1-J Valuation, Deductibles, & Coinsurance Flashcards
Valuation
The process of estimating what an item is worth
4 Types of Valuations
- Actual Cash Value (ACV)
- Replacement Cost (RC)
- Agreed Value
- Stated Amount
The term “property” refers to any physical or tangible object that can be________. If it can be owned and valued, it is________.
owned; property
_________estimates ensure that the policyholder will receive fair indemnification for covered losses, based on the terms of the policy.
value
Actual Cash Value:
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
Actual Cash Value Formula:
Replacement cost minus depreciation
Actual Cash Value Example
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.
Because ACV coverage does not pay to fully replace or repair an item, ACV policies have lower_______.
premiums
Replacement Cost:
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
Depreciation:
An item’s estimated loss of value due to wear, tear, and age
Can usually be determined with:
● Standard Depreciation Schedules
● Estimating Software
Annual Depreciation:
replacement cost divided by the item’s useful life
Accumulated Depreciation:
the item’s annual depreciation multiplied by its age
Two formulas used for estimating depreciation:
- ) annual depreciation
2. ) accumulated depreciation
Depreciation example
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.
Broad Evidence Rules
● Used in some states
● ACV does not s imply come down to RC minus depreciation
● Takes into consideration any evidence available to determine value
Broad Evidence example
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.
Reproduction Cost:
Cost to produce an exact replica of damaged property in the same manner it was originally produced
Characteristics of Replacement Cost:
● No depreciation
● Based on the replacement cost at the time of loss
● Higher premiums
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.
subtract; replacement
Replacement cost example
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).
RC coverage is common in homeowners policies, but rare in_____ policies.
auto
RC & The Principle of Indemnity:
The insured cannot profit from a loss
The insurer often will pay the full amount after the insured submits his proof of replacement.
RC & Principle if Indemnity example
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.
RC example
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
Functional Replacement Cost:
● Pays to replace an outdated, obsolete item with a functionally equivalent item - not an identical item
● Level of coverage falls between RC and ACV
Obsolescence:
● 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
One factor that often comes into play when determining functional replacement cost is “________.”
obsolescence
obsolescence example
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.
Valued Policy (a.k.a. Agreed Value or Guaranteed Value):
● Value is determined prior to the issuance of a policy
● Avoids the confusion of assessing appreciation or depreciation
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.
antiques; fixed
Valued policy example
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)
Stated Amount (Stated Value):
● 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
Agreed Value:
● Insured is paid the agreed amount, regardless of ACV
Stated Value
● Lower premiums
● Good choice if insured can’t afford
to insure an item for its full value
Agreed Value vs. Stated Value example
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.
Partial Loss:
When insured property is only partly damaged, and repair costs fall within the policy limit
Total Loss:
When insured property is damaged so badly that it is not worth repairing
2 Types of total loss
- ) Actual total loss
2. ) Constructive total loss
Partial loss Example
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.
Actual Total Loss:
When property is completely destroyed and unrepairable
Constructive Total Loss:
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
Actual total loss Example
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.
Constructive total loss Example
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.
Deductible:
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
3 Types of Deductibles
- Fixed
- Percentage
- Franchise
Note: Liability Insurance never has a deductible, except in very rare cases.
Fixed Deductible
one specific, predetermined amount that a policyholder must pay out-of-pocket before he can be indemnified.
Fixed Deductible Example
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
Percentage Deductible:
The insured pays a percentage of the insured risk’s value Some policies combine fixed and percentage deductibles.
Percentage Deductible Example
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.
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.
fixed
Franchise Deductible:
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
Franchise Deductible Example
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.
Coinsurance:
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
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.
80
Coinsurance Example
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.
The coinsurance clause in insurance policies requires ____ insurance if claims are to be fully paid by the insurer.
Full
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.
co-insurer; sharing
A ______ company will require a homeowner to be fully insured.
mortgage
Underinsured:
when a home is insured for less than 80% of its value
Coinsurance penalty:
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
Coinsurance maintains both the insurer’s financial health and the insured’s financial ____.
obligation
The decision to apply a coinsurance penalty is typically at the discretion of the ___, not necessarily the adjuster.
insurer
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.
partial; homeowners
Coinsurance Penalty Example
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)
Coinsurance and Deductibles Examples
● 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
