What is the correct amount of insurance for my investment property?

By Bill Palte, Palte Insurance Agency 

We are asked the question quite often. Unfortunately, there is no ”correct” answer. There are many variables in determining what this value should be.

Let’s look at some of the factors in determining this value.  

A note: the reconstruction value is not a “guaranteed” value – it is a “not to exceed” value. There is no guarantee your will receive that full value, if the property can be repaired / rebuilt for less than that value.

First, the “value” (reconstruction value) needs to be defined. The reconstruction value does not include the value of the land. It is only the cost to rebuild the structure. There are several versions of the reconstruction value, including actual cash value (ACV), functional replacement value (FRV) and replacement value REP or RCV). Each of these may vary significantly – and still be correct. Each reconstruction estimator program has different variables and all can be correct. 

As a base value, a “correct” replacement cost value is one that is within 80% of the value calculated by a claim adjuster. This is the target we strive to meet.

To further discuss this subject, the first value to discuss is “street value” (what the sales price would be). Unfortunately, for the reconstruction discussion, this number is not really a valid number – because it includes the price of the land.  The land has no value in the reconstruction world – since it is already owned and can’t be “rebuilt”. If one is looking only to recover their cost, this could be a valid number. However, this value can change with the market and is not a good basis.

The second value to consider is actual cash value (ACV). In simple terms, ACV valuation is “replacement cost valuation” (REP), adjusted to meet the current value of the building. The REP is calculated, and the depreciation is calculated based on the age of the buildings, the age and condition of the interior and exterior features, such as kitchen cabinets, bathroom condition, age of the roof, age of the outside wall coverings, age and wear of the flooring, etc. After this value is determined, the value is applied to the insurance calculation and a premium is calculated.

The third value to consider is “functional replacement value” (FRV). This valuation is simply calculating the reconstruction value based on current building practices, such as using drywall in place of plaster, using frame walls with brick veneer in place of triple brick walls, and using laminate in place of hardwood flooring. This is an optional reconstruction valuation system. If this is the reconstruction offer, you can decline and request full replacement cost valuation. It is your choice. If the building was built using triple brick walls, and plaster or horse hair plaster – and you want this for the replacement construction, should your building be severely damaged, understand this need to be noted on the insurance policy, typically noted as “historic reconstruction”. If this is not noted, you will be buying “air” as the building would be rebuilt using current materials – not necessarily the historic materials. 

You, as the investor, need to determine which valuation you want your property insured to. We can make a suggestion, using our calculations, but we cannot, by law, tell you want value to use to value your building. We can guide but it is your choice.

Our guidance is simple. Which valuation would you prefer – to recover your expense (purchase price plus repair cost), to get a “building” back or to get the building build back to its current condition, or some value in-between ?

An additional factor to consider the reconstruction cost estimate is “coinsurance”. Simply stated, this could be a deductible against your claim settlement. Some companies use 80% coinsurance, as a standard feature.  The risk to you is detailed below. The scenario is a $250K building, insured at $100K, with a $40K claim (copied from an insurance policy). The math is below.

The value of the property is                                   $250,000
The coinsurance percentage for it is                        80%
The limit of insurance for it is                                 $100,000
The deductible is                                                   $250
The amount of the loss is                                       $40,000

Claim calculation:
Step 1           $250,000 x 80% = $200,000
Step 2           $100,000 / $200,000 = .50
Step 3           $40,000 x.50 = $20,000
Step 4           $20,000 – $250 = $19,750

Maximum payout is $19,750. The remaining $20,250 is not covered.

In conclusion, determining your reconstruction value is not complicated but one need to determine their risk tolerance and how that valuation fits into their business operation. We are glad to discuss your questions so you can have the insurance coverage you want. 

Bill Palte, Palte Insurance Agency LLC   

Phone or Text: 419.890.1270                                 
billpalte@palteinsurance

Disclaimer: The above is our opinion and is not to be used as an insurance recommendation without doing your own due diligence