Replacement Cost Coverage
The Replacement Cost Claim: It's Just Like Any Other. Or Is It?
Page 1 of 3 1 2 3 Next View issue on one page
While the coverage might seem to contradict the principle of indemnity – by enriching rather than restoring – most professionals in our business understand that correctly administered replacement cost coverage works to the advantage of both the insured and the insurer. Less established, however, is the understanding how to handle replacement cost claims.
Some of this lack of understanding is due to the fact that the coverage is relatively vague.1
Misconceptions and ambiguities exist. It is the intent of this article to clarify some of them – by discussing replacement cost coverage from a claims perspective!
Enrichment vs. Restoration
The principle of indemnity is to return the insured to the condition they were in prior to the loss. Since lost property can most often only be replaced with new, one might feel that an insured actually benefits by getting new property in place of old. It was
Replacement cost coverage does not unjustly enrich the policyholder for two important reasons. First, the loss is neither foreseen nor deliberately caused by the insured. Second, the insurer is compensated for the additional coverage because premiums are based on replacement cost values rather than the lower actual cash value!
Please bear in mind that in the examples cited, the policy's limit of liability is always the highest level of recovery. Also note that we have not considered “guaranteed replacement value,” which may permit a recovery that exceeds the stated limit of liability.
180 Day Requirement
A common misconception involving replacement cost coverage is that the insured has 180 days to make repairs. This is not the case! Under most policies, the insured has 180 days merely to notify the insurer of their intent to exercise the replacement cost clause. Basically, the insured must inform the insurer within this period of time that they intend to make claim under the replacement cost coverage.
As for the time limit actually allowed for making repairs, courts in several states have ruled that the insured has a reasonable time in which to repair or replace the property.
The Holdback
One of the basic principles of replacement cost insurance requires that the insured not receive the expanded indemnification until the property is actually repaired and/or replaced. As a result, the insured first collects their depreciated or actual cash value loss, and when the property is repaired or replaced in accordance with the conditions of the policy, is paid the difference between the actual cash value loss and the replacement cost loss. The money withheld is customarily referred to as a “holdback.”
At the time of settlement it's also common for the insured to sign – in addition to the proof of loss – a Statement as to Full Cost for Repair or Replacement spelling out the amount
1. In the absence of actually limiting language in the insurance policy, a broad interpretation of such coverages must be made in favor of the insured. “It is fundamental that any ambiguity in an insurance policy will be construed against the insurer and in favor of the insured, and this is particularly so when the ambiguity is found in an exclusionary clause.” Breed v. Insurance Company of North America, 46NY2d351.
2. It should be pointed out that many courts have ruled that depreciation should not be taken when there is a partial loss. “Under the policy language, the cost of (repair, replacement) that you may consider is the cost of (repair, replacement) with material of like kind and quality within a reasonable time after such loss. In that calculation, you are concerned only with the cost of restoring the building to its condition prior to the fire, and depreciation plays no part.” Pattern Jury Instruction PJI 4:49.