POLICY LIMITS AND INSURANCE-TO-VALUE

The availability of coverage for dwellings and other structures is crucially dependent on the concept of insurance-to-value. The policy limits for these coverages are stated in the policy’s declarations. Choosing adequate policy limits is a crucial decision. Adequate insurance-to-value is a precondition to the availability of any of the varying forms of replacement cost coverage as may exist or nominally be provided for in your policy. No one should consider insuring only to actual cash value. Insuring to actual cash value makes it a virtual certainty that you will have only partial coverage in the event of a loss. In the event of a moderate loss, insuring only to actual cash value could make the difference between being able to repair your home and replace your contents and being forced to abandon your house. The concept of adequate insurance-to-value is another reason why your agent’s knowledge and expertise is crucial. He or she needs to be up to date on current construction and materials costs. All insurers and their agents rely on regionally adjusted construction costs guides for recommending and setting dwelling policy limits. Some of these guides are better, more realistic, and more current than others. You need to be able to describe your home to an agent when seeking a quote accurately—that includes square footage; number of stories, when built, type of construction (frame, stucco, brick); type and age of roof; type 88 The Complete Book of Insurance of electrical and plumbing systems; type of furnace and water heaters; etc. The list goes on, including any special or unusual features that apply to the home. These can include such things as decks, awnings, swimming pools, patios, canopies, and unusual masonry or stonework. This is especially important if you have unusual separate structures whose values are likely to exceed the standard policy limits provided. Many insurers arbitrarily set the policy limit for separate structures at only 10% of the dwelling limit. If you have a guesthouse or other unusual, higher than normal value, separate structure on your premises, you need to provide the agent with as much detail about that structure as you do for your main house. Similar comments apply to a garage with a finished space such as a bedroom, office, or studio or a photographic darkroom. Tell your agent everything about your home and property’s features that you do not want to have to spend your own money on to repair or replace if your policy limits turn out to be inadequate to cover a loss. Do everything you can to avoid under-insuring—assure that you have sufficient insuranceto-value. You are far better off over-estimating necessary policy limits rather than underestimating them. You are probably going to need to do some homework and will potentially need to be a little bit pushy to assure adequate insurance-to-value. A failure to maintain policy limits at a level sufficient to qualify for whatever form of replacement cost coverage your policy provides can have the result that your loss will be covered only on an actual cash value basis. When it comes to your home, you cannot really rely on real estate values as an indicator of actual cash value for insurance purposes, because the sale price of real estate includes the value of land and does not necessarily reflect construction costs. That’s why understanding what construction costs are or can be is so crucial to the concept of insurance-to-value. Each insurer defines replacement cost differently. There are six general categories of coverage for disclosure purposes as to the different forms of replacement cost coverage. From these general categories you can develop the right kinds of questions to learn what levels of coverage your insurer offers, Conditions 89 90 The Complete Book of Insurance what policy limits you need to carry to qualify for each level of coverage, and thereby to determine whether you want to seek alternative quotes for differing from other insurers. First, there is actual cash value coverage (i.e., coverage for the fair market value of the dwelling at the time of loss, up to the policy limit). This can be stated ultimately as the cost of replacing or repairing the damaged or destroyed dwelling with like or equivalent construction, up to the policy limit. Second, there is building code upgrade coverage. This covers the additional costs, up to stated limits, to repair or replace a damaged or destroyed dwelling to conform to current building codes as of the time of loss or rebuilding. Third, there is replacement cost coverage. This covers the cost to repair or replace the damaged or destroyed dwelling with like or equivalent construction, up to the policy limit. In addition, most replacement cost policies require that you actually repair or replace the damaged or destroyed dwelling to recover on a replacement cost basis, with loss payable only on an actual cash value basis until repair or replacement is complete. Replacement cost coverage of this type requires that you insure your dwelling to at least 80% of its replacement cost as of the time of loss. Fourth, there is extended replacement cost coverage—that is, the cost to repair or replace the damaged or destroyed dwelling with like or equivalent construction, subject to a specified additional percentage over the dwelling limit of liability. This specified