What is Replacement Cost and How is it Derived?
Replacement cost is TODAY’S VALUE – Depreciation (based on wear, tear deterioration and age) which equals the Actual Cash Value, aka Market Value (what is the property worth today).
The Replacement Cost value is derived from the “local” labor market along with the materials within the market. Let’s not forget that policyholders usually want their property insured at what they can sell it for. This is called Actual Cash Value.
Let’s reiterate the importance of adequately insuring commercial property:
75% of commercial properties are underinsured by 40% or more, according to industry data.
Insurance experts recommend using the replacement value of a property to conduct correct ITV calculations. Examples – third-party firms
Building Codes – increasingly, cities are leaning toward the 2022 – IBC Code.
The days of relying on Ordinance and Law to pick up all of this is a risky move; yes, that is what it is for. But in today’s world, I haven’t seen it to be enough.
Most agencies are relying on the cost estimator from the carrier to get the value to which they are wanting to insure it for, basically a balancing act on the desired premium. This may help get the policy written, but will it keep you out of the E&O realm when a claim occurs? The answer is short: no it won’t.
Here is a recent example:
I utilized the Xactimate calculator (which the carriers use on the claims side to write estimates and provide an ITV back to the carriers from the claim inspection).
Carrier cost calculator: $649,739 @ $130 p/sf
Xactimate cost calculator: $923,201 @184.64 p/sf
Total loss $57,000
$500 deductible
$9,947.12 dwelling
$1,005.28 other structures (a carport and shed)
$10,952.40 – CO-INSURANCE PENALTY (on a $57,000 loss) **
**In 2021, the building was insured correctly and there was no applicable co-insurance penalties applied at the time of the original estimate. In less than a year the material cost as well as the labor cost broke the threshold of the 80% coinsurance for this particular loss. Are you prepared to discuss a loss such as this with your policyholders, who will ask why they are being penalized despite coming to you for proper coverage?
The ITV provided is correct based on information provided. Discussing this with the policyholder allows the policyholder to understand the values and “why” equals educating the policyholder.
For more Risk Insights information, contact INSURICA today.
This article is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel or an insurance professional for appropriate advice.
