1-J Valuation, Deductibles, & Coinsurance

Question 1

Valuation

Answer 1

The process of estimating what an item is worth

Question 2

4 Types of Valuations

Answer 2

1. Actual Cash Value (ACV)
2. Replacement Cost (RC)
3. Agreed Value
4. Stated Amount

Question 3

The term “property” refers to any physical or tangible object that can be________. If it can be owned and valued, it is________.

Answer 3

owned; property

Question 4

_________estimates ensure that the policyholder will receive fair indemnification for covered losses, based on the terms of the policy.

Answer 4

value

Question 5

Actual Cash Value:

Answer 5

A valuation method that takes into account an item’s depreciation

● Same as fair market value and depreciated value
● ACV offers lower premiums for less coverage

Question 6

Actual Cash Value Formula:

Answer 6

Replacement cost minus depreciation

Question 7

Actual Cash Value Example

Answer 7

Bob’s 1995 Honda Civic had 130,000 miles and some dings and dents before he wrecked it. Even though he originally purchased the car for $13,000, his insurer paid only $1,700 on the claim, because the current actual cash value was only $1,700 due to wear, tear, and age.

Question 8

Because ACV coverage does not pay to fully replace or repair an item, ACV policies have lower_______.

Answer 8

premiums

Question 9

Replacement Cost:

Answer 9

A method of valuation based on the cost of replacing an item at current market prices, regardless of depreciation

Can be determined through simple market research

Question 10

Depreciation:

Answer 10

An item’s estimated loss of value due to wear, tear, and age

Can usually be determined with:
● Standard Depreciation Schedules
● Estimating Software

Question 11

Annual Depreciation:​

Answer 11

replacement cost divided by the item’s useful life

Question 12

Accumulated Depreciation:​

Answer 12

the item’s annual depreciation multiplied by its age

Question 13

Two formulas used for estimating depreciation:

Answer 13

1. ) annual depreciation

2. ) accumulated depreciation

Question 14

Depreciation example

Answer 14

For example…
Larry has a vacuum with a useful life of 10 years, and it is now 3 years old. A new vacuum today costs $100. The $100 replacement cost divided by the 10-years useful life results in $10 annual depreciation. $10 multiplied by its three years of use shows that Larry’s vacuum has depreciated a total of $30 in value. Now, use the estimated depreciation to calculate ACV. The $100 replacement cost minus the $30 of accumulated depreciation gives the vacuum an actual cash value (ACV) of $70. Larry
would be indemnified $70 in the event of an insured loss.

Question 15

Broad Evidence Rules

Answer 15

● Used in some states
● ACV does ​not s​ imply come down to RC minus depreciation
● Takes into consideration any evidence available to determine value

Question 16

Broad Evidence example

Answer 16

If one were to determine the ACV of a house using the Broad Evidence Rule, one would take into account the location of the house, the original purchase price, and the market value, among other factors.

Question 17

Reproduction Cost:

Answer 17

Cost to produce an exact replica of damaged property in the same manner it was originally produced

Question 18

Characteristics of Replacement Cost:

Answer 18

● No depreciation
● Based on the replacement cost at the time of loss
● Higher premiums

Question 19

Unlike ACV policies which do _________depreciation, replacement cost policies do not. For this reason, many policyholders prefer______ cost policies even though the premiums are higher.

Answer 19

subtract; replacement

Question 20

Replacement cost example

Answer 20

If Sally’s $10,000 roof is destroyed in a storm after three years, an ACV policy would only indemnify her at the roof’s depreciated value. Instead, her RC policy would cover her for the complete cost of a new roof of the same quality at today’s prices (minus the deductible, of course).

Question 21

RC coverage is common in homeowners policies, but rare in_____ policies.

Answer 21

auto

Question 22

RC & The Principle of Indemnity:

Answer 22

The insured cannot profit from a loss

The insurer often will pay the full amount ​after​ the insured submits his proof of replacement.

Question 23

RC & Principle if Indemnity example

Answer 23

For example…
If an insured suffers damage to her old, worn carpet, and the insurer pays the insured for brand new carpet, has not the insured “profited’? Not really, because the policy promises to indemnify—in this case, compensation adequate for new carpet.

