THE "CO-INSURANCE" PENALTY - OR INSUFFICIENT INSURANCE TO VALUE - AND ITS IMPACT ON AN INSURED
What happens when an insured does not carry enough insurance on his/her/its property? Often, the answer is that, that insured, when suffering a loss, also suffers what some have characterized as a “co-insurance” penalty, or as some prefer, a penalty for maintaining insufficient “insurance to value.”
Remember that, for the most part, the insured is the person initially setting the value of the property. In most instances, an insured will be asked what the property is worth by the agent, or perhaps how much insurance is designed. When that coverage is written, and a loss occurs, the companies will often look to see if the insured had sufficient insurance when compared to the value of the property.
Many policies - especially commercial policies - contain a formula for determining the amount of coverage owed in instances where there is insufficient insurance to value. Here is a typical formula:
1. Coinsurance
If a Coinsurance percentage is shown in the Declarations, the following condition applies.
a. We will not pay the full amount of any loss if the value of Covered property at the time of loss times the Coinsurance percentage shown for it in the Declarations is greater than the Limit of Insurance for the property.
Instead, we will determine the most we will pay using the following steps:
(1) Multiply the value of Covered Property at the time of loss by the Coinsurance percentage;
(2) Divide the Limit of Insurance of the property by the figure determined in Step (1);
(3) Multiply the total amount of loss, before the application of any deductible, by the figure determined in Step (2); and
(4) Subtract the deductible from the figure determined in Step (3).
We will pay the amount determined in Step (4) or the limit of insurance, whichever is less. For the remainder, you will either have to rely on other insurance or absorb the loss yourself.
So, let’s go through an example. Assume that an insured has a limit of coverage for $100,000.00. When a loss occurs, the value of the property at the time of loss is placed at $250,000.00. The policy has an 80% coinsurance percentage, meaning that the building has to be insured to 80% of value. The deductible is $500.00, and the amount of loss is $50,000.00. Let’s follow the steps set forth above:
(1) We first multiply the value of property at the time of loss ($250,000) by the coinsurance percentage (80%). This product is $200,000, which represents the minimum amount of insurance an insured must have to be in compliance with the Coinsurance requirements.
(2) Since the insured does not have that much coverage, we proceed through the calculation. We divide the limit of insurance ($100,000.00) by the figure derived in step 1 ($200,000). This leads to a figure of .50
(3) Then, we would multiply the total amount of loss ($50,000.00) by the figure in step 2 (.50), which gives us $25,000.00
(4) Then we subtract the deductible from this figure ($25,000.00 - $500.00), leaving $24,500.00.
The company’s proper obligation on a $50,000.00 loss is thus only $24,500.00.
Whose fault is under-valuation? In most cases I have seen, the fault lies with the insured. Remember that, typically speaking, an agent has no duty to verify the accuracy of information provided by an applicant when seeking coverage. Thus, when an applicant walks into an insurance agent’s office, and asks for $300,000.00 in insurance on his home, that’s what the agent will write. Clearly, there are some circumstances where the agent’s expertise is involved, and even circumstances when an agent provides the value, but the typical scenario involves the applicant/insured seeking a specified coverage amount. Also, remember that the carrier is actually not under a duty to inspect the property once the application is submitted and the policy is written. Elsewhere in this blog, we have discussed the imposition of the valued policy law, which can arise when the carrier has failed to inspect the property. But, the carrier can simply decide not to conduct the inspection and live with the valued policy law in cases of covered total losses. Therefore, the responsibility for valuation really lies with the insured, at least initially.
