Replacement Cost Recovery
The Replacement Cost Claim: It's Just Like Any Other. Or Is It?
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Newer ISO forms make the basement valuation (replacement cost vs. A.C.V.) the option of the insured, and the coinsurance application would follow accordingly. The insured must remember, however, that simply endorsing the policy for replacement cost is not sufficient to keep it in line with actual replacement costs; the values must be increased as well.
How is Replacement Calculated when there are Many Items?
The definition of what constitutes replacement is very vague in most insurance policies, therefore, it is what a reasonable person would expect. In other words, if the insured can reasonably expect recovery, they are entitled to it.
One example involved a loss for a school district that carried replacement cost coverage on its contents. Not all of the items lost were replaced, and the amount actually spent by the insured replacing those that were was less than the total actual cash value of all items lost. It was requested that the insurers pay the full replacement cost on those items that were replaced on an item-by-item basis. The insurers resisted, so the question was posed to the editors of FC&S Bulletins. We were pleased with the following response, which helped convince the insurer to accept our approach:
“An insured who has coverage for replacement is not required to replace each and every damaged item in order to receive replacement cost.... The insured is not required to replace every item that was involved in the original statement. Nor is the insured required to use any part of the A.C.V. recovery on any one item of insured property to pay for all or part of the replacement cost of another item of insured property.” FC&S Bulletins Q&A 811 (January 1991).
This is a very important point because the insured does not have to spend more than the total actual cash value of the loss to qualify for replacement cost recovery. As items are replaced individually, the line-by-line depreciation holdback should be paid to the insured, even if the dollars are spent on items different than those lost.
How is Replacement Calculated when there are Many Items?
The definition of what constitutes replacement is very vague in most insurance policies, therefore, it is what a reasonable person would expect. In other words, if the insured can reasonably expect recovery, they are entitled to it.
One example involved a loss for a school district that carried replacement cost coverage on its contents. Not all of the items lost were replaced, and the amount actually spent by the insured replacing those that were was less than the total actual cash value of all items lost. It was requested that the insurers pay the full replacement cost on those items that were replaced on an item-by-item basis. The insurers resisted, so the question was posed to the editors of FC&S Bulletins. We were pleased with the following response, which helped convince the insurer to accept our approach:
“An insured who has coverage for replacement is not required to replace each and every damaged item in order to receive replacement cost.... The insured is not required to replace every item that was involved in the original statement. Nor is the insured required to use any part of the A.C.V. recovery on any one item of insured property to pay for all or part of the replacement cost of another item of insured property.” FC&S Bulletins Q&A 811 (January 1991).
This is a very important point because the insured does not have to spend more than the total actual cash value of the loss to qualify for replacement cost recovery. As items are replaced individually, the line-by-line depreciation holdback should be paid to the insured, even if the dollars are spent on items different than those lost.
What Constitutes Replacement?
Nowhere in the policy is the insured required to replace with identical kind or quality. This wording merely establishes a limit for what it would cost to repair or replace lost property with property of identical kind and quality.
An insured who lost a milk pasteurizing plant bought an orange juice plant to replace it. The insurers agreed that this met the requirement of the insurance policy and paid the claim based on the cost to replace the milk plant.
Limit the Holdback
Many times insurers create an adjustment trap! Their position is: “Don't worry about the amount of depreciation taken, you'll recover those dollars once the property is replaced and you spend the money.”
To that stance we, as the insured's advocate, would ask the question – If it's not an item of concern, why, then, doesn't the insurer pay all the replacement cost dollars now?
In prudent claim handling, the amount of depreciation withheld should always be kept to a minimum. Doing so leaves fewer points open for discussion or to develop into problems later on. Just as important, when funds are withheld, the insured does not have use of them until and unless they meet the policy requirements. As a result, they must fund the replacement themselves.
Nowhere in the policy is the insured required to replace with identical kind or quality. This wording merely establishes a limit for what it would cost to repair or replace lost property with property of identical kind and quality.
An insured who lost a milk pasteurizing plant bought an orange juice plant to replace it. The insurers agreed that this met the requirement of the insurance policy and paid the claim based on the cost to replace the milk plant.
Limit the Holdback
Many times insurers create an adjustment trap! Their position is: “Don't worry about the amount of depreciation taken, you'll recover those dollars once the property is replaced and you spend the money.”
To that stance we, as the insured's advocate, would ask the question – If it's not an item of concern, why, then, doesn't the insurer pay all the replacement cost dollars now?
In prudent claim handling, the amount of depreciation withheld should always be kept to a minimum. Doing so leaves fewer points open for discussion or to develop into problems later on. Just as important, when funds are withheld, the insured does not have use of them until and unless they meet the policy requirements. As a result, they must fund the replacement themselves.
Walk Away
Sometimes the insurer and insured will entertain what is commonly known as a “walk-away” settlement. This means both have agreed to a settlement figure that is somewhere between actual cash value and replacement cost.
In accepting the figure, the insured agrees not to make a supplemental claim for replacement cost at a later date. This can be a win-win situation; the insurer wins because they have use of the money up-front, and do not have to buy items that they choose not to replace. Needless to say, this arrangement also saves a lot of time, accounting, and adjusting red tape!
In the final analysis, replacement cost coverage is both a desirable and necessary part of a contemporary property insurance program. The replacement cost provision will not live up to its potential, however, unless all conditions of the policy are in order. Good underwriting and well-established values are essential!
Just as important, knowing what you can and cannot expect from the policy's coverage before a loss occurs is critical to helping the insured manage their risk. It's also extremely valuable during a property loss adjustment.
Replacement cost coverage was developed to serve both insureds and insurers. But like all of the provisions in the policy, the degree to which it benefits each depends on how well it is understood and then applied when the insurance is called to deliver!
Sometimes the insurer and insured will entertain what is commonly known as a “walk-away” settlement. This means both have agreed to a settlement figure that is somewhere between actual cash value and replacement cost.
In accepting the figure, the insured agrees not to make a supplemental claim for replacement cost at a later date. This can be a win-win situation; the insurer wins because they have use of the money up-front, and do not have to buy items that they choose not to replace. Needless to say, this arrangement also saves a lot of time, accounting, and adjusting red tape!
In the final analysis, replacement cost coverage is both a desirable and necessary part of a contemporary property insurance program. The replacement cost provision will not live up to its potential, however, unless all conditions of the policy are in order. Good underwriting and well-established values are essential!
Just as important, knowing what you can and cannot expect from the policy's coverage before a loss occurs is critical to helping the insured manage their risk. It's also extremely valuable during a property loss adjustment.
Replacement cost coverage was developed to serve both insureds and insurers. But like all of the provisions in the policy, the degree to which it benefits each depends on how well it is understood and then applied when the insurance is called to deliver!