Managing Your Risk
Why bother with insurance to value?

By Michael Kelly
Risk Management Director

During the last quarter of 2011, the NCACC Liability & Property Pool began the cyclical reconstruction cost appraisal process for our members’ buildings – with a focus on structures with values greater than $100,000. Once these appraisals are completed they will be made available to our members upon request.

We have utilized the same reconstruction appraisal vendor for many years. During this cycle, 80 percent of the total membership will be appraised from a reconstruction value perspective in preparation for this next renewal season. Following next year we will begin a rotating 20 percent appraisal of the Pool’s total property schedule completed each year thereafter. This allows all members to have their property values checked at least once every five years.

The dilemma of how much insurance is needed to rebuild a given building, especially if constructed a number of years ago, is a truly important question that comes up fairly often.

While this issue of “How much do I need?” tends to show up in the purchase of property insurance for the private sector more often than in local government, it still warrants an understanding of why it is important to insure real property at realistic values. Obviously buying more property insurance costs more, so it is important to understand why you should bother to do so.

Most fire losses rarely result in a total loss – especially buildings of superior construction – and therefore it might be tempting to purchase a lesser total amount of fire insurance based on this premise. However, the rating structure and its fairness in premium allocation is based on the underwriting principal that it be calculated utilizing an amount of insurance equal to 90 percent to 100 percent of the building’s total value. Failing to use accurate values will cause pricing, coverage capacity and chosen retention levels to be based on faulty data and – in worst case scenarios – could put both the insured and the insurance carrier at risk financially.

In addition, utilizing accurate replacement-cost values across the entire property asset schedule regardless of construction type also allows an insurance carrier to receive premiums that are closer to being truly commensurate with its total exposure to loss. It is for this reason that standard insurance companies will traditionally include language in their policies that penalize the insured (called a coinsurance clause) if the total amount of property coverage purchased is below this 90 percent minimum requirement. Other coverage limiting practices include the use of a “margin clause,” which will limit the total amount of available payment to no more than 125 percent of each value shown in the property schedule, or the use of a “per location limit” as listed in the property schedule of the insurance policy – effectively capping the per location insurance amount at the listed, lower value.

These are acceptable practices because it is reasonable to be able to charge premiums based on the amount of total property actually exposed to loss – and is paramount given a true catastrophic loss event such as a Category 4 or greater hurricane. These penalty clauses are to offset and protect the standard insurance carrier from not collecting premiums that reflect a true level of possible total loss.

Understandably, predictability of such catastrophic events in a given geographical area is extremely difficult, and reserves must be accumulated in preparation for it. Collecting accurate premiums (or in our case, contributions) based on real property exposure limits, tempered with carefully selected retention levels, is how our membership collectively protects themselves as a group – and at a cost far below the “for-profit” insurance markets.

To summarize, the main reason to use accurate reconstruction values is to allow insurance companies to be able to more effectively reserve and prepare for that eventual catastrophic event. When you consider that the total amount of insured property damage that arose from Hurricane Katrina reached more than $50 billion, it is easy to see why insurance to value – and the collection of adequate reserves beforehand – is so important.

Just as a footnote, unlike “for-profit” insurance companies, the NCACC Liability & Property Pool’s property coverage form does not include a coinsurance penalty clause, margin clause or per location limit language. We rely on our member’s genuine desire to have the right amount of property coverage leveraged with routine reconstruction appraisals to meet this goal. We know our members understand and truly want to have adequate property coverage to address a catastrophe. We endeavor to style our coverage document accordingly.

At the risk of being self-serving, this is just one of the many advantages of collectively joining with the other 58 counties that are members of the Liability & Property Pool and sharing in the process of collective purchasing.

NCACC Risk Management Director Michael Kelly writes a regular column on risk management for CountyLines. With more than 33 years of risk management/insurance experience, he holds the Associate in Risk Management for Public Entities, Certified Risk Manager and Certified Insurance Counselor professional designations. He can be reached at michael.kelly@ncacc.org or (919) 719-1124. Archived versions of the column can be found online at www.ncacc.org/managingyourrisk.html.