Condo Media - February 2013 - (Page 20)

ASKED & ANSWERED Protecting Your Association Replacement Cost vs. Cash Value Q A QUESTION: What’s the difference (other than premium cost) between replacement cost and cash value insurance coverage for our community association? How do we decide which is best? ANSWER: A cash value policy will pay whatever the insurance company estimates your buildings were worth at the time of the loss, taking into account their age and condition and depreciation, among other factors. So a 20-year-old building would have a lower cash value than an identical 10year-old building. If the cash value stated in your policy is $500,000, that amount (minus depreciation and your deductible) is what the insurer will pay to repair or replace it. Replacement value, as the name implies, will pay what it actually costs to reconstruct your damaged buildings today, using materials of comparable quality. If it cost $1 million to construct your building 20 years ago but would cost $5 million to build it today, a replacement cost policy with a coverage limit of at least $5 million will pay that amount. So the answer to your question — Which policy is better? — is easy: replacement cost. A cash value policy may fall woefully short of the coverage you need to repair or replace buildings that have been damaged or destroyed. The more difficult but very important question is — If you have a replacement cost policy, how do you estimate correctly what the replacement cost is likely to be so you know how much coverage you will need? A “guaranteed replacement cost” policy eliminates the guesswork, guaranteeing to pay the full replacement 20 CONDO MEDIA • FEBRUARY 2013 cost, whatever it turns out to be. Unfortunately, this coverage is rare — few companies offer it and those that do are extremely selective about the communities they will insure. For communities with multiple buildings, a “blanket” policy offers the best alternative, according to David Holton, president of The Essex Agency, Inc. in Essex Junction, Vt. He explains it this way: If you have 10 buildings with an estimated replacement value of $1 million each, your coverage limit would be $10 million. If you suffer a $2 million loss at one building, you’d have $10 million of coverage available to cover it. It is highly unlikely that all 10 buildings would be destroyed in a single incident — the only circumstance in which that $10 million limit might be inadequate. The disadvantage of a blanket policy, Holton says, is “you have to accept whatever value the insurer sets.” Some less scrupulous agents will intentionally understate the estimated value in order to produce premiums that are attractive, but artificially low. For that reason (although it’s not the only one), you want to work with an experienced agent you know and trust. You also want to be sure the policy includes an inflation endorsement, automatically adjusting the coverage limit to reflect increasing construction costs. A blanket policy is a good solution for communities with multiple buildings, but it won’t work if you’re insuring a single property. Here, it will be important to start with a good, baseline estimate of the replacement cost. Most insurance companies will use a formula based on construction costs per square foot. These formulas will reflect geographic differences, recog- nizing, for example, that construction costs will likely be higher in San Francisco than in Muncie, Ind. But the industry benchmarks don’t reflect the differences within geographic areas, Holton cautions, noting that building code requirements, permitting expenses and other factors can make it more costly to build in urban than suburban locations; construction difficulties and site differences could make the cost per square foot higher for different buildings in the same community. Instead of relying on the industry formula, Holton recommends that boards go back to the developer of their community, if possible, and request a formal appraisal of what it would cost to construct the same building today. If that’s not an option, he suggests, boards should ask another developer who is constructing similar buildings today to provide an “honest appraisal” of the likely construction costs. Communities should have their buildings re-appraised at least every five years, Holton suggests (some industry executives suggest a threeyear cycle), to make sure their replacement cost estimates and coverage limits are accurate. You will also want to make sure your policy contains an inflation trigger (to provide extra protection against rising costs) and an ordinance or law endorsement, which will guarantee payment for improvements required to meet building code requirements that weren’t in effect when the property was constructed. You’ll pay a fee for the periodic appraisals Holton and others recommend, but it will be well worth the cost to know that if you have a disaster, inadequate insurance won’t create another one. CM

Table of Contents for the Digital Edition of Condo Media - February 2013

Condo Media - February 2013
Table of Contents
From the CED’s Desk
Editorial Board
CAI News
CAI Regional News
Asked & Answered
Homeowner’s Corner
Blanket Coverage
Vendor Spotlight
2013 CAI-NE Insurance & Restoration Directory
Classified Service Directory
Advertisers Index

Condo Media - February 2013