Method of Payment of Policy Limits
Wednesday, October 3, 2018
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At this point, it should be noted that most mortgage companies and banks usually demand that the homeowner maintain a policy which contains replacement cost coverage on the home equal to at least the amount of the home loan. However, absent mortgage requirements, a covered loss policy limit on Coverage A-B can be paid out on either an “actual cash value” basis or on a “replacement cost” basis depending on the type of policy purchased.
This means the value of the property if sold in today’s market less a certain percentage to account for its age. What this means translated into English is the insurance company is not obligated to pay the full market value for the home if it is destroyed. Instead they will pay an amount less than the fair market value discounted due to reasonable wear and tear on the home due to its age. A payment under the actual cash value rule means the older the home is, the less money the homeowner will receive should the home be destroyed regardless of what it was worth on the market prior to it being damaged.
While “replacement cost” appears to be better method of payment and/or coverage than “actual cash value” it also has its draw backs.
First, policies that guarantee to pay replacement cost are expensive. Usually, 100% replacement cost guarantees are extremely expensive. Consequently most insurance companies offer these policies using a lesser valued percentage as payment such as 80% payment of replacement cost. If your policy allows for an 80% replacement cost and the value of your home declared in the policy is $500,000.00, and the home is damaged or destroyed by a named peril, the insurance company would be obligated to pay you up to only $400,000.00
If your home is not a total loss, and merely needs repairs, and the limits of the policy are 80 percent of the replacement cost of the dwelling, you are most likely fully covered for a partial loss. This will remain true so long as the cost of those repairs does not exceed $400,000.00. But as can be clearly seen, the home is completely destroyed and the homeowner’s policy did not provide for 100% of the homes value, the homeowner will be paid only part of the replacement cost suffering a loss of $100,000.00.
In choosing a policy, which provides less than 100% of the replacement cost, the homeowner should remember that home values have probably gone up since his policy was first issued. Furthermore, the price of materials and cost of labor have probably increased since the time his or her home was completed. If the homeowner chooses anything other than 100% replacement costs, the homeowner also needs to be aware that a home being rebuilt or undergoing major repairs must be brought up to standard on all new safety and building codes. Under these constraints, depending on when the home was originally built, the costs to repair the home could easily exceed the coverage!
Regardless of the percentage in a policy that pays replacement cost, the homeowner should update his or her policy to reflect the current value of their home. The rising market value of homes combined with new home improvements is reason enough to update a replacement cost policy.
When a policy contains this endorsement the insurance company is obligated to increase the homes stated value to reflect the market value increase. The increased cost of the rider and coverage increase will be reflected in the yearly premium but having this endorsement could save you thousands of dollars. Most insurance companies will place a moratorium on policy amendments seeking to increase coverage or benefits if the home is deemed to be “in the path of the peril”. Once this happens to a homeowner, he or she will wish they had purchased the guaranteed replacement endorsement.
"Actual Cash Value" vs. "Replacement Cost" Personal Property Coverage:
With the exception of HO-8 for older homes, most homeowner policies pay replacement cost coverage on the home’s physical losses but only actual cash value coverage on personal property lost or destroyed.
Replacement cost coverage policy, for personal property, gives a homeowner more protection than actual cash value coverage policy. If a burglar breaks in and steals the homeowner’s ten-year-old stereo system, under an actual cash value coverage policy, the homeowner would recover the current market value of a ten-year-old stereo system. Under a replacement cost coverage policy, the insurance company pays to replace the homeowner’s stereo system with a new stereo system similar or identical to the stolen one.
This means the value of the property if sold in today’s market less a certain percentage to account for its age. What this means translated into English is the insurance company is not obligated to pay the full market value for the home if it is destroyed. Instead they will pay an amount less than the fair market value discounted due to reasonable wear and tear on the home due to its age. A payment under the actual cash value rule means the older the home is, the less money the homeowner will receive should the home be destroyed regardless of what it was worth on the market prior to it being damaged.
While “replacement cost” appears to be better method of payment and/or coverage than “actual cash value” it also has its draw backs.
First, policies that guarantee to pay replacement cost are expensive. Usually, 100% replacement cost guarantees are extremely expensive. Consequently most insurance companies offer these policies using a lesser valued percentage as payment such as 80% payment of replacement cost. If your policy allows for an 80% replacement cost and the value of your home declared in the policy is $500,000.00, and the home is damaged or destroyed by a named peril, the insurance company would be obligated to pay you up to only $400,000.00
If your home is not a total loss, and merely needs repairs, and the limits of the policy are 80 percent of the replacement cost of the dwelling, you are most likely fully covered for a partial loss. This will remain true so long as the cost of those repairs does not exceed $400,000.00. But as can be clearly seen, the home is completely destroyed and the homeowner’s policy did not provide for 100% of the homes value, the homeowner will be paid only part of the replacement cost suffering a loss of $100,000.00.
In choosing a policy, which provides less than 100% of the replacement cost, the homeowner should remember that home values have probably gone up since his policy was first issued. Furthermore, the price of materials and cost of labor have probably increased since the time his or her home was completed. If the homeowner chooses anything other than 100% replacement costs, the homeowner also needs to be aware that a home being rebuilt or undergoing major repairs must be brought up to standard on all new safety and building codes. Under these constraints, depending on when the home was originally built, the costs to repair the home could easily exceed the coverage!
Regardless of the percentage in a policy that pays replacement cost, the homeowner should update his or her policy to reflect the current value of their home. The rising market value of homes combined with new home improvements is reason enough to update a replacement cost policy.
When a policy contains this endorsement the insurance company is obligated to increase the homes stated value to reflect the market value increase. The increased cost of the rider and coverage increase will be reflected in the yearly premium but having this endorsement could save you thousands of dollars. Most insurance companies will place a moratorium on policy amendments seeking to increase coverage or benefits if the home is deemed to be “in the path of the peril”. Once this happens to a homeowner, he or she will wish they had purchased the guaranteed replacement endorsement.
"Actual Cash Value" vs. "Replacement Cost" Personal Property Coverage:
With the exception of HO-8 for older homes, most homeowner policies pay replacement cost coverage on the home’s physical losses but only actual cash value coverage on personal property lost or destroyed.
Replacement cost coverage policy, for personal property, gives a homeowner more protection than actual cash value coverage policy. If a burglar breaks in and steals the homeowner’s ten-year-old stereo system, under an actual cash value coverage policy, the homeowner would recover the current market value of a ten-year-old stereo system. Under a replacement cost coverage policy, the insurance company pays to replace the homeowner’s stereo system with a new stereo system similar or identical to the stolen one.