Personal Lines Loss Calculations
A personal lines producer is asked the same question again and again: what will the policy pay? The answer comes from a short list of steps. Value the loss, test it against any insurance-to-value condition, apply any special limit, subtract the deductible, and share the loss with any other insurance. Fourteen worked problems follow that order. The people and figures are invented for practice. Policy wording comes from the standard homeowners 3 form (edition 05 11), the dwelling property 3 form (edition 07 14) and the personal auto policy (edition 09 18). Insurers file their own editions, so the language in a client’s policy governs.
Valuation and the 80 Percent Condition
Problem 1: Replacement Cost with a Holdback
The Brennans insure their house for $270,000 on a homeowners 3 form. The full replacement cost of the house immediately before the loss is $300,000. Eighty percent of $300,000 is $240,000, and $270,000 is more than that, so the building is settled at replacement cost without deduction for depreciation.
A kitchen fire causes damage that a contractor prices at $18,000. Depreciated, the damage has an actual cash value of $12,500. The deductible is $1,000.
The form pays no more than actual cash value until repair or replacement is complete. That first payment is $12,500 less $1,000, or $11,500. A small-loss exception lets the insurer pay replacement cost at once when the cost is both less than 5% of the amount of insurance and less than $2,500. Five percent of $270,000 is $13,500 and the loss is $18,000, so the exception does not apply.
The Brennans finish the repair and the contractor’s final invoice is $17,400. After the repair the form pays the least of three amounts: the $270,000 limit, the $18,000 estimate of the cost to repair with like kind and quality, and the $17,400 actually spent. The least is $17,400. Less the deductible, the total is $16,400, so the second payment is $16,400 less the $11,500 already paid, or $4,900.
A Michigan fire policy must provide that the loss is payable within 30 days after receipt of proof of the amount of the loss, except as MCL 500.2845 provides for fire losses to real property (MCL 500.2833(1)(p)). The standard form’s loss payment condition runs 60 days after the insurer receives proof of loss, so the shorter Michigan period governs here.
Problem 2: The Underinsured House
The Okafors carry $200,000 on a house whose full replacement cost is $320,000. The 80% test requires $256,000, and they carry less. A loss would cost $40,000 to repair with new materials and has an actual cash value of $26,000. Where the test is failed, the form pays the greater of two amounts, never more than the limit.
- Actual cash value: $26,000.
- Proportion: ($200,000 divided by $256,000) times $40,000 is 0.78125 times $40,000, or $31,250.
The greater is $31,250. After a $1,000 deductible the payment is $30,250. The Okafors absorb the other $8,750 of the $40,000 repair cost plus the deductible. The $56,000 of extra insurance needed to reach $256,000 would have avoided that penalty. A producer who sets the limit at 100% of replacement cost loses nothing to this condition.
Problem 3: What Counts as Replacement Cost
The test counts only what a loss can damage. Items below the surface do not count. Excavations, footings, foundations and piers below the undersurface of the lowest basement floor are left out. So are underground flues, pipes, wiring and drains.
A builder’s estimate for the Lindqvist home is $360,000. It includes $24,000 for footings and foundation supports below the basement floor and $6,000 for underground pipes and wiring. The amount that matters is $360,000 less $24,000 less $6,000, or $330,000. Eighty percent of that is $264,000. A limit of $270,000 satisfies the test. If the estimate were taken whole, 80% would be $288,000 and the same limit would appear to fail.
Personal Property and Special Limits
Problem 4: Actual Cash Value of Contents
Personal property is settled at actual cash value, meaning replacement cost less depreciation, unless the policy has a replacement cost endorsement. Insurers apply their own depreciation schedules. This example uses a straight-line schedule over a stated life.
| Item | Replacement cost | Age and life | Depreciation | Actual cash value |
|---|---|---|---|---|
| Sofa | $2,000 | 4 of 10 years | $800.00 | $1,200.00 |
| Television | $900 | 5 of 8 years | $562.50 | $337.50 |
| Laptop | $1,400 | 3 of 5 years | $840.00 | $560.00 |
| Total | $4,300 | $2,202.50 | $2,097.50 |
A fire claim for these three items pays $2,097.50 before the deductible on an actual cash value policy. With a personal property replacement cost endorsement the insurer pays the cost to replace, with no deduction for depreciation, once the items are replaced. That is $4,300, a difference of $2,202.50.
Problem 5: Theft and the Special Limits
The homeowners 3 form caps the payment for certain categories of property. The cap is the total for all property in the category in one loss, and it does not raise the Coverage C limit. In this edition, theft of jewelry, watches, furs and precious and semiprecious stones is limited to $1,500. Theft of silverware and similar ware is limited to $2,500, and so is theft of firearms and related equipment. Money, bank notes, coins and similar items are limited to $200.
