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Jun 24
Follow Up: Inadequate Replacement Cost Letter

Building material costs have increased dramatically during COVID-19 because supply has not been able to keep up with demand. In response, the Big “I" Risk Management department in conjunction with Swiss Re recently provided a sample letter agents could use to notify their clients that current replacement cost limits may be too low as a result of these dramatic increases.

Although it may be useful for agencies to warn their insureds of these potential underinsurance issues arising from COVID-19, however short term it might be, the agency must be cautious when addressing this situation. If an insured contacts the agency as a result of the notification, the agency should:

  • Remember agency personnel are not licensed appraisers. Replacement cost estimators are just that—estimators.
  • Confirm the edition or version date of the estimator being used to generate the replacement cost. The cost of building materials has risen quickly—if the edition date of the estimator is more than a couple weeks old, the value generated may still be too low. For instance, if the data being used to generate replacement cost is based on costs from last month, the developed value may still be too low by anywhere between 10% and 15%. Confirm the most recent edition is being used.
  • Remember to run several valuations using multiple “grades" of construction (fair, average, superior, and so on). This should give a reasonable range of values.
  • Remember the difference between market value and replacement cost. Market values are currently even more volatile than replacement cost values. Insurance values are not dependent on what a willing buyer will pay a willing seller (market value) but are based on the cost to rebuild the structure.
  • Require the insured to pick the value they feel is appropriate (confirmed with a signature). The agent may consider recommending the insured hire an appraiser to develop the value.
  • Consider using a disclaimer on the estimator, such as: “The replacement costs developed are for information only and are not guaranteed or to be considered an appraisal. Values used are at the sole discretion and the responsibility of the property owner."

Unfortunately, the uniqueness of COVID-19 has not yet passed, especially regarding ongoing insurance issues. While this incredible increase in building material costs may be temporary, no one knows how temporary this situation will be. Prices may remain high for weeks or months following a return to normalcy within the supply chain.

Although agents are going beyond expectations by warning of this potential coverage limits problems and giving insureds the opportunity to address the issues, agents are not expected to provide expertise in areas where they are not licensed and/or trained. Apply the recommendations listed above when working with insureds regarding coverage limits.

Replacement cost estimators are simply a tool developed by third parties to assist the insurance industry in the development of the estimated replacement cost. Even the providers of these tools cannot guarantee the results because the real “replacement cost" is not known until the loss occurs and the structure is rebuilt.

If the developer of the tool cannot guarantee the results, neither can the agency utilizing the tool. Agents must guard against the temptation to provide the coverage limit for the insured.

Got questions on this or other agency risk management topics? Big “I" Professional Liability's risk management team is here to answer them. Visit E&O Happens, our dedicated agency risk management website, to learn more. 


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