What it means
Most property insurance pays the actual value of the loss, up to the policy limit. If a building insured for $400,000 is destroyed but was only worth $330,000 on the day of the loss, a standard policy pays the lower figure.
Under a valued policy law, the insurer must instead pay the amount stated on the policy when the property is a total loss from a covered peril. The idea is that the insurer accepted the value when it sold the policy and collected the premium, so it should not be able to dispute it afterwards.
The laws differ from state to state. Some apply only to fire, some to a wider list of perils, and some apply only to buildings and not to contents.
Many require a total loss, and a partial loss is paid in the ordinary way. For insurers, the consequence is that careful underwriting at the start of the policy matters more.
An inspection or valuation before the policy is issued helps ensure that the amount of cover is not above the real value, since the insurer may pay that amount in full later. For property owners and businesses, the law is a protection, but it is not a reason to over-insure.
Cover above real value costs more in premium, may raise questions of fraud, and in most places the benefit applies only in the states that have adopted such a law.
In practice
Real-world examples.
Example
A shopkeeper owns the building her shop is in and insures it for $250,000. A fire destroys it and an appraiser says the building was worth $210,000 before the fire. In a state with a valued policy law, the insurer pays $250,000.
Example
A property investor buys a rental house and insures it for $320,000 after a valuation by the insurer. A few years later the local market falls and the house is worth $280,000 when it is destroyed. The insurer still pays $320,000 for a total loss in a state with the law.
Example
A factory suffers a fire that damages only one wing, and the repair cost is $140,000 against a policy of $900,000. The valued policy law applies only to total losses. The insurer pays the cost of repair, not the policy amount.
Formula
Calculation
Payout without the law = Lesser of (Policy face amount, Actual value of the loss)
Payout under a valued policy law, total loss by a covered peril = Policy face amount
A warehouse owner insures a building for $400,000 against fire. A fire destroys it completely, and the market value of the building at the time was $330,000. Without a valued policy law, payout = lesser of 400,000 and 330,000 = $330,000. Under a valued policy law, payout = $400,000. The difference = 400,000 - 330,000 = $70,000 in favour of the policyholder. If the fire had caused only partial damage of $90,000, the law would not apply and the payout would be $90,000.Case study
Seen in the real world.
Coastline Mutual is an illustrative, fictional insurer that sells commercial property cover in several states. A bakery it insured for $600,000 burned to the ground, and the insurer's loss adjuster estimated that the building was worth $520,000.
The insurer prepared to pay $520,000, but the bakery's lawyer pointed to the state's valued policy law. Because the loss was total and caused by fire, the insurer was required to pay the full $600,000, which was 600,000 - 520,000 = $80,000 more than it had planned.
In the illustrative sequel, the insurer changed its underwriting rules. It began to require a recent independent valuation for every building in states with such laws, and it reduced cover amounts that were clearly above the real value so that the premium matched the risk it would actually carry.
Watch out
Common mistakes.
- Assuming the law applies in every state, when only some states have adopted one and the details differ.
- Expecting a full payout for a partial loss, when the law normally applies only to total losses.
- Insuring a building for much more than it is worth in the hope of a larger payout, which raises premiums and can cause disputes about misrepresentation.
Questions
People also ask.
Does a valued policy law apply to contents and stock?
Usually not, because most versions cover buildings and other real property, but the wording varies by state and should be checked.
Which causes of loss are covered?
Many laws cover fire only, while others include additional perils, and the policy must also cover the cause of the loss.
Why do insurers care about this law?
Because they may have to pay the full amount of cover on a total loss, they place more emphasis on accurate valuation when the policy is first written.
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