You have more than likely heard the terms replacement cost value and coinsurance penalty repeated again and again.  But why are these so important?  Familiarity with these terms and your policy provisions is important because if coverage is not maintained at the amount equal to the coinsurance limit on the policy, the insurance company will not fully reimburse the amount of a loss.

Replacement Cost Value is generally defined as the cost to replace the damaged property with materials of like kind and quality, without any deduction for depreciation.  Using this valuation method, insurers can determine the amount the insurer will pay in the event of a covered loss.  Keep in mind, the maximum amount the insurance company will pay for a loss is the limit of insurance carried by the insured.

Why is this so important to get right?

It is imperative that adequate coverage is in place for your property. If an insured does not maintain coverage of an amount equal to at least the coinsurance percentage listed on the property policy, the insured will not be fully reimbursed for a loss. If underinsured, the policy holder is charged a “coinsurance penalty” which is calculated as a ratio between the amounts of insurance carried divided by the amount of insurance that should have been carried multiplied by the amount of the loss.  For example, National Flood policies have an 80% coinsurance factor; therefore, charge a coinsurance penalty if the insured is not covered for at least 80% of value.

See the table below for examples of Inadequate Insurance vs. Adequate Insurance:

 FORMULA: Insurance Carried/Insurance that Should be Carried x amount of Loss=Limit of Recovery EXAMPLE #1: Inadequate Insurance – below 80% of full replacement cost EXAMPLE #2: Adequate Insurance – at least 80% of full replacement cost Replacement cost value of the building: \$99,450 \$99,450 Required amount of insurance: \$79,600 (80% of replacement value of 99,450 rounded up to the nearest \$100) \$79,600 (80% of replacement value of 99,450 rounded up to the nearest \$100) Actual amount of insurance carried: \$28,600 \$79,600 Amount of Loss: \$50,000 \$50,000 Deductible \$1,000 \$1,000 Step 1: \$28,600/\$79,600=.36 (36% of what should be carried) \$79,600/\$79,600=1.0 Step 2: \$50,000 x .36 = \$18,000 \$50,000 x 1.0 = \$50,000 Step 3: \$18,000 – \$1,000 = \$17,000 \$50,000 – \$1,000 = \$49,000 What the insured pays for the loss \$33,000 (Insurer pays only \$17,000 after deductible, for the \$50,000 loss) \$1,000 (Insurer pays \$49,000 of the \$50,000 loss-no coinsurance penalty for the insured)

How to get it right

Most property owners, managers, boards and/or insurance brokers believe that obtaining an insurance appraisal for a property is an essential best practice.  An insurance appraisal is a replacement cost analysis which provides an estimate of the amount of insurance required to replace each structure and/or amenity with materials of like kind and quality, without any deduction for depreciation.

This is important because:

• Obtaining an insurance appraisal can prevent under-insuring, which puts the property at risk for not having adequate funds to rebuild in the event of a catastrophic loss; or over-insuring, which results in paying higher insurance premiums than necessary.
• Obtaining an insurance appraisal demonstrates due diligence on the part of the owner, board members and property manager.
• An insurance appraisal assists your broker by providing documentation that insurance company underwriters need to properly quote coverage.
• An insurance appraisal provides a third party, unbiased valuation of the property’s replacement cost.
• If a loss occurs, an appraisal, along with all data acquired in performing the appraisal, will be available to the client to help expedite the settlement of a claim.
• All digital photographs taken at the time of the physical inspection are electronically archived for the client’s use in the event of a loss.

An up-to-date insurance appraisal provides accurate values for coverage, eliminating the possibility of a coinsurance penalty in the event of a loss. At the Armstrong Company Insurance Consultants, we believe it is good practice to have an updated insurance appraisal every 3 to 5 years.