Homeowners may not understand what is at stake until they incur damage to unique brickwork or ornamental features that accounted for a substantial part of a home’s value. Is an “engineered” hardwood floor, let alone a linoleum floor, really equivalent to a genuine hardwood floor, simply because it’s a surface?
Similarly, commercial property owners, especially those seeking to generate “walk in” trade, may be surprised to learn that an FRC policy may not pay to repair or replace features that are distinctive and attractive in their appearance but serve no unique “function.”
Make no mistake, functional replacement cost valuation is a valuable alternative for insurance buyers, especially those seeking to insure older structures whose replacement cost exceeds their market value. But when a loss occurs, an FRC loss settlement can put the insured at a disadvantage. Under full replacement cost coverage, the insurer clearly has an obligation to pay for replacing damaged property as it was, subject to a coinsurance requirement, and the requirement that the property actually be replaced.
With FRC coverage, an insurer can identify the least costly and minimally sufficient options for replacing and/or repairing damaged property. The burden then shifts to the insured to make the case that functional equivalence may require greater quality materials, design and workmanship than the carrier has considered.
While trying to make this case, an insured can also be constrained by a coinsurance requirement whose penalty can eliminate the benefit of having chosen FRC coverage in the first place.
To clarify what’s at issue when insuring property on a replacement cost basis — full or functional — it helps to know that the two dimensions of coverage used to be provided under two different forms of insurance, sometimes by different carriers.