What it means
Normally, a property insurer pays the actual value of the loss, up to the policy limit. If a building insured for $400,000 is worth $320,000 at the time it burns, the insurer would ordinarily owe only $320,000.
A valued policy law changes that outcome in states that have one. If the building is totally destroyed by a covered peril, the insurer must pay the full $400,000 it agreed to insure, because it accepted premiums on that amount and had the chance to inspect and value the property at the outset.
The laws exist to prevent insurers from collecting premiums on a high amount and then disputing the value after a loss. They put the burden on the insurer to set the amount sensibly when the policy is written.
The rules differ from state to state. Some apply only to fire losses, some cover other perils such as lightning or windstorm, some apply only to buildings rather than contents, and some only to total losses of owner-occupied homes.
For insurers, the effect is an incentive to value property carefully at underwriting, since an inflated amount cannot be corrected after a loss. For policyholders, it offers certainty, but it also means that a policy with an exaggerated amount may attract closer scrutiny and higher premiums.
Courts have debated what counts as a total loss, since a building can be destroyed in practice while parts of it remain standing. Because the details are set by each state, anyone relying on the rule must check the law of the state in question.
In practice
Real-world examples.
Example
A family insures their home for $350,000 in a state with a valued policy law. A fire destroys the house, and the insurer's own valuer says it was worth $300,000. The family receives the full $350,000 policy amount.
Example
A small shop owner insures a building for $600,000. A fire leaves only a damaged part, so the loss is partial, and the valued policy law does not apply. The insurer pays the actual cost of repairs, which is $150,000.
Example
An insurer reviews its portfolio in a state with a valued policy law and discovers that many policies are written for more than the buildings are worth. It orders fresh inspections and adjusts the insured amounts at renewal to reduce its exposure.
Formula
Calculation
Payout in a VPL state on a total loss = Policy face amount
Payout in a non-VPL state on a total loss = Lower of actual value at loss and policy limit
A homeowner insures a house for $400,000. A fire destroys it completely, and an appraiser concludes that the house's actual cash value just before the fire was $320,000. In a state with a valued policy law, the insurer pays the full $400,000. In a state without one, the insurer pays the lower of 320,000 and 400,000, which is $320,000. The valued policy law therefore delivers an extra 400,000 - 320,000 = $80,000.Case study
Seen in the real world.
This illustrative story is about a fictional insurer, Greywater Mutual, which wrote homeowner policies in two neighbouring states. One state had a valued policy law and the other did not, but the company priced both in the same way.
After a run of house fires, the finance team found that average claim payouts in the first state were about 12% higher than in the second, even for similar houses. The reason was that in the first state a total loss was paid at the full face amount, while in the second the insurer could pay a lower actual value.
Greywater started inspecting new properties in the first state before issuing cover, and adjusted its pricing to reflect the law. The fictional example shows why legal rules about valuation feed straight into insurers' costs.
Watch out
Common mistakes.
- Assuming every state has a valued policy law. Only some states do, and their provisions vary.
- Thinking the law applies to every loss. It generally applies only to total losses from covered perils, not to partial damage.
- Overinsuring a property on the strength of the law. Higher face amounts mean higher premiums and may draw scrutiny from the insurer.
Questions
People also ask.
Does a valued policy law apply to cars?
Usually not, because the laws are aimed at real property such as buildings, and vehicle policies commonly pay the actual cash value.
What if the building is only partly destroyed?
Then the law generally does not apply, and the insurer pays the cost of repair or the actual loss under the normal policy terms.
Is this the same as an agreed value policy?
They are similar in effect, but an agreed value policy comes from the contract, while a valued policy law comes from a statute that applies automatically.
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