Insuring for logical amounts

If it were possible to insure a $200,000 home for a million dollars, there are those consumers who would do so. Because insurers only wish to be liable for exact costs, there is liability limitations placed in policies. In the Standard Fire Policy, more than one provision limits liability. Limits may be expressed in several ways:

Actual cash value

The cost to repair or replace

Original cost

Interest of the insured

Pro-ration with all insurances involved

Subrogation.

Insurance payout is typically based on the face amount, no allowance for loss of use, the doctrine of proximate cause, excluded perils and included perils, coinsurance, and deductibles. All of these would be stated in the policy. Coinsurance and deductibles are not necessarily found in the Standard Fire policy but they are often made a part of the policy by use of endorsement.

The most basic limitation in a policy is the face amount stated. Generally the wording is stated as to an amount not exceeding $______. The insured usually selects the exact dollar amount and pays a premium accordingly. The insurance company will put parameters on the amount offered. As we said, they do not wish to insure a $200,000 for a million dollars. In the underwriting process, the insurer will set maximum limits by class of property or by geographic area. It may be possible to exceed limitations by purchasing more than one policy. Minimum amounts may also be stated by the insurer. This would apply where a lender has an interest. If that $200,000 home is mortgaged for $175,000 the lender would expect that much insurance be purchased to protect their interests. In this case it is the lender that sets minimum limitations of insurance.

The actual premium is determined by dividing the face amount of insurance by $100 to determine the units of insurance purchased. The number of units is multiplied by the appropriate rate per unit. This process is called policy rating. It is not the same as ratemaking, which encompasses the entire procedure of rate per unit determination.

At one time it was viewed that the face amount of a policy constituted the maximum liability of the insurer for the policy period. The reasoning was that when a part of the property had been destroyed, the amount left at risk was reduced. Unless the buyer rebuilt, he or she would then be over-insured.

When this method became a consumer issue other alternatives were tried. One method was to charge an additional premium by applying the basic fire rate to the total premium. This was, in effect, insuring the insurance premium. It was called unearned premium insurance. When a loss happened, the unearned premium insurance bought back the original face amount of the policy. If a total loss happened, the added coverage provided a refund to the insured of the unearned premium for the policy period. This worked well as long as agents remembered to add the unearned premium insurance. Unfortunately, agents did not always do so. When a loss occurred in those cases, consumers sometimes ended up underinsured.

Actual Cash Value

As every agent knows, the most common complaint comes from the way losses are replaced. If it costs $100 to replace an object, but the company only supplies the consumer with $50 the agent is sure to hear about it.

Many policies limit the insurer liability to the actual cash value of the property at the time of loss. Just as an automobile loses value the moment it is driven off the car lot, other items also lose value immediately upon purchase. The principal objective of the fire insurance contract is to furnish indemnity for values actually lost. A sofa that is five years old is not valued the same as a new sofa would be. Unfortunately for the agent who deals with the telephone calls, actual cash value is not the same as replacement value.

The policy does not define what the actual cash value will be, but the courts often have. Except for some exceptions, the courts have agreed that actual cash value is not the same as replacement value. The courts consider actual cash value to be replacement value at the time of loss less physical depreciation. In other words, the courts look at the current replacement cost and then deduct for age and wear. Neither the policy nor the courts require that the property destroyed actually be replaced; merely that the value of them at the time of loss be paid to the insured.

Actual cash value is not derived from the same accounting procedures used for taxation. An accountant starts with the original cost and writes off this cost at set intervals for the useful life of the property. As they relate to taxation, depreciation may have little to do with true values. Depreciation as it relates to insurance must consider the age of the destroyed property at the time of loss, without consideration to taxation depreciation. The insurance companies consider the age of the property at the time of loss, obsolescence, quality of the propertys maintenance, and any other factors that would affect value. The purpose is to follow the principle of indemnity as closely as possible.

Understanding the concepts of actual cash value would probably be easier for the consumer if the same principles were more widely used. Consumers often confuse actual cash value with market value, for example. Market value is the amount the property could be sold for. While that may mirror actual cash value, it does not necessarily do so. This especially can be an issue as it applies to damaged automobiles. Market value will give a reasonable approximation of actual cash value, but since the item was not actually sold prior to damage, there can be disagreement on what the market value would have been. As it applies to cars, insurers use standardized pricing, which may not be what the insured feels is the fair value. There are often opposing opinions as to vehicle values.

As it applies to buildings, actual cash value does not consider the value of the land it sits on. Therefore, market value, which would reflect the land, would be higher than actual cash value. Because of this, market value has insurance limitations. Despite the limitations of market value, some court cases have stated that the two are synonymous.

Some losses have some interesting results. For example, a building catches on fire and burns to the ground, but the building had already been scheduled for demolition. Does that then give the building a negative value? Courts generally uphold that insurers are not liable for something that is valueless.

Personal property is easier to assess values to (in most cases) than is real estate. The distinction between market and actual cash value, as a measure of indemnity, may or may not be easier. Some personal property, like real property, may hold its value or even appreciate at a rate greater than its depreciation. Other personal property, such as computers for example, quickly loose their market value as new technology moves ahead. The measure of loss would still be the cost to replace the item, less depreciation or obsolescence. Clothing may be market value to replace if it is still usable to the insured on the same basis as new clothing. On the other hand, if the clothing is not fairly new, styles may have changed which would either (a) indicate it was less valuable, or (b) due to demand as a collectible, create a higher market value.

