:
1. Fair market value
Generally defined as the price a willing buyer would pay a willing sellerif neither were under any special constraints
In principle & in large part in practice, the purpose of loss adjustment standards is implementation of the principle of indemnity
In approving market value as important evidence of ACV, the courts have emphasized that this is"the amount which in all probability would be arrived at by fair negotiations between an owner willing to sell and a purchaser desiring to buy."
COURT DEFINITIONS:
2. Broad Evidence Rule
Replaces the “insurance definition” of ACV
Combines the usual industry definition of ACV with fair market value concepts
Takes into consideration a variety of factors in determining the value of covered property
Selecting Property Insurance Limits
STEP #1
BROAD EVIDENCE RULE:
McAnarney vs Newark Fire (1928)
This case posed an interesting problem for the court:
In 1919 McAnarney purchased seven buildings designed for use as a brewery for $8,000, and in January 1920, insured them with various carriers for a total of $60,000.
The buildings were destroyed by fire in April 1920.
McAnarney submitted a claim for $60,000 based on replacement cost less depreciation.
However, the 18th amendment, had been ratified on 1/16/19 The carrier pointed out that McAnarney had been unable to find a
purchaser for the buildings:
o He advertised them for sale for $12,000
o He had submitted an affidavit to the local assessors saying that the buildings had no value as they were only suitable for the manufacture of malt liquor, which was illegal under
Prohibition; and
Selecting Property Insurance Limits
STEP #1
BROAD EVIDENCE RULE:
McAnarney vs Newark Fire (1928)
In the court case that followed, the jury awarded McAnarney $55,000. The insurers appealed and the Court of Appeals reversed the lower courts. It wrote:
Indemnity is the basis and foundation of all insurance law.
The contract with the Insurer is not that, if the property is burned, he will pay its market value, but that he will indemnify the assured, that is, save him harmless or put him in as good a condition, so far as practicable, as he would have been in if no
fire had occurred
The court rejected both the insured's claim that ACV equals replacement cost less depreciation and the insurer position that it equaled market value.
As a standard for determining the payment that would restore the insured to the same condition that existed before the loss, the Court adopted what's come to be known as the Broad Evidence Rule.
The Broad Evidence Rule says that everything that bears on the value of property should be considered. The list of possible factors is a long one: Market value , Replacement cost , Depreciation ,
Original cost, Condition of the property , Location, Use , Assessed value, Offers to sell and Offers to purchase1
Selecting Property Insurance Limits
FUNCTIONAL REPLACEMENT COST:
Functional Building Valuation (CP 04 38)
x The no coinsuranceendorsement is designed to insure an older building whose architectural style has become obsolete or simply unnecessary to the insured's current use of the building.
x It addresses situations when replacement cost valuation would be unnecessary in the event of a total loss
x BUT an ACV settlement would not meet the insured's needs in the event of a partial loss.
x In the event of a total loss, the endorsement provides for replacement of the building identified with a functionally equivalent but less costly building.
x In the event of a partial loss, the endorsement provides for payment of the cost to repair the damage in the architectural style of the damaged building, using less costly material whenever available.
x If the insured does not actually make the repairs,valuation is the lesser of the following:
1. The building's market value (prior to the damage), exclusive of the land value
2. The cost to repair or replace in the same architectural style but with less costly material if available, less an allowance for
"physical deterioration and depreciation"
"Market value" is defined in the endorsement to mean "the price which the property might be expected to realize if offered for sale in a fair market."
Selecting Property Insurance Limits
FUNCTIONAL REPLACEMENT COST:
Functional Personal Property Valuation (CP 04 39)
x Theno coinsurance endorsement is designed to be used when replacement of the personal property in question with
substantially identical property is either impossible or unnecessary, usually as a result of technological change.
x Technological change might make a functional equivalent o much less costly than the damaged property, because the
same features are currently available for considerably less cost than when that item was new
o much more expensive replacement item the only option, because a new process has rendered the old technology so obsolete that no one even makes anything like the damaged property anymore.
x In either case, the functional personal property valuation endorsement can respond appropriately.
x The insured selects a limit of insurance equal to the cost of the replacement property.
x In the event of loss, the property identified in the endorsement is valued at the cost to replace with the most closely equivalent property available, orthe amount actually spent to repair or replace it, subject to the limit(s) of insurance shown in the endorsement.
x If the property is not actually repaired or replaced, valuation is at thelesser of actual cash value or market value.
Selecting Property Insurance Limits
STEP #2
Methods of Estimating Property Insurance Values
x For new property, the original cost of that property is usually an appropriate value to use for insurance purposes.
x But for most businesses, valuing property for insurance is not quite so simple.
x There are several methods of estimating the value of covered property.
x Theideal method is to have the property professionally appraised. x If that approach is not feasible, alternatives are available.
