Property Valuation For Insurance Purposes

A fire damages your property. Vandals break in and slash your furniture and spray paint your walls. But that's O.K. – you have insurance. The insurance company will pay the cost to repair the damage. All $50,000 of it. You have replacement cost coverage. Of course the insurance company will. Then insurance company lowers the boom on you. Even though it will cost only $40,000 to repair your property, the company will only pay you $24,000. Your deductible is $1,000; what happened to the rest of your claim?

The scenario described happens all too frequently. And that it happens is not the fault of the insurance company, and probably not the fault of your insurance agent. He kept asking you about the value of the property. You told him the tax appraiser said it was worth $250,000, and that's what you wanted to insure it for. While valuation is far from an exact science, probably the least likely value to satisfy the requirements of your insurance company is the taxation appraised value. Any time you use it as the basis for your property insurance coverage, you are likely to be in deep trouble if you have a loss. In this case, the insurance company calculated that the replacement cost value of the insured property at the time of loss was $400,000.

All property insurance policies have a "co-insurance" clause in them. In general terms, these clauses provide that if, at the time of a loss, the value declared in the policy for insurance purposes is less that a stated percent of the replacement cost value of the insured property at the time of loss, the amount of the claim that will be paid by the insurance company will be penalized by the ratio of the declared value to appraised replacement cost value of the insured property at the time of loss. In most insurance policies, the stated percentage (called the coinsurance percentage) will be 80% (although it may be any other percent that both you and your underwriter agree to). In the scenario described above, with an 80% coinsurance clause, the value declared in the policy could not be less than $320,000; since it was less than the coinsurance required amount, the claim payment due under the policy was [(250000÷400000)*40000]−$1,000, or $24,000.

The definitions of property value that you need to be familiar with when you purchase property insurance are summarized below:

Market Value. The fair value you could expect to receive for your property if sold on the open market. The value should reflect the value you receive after having the property on the market a reasonable period of time; that is, it should not reflect the value you would receive if you sold the property under financial or other distress. The value reflects many issues other than the actual cost of material or labor involved in building or replacing the property, and hence is somewhat subjective and subject to fluctuations based on location and general economic activity. It has no relationship to a replacement cost value.
Tax Value. The value assigned your property for taxation purposes. Generally, this value is a percent of market value. It also has no relationship to a replacement cost value.
Replacement Cost Value. The amount that would be required to completely rebuild the property in today's economic environment, using the same or equivalent floor plans or blueprints, but including any additions or improvements completed since the property was first built. The value is based on using like or upgraded kind and quality materials and workmanship as the original or the original and any modifications, additions or improvements to the original made prior to the time of the loss.
Extended Replacement Cost Value. In an ordinary replacement cost value policy, as long as the co-insurance requirement is met, there is no limit on the amount the insurance company will pay to rebuild or replace the damaged or destroyed property other than the requirement of like kind and quality. In an extended replacement cost policy, while the coinsurance provisions still apply, the insurance company states a limit on maximum amount over the declared value that it will pay. This value is often set at a level totally favoring the underwriter, not the insured.
Actual Cash Value. This has a very specific meaning in insurance contracts. It is defined as the replacement cost value of the property. less depreciation for the period of time since the property was build. Note that the coinsurance provisions still apply; if the declared value in the policy falls below the the amount required to satisfy the coinsurance provisions, loss adjustment will be penalized accordingly.
Stated Value. The value insured in the policy is the maximum amount that will be available for loss adjustment, regardless of the level of loss. Again, the coinsurance provisions will be applied, but may have more impact on a partial loss adjustment than a total loss adjustment. The advantage to the insured is that if the property is totally destroyed, the insurance company is obligated to pay the stated value less any deductible. Not looked on with favor by many insurance regulators.

From these definitions, it is clear that in establishing the value you declare for your real or personal property for insurance purposes the key element is determining the replacement cost value. The best way to do this is by spending the money to obtain a valid, certified replacement cost evaluation of your property, that both you and the underwriter agree is accurate. An alternative method is through the use of a standard construction cost estimator. Your agent or broker has access to books or services that permit this estimation to be made relatively accurately.

A prudent practice is to obtain an independent appraisal of the replacement cost value of your insure properties not less often and every three to five years. At the renewal dates between the appraisal dates, carefully adjust the declared value of the property to reflect the impact of building cost inflation on the values shown.

Revised 10-03-2007