Question 24

RC example

Answer 24

For example…
Roberto’s hail-destroyed roof
● Replacement Cost (RC) of $10,000
● First check of $6,000 ACV
● Roberto replaces roof for $7,000
● So, insurer sends second check of only $1,000
Total indemnity for Roberto: $7,000 Insurer saves: $3,000

Question 25

Functional Replacement Cost:

Answer 25

● Pays to replace an outdated, obsolete item with a functionally equivalent item - not an identical item
● Level of coverage falls between RC and ACV

Question 26

Obsolescence:

Answer 26

● When something is no longer used or wanted, despite being in good working order
● Usually a result of a newer, improved alternative
● Causes rapid depreciation

Question 27

One factor that often comes into play when determining functional replacement cost is “________.”

Answer 27

obsolescence

Question 28

obsolescence example

Answer 28

For example…
Lath and plaster was a very common construction process for wall coverings up until the late 1950s. However, it became obsolete after the introduction of drywall—a quicker, cheaper, and more efficient construction method. Other examples include the obsolescence of the VCR after the invention of the DVD, and the obsolescence of the portable CD player after the invention of MP3s.

Question 29

Valued Policy (a.k.a. Agreed Value or Guaranteed Value)​:

Answer 29

● Value is determined prior to the issuance of a policy

● Avoids the confusion of assessing appreciation or depreciation

Question 30

Valued policies often are used to insure items whose value is difficult to quantify, such as______ or fine art.

A valued insurance policy avoids the difficulty of assessing value by establishing a_______ amount prior to the issuance of the policy.

Answer 30

antiques; fixed

Question 31

Valued policy example

Answer 31

For example…
● Appraised value of an antique Jukebox: $25,000
● Valued policy: $25,000
● Policyholder’s indemnification after loss or damage: $25,000 (less the
deductible)

Question 32

Stated Amount (Stated Value):

Answer 32

● Property value is stated by the insured when applying for insurance
● When loss occurs, policy pays up to the stated amount or ACV, whichever is less

Question 33

Agreed Value:

Answer 33

● Insured is paid the agreed amount, regardless of ACV

Question 34

Stated Value

Answer 34

● Lower premiums
● Good choice if insured can’t afford
to insure an item for its full value

Question 35

Agreed Value vs. Stated Value example

Answer 35

Evangeline inherited her grandfather’s collection of rare coins. She wants to insure the collection, but can’t afford a policy that will indemnify her for their full value of $400,000. She can choose a stated amount of $100,000, and maintain some peace of mind while paying more reasonable premiums.

Question 36

Partial Loss:

Answer 36

When insured property is only partly damaged, and repair costs fall within the policy limit

Question 37

Total Loss:

Answer 37

When insured property is damaged so badly that it is not worth repairing

Question 38

2 Types of total loss

Answer 38

1. ) Actual total loss

2. ) Constructive total loss

Question 39

Partial loss Example

Answer 39

For example…
If Bill’s bathroom floods, but the rest of the house is still fine, the damage to the bathroom would be considered a partial loss.

Question 40

Actual Total Loss:

Answer 40

When property is completely destroyed and unrepairable

Question 41

Constructive Total Loss:

Answer 41

When the cost of repairing damaged property is higher than the property’s current value
● Sometimes used when repairs would cost more than the policy limit
● The insurer may keep the damaged property or deduct its salvage value from
the claim

Question 42

Actual total loss Example

Answer 42

A house that is flattened by a tornado would be an actual total loss, and so would a car that gets so smashed in a collision that body shops could not fix it, even if they tried.

Question 43

Constructive total loss Example

Answer 43

Say you drive an old car that is only worth $2,000. If you get into an accident and the body shop estimates that the repairs will cost $3,500, your insurance company will probably not pay for those repairs. Instead, it will declare your car a constructive total loss, since the cost of restoring it to its pre-accident condition would cost more than the car’s current value.

Question 44

Deductible:

Answer 44

The amount the policyholder must pay out-of-pocket before the insurer will pay for losses
● Lets the policyholder decide how much risk he is willing to take
● Found on the declarations page of an insurance contract

Question 45

3 Types of Deductibles

Answer 45

1. Fixed
2. Percentage
3. Franchise

Note: Liability Insurance never has a deductible, except in very rare cases.

Question 46

Fixed Deductible

Answer 46

one specific, predetermined amount that a policyholder must pay out-of-pocket before he can be indemnified.

