Mind the gap — that is, beware the difference between the cost of purchasing an expensive home that has unique features and the cost of actually replacing that home with all the same features. That ever present gap may widen amid unstable market values, making a thorough, accurate replacement valuation — including a diligent inspection — a must in placing high-value coverage.
“Just because the resale value of a dwelling has declined does not mean it costs any less to rebuild the dwelling in the event of a covered-peril loss,” cautions Steven Hitz, President of US-Reports, a Colorado-based inspection and risk management company. Hitz recently got a first-hand glimpse of the gap in a case involving a 1950s-era apartment building he’d just purchased for a below-market price.
“The quote came back at double the premium I had anticipated,” he recounts, “based on the value the building had been insured for by the previous owner with the same carrier. What surprised me even more was that the insurance value or replacement cost came in at twice the purchase price.”
The discrepancy in this case stemmed from a minor deflation in labor and materials costs in the region being far surpassed by a double-digit drop in the market value of buildings, Hitz says. It might seem tempting to save premium by insuring the property based on its market value instead of on an accurate replacement valuation. But because people tend to use insurance to make them whole after a loss, failing to insure to the right value could leave substantial portions of a claim unpaid.
The Inspection-Valuation Link
A typical mass-market homeowners policy includes a replacement-loss contract that shows how much would be paid in the event of a total loss. That is, if the policy pays $1 million, the property owner would get up to $1 million, even if it cost $1.5 million to replace. Some mass market and high-value policies include extended replacement costs covering 150 percent of the policy limits to account for changes in the cost of materials and other factors during the policy period. However, even that flexibility doesn’t guarantee the homeowner won’t have to dig deep into their pockets to cover a major loss.
In many states, high-value properties are insured with guaranteed replacement costs that pay the full cost of replacement or repair. While these are important guarantees for the owner, they put a premium on accurate inspection and proper valuation, according to Heather Posner, regional marketing manager of Chartis Private Client Group.
As an owner, she says, “you don’t want to be over-insured or underinsured,” while as an insurer, the inspection process is “another opportunity to provide risk management to prevent a claim from happening.” Chartis relies on in-house inspection teams as well as private inspectors for some remote locations. Agents, brokers and insureds receive copies of the inspection report; sometimes they even come along for the actual inspection.
Typically, an expensive property is bound based on information the policyholder furnishes, which is subsequently verified by the inspector, who then either confirms or recommends a change in the valuation. Rarely does an inspection cause a carrier to withdraw from a policy, though it often prompts new risk management recommendations, Posner says.
Inspections may surface as a valuable resource again during the claim process, if there is a discrepancy in the valuation or difficulty establishing what was lost, notes Melanie Elias, director of claims at Burns & Wilcox. In a recent case, a mortgage company acquired a piece of property by default. Soon thereafter, one of its inspectors noticed the outdoor air conditioning unit at the property was missing and submitted a claim. A review of the inspection report indicated there had been a base for the unit but no unit when the policy was written, so there was no loss.
Photographs from an inspection report may prove especially valuable in instances where the damage to a property is particularly severe, such as from a hurricane or wildfire, when it may be hard to even distinguish a home’s footprint, notes Elias.
Accurate inspections pave the way for insurers to offer high-end policies with extended replacement and guaranteed replacement. Usually, owners see the wisdom of having an inspection, though the agent may need to do some convincing, says Posner. “You simply ask the owner, ‘In the event of a total loss by fire, which side of your house do you want the insurance company to replace?’ The message is pretty clear.”