An Insured Need Not Rebuild at the Same Premises in Order to Recover Replacement Cost
Parks' recent post about whether an insured has to rebuild at the same location in order to recover replacement cost got me thinking, and then researching. Here's what I found:
Although none in Tennessee, there are a dozen or so cases across the country dealing with the issue of whether an insured has to rebuild at the same location in order to recover replacement cost. For example, in Hess v. N. Pac. Ins. Co., 859 P.2d 586 (Wash. 1993), the Supreme Court of Washington held that insureds are entitled to replace at an alternate location, but that the reimbursement amount is limited to the amount it would have cost to rebuild at the original location. Specifically, the court stated,
"This particular limitation does not require repair or replacement of an identical building on the same premises, but places that rebuilding amount as one of the measures of damage to apply in calculating liability under the replacement cost coverage. The effect of this limitation comes into play when the insured desires to rebuild either a different structure or on different premises. In those instances, the company's liability is not to exceed what it would have cost to replace an identical structure to the one lost on the same premises. Although liability is limited to rebuilding costs on the same site, the insured may then take that amount and build a structure on another site, or use the proceeds to buy an existing structure as the replacement, but paying any additional amount from his or her own funds."
Several other courts have rendered similar decisions. See, e.g., Kumar v. Travelers Ins. Co., 211 A.D.2d 128 (N.Y. 1995) (holding that insurance provision offering to pay full cost to repair or replace damaged dwelling on the same premises merely established the limits of coverage and that replacement cost is limited to what it would cost to replace the damaged structure on the same premises, however, the insured is not required to replace the damaged dwelling on the same premises in order to recover replacement cost); Conway v. Farmers Home Mut. Ins. Co. , 26 Cal. App.4th 1185 (Cal. App. 1994 (“[W]hen the insured desires to rebuild either a different structure or on different premises . . . the company’s liability is not to exceed what it would have cost to replace an identical structure to the one lost on the same premises); S and S Tobacco and Candy Co., Inc. v. Greater New York Mutual Ins. Co., 617 A.2d 1388 (Conn. 1992) (holding that construction of replacement structure at different location constituted replacement under the policy).
So as much I hate to say it, Parks seems to have a lot of folks with "Judge" in front of their names who agree with him. And so I guess I agree as well.
Hope everyone had a great Thanksgiving!
In Order to Invoke Replacement Cost Coverage, Does An Insured Have to Rebuild at the Same Location?
In most cases, the answer is no. Most policies use replacement cost at a specific location as a measure of the maximum recovery that can be afforded under a property insurance policy. Most policies contain a “Valuation” condition similar to the following:
B. Replacement Cost – When replacement cost is shown on the “declarations” for covered property, the value of covered property will be based on the replacement cost without any deduction for depreciation.
The replacement cost is limited to the cost of repair or replacement with similar materials on the same site and used for the same purpose. The payment shall not exceed the amount “you” spend to repair or replace the damaged or destroyed property.
Replacement cost valuation does not apply until the damaged or destroyed property is repaired or replaced. “You” may make a claim for actual cash value before repair or replacement takes place, and later for the replacement cost if “you” notify “us” of “your” intent within 180 days after the loss.
Typically, absent any other endorsement or provision, this policy language simply limits the amount of replacement cost coverage that is available to the cost of repairing or rebuilding on the same site, with like kind and quality. Therefore, if an insured wants to move to a different location, and spends more than the actual cash value payment made by the insurance company, that insured could possibly be entitled to replacement cost coverage, even though not rebuilding at the same location.
However, it is important to recognize that the “same site” (some policies use the phrase “same location”) requirement will be a cap upon the amount of replacement costs. Let’s assume that the property insured is in Hickman County, Tennessee (a fairly rural area). It is a 2000 sq. ft. brick home with all amenities. The replacement cost of that home, for the sake of argument, would be $175,000.00. When a loss occurs, the policyholder decides that she wants to move to Williamson County, Tennessee (a more suburban area) and builds a home almost exactly like the one that existed in Hickman County. The price of this home was $380,000.00. The carrier previously paid an actual cash value amount (replacement cost less depreciation) of $125,000.00. What additional monies does the policyholder get upon completing the property in Williamson County?
The answer should be only $50,000.00 – the amount it would have taken to rebuild the house with material of like kind and quality at the same site or same location in Hickman County.
