Replacement value

The term replacement cost or replacement value refers to the amount that an entity would have to pay to replace an asset at the present time, according to its current worth.

In the insurance industry, "replacement cost" or "replacement cost value" is one of several method of determining the value of an insured item. Replacement cost is the actual cost to replace an item or structure at its pre-loss condition. This may not be the "market value" of the item, and is typically distinguished from the "actual cash value" payment which includes a deduction for depreciation. For insurance policies for property insurance, a contractual stipulation that the lost asset must be actually repaired or replaced before the replacement cost can be paid is common. This prevents overinsurance, which contributes to arson and insurance fraud.[1] Replacement cost policies emerged in the mid-20th century; prior to that concern about overinsurance restricted their availability.[1]

If insurance carriers honestly determine replacement cost, it becomes a "win-win" for both for the carriers and the customers. However, when a replacement cost determination is made by the carrier (and, perhaps, its third party expert) that exceeds the actual cost of replacement, the customer is likely to be paying for more insurance than necessary. To the extent that the carrier has knowingly or carelessly sold excessive (i.e. unnecessary) insurance, such a practice may constitute consumer fraud.

Replacement cost coverage is designed so the policy holder will not have to spend more money to get a similar new item and that the insurance company does not pay for intangibles.[2] For example: when a television is covered by a replacement cost value policy, the cost of a similar television which can be purchased today determines the compensation amount for that item.[3] This kind of policy is more expensive than an Actual Cash Value policy, where the policyholder will not be compensated for the depreciation of an item that was destroyed. The total amount paid by an insurance company on a claim may also involve other factors such as co-insurance or deductibles. One of the champions of the replacement cost method was the Dutch professor in Business economics Théodore Limperg.

Vendors

Insurers purchase estimations on replacement cost. Major estimation companies include CoreLogic subsidiary Marshall Swift-Boeckh, Verisk Analytics PropertyProfile, Bluebook International, and E2Value. Consumer-focused tools include AccuCoverage and Home Smart Reports.

Home insurance in the United States

If insufficient coverage is purchased to rebuild the home, the insured may have to pay substantial uninsured costs out of their own pocket. In 2013, a survey found that about 60% of homes have replacement cost estimates which are too low by an estimated 17 percent.[4] In some cases, estimates can be too low because of "demand surge" after a catastrophe.[5]

Historically, consumers could purchase "guaranteed replacement cost" coverage which ensure sufficient limits if the estimate was too low, but these became "virtually extinct" after several California disasters including the Oakland firestorm of 1991, the Laguna Beach fires, and the 1994 Northridge earthquake.[6]

Underinsurance responsibility

Although insurance is decided at the state-level, most states follow similar practices. In California[7][8] and Texas,[9] the insured is responsible for determining the proper amount of insurance. However, one survey found that about half of consumers believe it is insurer's responsibility, and consumers may come to this conclusion through the insurer's processes, which one legal scholar argues creates a "reasonable expectation" of coverage,[10] which is a controversial insurance law doctrine adopted in certain states.

In California, the 2007 case on the issue, Everett vs. State Farm General Insurance Company, provoked an unsuccessful request by the California Department of Insurance and insurance nonprofit United Policyholders to depublish the case.[7]

References

  1. 1 2 Thomas JE, Wilson B. (2005). The Indemnity Principle: Evolution from a Financial to a Functional Paradigm]. Journal of Risk Management & Insurance. Free full-text.
  2. ↑ "The Replacement Cost Claim: It’s Just Like Any Other, or Is It?". Adjusting Today. Adjusters International.
  3. ↑ "Keeping the Roof Over Your Head: A Consumer Guide to Homeowners insurance". University of Missouri Extension. Family Financial Education Extension.
  4. ↑ "Insurers Continue to Improve Their Home Valuations, Says MSB". www.insurancejournal.com. Retrieved 2016-01-17.
  5. ↑ Covered by homeowners insurance? Don't be so sure. CNN Money. WebCite archive.
  6. ↑ San Nicolas, Silvia (2006). "Collateral Replacement Cost Risk: What Every Lender and Investor Needs to Know" (PDF). Bluebook International. Retrieved 2016-01-17.
  7. 1 2 "Everett vs. State Farm General Insurance Company". United Policyholders. Retrieved 2016-01-17.
  8. ↑ Gibson v. Geico (1984) 162 Cal.App.3d 441, 447., as cited by Silvia San Nicolas.
  9. ↑ "Who is Liable if You Find Yourself Underinsured in Texas? : Property Insurance Coverage Law Blog". www.propertyinsurancecoveragelaw.com. Retrieved 2016-01-17.
  10. ↑ Fox, Joshua (2011). ""Softening the Short Shrift: Regulating Homeowners Insurance Limits as " by Joshua Fox". California Western Law Review. Retrieved 2016-01-17.
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