What Are Valued Policy Laws?
Valued Policy Laws Affect Total Losses Only
Purpose of Valued Policy Laws
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 replacement cost at the time the loss occurred.
Valued policy laws prevent insurers from collecting a premium to insure a building at its full value and then paying less than that amount after a loss has taken place. For instance, an insurer agrees to insure a building at a value of $1 million. After the building is destroyed by a fire, the insurer determines that the building's actual cash value is only $800,000. The policyholder has paid for $1 million in coverage but received only $800,000 as a loss payment.
When a valued policy law exists, insurers have an incentive to verify the value of insured property at the inception of the policy. If an insurer fails to substantiate the value of a building that later suffers a total loss, the insurer will have to pay the policy limit even if the building was overinsured.
Covered Property and Perils
While most valued policy laws apply to buildings only, 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 of the policyholder.
Adjusting losses in valued policy states can get tricky when property has been damaged by two perils, one of which is covered by the law and one that isn't.
For example, 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. If the building is insured for $1 million, will the policyholder receive a $1 million loss payment?
The answer depends on the state. Some states would require the insurer to pay the entire face value of the policy. In other states, the insurer would be liable only for the amount of loss caused by wind (the peril covered by the law).
Examples of Valued Policy Laws
Valued policy laws vary widely by state. Here are some examples:
- California law: Applies to all perils covered by the policy. If the policyholder wishes to have a specific value assigned to the insured building, he or she may require the insurer to inspect (at the policyholder's expense) the building and assign a fixed value. If the property later sustains a total loss, the insurer must pay the fixed value.
- Tennessee law: If a building is insured for fire, the insurer must inspect it within 90 days of writing the policy. If the building is destroyed by fire, the insurer is not liable for paying more than the building's actual cash value (ACV). If the building has been insured for more than its ACV, the insurer must return the premium collected on the excess value. After the policy has been in force for 90 days the value on the policy is assumed to be reasonable and the insurer shall pay that amount for a total loss.
- Nebraska law: If any real property insured for loss by fire, tornado, windstorm, lightning, or explosion is wholly destroyed, the amount of insurance on the policy shall be the true value of the property and the true amount of loss and measure of damages.
What's a Total Loss?
States use different criteria to determine when a building has sustained a total loss. Generally, the building needn't be totally obliterated.
Depending on the state, a building may be deemed a total loss when:
- The cost to repair it exceeds its actual cash value
- The structure has lost its identity as a building due to the damage
- No substantial parts of the building remain above the foundation
- The building has sustained significant damage and a local ordinance prohibits its repair. For instance, an ordinance may require a building to be demolished and reconstructed rather than repaired if the damaged portion is worth 50% or more of its value.
When No Valued Policy Law Exists
Most states do not have a valued policy law. When no such law exists, insurers will pay losses in accordance with the policy terms. If an insured building suffers a total loss, the insurer will typically pay the lesser of the replacement cost or ACV of the building (whichever applies) or the limit of insurance.