Thoughts on Advances
If you're a reader of insurance blogs, I'm certain you've read the recent warfare between Parks Chastain and Chip Merlin. They both make good points on the issue of advance payments (see their posts here and here). The truth is that there really is very little law in Tennessee concerning advance payments. Even so, Tennessee's Unfair Claims Settlement Act of 2009 provides some guidance:
- An insurer must adopt and implement reasonable standards for the prompt settlement of claims arising under its policies (T.C.A. 56-8-105(3)). This would seem to necessarily require that an insurance company have standards in place for advances as to undisputed portions of a claim. Even an insurance company would have a hard time making the argument that it doesn't have an obligation to pay a few thousand dollars to its insureds after a fire to ensure that they aren't sleeping on the street until the claim is resolved in full.
- An insurer must attempt to effectuate prompt, fair, and equitable settlement of claims submitted in which liability has become reasonably clear. (T.C.A. 56-8-105(4)). In other words, an insurance company has an absolute obligation to promptly pay undisputed portions of a claim.
- When making a payment, an insurer must indicate the coverage under which payment is being made. (T.C.A. 56-8-105(10)). Certainly an insurance company is entitled to a credit against the policy limits of the applicable coverage when it makes an advance, but this provision makes it mandatory that the insurance company let the insured know the coverage under which an advance is being made.
Policyholder's Advocate's Blog Questioning Misconceptions on Advances Shows Extent of Misconceptions, and the Reasons Why They Are Problematic
William F. "Chip" Merlin, Jr., of the Merlin Law Group, wrote a blog in which he derided (a nice word) the blog I posted on August 18, entitled “Advances-Common Misconception.” Mr. Merlin is a Plaintiff's/Policyholder's Attorney. (www.merlinlawgroup.com). His website describes him as “The Policyholder’s Advocate.” His advocacy is evident as his comments concerning advances misunderstand the very points I was making, misconstrue the true nature of advances, evidence a misreading of the actual blog I posted. Check out his commentary at:
Chip missed the point, and also missed the reason the blog was posted. He asks:
Why do insurance company attorneys tell their insurance company clients that they can abuse their policyholders with legal immunity?
Did you see anywhere in the blog where I suggested advances should never be made? Of course not, as most who read it could tell. Even Brandon, my worthy usual adversary and co-author of this blog, has not “taken me to task,” as Chip purports to do. My point was to educate and prevent misconceptions from arising. Here are Chip’s two biggest mistakes – let’s call them continued “misconceptions” – although one wonders how someone with his experience could unintentionally misunderstand statements made in the blog:
1. He cited to some policies that do require advances. The exact wording of my blog posted August 18 states:
Generally speaking, most insurance policies do not require the insurance carrier to make an advance
That did NOT say that no policy exists which may not require an advance.
2. He then says we have an obligation to pay the undisputed portion of the claim – and I agree. But any knowledgeable reader knows that is not what an advance is – an advance is money paid before an investigation is complete. If it is complete, we know the undisputed portion. Based upon that analogy, he argues that payments could wait years, and violate applicable laws. Obviously, that is an incorrect assessment. If you start with a bad premise (i.e., the advance is the really the “undisputed portion”), you must reach a faulty conclusion, as Chip has done.
Anyway, thanks to Chip for pointing out exactly why we needed to clear up misconceptions. His blog demonstrates my point exactly, although I really had not thought that anyone would have these misconceptions.
And, let me add this, my blog notes that some carriers do make advances and some do not. It is not a condemnation of advances, but rather an attempt to clear up misconceptions to which some policyholder attorneys contribute. These misconceptions evidenced by Chip’s posting cause a problem, when the attorney for the policyholder convinces the insured that a company is treating them unfairly by not making advances. The insured often decides to become adversarial, to the benefit of the policy holders attorney, when it is often not necessary. If attorneys would be objective in their assessments as to policy obligations, much litigation could be avoided.
I enjoy the challenge of litigating with lawyers who know the rules, and understand the issues involved. When I deal with lawyers new to coverage litigation, I find that they have many of the same misconceptions I have set forth, and perhaps those that Chip has evidenced. In many cases, the companies I have represented have made advances, but the insured claimed they were not enough. The policyholder’s attorney usually writes a letter demanding an advance, copies to his client. That creates a perception it the mind of the policyholder that an advance is required, when it may not be. Things are never the same after that, as the policyholder is convinced the carrier has failed to do something required. In most cases, nothing could be further from the truth.
