Insuring Property Well
Updated: Aug 25, 2020
What is fundamental to insuring property correctly? Getting the value correct? Of course! But what might that value be?
That question obviously leads to the replacement cost vs. market value vs. ACV vs. agreed value question. For this article however, I am sticking to replacement cost. What is replacement cost, really? Is it the cost to rebuild with like/kind/quality? Is it the cost to rebuild with virtually identical materials or just similar materials?
Is it the cost to rebuild from a clean slab or does it include the cost of debris removal and foundation work? Does it include restorative dirt work? One needs to know. As an important aside, I have seen many instances of agents thinking foundations and dirt work need not be included in calculating replacement cost. That assumption reveals inadequate knowledge. As one example only, fires can severely damage concrete foundations requiring replacement and if foundations must be removed, restorative dirt work is often also required. Sometimes even landscaping recovery is required.
I find, as the reader probably does, that insureds do not know and there is no reason they should know, the answers to these questions. Agents should know the answers to these questions. Agents absolutely should know which policies are "similar" instead of like/kind/quality. They should know if debris removal is or is not included in replacement cost. They should know if the replacement cost calculation includes foundation work.
The fact that agents should know these important elements is not the same as saying agents should be getting the exact replacement cost correct every time. These are two different issues. One can't get the replacement cost correct if one does not know these details. But, if one knows these details, the odds of being materially wrong decreases substantially, all else being equal.
A few key areas agents often misunderstand. Many do not understand that land is not part of replacement cost (land is not equal to restorative dirt work) even though land is usually part of market value. Going back to foundations and restorative dirt work, I've met agents who think (to be kind) insureds only need to insure their homes to 80% because foundations need not be included in the calculations as "the foundations will never be damaged." That is just not good judgment. To those who know better but would argue the odds of foundations needing to be replaced is so small as to be negligible, you are just playing the odds versus providing the correct coverage. Is your job to gamble or offer clients the coverages they truly need?
I am not an advocate for agents being held to exacting standards when calculating replacement cost with a high degree of accuracy. Agents do not have the verified data (versus data) they need and they are not trained to be contractors. Replacement costs are best calculated by experts in that field. I do believe agents have a responsibility to make a good faith effort to complete the ITV form completely and as accurately as they can. The industry understands a material margin of error exists which is why forms and endorsements exist to close reasonable potential gaps.
ITVs are notorious for these margins of error too, so care is required when using them. I know this from my experience the last time I completed an ITV on my own home, with serious effort to offer honest answers, but did not know, for example, if I should be classifying my cabinets as standard or custom. The value difference from one to the other was 40%! By cutting corners to arrive at lower values and lower premiums you run the serious risk of falling below the co-insurance requirements and even leaving clients severely under-insured in other ways too.
But all that stated above may be small potatoes compared with the issue of Ordinance or Law coverage. So many new building codes have been instituted that even relatively new buildings and homes have Ordinance or Law exposures such as green roofs (way more expensive than normal roofs), clearances, materials, access issues, bathrooms, energy efficiencies, wind strength engineering, and so forth. In some cases, the original materials may no longer be allowed to be used. In some cases, Ordinance or Law expense may exceed rebuilding cost because of the presence of hazardous materials.
Does the replacement cost calculation include the cost of rebuilding to new codes? I ask this question of agents often and I get all kinds of answers. Is replacement cost the cost to replace as was or is it the cost to replace per current codes or just to the codes that existed as of the original construction date? The answer lies partially in the specific form you are selling. I suggest you read the policies you are selling carefully, well, and not make any assumptions. The forms likely do not all read the same (as Ripley would say, "Believe it or NOT!").
Which brings me to another question -- that is, what exactly is the ITV calculating if it is not calculating replacement cost using current building codes? I am not familiar with ITVs that determine a different replacement cost based on the code that existed as of the original construction date. My understanding is that ITVs use the date of construction for many purposes but they do not search a database to identify the building code for 1968 in Polk County. To test this, if you run an ITV on exactly the same home built in 1980 and in 2010, and you know a major building code changed in 1990, is the resulting value materially different? If the values are materially different, then the code change may be, but is not guaranteed to be considered by the ITV. If not, then code changes are most probably not considered.
My personal belief is, and I use personal belief because a definitive answer is problematic, is that most buildings need far more Ordinance or Law than the throw-in coverage usually provides. This assumes the replacement cost estimator includes the current code but the form being sold excludes coverage for current code compliance, meaning the replacement cost estimate is probably inflated relative to the coverage being afforded. Think about the new green roof requirement, ADA compliance, elevation codes, wind codes and the Ordinance or Law expense can easily be 25% and sometimes 50% of the replacement cost. The throw-in coverage is likely inadequate in these situations.
What can agents do to excel in offering their clients adequate property coverage? First, offer the true replacement cost at 100%, no corners cut. Then consider, with the assistance of the insured's realtor or contractor, all the codes that would need to be considered if the building had to be rebuilt and then add an appropriate amount of Ordinance or Law. Remember, these are TWO separate calculations.
NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand Insurance Education, Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.