Claims Settlement

Claim Settlement

Losses are settled according to the loss or valuation provisions listed in the policy. Property and Casualty (P&C) policies provide coverage “up to specified limits” stated in the policy. For example, if a home is insured for $300,000, the insurer’s limit of liability for loss to the home resulting from a covered peril is $300,000.

A claim becomes payable once the insured submits a written proof of loss - a signed statement documenting the loss, its cause, and its value. Payment is triggered by the submission of this proof of loss, not by the date the loss occurred, the date the insurer received notice of the claim, or the completion of the adjuster’s investigation.

You’ll also see “limits of liability” described as coverage limits, stated limits, coverage amounts, policy limits, or indemnity limits.

• Market Value is the price a willing buyer would pay and a willing seller would accept in the open market. It may be higher or lower than ACV and is rarely used in standard policies.

• Valued Policy establishes an agreed amount payable for a total loss. It is often used for unique items like fine art and may also refer to state “Valued Policy Laws,” which require insurers to pay the full policy limit for a total dwelling loss due to fire or another covered peril (e.g., FL, TX, LA).

• Agreed Value is a valuation method where the insurer and insured agree on the value of the property before a loss. It replaces the need for coinsurance and locks in the settlement amount for covered total losses. Agreeing on a value up front usually requires an appraisal, which adds cost, so this method is generally reserved for unique or hard-to-value property, such as fine art, antiques, or collector vehicles. For ordinary property whose value can be readily determined, coinsurance is simpler and cheaper, so agreed value isn’t the default valuation method.

• Stated Amount is commonly used for classic or antique vehicles. The insured declares a stated value, and insurance is written for that amount. The insurer generally pays the stated amount or the cost to repair or replace the property, whichever is less, unless fraud or material misrepresentation is proven.

• Functional replacement cost is used when property is repaired or replaced with less costly or modern materials that perform the same function, often in historic or older structures where original materials are unavailable or impractical.

Actual Cash Value (ACV)

Actual cash value (ACV) is designed to prevent an insured from profiting from a loss or collecting the coverage amount regardless of the amount of the loss.

For example, if Jean owns a $100,000 dwelling but insures it for $200,000, she will not be able to collect $200,000 if a total loss occurs.

ACV is a method of loss valuation commonly used in property and liability policies. It is typically calculated as replacement cost minus depreciation, or by using the “broad evidence rule,” depending on the jurisdiction.

Replacement Cost

Replacement cost is the amount needed today to replace damaged or destroyed property covered under the policy. Some policies will pay a loss based on replacement cost only if the contract specifically provides for it, and this coverage generally carries a higher premium than ACV coverage.

Replacement-cost coverage pays to repair or replace property with materials of like kind and quality, without deduction for depreciation, but only up to the policy limit. This does not violate the principle of indemnity because the insured cannot recover more than the amount of insurance purchased. Some optional “guaranteed replacement cost” endorsements extend coverage beyond limits, but these are clearly disclosed and are not standard.

This coverage form includes a coinsurance clause, which requires the insured to carry insurance equal to at least a specified percentage of the property’s value (typically 80%). If the insured meets this requirement, the insurer pays the full amount of a covered partial loss (up to the policy limit) less any deductible. If the insured carries less than the required amount, the insurer applies a formula that reduces the payment to penalize the underinsurance. Coinsurance applies only to partial losses, not total losses.

Insurers require coinsurance because most property losses are partial, not total. Without a coinsurance requirement, an insured could carry, say, half the property’s value in coverage, pay premium on only that half, and still collect in full for the vast majority of losses (which fall well under the property’s total value) - getting more benefit per premium dollar than an insured who carries full value coverage. Coinsurance keeps the premium proportional to the insurer’s actual exposure by requiring adequate insurance-to-value and reducing payment whenever the insured falls short of it.

The formula is as follows:

$$\begin{array}{rl}\text{Amount paid}& =\text{insurance carried}÷\text{insurance required}\times \text{loss}-\text{deductible}\end{array}$$

For example, let’s assume that Behunin’s Hardware buys a building and personal property coverage form with an 80% coinsurance requirement. The policy includes a $250 deductible, and Behunin’s Hardware carries $120,000 of coverage. The building is valued at $200,000. A fire ensues, and the damage is $6,000. How much will the insurer pay?

Deductibles under property policies (including ocean marine and inland marine cargo policies) apply on a per-occurrence basis: the deductible is subtracted from each separate loss, not just once per policy period. A loss at or below the deductible amount results in no payment. For example, with a $250 deductible, a $700 loss pays $450, a $1,000 loss pays $750, and a $200 loss pays $0 - a total of $1,200 across the three separate occurrences.

Chapter Vocabulary

Definitions

Actual Cash Value (ACV)

Payment value for indemnification due to loss or damage of property; in most cases, it is replacement cost minus depreciation

Agreed Amount Endorsement

An endorsement that substitutes a dollar amount for a percentage of other coverage.

Depreciation

A reduction in the value of an asset with the passage of time, due in particular to wear and tear

Market Value

The amount a willing buyer would pay and a willing seller would accept in the open market, which may differ from replacement cost or ACV

Replacement Cost

The cost of replacing property with materials of like kind and quality without a reduction for depreciation due to normal wear and tear, subject to the policy limit unless an optional endorsement provides otherwise.

Stated Value

Commonly used in antique or collector auto insurance. The insured declares a stated value, and the insurer agrees to pay the stated amount or the actual cost to repair or replace, whichever is less, unless the value was overstated fraudulently.

Valued Policy

A policy that specifies an amount payable in the event of a total loss. Some jurisdictions have valued policy provisions that require insurers to pay the policy’s full face amount for a total loss to certain dwellings, rather than the property’s actual cash value.