Advances - Common Misconceptions
I want to address some misconceptions about advances under first party policies. By this, I mean a request for money made by an insured before the investigation is complete. While the circumstances of an insured’s loss often place the insured in a difficult financial situation, that situation does not alter the insurance contract. Therefore, let’s debunk some common misconceptions:
1. Generally speaking, most insurance policies do not require the insurance carrier to make an advance. Rather, the policies provide a timeframe for investigation and the insured’s compliance with conditions precedent to recovery. With only a couple of exceptions, there is no right to payment until the policyholder has complied with policy conditions.
2. Therefore, there is no “right” or “entitlement” to an advance.
3. Advance payments do not constitute an admission of liability. I direct your attention to T.C.A. § 56-7-131, a statute that seems to address both first and third party advance payments. To download a PDF copy, click here.
4. If a verdict results in favor of the insured, the advanced amount should reduce the amount awarded to the plaintiff. T.C.A. § 56-7-131.
5. Subsection (c) of T.C.A. § 56-7-131 specifically provides that any payments made by an insurance company shall be deemed to have been made pursuant to the limits of the policy, and shall be credited against the insurer’s obligation to the insured arising from the policy.
6. If an advance is made, and there is no coverage, the carrier should be entitled to recover that advance.
7. The statute also provides, as does most case law, that an advance does not toll any statute of limitations or contractual suit period.
Some carriers make advances, and others do not. Much depends upon the nature of the claim, the status of the investigation, and the situation of the insured/policyholder. When advances are made, there is no right to another advance.
I would just reinforce for all readers that the policy will set forth the requirements imposed upon an insured, and the quicker and more completely an insured complies, the quicker and ore completely the carrier can evaluate the claim.
Tennessee Court Of Appeals Rules That Submission To Examination Under Oath Is Condition Precedent To Recovery
I commend to your reading the recent case of Spears v. Tennessee Farmers Mutual Insurance Company, No. M2008-00842-COA-R3-CV (Tenn. Ct. App. Middle Section), filed July 17, 2009. For a PDF copy of this case, download here (pdf). In this case, the Court was presented with the question of whether the failure of an insured to answer questions in an examination under oath was a material breach of the policy terms, and whether compliance with an EUO request was a condition precedent to the insured’s recovery under the policy. The Court noted:
We likewise find that submission to answer questions under oath when requested as provided for in the insurance policy at issue is a condition precedent to an insured’s recovery under that policy.
As an aside, the court also acknowledged that depositions are different than examination under oath (see my post of June 18, 2009 under “Claim Tips”). The Court found that:
Giving a deposition after having filed suit against the insurer for failing to pay an insurance claim does not constitute cooperation under the terms of the policy.
The Court noted that Tennessee Farmers’ decision to seek an examination under oath was discretionary, but once the carrier made such a request, the policyholder was under an obligation to submit.
Examinations Under Oath and Depositions are Different
I cannot count the number of times I have had an insured’s lawyer misunderstand the difference between these two proceedings. Depositions and examinations under oath are different activities. Cases recognize that “depositions and examinations under oath serve different purposes.” Nationwide Ins. Co. v. Nilsen, 745 So. 2d 264, 268 (Ala. 1999); accord Goldman v. State Farm Fire Gen. Ins. Co., 660 So. 2d 300, 305 (Fla. 4th DCA 1995). The Supreme Court of Alabama explained:
[A]n examination under oath is a part of the claims investigation process. In contrast, a deposition is not part of the claims investigation process; it is designed to facilitate the gathering of information once an insured has denied the insured’s claim.
