Managing Your Risk
Know your coverage: Not all property losses paid the same

By Michael Kelly
Property and Casualty Program Specialist

If the unfortunate does occur and one or more of your county buildings are heavily damaged – for example by a fire or windstorm – understanding the different types of damage evaluation and loss settlement options can be extremely important.

Real property is normally insured and claims are paid using one of four basic methods of loss valuation: actual cash value, replacement cost value, functional replacement cost value and historical replacement cost value. All provide significant variations of settlement that depend upon the level and design of your property coverage. Selection of each can and will affect your property insurance costs as well as the portion of reconstruction costs you may have to pay in order to be back in the same financial position as before the loss occurred.

Replacement cost valuation – the amount of funds required to rebuild the damaged building back as close to original condition as reasonably possible, using modern materials and workmanship, without any applied depreciation for obsolescence, age, use or condition – is most prevalent in commercial property insurance policies today.

Actual cash value is simply the replacement cost value as described, less applied depreciation for obsolescence, age, use and condition. Absent suspected arson or other foul-play, insurance carriers typically pay the actual cash value amount quickly after the loss. This gives the insured immediate working capital to begin making repairs. After the reconstruction of the building is completed, a second and final check is cut for the remaining balance between the actual cash value and replacement cost amounts. It also is at this point that any chosen deductibles that apply are subtracted against the total recovery amount.

The functional replacement cost value method is sometimes used to control cost and allows reconstruction with materials that may be different but that still provide the current functionality of the structure comparable to pre-loss. Many older county buildings are constructed of materials difficult or impossible to obtain today, and they often serve a different purpose than what was originally intended. It essentially changes the valuation basis to the cost to replace the damaged or destroyed property with property that can serve the same function, but not necessarily be of the same materials.

Such an example might be an old school building that has been converted to office space. The county would not rebuild a school and then convert it to office space; it would simply build a new office facility, assuming it is economically advantageous.

The last method of property loss valuation, historical replacement cost, is the hardest to procure and the most expensive. Sometimes also called "original reproduction cost," the purpose is to reproduce the damaged building or specific building features to the exact design, decorative style and dimensions as they existed at the time of loss, using identical materials with respect to kind and quality. Substitution of materials and architectural features with those of like kind and quality will be required only if the identical materials and features cannot be reasonably obtained.

This kind of policy requires a historical replacement cost appraisal, which calculates the additional costs needed to restore the building. This normally will inflate the value of the building significantly and, as such, inflates the insurance cost proportionally. Requirements also normally dictate that this class of building be included on the National Register of Historical Places, and the insured must have submitted a specific written request to the insurance carrier for historical replacement cost valuation to apply.

Finally, there is normally a time limit on how long an insured can refrain from the rebuilding process and still expect to collect an amount larger than the actual cash value. The NCACC Liability & Property program allows a two-year window. Since it may vary among the standard "for-profit" insurance carriers, if your county is not a member of the Liability & Property Pool, it would be sound advice to review this point with your agent. Unlike the private sector, in government operations the process of rebuilding may end up being a slower process, and depending on the size of the project, it is possible to approach a two-year time line in unusual circumstances.

Regardless of the valuation method ultimately used by the insurance adjuster handling your property loss, it is best to read your property coverage provisions, ask appropriate questions and understand how the computation for loss payment is derived before a loss occurs.

Michael Kelly writes a regular column on risk management for CountyLines.