Question 47

Fixed Deductible Example

Answer 47

Tom’s car suffers $3,500 worth of damage and he has a $500 fixed deductible on his auto insurance policy. Tom will receive $3,000 from the insurance company because of his fixed deductible of $500

Question 48

Percentage Deductible:

Answer 48

The insured pays a percentage of the insured risk’s value Some policies ​combine​ fixed and percentage deductibles.

Question 49

Percentage Deductible Example

Answer 49

f Karen insures her home for $500,000, and the deductible on the homeowners policy is set at 3%, her deductible is $15,000. This means that Karen is responsible for paying the first $15,000 of a damage claim before the insurance company will pay the rest.
If the total damage on Karen’s home is less than $15,000, she is responsible for 100% of the damages.

Question 50

Some policies will use a combination of____ and percentage deductibles. An insurer may allow a $500 fixed deductible for fire and hail damage but charge a percentage for wind and tornado damage.

Answer 50

fixed

Question 51

Franchise Deductible:

Answer 51

Policy kicks in only after the loss exceeds a predetermined amount
● If losses are below the deductible, the insurer pays nothing
● If losses are above the deductible, the insurer pays 100% of the damage

Question 52

Franchise Deductible Example

Answer 52

If a policy comes with a franchise deductible of $1,000, and the insured item experiences $1,200 worth of damages, the insurer pays $1,200 and the policyholder pays nothing. If, however, the total cost of damage is $700, the policyholder pays the full amount.

Question 53

Coinsurance​:

Answer 53

Encourages the insured to purchase an adequate amount of coverage, typically at least 80% of a property’s value

● Financially protects the insurer
● Imposes a penalty on coverage for partial losses if the property is not fully
insured - 80% of its RC

Question 54

Typically, insurers define “fully insured” as ___% of the cost to rebuild the principal structure from the ground up if it were to suffer a total loss.

Answer 54

80

Question 55

Coinsurance Example

Answer 55

If Bob’s home is valued at $100,000, Bob must insure it for at least $80,000 to be fully insured. When a homeowner is fully insured, his partial losses are 100% covered minus the deductible. However, if the property is insured for anything less than $80,000, it is considered underinsured.

Question 56

The coinsurance clause in insurance policies requires ____ insurance if claims are to be fully paid by the insurer.

Answer 56

Full

Question 57

If the property is less than fully insured, the insured is considered a “_____,” meaning that he is insuring his property with the insurer, and _____ in the cost for losses.

Answer 57

co-insurer; sharing

Question 58

A ______ company will require a homeowner to be fully insured.

Answer 58

mortgage

Question 59

Underinsured​:

Answer 59

when a home is insured for less than 80% of its value

Question 60

Coinsurance penalty:

Answer 60

if a property is underinsured, the insurer will only cover a percentage of partial losses

● If multiple partial losses occur, the low premiums are not enough for the insurer to cover all the damages
● The insurer decides if a coinsurance penalty should be applied

Question 61

Coinsurance maintains both the insurer’s financial health and the insured’s financial ____.

Answer 61

obligation

Question 62

The decision to apply a coinsurance penalty is typically at the discretion of the ___, not necessarily the adjuster.

Answer 62

insurer

Question 63

some policies may not include a “coinsurance” clause per se, but they will often have a similar “loss settlement” provision, which works in the same way: that is, it makes sure that an under-insured property will only get _____ coverage for partial losses. The ______ policy is a good example of this.

Answer 63

partial; homeowners

Question 64

Coinsurance Penalty Example

Answer 64

Value of Betty’s home: $100,000 Minimum coinsurance amount: $80,000 Betty’s actual coverage: $40,000
1. ​Calculate coinsurance penalty
$40,000 (actual coverage) ———————————————– = 50% $80,000 (coinsurance requirement)
2. ​Apply penalty to partial losses
The home suffers a partial loss of $10,000 Coinsurance penalty: 50%
Insurer will only pay $5,000 (50% of $10,000)

Question 65

Coinsurance and Deductibles Examples

Answer 65

● Coinsurance requirement: $150,000
● Betty’s policy limit: $120,000
● Deductible: $2,000
● Coinsurance formula: $120,000/$150,000 = 0.8
● So, policy will pay 80% of a claim
● Covered loss: $10,000

Coinsurance and Deductibles: Which Comes First?

Deductible first:
$10,000 - $2,000 = $8,000 $8,000 x 0.8 = ​$6,400

Coinsurance first:
$10,000 x 0.8 = $8,000 $8,000 - $2,000 = ​$6,000