A burglar takes the items below from the Carvers’ home. Coverage C is $120,000, which is far more than the loss.
| Property | Loss | Special limit | Payable |
|---|---|---|---|
| Jewelry and watches | $6,200 | $1,500 | $1,500 |
| Silverware | $3,400 | $2,500 | $2,500 |
| Firearms | $2,800 | $2,500 | $2,500 |
| Cash | $350 | $200 | $200 |
| Laptop (no special limit) | $1,600 | none | $1,600 |
| Total | $14,350 | $8,300 |
The deductible applies to the total payable: $8,300 less $1,000 is $7,300. The Carvers bear $6,050 of loss above the special limits, plus the deductible. A producer solves this by scheduling the jewelry and silver, on a floater or endorsement, not by raising Coverage C.
Problem 6: Business Property at Home
Property on the residence premises that is used primarily for business is limited to $2,500 in this edition. Dana Whitcomb works from home and a fire destroys office equipment worth $4,000 at actual cash value, along with $9,000 of ordinary household contents. The payable amount is $2,500 plus $9,000, or $11,500. After a $1,000 deductible the payment is $10,500. Dana’s $1,500 shortfall on the equipment shows why a home business needs its own coverage.
Other Structures and Loss of Use
Problem 7: Other Structures on a Dwelling Form
A rental house is insured on a dwelling property 3 form for $150,000 with no separate Coverage B amount. A fire damages the dwelling by $140,000 and a detached garage by $14,000. Assume the amounts are already settled under each form’s valuation rule and set the deductible aside.
On the dwelling 3 form, the insured may use up to 10% of the Coverage A limit for loss to other structures, and that coverage is additional insurance. Ten percent of $150,000 is $15,000, which covers the garage. The insurer pays $140,000 and $14,000, or $154,000, and the dwelling limit is untouched.
On the dwelling basic form, standard forms generally treat the same 10% as part of the Coverage A limit. A payment for the garage reduces the dwelling limit for the same loss, so the insurer pays at most $150,000 on the $154,000 loss. The difference is $4,000. A producer comparing the two forms should compare how the limits are built as well as the perils.
Problem 8: Loss of Use
The Haddad home has a $240,000 Coverage A limit and a $72,000 Coverage D limit, 30% of Coverage A. A fire makes the house unfit to live in for five months. The form pays any necessary increase in living expenses, so that the household maintains its normal standard of living, for the shortest time required to repair or replace the damage. The monthly increase is the added cost less the normal costs that stop while the family is away.
| Monthly item | Amount |
|---|---|
| Temporary rental | $2,800 |
| Added food cost | $450 |
| Added mileage | $120 |
| Normal utilities not incurred | less $230 |
| Net increase | $3,140 |
The example sets the deductible aside. Over five months the additional living expense is 5 times $3,140, or $15,700. The Haddads also rent a basement apartment for $1,000 a month, and expenses of $120 a month stop while it is unfit. Fair rental value is the rent less the expenses that do not continue, so it is ($1,000 less $120) times 5, or $4,400. The total under Coverage D is $20,100, well inside the $72,000 limit. The coverage pays the increase in the household’s costs. A mortgage payment that continues is not part of the claim, and it is not subtracted either, because rent paid on top of it is all increase. A tenant whose normal rent stops, by contrast, claims only the excess over that rent.
Deductibles
Problem 9: Two Deductibles, One Loss
A homeowners policy has a $1,000 deductible for all other perils and a 2% windstorm or hail deductible, which is 2% of the Coverage A limit of $240,000, or $4,800. A windstorm strips shingles, causing a $9,500 loss, and rain then ruins $6,000 of interior finishes. If two or more deductibles apply to one loss, only the highest applies. The payment is $9,500 plus $6,000, or $15,500, less $4,800, or $10,700. Adding the two deductibles would give $9,700 and understate the claim by $1,000.
Problem 10: The Earthquake Deductible
The earthquake endorsement replaces the regular deductible with a percentage of the larger of the Coverage A or Coverage C limit. The Nakamura home has $240,000 on Coverage A and $120,000 on Coverage C, and a 5% deductible. The deductible is 5% of $240,000, or $12,000. Shaking damages the dwelling by $28,000 and the contents by $6,000. The loss is $34,000 and the payment is $22,000. The percentage deductible costs the Nakamuras $11,000 more than a $1,000 deductible would. All shocks within a 72-hour period count as one earthquake, so a series of aftershocks does not bring a second deductible. A flood deductible works differently, because the flood policy applies separate deductibles to the building and its contents.
Other Insurance
Problem 11: Two Policies on One Building
An owner has a homeowners policy with a $250,000 limit and, by an administrative error, a lender-placed dwelling policy with a $150,000 limit on the same house. A fire causes $60,000 in damage. The homeowners form pays only the proportion of the loss that its limit bears to the total insurance covering the loss. The dwelling form says the same for other fire insurance. The total is $400,000.
