Have you ever felt ignorant when an insurance agent is throwing terms around that you don’t understand? Before becoming an agent, I did. I felt stupid and refused to ask the questions I should have asked about what on Earth he was talking about.
So, here are some explanations.
Replacement Cost vs. Actual Cash Value
Replacement Cost may be the most misunderstood term by those not in the industry. When you look at your insurance policy, is the value of your building coverage much higher than what you think it would be if you sold the property? This is because, although there is only a loose connection between replacement cost and market value. Market value, obviously, is the price you could get from a buyer on the open market. Replacement cost is what the price tag would be if the property were demolished (by fire or other peril) to rebuild the property exactly the way it was the split second before it was demolished.
When it comes to personal property (contents in the property, like your electronics, furniture, clothing, etc.), replacement cost coverage means that if you have a total loss of an item (e.g., your sofa burned to an unrecognizable crisp), you would be able to replace it (after your deductible is taken out) with a sofa of equal function. Imagine if the sofa that burned was 50 years old, had springs poking out of the cushions and the leg was about to fall off. That sofa would be replaced with a new sofa (now, don’t get carried away – I doubt the insurance company would allow you to replace a sofa purchased originally from “the Dump” with a designer sofa, but you get the point here.
If you had Actual Cash Value coverage on your policy, the value that you would have to spend to acquire a replacement sofa would start out with the same figure for the equivalent function and quality sofa, but then a depreciation factor would be applied. If your sofa was a couple of years old, the deduction for “wear and tear” may not be too significant, but if you have the 50 year old sofa above, you may receive nothing for the loss.
A deductible, like in medical insurance, simply means the amount of the loss that you pay before the insurance company pays the first dime. So, if, when all said and done, the claims adjuster calculates the loss you experience to be $5,000 and you have a $1,000 deductible, your check will be for the difference or $4,000.
Coinsurance is a sneaky provision put in many property insurance policies. It’s ultimately a way for the insured and insurer to share responsibility for the risk. It can also help reduce the cost of the insurance policy premium. Most homeowners’ policies require that you insure the building to 100% of its replacement cost
There is an available endorsement to policies for a guaranteed replacement cost – look for it in your policy!! If you don’t have that and if your home is under-insured for whatever reason, the consequences can be severe.
Imagine you have serious fire with the effect of a repair cost of $100,000. Your insurance policy has the value of your home at $350,000. When the calculation of the loss comes in, it totals $700,000. Your deductible is $1,000. With a guaranteed replacement cost endorsement, the insurance company would pay $99,000 (with the proviso that you actually use the money to repair the home). If there is a 100% coinsurance requirement (or, in other words, you must insure the property for 100% of its replacement cost), and you have insured the property for 50% of that value ($350,000 ÷ $700,000), the eligible amount of repair for reimbursement is 50% of $100,000 or $50,000 less the $1,000 deductible of $49,000!
So keep this in mind if you are trying to save a few pennies on your annual insurance premium by lowering the coverage on the structure of your property (Building coverage)!!