Functional Replacement Cost: Its Origin, Evolution and Application

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This coverage replaces an ordinance or law exclusion in ISO commercial property forms and reflects the fact that older structures insured for FRC must often be upgraded to comply with building codes enacted and revised after those structures were first built.

Personal Property

For business personal property (other than stock), ISO offers a separate FRC endorsement (CP 04 39) with its own schedule of insured locations, described personal property and limit of insurance. That limit is the only limit applicable to the described property and there is no coinsurance requirement. So, in essence, the insured and insurer estimate at the policy’s inception what it will cost to replace older furnishings, equipment, and supplies with newer ones.

As with the building FRC endorsement, the personal property endorsement gives the insured 180 days (unless there is an agreement otherwise) to contract for the repair or replacement of damaged property. If the insured does so, the insurer will pay the least of the following:

If the insured does not contract to repair or replace the damaged property within a stipulated time period, the insurer will pay the smallest of the following:

While the ISO endorsements serve as standard models followed by most companies, be aware that there are many independent FRC forms that deviate from the ISO specifications, especially in commercial lines.

What is the “Function?”

With their coinsurance requirements, FRC coverage provisions are designed to prevent policyholders from trying to take advantage of the system. Without coinsurance, insureds could contract for the lower premium available for FRC coverage, then contest the insurer’s estimation for what constitutes functional equivalence. With a coinsurance requirement in place, the greater an insured’s demands regarding functionality, the greater the cost will be, and the more likely a coinsurance penalty will result.

This still leaves a rather large gray area for establishing functionality, especially for repurposed structures. Consider this example:

In a Pennsylvania case, a woman had purchased a small former church as her home. When it was damaged by fire, she sought recovery under an FRC policy for the full replacement of some stained-glass windows and an old pipe organ. Under the terms of the policy, the company offered only to replace the windows with thermal glass, and to provide a new electric organ. The policyholder challenged that offer, but a state court upheld the company’s position.

That’s an unusual case, but an illustration of the questions that arise when the features of a building no longer relate to its function. How would the insurer in the case above have responded to the claim if the building was still used as a church? Presuming that a comparable loss settlement provision was in place, it seems that a case could certainly be made for replacing the stained glass windows, if not the organ.


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