E&O Replacement Costs: Know Your Limits

REPLACEMENT COST: KNOW YOUR LIMITS

By: Mallory Cornell

IIAW Vice President & Swiss Re Approved Auditor

There is a recurring theme within the questions that have been brought to my attention over the last thirty days: replacement values. In reviewing agency operations, I always ask employees how they determine replacement cost, and more importantly, how do they show that the client selected the values. The first part of the question was historically simple. The second part always ignites some great conversations. It’s important to tackle both and have a consistent procedure within the agency.

Determining Values

What used to seem like a straightforward answer now carries a bit more weight considering the rising costs of building materials. Utilization of replacement cost estimators is a good place to start, but always be mindful that the information that is generated by the RCE software is only as good as the data that is entered. The replacement cost estimator is exactly what it says, an estimator. There are many variables to consider in addition to educating your customers on market value versus replacement value. I have yet to meet an insurance agent who is also a licensed appraiser, so consider recommending an appraiser or online cost estimator to your insured. In addition to replacement cost estimators, agents may also use a builders estimate or various online resources. Whatever tools the agency chooses to invest their time and money in using, it should be consistent across the agency.

Personnel should also consider the endorsements to the policy they are issuing, upgrades the property owners may be making and advising customers on current market conditions and building costs. While it may be additional work for the agency, it is important to evaluate customer coverage limits at renewal or send correspondence offering a review of coverage and limits.

It is always important to use disclaimers when providing the results of the replacement cost estimator. Agents must avoid providing coverage limits for their client.

Client Acknowledgment

Agents who select values and coverage limits for clients are operating in dangerous territory. The agent should never make decisions for the customer and should always obtain documentation on how values were determined and an acknowledgment from the customer that they agree with the coverage limits. This is NOT a note in the agency management system, this is an attachment or email showing written customer acknowledgment. A signed application is great, but correspondence on values should also be included.

Sample Disclaimer Language:

Building and personal property coverage limits are estimates only and were arrived at based on information provided by the policyholder and/ or industry standard software used to estimate replacement costs. The actual cost to rebuild the structure or replace the personal property may exceed the policy limits, especially in circumstances where a catastrophic event has disrupted the normal supply of materials, labor, and resources. The agency makes no assurances or guarantees that the policy limits provided will be adequate to rebuild the structure or replace personal property. If there is doubt about the adequacy of the policy limits, the policyholder should obtain a professional appraisal or obtain the services of a qualified company or builder who is able to provide replacement cost estimates. ... Also be aware that anytime you provide advice on coverage or limits, you are increasing your duty to advise and taking on a role that may be hard to defend if there is ever an E&O claim with that client.

Always let your customer make the final decision and only provide information to help them come to that decision.

If a customer selects limits below what your recommendation may be, strongly consider a waiver stating the customer understands the limits may be below what it would cost to replace the property. You also have the option to recommend that customer find another agent if they are not willing to select higher values.

There is no exact science or magic equation when it comes to selecting property values and coverage limits. My advice is to continue to responsibly utilize updated replacement cost estimator software, provide regular updates, and utilize disclaimers. You are great insurance agents, but likely not expert appraisers.

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