Valued policy laws are designed to protect policyholders whose property has incurred a total loss. They ensure that property owners receive the face amount of the policy. The laws save policyholders the hassle of proving the property's actual cash value or its replacement cost at the time the loss occurred.
Definition and Examples of Valued Policy Laws
Valued policy laws prevent insurers from collecting a premium to insure a building at its full value, then paying less than that amount after a loss has taken place. For example, a company might agree to insure a building at a value of $1 million. The insurer then determines that the building's actual cash value is only $800,000 after it's been destroyed by a fire.
The policyholder paid for $1 million in coverage, but received only $800,000 as a loss payment.
Valued policy laws vary widely by state. Here are some examples:
- California law: This law applies to all perils covered by the policy. The policyholder can require that the insurer inspect the building and assign a fixed value, at the policyholder's expense, if they want to have a specific value assigned to the insured building. The insurer must pay the fixed value if the property later sustains a total loss.
- Tennessee law: The insurer must inspect the building within 90 days of writing the policy if it's insured for fire in Tennessee. The insurer isn't liable for paying more than the building's actual cash value (ACV) if the building is destroyed by fire. The insurer must return the premium collected on the excess value if the building has been insured for more than its ACV. The policy is assumed to be reasonable and the insurer will pay that amount for a total loss after the policy has been in force for 90 days.
- Nebraska law: The amount of insurance on the policy will be the true value of the property in Nebraska, and the true amount of loss and measure of damages when real property that's insured for loss by fire, tornado, windstorm, lightning, or explosion is wholly destroyed.
How Do Valued Policy Laws Work?
Insurers have an incentive to verify the value of an insured property at the inception of the policy when a valued policy law exists. The insurer will have to pay the policy limit even if the building was over-insured if it fails to substantiate the value of a building that later suffers a total loss.
Most states don't have valued policy laws. Insurers will pay losses in accordance with the policy terms when no such law exists. The insurer will typically pay the lesser of the replacement cost or the ACV of the building, whichever applies, or the limit of insurance if an insured building suffers a total loss.
What Do Valued Policy Laws Cover?
While most valued policy laws apply only to buildings, a few cover personal property as well. Some laws cover fire damage only. Others cover damage caused by fire and a few other perils, such as lightning and wind. Some laws apply to damage caused by any peril covered by the policy.
Valued policy laws do not cover damage caused by criminal acts committed by the policyholder.
Adjusting losses in valued policy states can get tricky when a property has been damaged by two perils, one of which is covered by the law and one that isn't.
Suppose a building is completely destroyed by a combination of wind and flooding. The building is located in a state with a valued policy law that covers wind but not flood. Will the policyholder receive a $1 million loss payment if the building is insured for $1 million?
It depends on the state. Some states require that the insurer would pay the entire face value of the policy. The insurer would be liable only for the amount of loss caused by wind (the peril covered by the law) in other states.
States use different criteria to determine when a building has sustained a total loss. Generally, the building needn't be totally obliterated.
- Valued policy laws prevent insurers from collecting a premium to insure a building at its full value, then paying less than that amount after a total loss has taken place.
- Depending on the state, a building can be deemed a total loss when the cost to repair it exceeds its actual cash value.
- A building might also be a total loss if the structure has lost its identity as a building due to the damage. In most cases, no substantial parts of the building remain above the foundation.
- An ordinance might require a building to be demolished and reconstructed rather than repaired if the damaged portion is worth 50% or more of its value.