Replacement Cost Less Than ACV

Our insured owned a building that was destroyed by fire. The building was insured on an ISO form CP 00 10 10 90. The actual cash value (ACV) of the building was $190,000, but the insured had it covered at replacement cost for $300,000. Rather than replacing the building at the same location, the insured got a good deal and bought another building at another location.

The new building was one third larger than the destroyed building, yet it cost less. It cost $230,000 and the insured put $20,000 into it to make it usable for a total of $250,000. Since the building is one third larger than the old building, the insurer wants to pay only 75 percent of the cost of the new building, or $187,500. This figure is less than the ACV on the old building. The insurer claims that the extra square footage in the new building is betterment and should not be paid for by them.

Is it right for the insurance company to pay less than actual cash value when the insured was able to do everyone a favor by negotiating a good deal at a cost that was under the replacement cost limit? Should the insured get full replacement cost, actual cash value, or the value of the new building pro-rated for the number of square feet in the destroyed building?

Ohio Subscriber

This is one of the few examples of a replacement cost settlement on a commercial property loss paying less than an actual cash value settlement. Situations such as this are why the insured is given the chance to choose an actual cash value settlement even though the replacement cost option is in force.

 

Under paragraph e. of the replacement cost option, the insurer states that it will pay the least of three replacement costs: (1) the limit of the policy; (2) the cost to replace the property at the same location with comparable material and quality for the same use — whether the building is actually replaced or not; or (3) the actual amount spent to replace the property at any location.

 

In your insured's case, the third option applies and must be used. Since the replacement property was one third larger than the original property, the cost of actually replacing the destroyed property's square footage is 75 percent of the cost of the new property (That is, 100 sq. ft. X 1.333 = 133 sq. ft.; but 100 sq. ft. = 75% of 133 sq. ft., because 133 X .75 = 100). Since the new property cost less per square foot to construct than the old property, the insured receives a lower settlement at replacement cost than if he or she had chosen the actual cash value valuation.

 

This is why the replacement cost option gives the insured the opportunity to choose an actual cash value settlement even though the replacement cost option had been activated. The framers of the policy realized that, in some cases, ACV would yield a larger settlement than replacement cost.

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