)
Regardless of the method used, many commercial policies exclude both real and personal property categories and these should not be included in the insurance valueSelecting Property Insurance Limits
STEP #2
Methods of Estimating Property Insurance Values
Using Professional Appraisals
x Appraisal by a professional appraisal firm should provide the most accurate estimate of the value of the insured property.
x Professional appraisals generally have more credibility with insurers that demand substantiation of property values.
Market Value Appraisals
x Appraisals are often prepared for purposes unrelated to insurance valuation, including determining its market value for purchase or possible sale.
x Since real estate values depend on many factors unrelated to the replacement cost of the buildings, a market value appraisal must be examined carefully to determine if the figures arrived at are useful for insurance purposes.
x A typical market value appraisal will employ three methods: .
¾ The income approach – determines future income stream
¾ The market approach - estimates the property’s selling price
¾ The cost approach - Only these figures can be used for
insurance purposes. This approach develops the "reproduction
cost" of the buildings and assesses an amount of depreciation, if applicable. It may or may not reflect any additional costs of reproduction that are due to compliance with building codes.
Selecting Property Insurance Limits
STEP #2
Methods of Estimating Property Insurance Values
Property Insurance Value Appraisals
x
Property insurance value appraisals address the value of all property types that the insured has requested be appraised.x
Thefigures should be usable as is with possible adjustment to add the value of any property not addressed by the appraisal.Using Indexed or Trended Original Cost Figures
x For personal property, it is possible to use original cost information to develop property insurance values.
x This approach employs one or more index or trend factors applied to the original cost figures to adjust for inflation and other
changes in costs from the time of acquisition to the present.
x Index factor schedules are available from insurers x Indexing can be very general or detailed:
¾ Some of these schedules list the index factors by year of acquisition, subdivided by industry group, by geographic region, and property type (e.g., real or personal property); ¾ Others provide a list of average index factors by year of
Selecting Property Insurance Limits
STEP #2
Methods of Estimating Property Insurance Values
Using Indexed or Trended Original Cost Figures
x It is important that the original cost figures include all costs associated with each acquisition.
o EXAMPLES:
The original cost for machinery should include the purchase price, and the cost of transporting it to the facility and installing and testing it.
The original cost for buildings should include material and labor costs, and all other costs that would be incurred in the reconstruction of a destroyed building, including architects and engineering fees, government permit and registration fees, and construction administration, overhead, and profit.
x For used property the original cost when new— not acquisition cost which usually reflects the market value not the replacement
cost—is the appropriate basis for indexing.
o If no original cost information is available, the current estimated replacement cost
o Appraisal firms and building contractors can provide estimates on the cost to rebuild existing buildings.
o Machinery dealers and equipment suppliers can advise the current replacement cost of used machinery and equipment
Selecting Property Insurance Limits
STEP #2
Methods of Estimating Property Insurance Values
Using a Square Footage Multiplier Approach
It is possible to make a rough estimate of replacement cost based on square footage and construction information, using property valuation guides (i.e. Marshall & Swift/Boeckh)
Estimatorscalculate cost per square foot to arrive at an estimated replacement cost of both real and personal property based on the:
o Construction features o Building age
o Type of industry o Geographic area
o And other information about the covered property The more detail about the building that is available, the more
accurate the estimated value is likely to be.
The square footage multiplier approach is appropriate as a starting point when no other figures are available.
The values derived should be followed up with either a
professional appraisal or a carefully adjusted indexed original cost estimate.
Selecting Property Insurance Limits
STEP #3
Selecting the Direct Damage Limit
Factors to Consider:
Geographic spread of the insured locations - The
geographic
spread of the insured locations determines how much of the
insured's property is subject to damage by a single loss
occurrence. If the insured's property is spread over several
locations that are separated by enough distance to rule out
the possibility of damage by a single event, a limit of
insurance that is
less than 100% of the total value of all the
property may be adequate
in some cases—depending on the
coinsurance provision that applies and the type of limit being
used
Coinsurance requirements - Most property policies include a
coinsurance provision that sets a minimum coinsurance percentage. The insured may have other options, other than the basic coinsurance. These coinsurance percentage effect the limit. Agreed value
provisions also are available to suspend the coinsurance clause for a specified period of time.
Type of limit that applies - The limit may be scheduled or blanket.
Fluctuations in the insured's property values - There are
endorsements options available that also affect the limit. These include the Peak Season and Value Reporting Form.
Anticipated debris removal costs - When debris removal expense is subject to the property limit the insured should select a limit that is high enough to cover the anticipated debris removal expense and the property value to cover the cost of removing the debris in the event of a total loss. If a separate limit applies, its adequacy needs to be evaluated and increased if necessary.
