Will Making a Claim for Actual Cash Value Help the Insured Avoid a Coinsurance Penalty?
Question: “We have a fire claim on a building, and I know I have a coinsurance problem. The building limit is around 55% of what it should have been. The correct estimate to repair the building, including replacing plaster walls, is greater than the limit, while the replacement estimate with Sheetrock and less expensive fixtures is less than the limit. Does coinsurance apply if you wish to accept actual cash value? If so, I would go with the higher estimate. Which way should I go?”
Answer: The Coinsurance condition applies regardless of whether coverage is on a replacement cost (RC) or actual cash value (ACV) basis. However, your insured may escape a coinsurance penalty if they elect to settle on an ACV basis.
The following are from pages 32 and 34 of the file you sent:
E. Loss Conditions
The following conditions apply in addition to the Common Policy Conditions and the Commercial Property Conditions. …
- Valuation
We will determine the value of Covered Property in the event of loss or damage as follows:
a. At actual cash value as of the time of loss or damage, except as provided in b., c., d., e. and f. below.
F. Additional Conditions
The following conditions apply in addition to the Common Policy Conditions and the Commercial Property Conditions.
- Coinsurance
If a Coinsurance percentage is shown in the Declarations, the following condition applies.
a. We will not pay the full amount of any loss if the value of Covered Property at the time of loss times the Coinsurance percentage shown for it in the Declarations is greater than the Limit of Insurance for the property.
Instead, we will determine the most we will pay using the following steps:
(1) Multiply the value of Covered Property at the time of loss by the Coinsurance percentage;
(2) Divide the Limit of Insurance of the property by the figure determined in Step (1);
(3) Multiply the total amount of loss, before the application of any deductible, by the figure determined in Step (2); and
(4) Subtract the deductible from the figure determined in Step (3).
We will pay the amount determined in Step (4) or the limit of insurance, whichever is less. For the remainder, you will either have to rely on other insurance or absorb the loss yourself. …
G. Optional Coverages
If shown as applicable in the Declarations, the following Optional Coverages apply separately to each item. …
- Replacement Cost
a. Replacement Cost (without deduction for depreciation) replaces Actual Cash Value in the Loss Condition, Valuation, of this Coverage Form. …
c. You may make a claim for loss or damage covered by this insurance on an actual cash value basis instead of on a replacement cost basis. In the event you elect to have loss or damage settled on an actual cash value basis, you may still make a claim for the additional coverage this Optional Coverage provides if you notify us of your intent to do so within 180 days after the loss or damage.
Here’s how I interpret this:
- Page 9 of the file shows that the Replacement Cost Optional Coverage applies to the building.
- However, page 34 of the file (G.3.c. above) permits the named insured to make a claim on an actual cash value basis instead of a replacement cost basis.
- The Coinsurance condition applies if the Declarations show a Coinsurance percentage. Page 9 of the file shows a Coinsurance percentage of 80%, so that condition applies to any loss regardless of how the insurer values it.
- The Coinsurance condition states that the insurer will multiply “the value of Covered Property at the time of the loss” by 80% and compare that to the Limit of Insurance on the property.
- If the named insured exercises their right to make a claim on an actual cash value basis, the value that the insurer should use when applying the Coinsurance condition should be the building’s actual cash value at the time of the loss, not its replacement cost.
By definition, the building’s actual cash value at the time of a loss is almost certainly less than its replacement cost. This means that the insurer will multiply the 80% coinsurance percentage by a lower number and compare that to the applicable limit. It is possible that the result will be that the insurer will not apply a coinsurance penalty.
However, it’s an open question as to whether the loss settlement after deducting for depreciation will be greater than it would have been with no deduction for depreciation but with a coinsurance penalty. Unless/until you find out what numeric factor the insurer would use for depreciation, you can’t tell which choice would put the insured farther ahead. I would hope that the insurer’s claims department would assist you in figuring that out.
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