MF Insurance: Actual Value vs. Replacement Value Opinions

[Konrad L.]

Hello Everyone,

I will be closing on my first MF investment property in about two weeks.  One of the things left is to pick out homeowner's insurance.  I've been shopping around and have gotten different quotes for Replacement Value policies.  However, yesterday, an agent brought up an option of an Actual Value policy. 

The house is a 3-family built in 1890 in central CT and has almost 3,800 sq.ft. Purchase price is $163k.  Because of the size and age of the house, the RV quotes I've received were pretty high:

USAA - Replacement Value @ $938k; $2,950 annually, but agent said they will send out an inspector to do an on-site RV appraisal and there's a chance it might be lowered.

Travelers - RV @ $923k; $2,933 annually

Liberty Mutual - RV @ $718k; $2,128 annually

The agent I talked to yesterday told me about the AV policy through Foremost and told me if they will value it at $200k, my annual premium should be around $1,400, which is a big difference.  

The house is not in the best neighborhood and I think the highest priced house on the street is about $180k, so if something was ever to happen and I had the RV policy, having this house rebuilt for 700k or 900k doesn't make sense to me.  It would only be work maybe 250k in that neighborhood, at the most.  In this situation, would it make sense to take the AV policy?  

What if I just need repairs due to a branch falling on the roof or water damage due to burst pipe?  Do both cover the same way, aside from a total loss instance? 

Are liabilities brought by my tenants covered the same way, given that the coverage is the same?

Looking for opinions and expertise.

Thanks in advance - Konrad

[Paul Caudell]

Hi Konrad,

I'm glad you asked this question, as I've been considering writing an article on this ever since I saw a BP article a couple weeks back with a lot of insurance misinformation.  I believe that article has been removed from the site.

I've been a property insurance claim adjuster for about 10 years for one of the companies you mentioned.  Please know that I handle residential (4-units and less) claims, so this info is geared toward that realm as opposed to commercial multi-family -- there are some differences in coverage between the two.

So, I think there may be some confusion on the terms you're using, which is common.  The confusion was evident in the BP article I mentioned, and I've even spoken to insurance agents who mis-use the terms.  I'll try to clarify and differentiate them here.

Almost every property insurance policy provides coverage on either an actual cash value (ACV) basis or a replacement cost value (RCV) basis.  Neither of these determines the policy coverage limit, but instead they dictate how a loss is paid.  

RCV means the full cost of repairs for a covered loss (less your deductible, of course).  ACV means the full cost of repairs, minus depreciation (and your pesky deductible).  The depreciation is figured based on the age and condition of the damaged materials. For instance a 30-year laminate roof that is 15 years old would be depreciated by 50%.

Here's an example that's common in the Midwest where we have lots of hail storms: Suppose a hail storm comes through and causes significant damage to your roof, and the estimated cost to tear it off and replace it is $10,000.  Also suppose your deductible is $1,000.  If you have an RCV policy, your insurance company would pay the full cost of repairs less your $1,000 deductible, so you'd get $9,000.  

If you have an ACV policy in the same example, you would expect to receive the full cost of repairs, minus your deductible, and minus depreciation.  So the 30-year roof that's 15 years old would be depreciated by 50%, or $5,000.  So, your insurance company would pay out $4,000, based on $10,000 repairs less $5,000 in depreciation and the $1,000 deductible.

Also, with an ACV policy, most policies specify (because many or maybe all states require this) that in the case of a total loss, the full policy limit will be paid.  This means that even though it's an ACV policy, the depreciation does not factor into a total loss.

As a side note, most insurance companies make an RCV settlement in two payments -- the first payment (which is typically the ACV amount of the loss) is made when the loss is evaluated.  Then, the second payment is made after the repairs are complete, as long as the repairs are completed by a deadline specified in the policy -- typically 180 days or 365 days from the date of loss or the date of the first payment.  But between the two payments you'd get the $9,000, which you would turn around and pay plus your $1,000 deductible to the roofer to complete the $10,000 job.  The second payment is typically adjusted based on the actual cost of repairs, with the idea being that your out-of-pocket should be no more and no less than your deductible, regardless of whether you shop around for a better price on the job.

Another side note.  Even RCV policies typically settle certain items at ACV.  For a residential (4 units or less) landlord policy, those items will vary slightly by company/policy but are typically landlord personal property, carpeting, domestic appliances, awnings, outdoor equipment and antennas, fences, and other structures that are not considered buildings.

I mentioned above that ACV and RCV coverage do not affect the policy limit, and here's where the terms get a little more confusing.  Many insurance companies give you the option to insure a property at its market value, which may be significantly less (or more, I suppose) than the cost to rebuild the structure (the rebuild amount is typically referred to as the replacement cost, which is where the confusion comes in, as this is not referring to RCV coverage).  In your example, it sounds like the replacement (rebuild) cost is between $718k and $923k and the market value is between $163k and $200k.  If you shop around, you will likely be able to find both RCV and ACV policies for the replacement (rebuild) cost, and you will likely be able to find both RCV and ACV policies for the market value of the property.

Here's an example.  I have a 1905 all-brick 2-family building with a replacement (rebuild) cost around $350k and market value around $60-$80k.  Because I would not plan to rebuild in the case of a total loss, and I don't want to pay the additional premium, I have it insured at $80k, and the policy includes RCV coverage.  

Unless you have significant reserves set aside, I would not recommend an ACV policy on a site-built home (mobile homes, maybe).  Those claims with ACV policies are no fun for the homeowner or the adjuster.

The last thing I'll add, but won't go into because it would involve another article-length response, is that an "open peril less exclusions" policy is pretty much always preferable to a "named-peril" peril policy, though the premium will be somewhat higher.  The reason being that open-peril policies provide coverage for more types/causes of loss.

Whew.  

I hope this helps you (and others) have more informed conversations when out shopping for insurance -- everyone's favorite thing.

Paul C.