The Big I Virginia Winter 2022-23
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IRV METHODOLOGIES,<br />
REPLACEMENT COST<br />
iStockphoto.com/Olivia Rich<br />
AND<br />
RECONSTRUCTION COST<br />
By Chris Boggs<br />
Determining a structure’s insurance<br />
replacement value (IRV) is not complicated.<br />
Very few viable methodologies are available<br />
to develop an IRV. Any complications in<br />
calculating the IRV arise only because<br />
there are multiple sources for each option. Once the<br />
methodology and source are chosen, estimating the IRV is<br />
relatively simple.<br />
Although not complicated, developing and applying<br />
the correct IRV within the property insurance policy<br />
does not guarantee payment of the structure’s entire<br />
reconstruction cost following a major loss. Key provisions<br />
within the “standard,” unaltered commercial property<br />
policy (CPP) preclude payment of certain costs and<br />
expenses. <strong>The</strong> realities of “replacement cost” within the<br />
insurance policy can leave a large payment gap between<br />
the amount paid by the insurance policy and the cost to<br />
reconstruct the structure.<br />
<strong>The</strong> unexpected results of COVID have also created<br />
a problem. Not only must the realities of replacement<br />
cost and reconstruction cost be understood, but supply<br />
chain issues have increased the cost of construction and<br />
reconstruction. <strong>The</strong> cost to reconstruct may be abnormally<br />
high for the foreseeable future.<br />
ADJUSTMENT OF A<br />
MAJOR PROPERTY LOSS<br />
“Replacement cost” is a fundamentally misunderstood<br />
concept. Unfortunately, the insurance industry may be<br />
primarily to blame for these misconceptions.<br />
Over time, the insurance industry and its representatives<br />
have explained replacement cost to mean new stuff in<br />
place of old stuff. While there is a grain of truth in this<br />
description, this oversimplification of replacement cost<br />
has led to an expectation that is not supported by the<br />
policy language.<br />
Replacement cost coverage provided by the “standard,”<br />
unendorsed CPP pays ONLY for the part of the structure<br />
damaged by a covered cause of loss. Beyond providing<br />
coverage for ONLY the damaged part of the structure,<br />
the unendorsed CPP pays ONLY the amount necessary<br />
to rebuild the damaged structure back to its original<br />
condition using materials of like kind and quality (LKQ).<br />
<strong>The</strong>se two ONLYs represent the key differences between<br />
the reality of replacement cost and the expectation of<br />
reconstruction cost following a major loss to the insured<br />
structure. <strong>The</strong> CPP pays:<br />
• ONLY to repair or rebuild the damaged part of the<br />
structure; and<br />
• ONLY to return the damaged part to its original<br />
condition and state regardless of building codes.<br />
A large property loss, if not total, exposes the<br />
shortcomings of replacement cost coverage. Following a<br />
major property loss, the building codes applicable to the<br />
damaged structure may disallow repair and may require<br />
the destruction of the undamaged portion of the building.<br />
None of the expense associated with the loss in value of,<br />
the demolition of and the removal of the undamaged<br />
portion is paid under a replacement cost policy.<br />
Additionally, no building can be rebuilt out of compliance<br />
with the applicable building code. Replacement cost<br />
coverage specifically excludes any additional costs<br />
necessary to bring the building into compliance with the<br />
26 THE BIG I VIRGINIA WINTER <strong>2022</strong>-<strong>23</strong>