Dig a Little Deeper
IN VINO NO VERITAS
When unique valuation conditions are provided, review the entire con
The Court Decisions column is one of the most popular features of Rough Notes magazine. One reason may be that it is often in the courtroom where the paper promises made in an insurance contract become real. All insurance professionals can develop “what if” scenarios, but until those scenarios are tested with an actual loss and a court decision, they remain mental exercises. In this column, the editors of PF&M Analysis, a publication of The Rough Notes Company, will dig a little deeper into the coverage provided in one of those court decisions as a way to identify a coverage problem and then provide possible solutions.
This decision is unusual because it involved a first-party claim where no physical damage actually occurred to the property in question. The wine in a temperature-controlled wine cellar suddenly lost value. One day it was worth $19 million, and the next day it was practically worthless. The reason for the valuation change was the label. The wine bottles bore prestigious labels, and it was revealed that the labels were fakes. The contents of the bottles were unchanged because they had always been a little-known private stock owned by the dishonest wine broker who had sold the wine to the unwitting retailer.
This case ended before the value of the wine was ascertained because no event had occurred that resulted in a covered direct damage loss to the wine. If an actual physical damage loss had occurred prior to the fraud discovery, how would the loss have been valued?
One day the wine in a temperature-controlled wine cellar was worth $19 million; the next day it was practically worthless.
The ISO property and inland marine coverage forms contain a condition called “valuation” that must be consulted in ascertaining the value of an item. It is important to consult this condition twice. The first time is when advising a client on the appropriate limit to select. If all goes well and the appropriate limit is chosen, there should be no surprises the second time the condition is consulted: during a loss settlement.
CP 00 01–Commercial Property Building and Personal Property Coverage Form contains a five-part valuation condition:
Actual Cash Value
All property is valued at actual cash value unless it is modified in one of the other parts of the condition. The term “actual cash value” is commonly accepted to be the cost of a new replacement item at the time of loss, less depreciation. The coverage form does not include the word “depreciation” and does not include a depreciation table, so the determination should be made based on commonly available tables. Two important points to consider:
- Replacement cost is not the same as the original purchase price of the item. Instead it is how much it would cost to replace that item new at the time of loss. This is important because of inflation and technology. The costs of items naturally increase because the costs and materials to make the items increase with inflation. A good example is a sofa or a dining room table and chairs. Other items decrease in value as technological improvements in later models make the current model less valuable. Smartphones and televisions are good examples.
- Depreciation varies by item. The depreciation tables commonly used are IRS tables. Certain items lose almost all of their value within two years whereas others, such as buildings, rarely lose more than 50% of their value.
Less than $2,500 exception
A loss of less than $2,500 will be paid at replacement cost valuation. This means that no depreciation is applied to the loss. The coinsurance requirement of adequate insurance to value must be met to obtain this perk.
Stock—sold but not delivered
Instead of starting with replacement cost, this valuation method is based on the selling price of the stock. The net selling price (not the gross) is the starting point, and that amount is further reduced by costs that are built into the selling price that will not be incurred. Examples of such costs are delivery expenses and post-sale customer discounts like those given for early payment.
Many states require that certain damaged glass be replaced with safety glass to prevent injuries. In this case, the cost of upgraded safety glass will be the starting place for replacement cost valuation instead of the cost of replacing with non-safety glass. This could be a significant cost that should be reflected in the purchase limit.
Tenant’s improvement and betterment
This valuation applies when the named insured is a tenant, and it applies only to items added to the tenant’s space in a building at the cost of that tenant and that cannot be removed. This explanation must be addressed in a separate column because it is based not only on actual cash value but also on the remaining term of the lease, including automatic renewal extensions.
Optional coverage and endorsements
The valuation condition can be modified within the coverage form by selecting Replacement Cost Optional Coverage. This important valuation is much more popular at the time of loss than at the time the limit is set because it requires the client to purchase limits well in excess of the values displayed on a balance sheet.
Here are three popular optional valuation endorsements:
- Functional Replacement Cost, which provides accommodation for building or personal property that will not be replaced with identical kinds of building materials or methods of construction.
- Distilled Spirits and Wines Market Value, which provides a valuation that is specific to this property, which typically increases in value as the items age.
- Alcoholic Beverages Tax Exclusion, which provides valuation for two different limits. The reason is that when a loss is for any covered cause except theft, the value of taxes due is excluded because the government does not require repayment. If the items are stolen, the taxes are not forgiven. For a loss to be appropriately insured, the limit must include taxes for theft but exclude them for all other losses.
Having the valuation condition discussion during an initial client meeting and also during renewal reviews can prevent underinsurance, which will lead to client dissatisfaction when a loss occurs. It is important that a client who is purchasing limits to cover only actual cash value understand exactly how much he or she will need to pay should a total loss occur.
The wine in the court case was covered under an agreed value non-ISO form. The unique valuation terminology may have provided for market value or other methods of evaluation. Whenever unique valuation conditions are provided, it is important to review the entire condition as we just did with the ISO valuation condition.
Linda D. Ferguson, CPCU, is senior vice president of Technical and Educational Products at The Rough Notes Company, Inc., and has over 45 years of insurance industry experience.