What is replacement cost and how does it apply to property insurance?
In property insurance, a loss is generally valued in one of two ways, either the replacement cost, which is the cost to repair the property at today’s cost of construction or a depreciated value, known as actual cash value, which is replacement cost minus depreciation. You better believe you will be asked the definition of actual cash value on your insurance licensing exam, so you better know it.
Click here to learn more about actual cash value.
Which type of valuation is better, actual cash value, or replacement cost?
Replacement cost coverage is definitely better. If you are purchasing property insurance, you would want to purchase a policy that values a loss in this manner. Of course, since it is better, policies that value a loss in this manner generally have a higher premium than those which value a loss based upon actual cash value.
Is there anything required of the insured by the insurer in order for the insured to get replacement cost coverage?
Yes, in any policy that provides replacement cost coverage, the insurer (insurance company) will require the insured (owner of the policy) to insure a structure at a minimum of 80% of the replacement cost. This is known as the coinsurance requirement.
If the insured purchases less than 80% of the current replacement cost of the structure, the insurer will penalize them. If the insured carries less than 80% of the current replacement cost of the structure as their policy limit and then has a loss, the insurer will pay either the actual cash value of the loss or apply the co-insurance penalty to the loss. The insurer will pay whichever of these is higher.
What is the purpose of the coinsurance requirement?
This is another test question you will most likely encounter on your insurance exam. The purpose of the coinsurance requirement (80%) is to ensure the insured is carrying adequate limits. However, check this out. In order to get replacement cost coverage, the insured only has to purchase 80% of the current replacement cost of the structure as a policy limit. So, say they do that. Then they have a total loss. How much will the insurer pay? 80% of the total loss. Who pays the other 20% to rebuild the structure? The insured!
So, does the coinsurance requirement ensure the insured will be fully insured? No! Fully insured would be 100%, not 80%.
Are there any types of property that are usually NOT insured on a replacement cost basis?
Yes, usually the insured’s personal property (contents – the stuff inside their property) are insured based on an actual cash value basis. The same usually holds true for damage to automobiles.
What else can help me prepare to pass my insurance licensing exam on my first attempt?
Other tips to help you pass your insurance licensing exam on your first attempt:
Insurance Exam Test Taking Tips
Also, check out our definition and question of the day videos on our YouTube channel: