Property Valuation & Loss Settlement

Valuation Methods

How much the insurer pays for a property loss depends on the valuation method in the policy.

• Actual Cash Value (ACV): Replacement cost minus depreciation. Depreciation accounts for age, wear, and obsolescence. A 12-year-old roof with a 20-year life is depreciated roughly 60%, so ACV pays a fraction of a new roof. DP-1 and HO-8 lean on ACV.
• Replacement Cost (RC): The cost to repair or replace with new property of like kind and quality, with NO deduction for depreciation, subject to the policy limit. Most modern homeowners and DP-2/DP-3 building coverage is replacement cost — but insurers typically pay ACV first and release the held-back (recoverable) depreciation only after the insured actually repairs/replaces the property.
• Functional Replacement Cost: Pays to replace damaged property with functionally equivalent but less costly materials (e.g., drywall instead of original plaster). Common on HO-8 older-home losses where exact restoration would be cost-prohibitive.
• Market Value / Agreed Value / Stated Value: Special bases discussed below.

Trap: Market value (what the home would sell for, including land) is NOT the insurable value. Insurance pays to rebuild the structure, which can be far above or below market value.

To qualify for full replacement cost settlement on a dwelling, most homeowners forms require the insured to carry at least 80% of the full replacement cost at the time of loss — the homeowners version of a coinsurance condition. If the limit is below that 80% threshold, a partial loss is paid at the larger of ACV or a proportion based on the amount carried, and total losses are still limited to the policy face. This is why insurers push 'insurance-to-value' tools and inflation-guard endorsements that automatically increase Coverage A each year to keep pace with construction costs.

The Coinsurance Clause

The coinsurance clause requires the insured to carry insurance equal to at least a stated percentage of the property's replacement value (commonly 80%, sometimes 90% or 100%) as a condition of full loss payment. Its purpose is to discourage under-insuring, since most losses are partial and an insured could otherwise buy a thin limit and still collect for small fires.

The penalty formula tested on the exam is:

Recovery = (Amount of insurance CARRIED ÷ Amount of insurance REQUIRED) × Loss − Deductible

where Amount Required = Coinsurance % × Replacement Cost at the time of loss. Examiners call this the 'did-over-should' method: what you DID carry over what you SHOULD have carried. Three rules:

1. If carried ÷ required = 1.0 or more, there is no penalty — the loss is paid in full up to the policy limit (less deductible).
2. If carried ÷ required is less than 1.0, the insured becomes a coinsurer and shares the loss proportionally.
3. The payout never exceeds the policy limit regardless of the formula.

Key test points: coinsurance is measured against value at the time of loss, not the value when the policy was written, so inflation can quietly push an adequately insured building below the required percentage. The penalty applies to every partial loss, not just large ones, which is why it bites even on a small fire.

And the coinsurance percentage is chosen by the insured in exchange for a rate credit — agreeing to a higher percentage (carrying more insurance to value) earns a lower rate per $100 of coverage, while a lower percentage costs more per unit because the insurer expects to collect proportionally less premium relative to exposure.

Worked Coinsurance Example

Facts: A commercial building has a replacement cost of $1,000,000 and an 80% coinsurance clause. The owner carries only $600,000 of insurance. A fire causes a $200,000 loss. The policy has a $1,000 deductible.

Step 1 — Amount required: 80% × $1,000,000 = $800,000 should have been carried.

Step 2 — Apply the did/should ratio: $600,000 ÷ $800,000 = 0.75 (the insured carried only 75% of what was required).

Step 3 — Multiply by the loss: 0.75 × $200,000 = $150,000.

Step 4 — Subtract the deductible: $150,000 − $1,000 = $149,000 paid.

The owner absorbs $51,000 ($50,000 coinsurance shortfall + $1,000 deductible) for failing to insure to value. Had the owner carried at least $800,000, the ratio would be 1.0 and the insurer would pay the full $200,000 − $1,000 = $199,000.

Agreed Value, Stated Value, Pair-and-Set, and Depreciation

• Agreed Value: The insurer and insured agree in advance (usually via a signed statement of values) that the limit equals the property's full value. Once accepted, the policy suspends the coinsurance clause — no penalty applies. Used for fine art and high-value buildings.
• Stated Value (Stated Amount): The insured declares a maximum value; the insurer pays the lesser of the stated amount, ACV, or repair cost. It caps the insurer's exposure on hard-to-value items but does NOT guarantee that amount.
• Pair-and-Set Clause: When one item of a matched pair or set (earrings, a pair of antique chairs) is lost, the insurer may pay the difference in value of the set before and after the loss, or repair/replace the lost piece — it is not obligated to buy and replace the entire set.
• Depreciation: The reduction in value for age, wear, and obsolescence that turns replacement cost into ACV. Under recoverable-depreciation (replacement cost) settlements, the insurer holds back depreciation and releases it once the insured repairs or replaces, preventing the insured from profiting by pocketing a depreciation 'discount' and never rebuilding.