When loss is not total, the actual cash value can become more complicated. Although the same principle would apply, the amount of loss can be harder to determine. Depending upon the type of loss, the courts have applied an enhancement of value rule, which states that if the replacement of new for old does not increase the value of an identifiable unit, then deprecation should not be part of the equation. This would primarily apply to such things as a home that was partially damaged or a car that experienced a minor accident.

Sometimes replacing the loss is not practical or even economical. In buildings, for example, some types of replacement would not be practical from an economic standpoint. A home that is located in an area that is quickly moving to commercial zoning may not be practical to replace since it would soon be sold for commercial reasons and torn down anyway. Some types of replacement are not practical for reasons of cost. An antique bar, while replaceable, would perhaps be cost prohibitive by todays standards. Purchasing insurance that would replace substantially in situations that are not economically practical would be too expensive. Therefore, replacement value policies are more likely to be used in business or commercial policies while actual cash values are usually seen in residential policies.

Repair or replace?

Most policies leave the decision of whether to replace or repair an item up to the insurer. It is true that most companies find it easiest to simply pay the insured the cost of their choice and then leave the actual decision up to the insured. They are most likely to opt for repair, paying the costs directly to those who do the work, when the insurer has been unable to come to a satisfactory settlement with the insured. When a satisfactory settlement cannot be made monetarily, restoring the goods or building to their original condition at the time of loss is simply easier.

When this is the decision made by the insurer, settlement typically is considered acceptable by the insured. If the insured is not happy with their goods or building being restored to the condition at the time of loss, the consumer may be hoping to gain at the insurers expense. Unfortunately for the insurance companies, many court cases favor the insured even when companies feel the consumer is trying to profit (which policies are not designed for). Court cases often come about because there is disagreement between the insured and the insurer as to what constitutes restoration. This might especially be true in specific situations involving unusual property. For example, many older buildings have unusual features, such as decorative designs from special types of wood.

Companies try to avoid opting for restoration for another reason. Few of them are set up to oversee restoration projects. The time and complications of such projects are usually not worth it to the insuring companies.

The increased costs associated with building today versus even just ten years ago can make restoration more complicated. Most cities have passed requirements for building in an effort to increase safety. This may especially be true in areas that have experienced wind damage, earthquake activity, or other mother nature problems. In high congestion areas, there may also be requirements concerning sidewalks for public use, hydrants for fire safety, or bonds for public use affected by building, such as schools or parks. New construction standards nearly always increase building costs. Even when a building is only partly damaged, the city may require that the entire building be brought up to safety codes when repaired.

Insurers that feel new safety codes may affect replacement costs are likely to include a Building Ordinance Coverage endorsement in their policies, which of course will result in a higher premium. This endorsement covers the value of the undamaged portion of the building that must be upgraded to comply with current codes, the cost of demolishing and removing the undamaged portion, if necessary, of the building, and the increased cost of repair or reconstruction that might be necessary.

The insurer, unless a special agreement is in the policy, will typically limit their liability by stating there is no allowance for loss of use. The wording may vary, but generally it will state the coverage is without compensation for loss resulting from interruption of use during the time of damage and repair. The intent is to limit the companys liability since loss of use can be a wide area.

Some policies specifically allow the insurer to seek compensation from other parties if the loss can be proven to be their fault. Equity clauses state that the insured should not be able to collect from both the insurance company and the party that caused the loss. Since the insurance company paid for the loss, it stands to reason that they should be the ones to gain from the party causing the loss. Again, it is never the intent of an insurance policy to allow someone to profit from a loss. Profiting from a loss is a clear violation of indemnity principles.

In policies the third party causing the loss is typically referred to as the other party. If the other party is held responsible for the loss because of either a contractual relationship or a negligent act, the insurer that covered that loss will seek financial recovery from them. The third party, especially in contractual relationships, may have insurance that will handle this so that one insurer is essentially paying another insurer.

When the loss is due to negligence by a third party, there may also be insurance in place. Again, if this is the case, it may be a situation of one insurer paying another insurer for their loss. If no liability insurance was in place by the other party, then the insurer may seek legal recourse to recover what they have paid out.

So, when a loss happens, the insurance company pays the insured, and then under the rights of the contract stands in the place of the insured to proceed against the liable party. Once the insured accepts the money from their insurer, they give up their rights to collect from another party that is deemed legally responsible for the loss. There will be some exceptions to this, especially where personal injury is concerned, but for the purposes of fire insurance, this would be the case.

Policy language has specific meanings

Every agent must be aware that policy language is legal language. As such, it has specific meanings. This is certainly apparent in the Doctrine of Proximate Causes. The word direct in the phrase against all direct loss by fire can have a dual meaning. The concept of cause, while always important legally, is especially important when insurance is involved. Insurance deals with a cause-and-effect relationship between insured perils and loss. This concept is called the Doctrine of Proximate Cause.

As it applies to insurance, each event that causes a financial loss had a cause. It may be a domino effect, with one loss caused by an event that was caused by another event, but regardless of the chain, the loss is caused by something. While the law is not concerned with analyzing the chain of events that occurred, it does affect what company pays what claims and to who. Insurance merely looks at the immediate reason they paid for a loss. The doctrine of proximate cause is specifically looking at whether the loss resulted from negligence or an insured peril.

Such deciding factors make a difference as to whether or not the insurance company must cover the loss. If a fire was the result of arson by the insured, obviously the insurer will not cover the loss. Personal arson by the insured is excluded under the contract. On the other hand, if arson was committed by a third party, the insurer would cover the loss (unless it was proven the insured hired the arsonist). The insurer is liable for only the loss and damage to the property insured and not for all the consequences that may spring from such a loss or damage.