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April 23, 2015  

 Q&A of the Week

An Ohio subscriber recently asked the following question:

I have a loss to other structures on the homeowners policy. Is coverage and coinsurance determined by taking the value of ALL other structures and adding them together? How does coinsurance work when the damage is to only one of multiple other structures?

ANSWER: Coverage for other structures is 10 percent of coverage of the dwelling; this applies to all the other structures. If the insured has a number of other structures, the ISO HO 04 48 can be added to increase available coverage for other structures. As far as coinsurance goes, the damaged property must be insured to 80 percent of its value. For example, the insured has a dwelling worth $200,000 but has four other structures valued at $10,000, $20,000, $40,000, and $55,000, and the $40,000 structure is the one damaged with damage being $15,000. The calculation of the limit will be the $20,000 of coverage divided by the $40,000 of value; this is a 50 percent proportion, so the insured is underinsured for the loss. Therefore payment will be the lesser of the actual cash value of the damaged portion of the building or the proportion of the cost to repair or replace the damaged property to the 80 percent of the replacement cost. The calculation is ($20,000/$40,000) × $15,000= $7,500. So $7,500 is what is paid out.

Editors' Note

We have had responses from several readers following our question from an Ohio subscriber concerning coinsurance and how this relates to other structures. We hope this clarifies our thinking. And, as always, we welcome replies.

First, many of you said that there was no "coinsurance" word in the homeowners policy. This is true; however, the concept is there. The word is not because the policies, according to the State Departments of Insurance, must be able to be read (and hopefully understood) by someone with at least a fifth grade education. Now, think back to the first time you sat through "Insurance 101" and the instructor sprang coinsurance on you. You probably had it explained as "did over should times the amount of loss," the "did" being what the insured did have by way of insurance; the "should" being what the insured should have had, and the amount of loss was, of course, the amount of loss sustained. A shortfall in the amount of insurance carried resulted in a penalty for the insured—the insured would be out-of-pocket for the underinsured part of the loss.

So, even though the word "coinsurance" is not in the policy, the wording outlines the steps taken in event of an underinsured loss. In the standard homeowners policy, the insured is required to carry at least 80 percent of the full replacement cost of the building immediately before the loss to avoid the coinsurance penalty. When the amount of insurance carried meets this requirement, the insurer will pay the cost to repair or replace without deduction for depreciation, but not more than the least of Ƒ) the limit of liability applicable to the building, (2) the replacement cost of that part of the building damaged with material of like kind and quality and for like use, or (3) the necessary amount actually spent to repair or replace the damaged building.

Second, we gave the example of a dwelling insured to value at $200,000. The limit for other structures will then be 10 percent of $200,000, or $20,000. Typically, this limit will appear on the declarations page. As pointed out, ISO endorsement HO 04 48 can be added to increase coverage if necessary for other structures. Remember, the term "other structures" can include sidewalks, fences, patios, driveways, a backyard "fort/slide/swing" of the type currently popular for children, as well as to structures that are buildings, such as a detached garage, storage shed, or even the huge outbuilding used by the proud possessor of a collection of classic cars. Unendorsed, the policy in our example nonetheless provides only $20,000 of coverage for these structures.

In event of a loss to other structures, the loss settlement condition states that structures that are not buildings will have the loss settled at actual cash value at the time of the loss but not more than the cost to repair or replace.

Before we move on to loss settlement when the other structures are buildings, we want to make some points. First, the $20,000 limit in our example is a blanket limit—that is, it applies to all other structure property. Second, a claims mantra is to pay the insured all that can be justified by the coverage and limits and not a dime more. Third, the policy is silent as to loss settlement for extraordinary situations, so this is when an insurer's claims practices should be referenced. Finally, courts have held that it is an insured's responsibility to read the policy. If you are the claims adjuster for such a loss as we are describing, you might well have to point out exactly where in the policy it says that an underinsured building will not be completely restored.

In our example, the insured has a $200,000 dwelling, so the other structures limit is $20,000. Suppose there is an outbuilding with a replacement cost of $40,000. It is damaged in the amount of $15,000. In order to meet the 80 percent of replacement requirement, the insured should carry at least $32,000 on the $40,000 building. (In our earlier response, for convenience we did not use the 80 percent figure, but the $40,000 as our starting point.) But, the insured has only $20,000. What then?

Policy loss settlement language states that if, at the time of loss, the amount in the policy on the damaged building is less than 80 percent of the full replacement cost of the building immediately before the loss, the insurer will pay the greater of (note the contrast with least of found when at least 80 percent insurance to value is carried) (1) the actual cash value of that part of the building damaged; or (2) that proportion of the cost to repair or replace, without deduction for depreciation, that part of the building damaged which the total amount of insurance in this policy on the damaged building bears to 80 percent of the replacement cost of the building. In no case will more than the limit of liability applying to the building be paid.

So, following the policy, we divide 20,000 by 32,000, which equals .625 times $15,000 (the amount of loss), which means the insured can collect at most $9,375 (assume no deductible, which would apply in practice). Of course, the actual cash value option is available.

Now, what if the insured has, in addition to the $40,000 building, a building with a replacement cost of $20,000? It, as well as the $40,000 building, is damaged; the damage to it is $10,000. Here, 80 percent of $20,000 is $16,000. So, if we did not take the $40,000 building into account, the $16,000 would be sufficient to avoid the coinsurance penalty. In theory, the insured could collect $10,000 (after application of the deductible). However, remember the limit of insurance is $20,000. Here is where the calculations get tricky. The policy language at this point is no guide. We have already set aside $9,375 for the loss to the $40,000 building, so, in fact, the remainder of the $20,000 limit is $10,625. If then we worked "did over should" we would end up with $6.640.62 as the payment. The total paid is then $16,015.62. The insured would then collect that amount less any deductible. That leaves $3,984.38 of the $20,000 limit on other structures. And, remember, the insured has the option to choose an actual cash value settlement if greater than the calculated amounts shown, if greater.

We could also approach this a bit differently. Remember, the $20,000 is a blanket limit, so we could possibly work the problem based on that. Both the $40,000 and $20,000 buildings have been damaged in the amounts of $15,000 and $10,000, respectively. We have already determined that the 80 percent amounts necessary for replacement are $32,000 and $16,000. We have $20,000 as our "did," and $48,000 as our "should." The multiplier is then .416; the result of that times $25,000 is $10,416.66. That would be the payment less any deductible.

Now, we said at the beginning of this that a precept of claims adjusting is that the insured is entitled to the maximum allowed by policy language and the limits, and not a dime more. Although the "blanket" approach is certainly quicker than the first, the policy language does refer to "the building" so the first approach, while involving more fun with a calculator, would appear to be more consistent with policy language and with fair claims practice. Also, the first approach avoids the insurer's being in the position of taking in premium not commensurate with the property being insured, since the amount of insurance available for a possible loss to yet another other structure has been diminished by the previous two losses.

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