What is Insurance-to-value?
Simply put, it is the amount approximating the actual replacement cost of insured property. It is an important concept applied in insurance to ensure that an insurance policy adequately covers and protects the value of a property (ie, building) in the event of a partial or total loss.
There are several ways to assign a “value” to a building:
- Market Value: An estimate of the current price that a building could be sold for in the real estate market that includes characteristics such as the desirability of the neighbourhood location, lot size, condition of the building, etc.
- Assessed Value: The value usually assigned by the municipality and is generally used for determination of property taxes
- Replacement Value: A calculation of the cost to replace/rebuild the building that includes the cost of material and labour, architect services, permits, debris removal, etc
It is the replacement cost valuation that should be used to determine the appropriate limit of coverage for insurance policies.
What happens if a building is not insured to value?
If a building is underinsured, there could be financial consequences in the event of a partial loss or total loss.
For a total loss, the concept is very simple:
Example: A building is insured for an $800,000 Limit, and suffers a total fire loss. At the time of the loss, it is determined that it will cost $1,000,000 to rebuild a similar building. However, because the insurance policy only covered an $800,000 Limit, the insured suffers a $200,000 shortfall.
For partial losses, it is the Co-insurance Clause–commonly found in commercial insurance policies–that will determine the penalty that an insured may incur for underinsurance. For example, a policy with a 90% Coinsurance Clause requires the limit of insurance for the building to be at least 90% of the building’s replacement value. If the policy limit purchased does not meet the specified percentage, the payout in the event of a partial loss will be reduced in proportion to the deficiency:
Example: A building is insured for an $800,000 Limit and suffers a partial water damage loss totaling $50,000. At the time of the loss, it is determined that the replacement cost for the building is $1,000,000. A 90% coinsurance clause is applicable to the policy. The payout for the loss would be calculated as follows:
- The building limit = $800,000
- The value of the building at the time of loss = $1,000,000
- The coinsurance percentage is 90%
The limit of insurance should be at least $1,000,000 x 90% = $900,000
Because the amount of insurance purchased is only 80% of the amount required ($800,000/$1,000,000), coverage is afforded for only 80% of the repair cost:
The cost to repair the covered damage is $50,000
80% of the repair cost is 50,000 x .80 = $40,000 (less the applicable deductible)
As the above examples demonstrate, underinsurance can come with costly consequences if the replacement cost is not accurately determined at the time the policy is put in place. At Unica, we would recommend a professional appraisal to assist in that valuation to best protect the insured’s interests.
