How much fire insurance is enough?How much is enough? This may be a philosophical question that addresses the excesses of the 80's, but it poses a very concrete dilemma for the real estate operator of the 90's. An oversupply o·ver·sup·ply n. pl. o·ver·sup·plies A supply in excess of what is appropriate or required. tr.v. o·ver·sup·plied, o·ver·sup·ply·ing, o·ver·sup·plies of any "commodity" is expensive to maintain, be it in vacant units or redundant staff. With respect to property insurance, however, it is much more likely to be insufficient coverage rather than "overspending" which will cause the inattentive in·at·ten·tive adj. Exhibiting a lack of attention; not attentive. in  at·ten buyer to find
himself out-of-pocket" after a loss.A Confusion in Terms As in many professional disciplines, the language of insurance has a mystique mys·tique n. An aura of heightened value, interest, or meaning surrounding something, arising from attitudes and beliefs that impute special power or mystery to it: the cowboy mystique; the mystique of existentialism. of its own, and this can make a proper evaluation of ones portfolio difficult. Terms such as "actual cash value", "co-insurance", and "building ordinance" coverage have been misunderstood for years. The effect of this confusion is best illustrated in a real life example. You might want to take out your calculator. Enough Insurance for What? Recently Harry Herter's 60-unit apartment building in Queens suffered extensive fire damage to the roof. The repairs and replacement were estimated at $600,000. In addition, a portion of the roof which was undamaged by the fire but judged to be structurally unsafe had to be taken down by order of the city at a projected additional cost of $75,000. Imagine Harry's shock when the insurance carrier's adjustor advised him that his recovery would be approximately $319,000. Here are some of the clues to this sorry mystery: Harry miscalculated the value of his building, didn't buy enough insurance and rejected the offer of a very important optional coverage endorsement. Actual Cash Value This term, simply put, serves to value a building at what it would cost to repair or replace the property at current-costs of labor and materials labor and materials (time and materials) n. what some builders or repair people contract to provide and be paid for, rather than a fixed price or a percentage of the costs. less physical depreciation based primarily upon age and condition. Referred to by insurance people as "ACV ACV abbr. 1. actual cash value 2. air-cushion vehicle ", this term is not defined in any policy, nor does any policy recite what elements of physical depreciation will be used, or what percentage will be deducted. Attoday's construction prices, it would cost $2.34 million to replace Harry's property. Let's now assume 30 percent as the depreciation factor and, therefore, deduct $702,000. We are left with $1,638,000 as actual cash value for insurance purposes. As can be readily seen, this calculation has nothing to do with book value, market value, or assessed value for tax purposes. The operative word is "physical", and Harry, as we shall soon see, has a problem here. Co-insurance In major medical insurance, co-insurance is simply the/portion of the claim you pay after the deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). . In fire insurance, it's Much trickier. Some background: the social goal of all insurance is to spread risk. For this to work, each potential claimant CLAIMANT. In the courts of admiralty, when the suit is in rem, the cause is entitled in the Dame of the libellant against the thing libelled, as A B v. Ten cases of calico and it preserves that title through the whole progress of the suit. must pay a premium which fairly reflects the exposure to loss which he asks his neighbors to share with him. Based purely on value, forgetting for the moment any other construction or occupancy factors, a $2 million building presents a much greater exposure to even a partial-loss than a $200,000 building-across the street. Co-insurance is the tool used to level this part of the playing field. The usual figure is 80 percent. In plain English Plain English (sometimes known, more broadly, as plain language) is a communication style that focuses on considering the audience's needs when writing. It recommends avoiding unnecessary words and avoiding jargon, technical terms, and long and ambiguous sentences. , the policy says that, in order to collect in full on a partial loss, the $2 million owner must purchase at least $1.6 million in coverage, and the $200,000 owner, $160,000. Harry's problem just got worse, but wait... Building Ordinance Coverages The broadest coverage language available in a property policy usually includes the term "all-risk". Rather than listing covered perils such a fire, windstorm wind·storm n. A storm with high winds or violent gusts but little or no rain. windstorm A storm with high winds or violent gusts but little or no rain. , explosion, etc., the "all-risk" policy says, in effect, anything that happens is covered unless the policy excludes it. Of course, no policy is really that simple or unconditional. But the "all-risk" language does shift the burden of proof