percentage can very widely from insurer to insurer. You need to check. Most extended replacement cost coverages require that the insured carry policy limits equal to the full replacement cost at the time of policy issuance, not at the time of loss, and to agree to periodic increases in the policy limit to adjust for inflation. Such coverages also require the insured to permit your dwelling to be inspected by the insurer and to require you to notify the insurer of any improvements that increase the value of the dwelling by a specified percent. As with replacement cost policies, most extended replacement cost policies require repair or replacement in full before a replacement cost recovery will be paid by the insurer. Conditions 91 Fifth, there is guaranteed replacement cost without regard to policy limits with limited or no building cost upgrade coverage. This variant of replacement cost coverage will pay the full amount required to repair or replace the damaged or destroyed dwelling with like or equivalent construction regardless of policy limits, but does not include all additional costs of repair or replacement of the dwelling to comply with new building statutes in effect at the time of rebuilding. To qualify for this form of coverage, you must insure the dwelling to its full replacement cost at the time of policy issuance, must accept periodic increases in the policy limit to adjust for inflation, and must permit the insurer to inspect the property. Finally, you must notify your insurer of any alterations that increase the value of the dwelling by a specified percentage in the policy. Sixth, there is guaranteed replacement cost with full building code upgrade coverage. This form of replacement cost coverage pays the full amount to repair or replace the damaged or destroyed dwelling with like or equivalent construction regardless of policy limits, including all increased costs of construction caused by new or different building statutes. The same preconditions for coverage apply: full insurance to value; acceptance of periodic increases in policy limits; permitting the insurer to inspect; and, notification of increases in value due to alterations that exceed a minimum percent specified in the policy. A particular insurer may not offer all of these variations, regardless of your willingness to pay increased premiums for a particular form of coverage. This, again, is the situation where an independent agent may have an advantage over a captive agent that represents only one insurer. An independent agent may have access to insurers willing to quote and write the form of replacement cost coverage you desire that a direct writing agent may not be able to provide. Having accurately calculated the replacement cost to their home and provided the percent of additional coverage in excess of policy limits for which coverage is included if sufficient, most people can do fine with a policy that includes both extended replacement cost coverage and building code upgrade coverage. If your policy limit is set at a sufficiently high level, extended replacement cost coverage not including building code upgrade coverage may 92 The Complete Book of Insurance be sufficient. If you choose this alternative, you will need to do a very good job of calculating the costs of reconstructing your home. NOTE: All forms of replacement cost coverage are stated in terms of repair or replacement with like or equivalent construction. If you decide that you want to make improvements as part of the repair or replacement of your damaged dwelling, the costs of improved materials or fixtures is not covered. Replacement cost coverage is intended to put you back in the same position you were in before loss, not in a better position. If your policy limits fall below a certain percent of the dwelling’s replacement cost at the time of loss—usually 80%—the amount you recover may be reduced. Often, homeowners policies contain provisions that allow for recovery only in the proportion that your policy limits bear to 80% of the replacement cost of the dwelling. For example, the value of your home is $500,000, but your policy has a dwelling policy limit of only 60% of the replacement cost ($300,000). Eighty percent of your dwelling’s replacement cost is $400,000 ($500,000 x 80% = $400,000). $300,000 divided by $400,000 equals 75%. Therefore, after applying your deductible, you would be entitled to recover only 75% of the amount of your loss subject to the policy limit. In the event of a total loss, you would only be able to recover 75% of $300,000, or $225,000. As you can see, the potential financial consequences of not maintaining sufficient insurance-to-value can be severe. Consult with your agent regularly to ensure that your policy limits are sufficient. When you consult with your agent about the sufficiency of your policy limits, document his or her advice as to the amount of recommended coverage. If you later have a loss and the insurer determines that you were not insured-to-value, you have created a basis for: ◆ requesting that the insurer retroactively increase your policy limit on the grounds that you relied on the advice of its agent in setting your policy limit or ◆ an errors or omissions claim against your agent based on the improper advice as to your policy limit that caused a partially uninsured loss.

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