Nationwide Ins. Co., 745 So. 2d 269; accord Goldman, 660 So. 2d 305 (listing numerous distinctions between EUO’s and depositions, one of which explains that “examinations under oath are taken before litigation to augment the insurer’s investigation of the claim while a deposition is not part of the claim process”); see also Archie v. State Farm Fire & Cas. Co., 813 F. Supp. 1208, 1213 (S.D. Miss. 1992) (holding that depositions are different from examinations under oath); Craft v. Western Mut. Ins. Co., No. E030318, 2002 WL 225947, at *3 (Cal. Ct. App. Feb. 14, 2002) (“A deposition is not the examination under oath which the policy required.”)
In Tennessee, an insured may have a lawyer present at the Examination Under Oath, but the lawyer cannot participate in the Examination, either by asking questions or lodging objections. See e.g. Shelter Ins. Companies v. Spence 656 S.W.2d 36, 38 (Tenn.App.,1983)
Also, keep in mind that the mere filing of suit may not terminate the carrier’s right to demand an Examination Under Oath. There are many cases, mainly from other jurisdictions, that allow a carrier to take an Examination Under Oath even after litigation has been filed. Of course, it depends upon the status of the case, but even in those post-litigation situations, an attorney for the insured may not be able to participate.
An Insured's Willingness to Take a Polygraph Test - Admissible?
Here's a tidbit that can come in handy in the right case. In Murphy v. Cincinnati Ins. Co., 772 F.2d 273 (6th Cir. 1985), the Sixth Circuit Court of Appeals affirmed a district court's ruling that an insured's willingness to submit to a polygraph test as part of the insurance company's investigation was admissible evidence at trial. In so holding, the court noted that a willingness to submit to a polygraph test does not depend on the scientific acceptability which is necessary to support the admissibility of polygraph test results. In other words, an insured's willingness to submit to a polygraph test may be admissible as probative of the insured's credibility and the insurer's motive for denial, but the polygraph test results most likely will be ruled inadmissible.
This type of evidence can obviously be very persuasive, especially in an arson case. So the next time an insurance company seems to be ramping up their investigation for suspected arson but your client swears up and down he or she had nothing to do with the fire, send a letter to the insurance company notifying it of your client's willingness to submit to a polygraph test. This approach obviously demands a risk v. reward analysis, but it is a great tactic in the right case. Also be aware of a distinguishing case, Wolfel v. Holbrook, 823 F.2d 970 (6th Cir. 1987), which made a point of noting that it was the insurer in Murphy that requested that the insured submit to the polygraph test.
The Importance of a Diary
Policyholders all too often underestimate the importance of keeping a diary of the various events that occur during the course of a claim. Why is it important? First, it is a simple fact that memories fade with time. Although claims should be resolved promptly, they often are not. The process can be complicated with numerous adjusters, claims managers, forms, conflicting instructions, etc. Without making a record of what happened and when, important events become a blur. By the time the claim is denied, insureds often have forgotten very important conversations and even when they remember them, the details are fuzzy. For example, if in a bad faith claim one of the assertions is that the insurance company failed to act promptly and failed to respond to requests by the insureds, it is critical that the insured be able to show - with detail - exactly what the insurance company failed to do and the severity of the delay. If the insured complains that an adjuster did not return his phone calls, that complaint has a lot more merit in a subsequent bad faith lawsuit if the insured can list every single unreturned phone call and the reason the insured was calling in the first place.
So what should be recorded? Take detailed notes of all conversations with representatives of the insurance company. Write down their names, their phone numbers, what was discussed, the date the conversation occurred, etc. When an agreement is reached, write it down in your diary and confirm it in writing in a letter to the insurance company. Your own actions should also be documented. When you mail in your sworn proof of loss, document that action in your diary. When you timely submit your personal property inventory, write down the date it was submitted and who you gave it to. Most every insurance policy imposes certain duties on the policyholder. Read the policy, determine what your duties are, and document your efforts to comply with those duties.
Don't make the mistake of believing that your claim is different and put off starting a diary because you assume the insurance company is going to do the right thing and pay your claim. If you're going to assume anything, go the opposite direction and document everything. The little bit of extra effort will be worth it, and could be the difference in ultimately getting the claim paid.
