Insurance Property Valuation and Loss Settlement Clauses

[Reyed Mia (Apprentice, DIU)]

Insurance Property Valuation and Loss Settlement Clauses

While a risk management professional should be concerned about what may damage or destroy covered property, an equal concern should be that the insured's settlement received post-loss is appropriate to continue post-loss operations as if nothing had happened. An insured's pre-loss expectations should be equal to the insurer's post-loss policy (contractual) obligations.

Disaster Strikes

A total fire loss occurs later in the coverage year at one location and the insured learns that even a favorable renewal may result in an unexpected coverage deficiency at time of loss settlement. How could this happen?

The policy excerpts listed above are taken from the Insurance Services Office, Inc. (ISO), building and personal property coverage form, CP 00 10 04 02. These provisions are similar to that used in non-ISO property insurance policies, so this loss scenario could happen to any risk management professional. Exposure review for property insurance starts with proper identification and determination of property and its pre-loss value and how the insured post-loss event may have it repaired, replaced, demolished, or left as is.

Values at Risk

Soft insurance markets may allow a risk management professional to obtain coverage tools that can "overlook" possible deficiencies in property values by providing blanket limits to make up for inadequate limits at any one location, removal of a coinsurance requirement, and providing replacement cost valuation. Hard markets and restrictive coverage renewal terms can occur suddenly after catastrophic events, such as what happened to many U.S. insureds after both September 11, 2001, and Hurricane Katrina.

Can an insured suddenly create appropriate building and contents values when faced with stringent renewal terms such as limits specific per location, coinsurance, and actual cash value loss settlement? For most insureds, the answer is probably not. Establishing proper property insurance values is an ongoing risk management activity that must be viewed independently of current market conditions.

Valuation Methodology

A decision to change the valuation of buildings or contents from replacement cost to actual cash value must be reviewed carefully. The change in value will obviously decrease the insurance limit for total loss and reduce the potential for adequate loss settlement for other coverage provisions. Debris removal coverage is predicated on 25 percent of the sum of the deductible plus the amount paid by the insurer for the direct physical loss or damage to covered property, not to exceed the limit of insurance applicable to the covered property. A change from replacement cost to actual cash value will cause a significant reduction in debris removal coverage. While additional debris removal coverage may be provided by the insurer upon specific request using "Debris Removal Additional Insurance," CP 04 15 10 00, the insured must consider the exposure and request for the increased limit prior to loss event.

Increased costs of construction (a minor coverage in ISO property policies) may not be enough if local ordinances have stringent requirements regarding rebuilding damaged property. Exposure identification by way of inadequate loss settlement post-loss event is not an efficient use of a property risk management process.

Loss Scenario—A Hypothetical Look at Valuation Issues

Jones & Company manufactures electric motors that range in use from residential swimming pool filters to running commercial heating and ventilating systems. It has been in business for 50 years and operates out of three facilities. Building 3, fully sprinklered, was constructed 10 years ago specifically for Jones' manufacturing processes, utilizes state-of-the-art machinery, and is approximately 20,000 square feet of fire-resistive construction. Building 2, which is 10,000 square feet and masonry construction, was acquired 15 years ago and was renovated several times to accommodate expansion of Jones & Company electric motor products and to extend the sprinkler system to all of the building.

https://www.irmi.com/articles/expert-commentary/insurance-property-valuation-and-loss-settlement-clauses