to the carrier to show why a claim is not covered not covered Health care adjective Referring to a procedure, test or other health service to which a policy holder or insurance beneficiary is not entitled under the terms of the policy or payment system–eg, Medicare. Cf Covered. instead of the policyholder having to show why it is. However, the language doesn't stop at "all-risk"; it goes on to add"... of direct physical loss or damage." It is not unusual after a fire in the New York City New York City: see New York, city. New York City City (pop., 2000: 8,008,278), southeastern New York, at the mouth of the Hudson River. The largest city in the U.S. area for enforcement of a local ordinance A local ordinance is a law usually found in a municipal code. In the United States, these laws are enforced locally in addition to state law and Federal law. See also
Transformation of a society from a rural and agrarian condition to a secular, urban, and industrial one. It is closely linked with industrialization. As societies modernize, the individual becomes increasingly important, gradually replacing the family, to current code specifications or demolition of remaining sections of a building not directly damaged by the peril that occurred. This type of additional cost is not covered by the standard property policy. We are beginning to understand Harry's deepening gloom. Some Fuzzy Thinking When Harry renewed his insurance policy, he confused some important issues. Discouraged with the state of the economy and the real estate industry in particular, he reasoned that his building, fully depreciated Fully depreciated An asset that has already been charged with the maximum amount of depreciation allowed by the IRS for accounting purposes. fully depreciated Of or relating to a fixed asset that has been depreciated to a book value of zero. for tax purposes and with too many vacancies, simply wasn't worth what it used to be. If it were completely destroyed by a fire, he certainly wasn't going to replace it - he'd retire. In any event, he had to economize e·con·o·mize v. e·con·o·mized, e·con·o·miz·ing, e·con·o·miz·es v.intr. 1. To practice economy, as by avoiding waste or reducing expenditures. 2. , and $1 million seemed like a nice round number for ACV insurance. And he wasn't interested in any bells, whistles, or "ordinances" on the policy. So now we can quantify this faulty logic. How Much is Enough? Today's cost to replace building $2,340,000 Actual Cash Value (at 30% depreciation $1,638,000 Amount of ACV insurance required by 80% clause $1.310,000 Amount of insurance Harry purchased $1,000,000 At this point we can see he purchased only 76% of what he should have to collect in full even on an ACV basis ($1 million divided by $1.310,400=76 percent). Now let's look at the loss: Cost to repair and replace direct damage to the roof $600,000 Cost of city-ordered demolition
of undamaged portion $75,000
Total Loss 675,000
Coverages, the $75,000 demolition cost is not covered at all. Next, since he bought only ACV insurance, the value of the $600,000 replacement work will also be reduced by the same 30X factor, leaving $420,000 "collectible". But remember, Harry didn't fulfill his co-insurance requirement-he only bought 76 percent of what he should have. You've probably guessed by now that he will only collect 76 of the depreciated Depreciated may refer to:
Note: for purposes of this illustration, the nominal policy deductible would have little impact, so we've ignored it. The sad irony is that none of this had to happen. Competitive pressures have made insurance companies very liberal and flexible in negotiations for coverage. "All-risk" insurance can be readily purchased on a replacement cost basis with no depreciation, and for property owners willing to insure up to a realistic current day physical value, the coinsurance A provision of an insurance policy that provides that the insurance company and the insured will apportion between them any loss covered by the policy according to a fixed percentage of the value for which the property, or the person, is insured. "penalty" clause can be waived entirely and replaced by an "agreed amount" endorsement. What's more, the various important Building Ordinance Coverages are available in some programs for free. Get the Straight Story No insurance decision is simple. Even the most basic coverage contract has confusing conditions. Claims settlements are frequently based on practices which are not defined or set forth in the policy at all. There is not substitute for expert help from a knowledgeable agent or broker, and now is an especially good time to obtain broad, reasonably priced protection. Next month: A smile won't be your umbrella. An account executive with Kaye Insurance Associates, Marc Cohen PERSONAL Marc Cohen lives in the San Fernando Valley and attended Cal State Northridge University He is married with two children. Marc was formerly President of the Starlight Childrens Foundation. specializes in Kaye's comprehensive multi-peril insurance program especially designed for residential real estate properties. Kaye Insurance Associates is one of the largest brokerages in the nation. |
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