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Replacement cost policies for your home: Getting what you pay for

Replacement cost insurance is designed to cover the costs of replacing your home, and those contents covered under the policy, if they are severely damaged or destroyed.  Some insurance companies and policyholders have argued, over just what constitutes “replacement cost.”

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Some insurance companies have refused to pay policyholders for a general contractor's overhead and profit (o&p), which is typically 21 percent of the estimated material and labor costs, when policyholders decide not to rebuild or repair their homes.

Harvey Lewis, a claims expert in Oklahoma City, says that means a policyholder who repairs his house receives more money than a homeowner who doesn’t, even though both might be paying the same amount in insurance premiums.

"Some insurers have taken the attitude that, 'If you don't rebuild, you're not entitled to o&p,'" Lewis says. "But the insured is paying an extra premium for the replacement cost coverage and, therefore, the insurance company owes the contractor o&p to the policyholder whether they make a replacement or not."

There's no dispute when a policyholder rebuilds, Lewis says. Insurers routinely pay o&p in those instances.

Insurance departments and courts weigh in

Departments of insurance (DOI) in Colorado and Texas reminded home insurers they owe o&p on all home replacement cost claims. The Texas DOI ruled insurance companies must reimburse policyholders for payments "equal to that of the covered loss so that the insured will be restored to the same position after the loss as before the loss. The calculation of this payment results in under compensation if an insurer deducts prospective contractors' overhead and profit and sales tax." The Colorado DOI issued a similar order.

Courts in other states have made similar rulings regarding an insurer's payment of contractor o&p, when a policyholder elects not to rebuild or replace the damaged property. A Pennsylvania court ruled in the class action suit, Gilderman vs. State Farm, an insurance company must pay its policyholder for a contractor's o&p, even though the policyholder did not intend to hire a contractor to rebuild or replace damaged property.

In addition, the Court of Appeals of Michigan decided in the case of Salesin vs. State Farm that people who have replacement cost policies are entitled to o&p payments when they don't intend to rebuild their houses. The court stated, "Salesin has paid a premium for a full replacement cost policy. There is no logical reason, nor any reason based on the insurance policy itself . . . for deducting estimated contractor's overhead and profit when making payments under State Farm's insurance policy."

Other insurance companies have also refused to pay o&p.

The Kentucky Department Of Insurance ordered Allstate to "include reasonable overhead in instances where the insured intends to make repairs."

Lewis says he's encountered 40 to 50 insurance companies that have attempted to deduct o&p payments from replacement cost settlements in Oklahoma. "This is a pretty widespread problem," he says.

Is replacement cost always replacement cost?

Insurers argue when a policyholder does not intend to rebuild or replace the damaged property, the insurance policy states the policyholder is entitled to the actual cash value of the damaged property. Most insurers calculate the actual cash value with this formula:

(replacement cost value)-(depreciation)=(actual cash value)

Most policyholders do not realize they're entitled to o&p payments because they have no idea what it is.

Another argument insurance companies make is when policyholders don't intend to rebuild or replace their property after a disaster, paying them for o&p is "unjust enrichment" — meaning policyholders would be receiving more than they deserve. The Court of Appeals in Michigan in Salesin vs. State Farm acknowledges this argument, but dismisses it because the policyholder paid a premium for replacement cost coverage and, therefore, is entitled to the o&p payment.

Lewis says most policyholders do not realize they're entitled to o&p payments because they have no idea what it is. "There's usually no definition of 'actual cash value' in an insurance policy and, if there is, it's the industry's standard definition," Lewis says.

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