- Homeowners: ($250,000 divided by $400,000) times $60,000 is $37,500.
- Dwelling: ($150,000 divided by $400,000) times $60,000 is $22,500.
The two shares add to $60,000. The owner collects the loss once and pays for two policies. Both forms also treat their coverage as excess over a service agreement, such as a home warranty, so the warranty pays first on a loss it covers.
Problem 12: A Borrowed Car
Elena Ruiz drives her neighbor’s car and injures a pedestrian whose damages are $320,000. The neighbor’s policy has a $250,000 per person limit. Elena’s own personal auto policy has a $100,000 per person limit. The policy makes the insurance it provides for a vehicle the insured does not own excess over other collectible insurance. The neighbor’s policy responds first for $250,000. Elena’s policy is then excess for the remaining $70,000, which is within its limit. Had the damages been $180,000, her policy would have paid nothing.
Liability Limits
Problem 13: Split Limits After a Three-Person Crash
Michigan’s default residual liability limits are $250,000 for one person, $500,000 for one accident and $10,000 for property damage (MCL 500.3009(1)). A named insured may choose lower bodily injury limits, but not below $50,000 and $100,000, by signing the Director’s form (MCL 500.3009(5)). A driver causes a crash that injures three people. Their damages are $300,000, $180,000 and $140,000, a total of $620,000.
- The per-person limit caps the first claimant at $250,000, so the three are limited to $250,000, $180,000 and $140,000. The total is $570,000.
- The per-accident limit is $500,000 for all bodily injury in the accident, so the insurer can pay no more than $500,000.
- The driver is personally exposed for $620,000 less $500,000, or $120,000.
How the insurer divides the $500,000 is a matter of settlement, and no claimant can receive more than the per-person limit. This is the exposure a personal umbrella is bought to absorb.
A combined single limit works differently, because one amount applies to the accident for bodily injury and property damage together. Take a $500,000 combined single limit and two injured people with damages of $300,000 and $90,000. The $390,000 is paid in full. Under split limits of 250/500, the first claimant would be capped at $250,000 and the payment would be $250,000 plus $90,000, or $340,000, leaving $50,000 uninsured.
Auto Physical Damage
Problem 14: Collision, Total Loss and Rental
Marcus Ellis’s car has an actual cash value of $14,000 and his collision deductible is $500. The collision limit is the lesser of the car’s actual cash value or the amount needed to repair or replace it.
- Repair estimate $9,800: the payment is $9,800 less $500, or $9,300.
- Repair estimate $16,500: the cost exceeds the car’s value, so the lesser amount is the $14,000 actual cash value. The payment is $13,500.
In this edition the policy also pays temporary transportation expenses of up to $30 a day, to a maximum of $900, without a deductible. Marcus rents an equivalent car at $38 a day for 22 days. He incurs $836 and the policy pays 22 times $30, or $660. A longer repair of 35 days would produce $1,330 of rental and a cap of 35 times $30, or $1,050, reduced to $900. The daily and total limits vary by edition and insurer, so a producer reads the declarations.
Choosing the Policy Before Calculating
Every calculation above assumes the right policy is answering. The Sorensons’ basement is damaged in a Michigan winter storm. A burst pipe is a covered peril under a homeowners policy, so the building loss is subject to the 80% condition, the deductible and the special limits above. A rising river is a flood, and a flood policy pays it with its own deductibles. Water that backs up through a floor drain is excluded unless the homeowners policy was endorsed for it. The arithmetic is only as good as the identification of the cause, which is why the claim starts with a question about how the water got in.
Lesson summary
- Settle a loss in order: value it, test it against any insurance-to-value condition, apply special limits, subtract one deductible from the total payable, then share it with other insurance.
- A homeowners building loss is paid at replacement cost only if the limit is at least 80% of full replacement cost. Below that, the insurer pays the greater of actual cash value or the proportion of 80% that the limit bears to that amount.
- Subsurface foundation items and underground pipes are left out of the replacement cost used for the 80% test.
- Special limits cap categories such as jewelry theft ($1,500), silverware and firearms theft ($2,500), money ($200) and business property on the premises ($2,500) in the edition studied. They do not raise Coverage C.
- When two or more deductibles apply to one loss, only the highest applies. A percentage earthquake deductible is figured on the larger of Coverage A or Coverage C.
- Dwelling forms treat other-structures coverage differently. It is additional insurance on the broader forms and part of Coverage A on the basic form.
- Other insurance divides a loss by limits, and coverage for a borrowed car is excess over the owner’s insurance. Split limits cap each person and each accident, so a three-person loss can exceed the per-accident limit.