Property insurance valuation options are not limited to replacement cost, actual cash value or even market value (although market value is not a customary insurance value). Insureds can choose among several specialized options to meet specific needs: functional replacement cost, agreed amount and stated value. Each valuation method has a specific use and meets a unique need as highlighted in the next several paragraphs.

Functional Replacement Cost

Building codes may not allow or the realistic needs of the insured may not require that a building be rebuilt to the same square footage or utilizing the same materials existing prior to a major loss. Likewise, the insured may not need furniture, fixtures or equipment with a myriad of additional features. ISO offers two endorsements which allow insureds to value real and personal property at less than replacement cost, but in amounts adequate to rebuild or replace with property that is operationally equivalent:
• CP 04 38 - Functional Building Valuation; and
• CP 04 39 - Functional Personal Property Valuation - Other Than Stock.

Functional replacement cost endorsements value property at the cost necessary to replace damaged or destroyed property with new property of unlike kind and quality which perform the same general function allowing the insured to accomplish their business objectives. Property replaced using functionally equivalent materials and products are less expensive and often require a shorter replacement schedule. Buildings may be smaller or built using less expensive building materials; and business personal property will perform the essential functions, but may not have the amenities of the furniture or equipment it replaces. This valuation option may be appropriate:
• When the insured cannot rebuild the same square footage, usually due to the application of building codes, and a smaller building will be built in its place;
• When the insured does not want to rebuild the same square footage;
• When lower cost building materials can or should be used (i.e. masonry/non-combustible vs. fire resistive); or
• If the insured does not need all the functions available on a particular piece of machinery or equipment (they found a great bargain on a top-of-the-line model, but don't need or use all the functions available and the insured does not want to pay the premium to insure it for cost new).

Both functional replacement cost endorsements allow the insured to purchase a lower amount of coverage (enjoying some premium savings) while retaining a form of replacement cost coverage for partial losses (subject to "lesser of" policy provisions). Other advantages within these forms include: 1) Coinsurance is waived; and 2) Ordinance or Law coverage is included in the form (no need for a separate endorsement).

Agreed Value

As the name suggests, this is the amount the insured and the insurer agree the property is worth. Since it is a "pre-negotiated" limit, the coinsurance condition does not apply provided the insured carries the amount of coverage agreed upon by both parties. The face amount is paid in the event of a total loss and partial losses are paid on a repair or replacement basis without the customary "lesser of" conditions common to other valuation methods.

Commercial property policies contain agreed value language. To trigger coverage the insured must 1) request the agreed value option in the application; and 2) complete and sign a statement of values for the insurance company to prove the values. The statement of values must be completed every 12 months in order to maintain agreed value coverage. If the statement of values is not completed, the coinsurance condition is reinstated.

Agreed value is appropriate anytime the insured wants to avoid potential coinsurance penalties. Such problems may arise when property is difficult to value due to its unique nature, availability or unstable values (which may trigger value and coinsurance issues as the cost at the time of loss may not be predictable). Retail or manufacturing operations which experience broad swings in stock value should avoid agreed value coverage on stock as limits may not be adequate to cover the amount on hand at the time of the loss.

Stated Amount

Stated amount is oft times confused with agreed value when discussing and planning coverage with the insured; these terms are not synonymous. In fact, stated amount valuation is detrimental to the insured as it is wholly subject to the "lesser of" limitation with no available option to increase payment.

Most often applied in inland marine policies and auto physical damage coverage, stated amount will only pay the lesser of:
• The stated amount on the policy;
• The actual cash value; or
• The cost to repair the item.

There is rarely a situation where this valuation method is advantageous to the insured. Stated amount endorsements should be avoided, and every attempt should be made to negotiate a different settlement option in policies using this as the primary valuation method (mostly inland marine coverage). If the only way an underwriter will agree to write the coverage is use of the stated value method and there are no other viable options, then the provisions must be clearly explained to the insured.

Coinsurance and Inflation Guard

Coinsurance provisions, requirements and penalties were addressed in a previous article. Not discussed were the available coinsurance options along with the benefits and pitfalls of each. Remember, coinsurance was introduced to penalize the insured for failure to purchase a required minimum amount of property coverage.

Standard commercial property policy coinsurance is 80 percent. That is, the insured must insure to at least 80 percent of the property's "value" to receive full payment for partial losses. "Value" can be either actual cash value or replacement cost value based on the insured's indicated desire in the application. Ninety percent and 100 percent are the other commonly used coinsurance percentages in property policies.

Rate credits are granted when the insured increases the coinsurance percentage. However, increasing the coinsurance percentage requires the insured to confirm that the limits of coverage correspond to the new "minimum" limit of protection created. The potential to suffer the coinsurance penalty increases as the insured increases the coinsurance percentage. If the insured opts to use 100 percent coinsurance, they must be absolutely sure that the limit of coverage equals 100 percent of the "value" (however defined in the particular policy) to avoid a coinsurance penalty. Opinions differ, but the rate credit is not worth the potential penalty for miscalculation.

Insure the property at 100 percent insurance to value (again, whichever definition of value is applied), but use 90 percent coinsurance as the basis. This accomplishes two goals: 1) guarantees that the insured is fully insured for all partial losses (subject to the deductible); and 2) assures the insured will be fully covered for total losses since the policy will never pay more than the limit purchased.

Agents and insureds that insist on using 100 percent coinsurance do have an optional coverage to allow the property limit to increase throughout the year. The optional inflation guard coverage increases the limit of coverage over the course of the policy year. Coverage is increased by the percentage selected by the insured. Annual inflation factors generally range between 2 percent and 8 percent and are prorated throughout the year (i.e. after six months, property values have been increased by one-half of the factor applied). Using 8 percent, property valued at $100,000 at the beginning of the policy period will be valued at $104,000 after six months and $108,000 at the end of the 12-month policy period.

The inflation guard optional coverage is essentially required when the insured insists on 100 percent coinsurance or in volatile economic times.

Conclusion

Property has many different values; some relate to insurance and many do not. Accurately valuing property for insurance, and even market, purposes is as much an art as a science. Insureds depend on their agents to protect them against devastating financial consequences following a loss. If the correct amount or the right type of coverage is not there, insured's can be bankrupted by the costs.

Insureds must understand the definition of "value," how to calculate the correct "value" and how policy provisions truly apply. Coverage gaps and solutions to close those holes must also be explained to insureds.