Here at Rockford Mutual we offer Functional Replacement Cost as a loss settlement option in our Businessowners and Commercial Package Policy programs.
Functional Replacement Cost, as defined by IRMI (International Risk Management
Institute, Inc.) is the cost of acquiring another item of property that will perform the same function with equal efficiency, even if it is not identical to the property being replaced.
Functional replacement cost is commonly used when the owner would not rebuild the same type of building at the time of a covered loss. The insured would instead replace the structure with a new building that is a different square footage or construction.
An example is when a business is only using the first floor of a two story, 6,000 square foot building. The second floor is vacant, and the owner has no plans to use it. If they insure the building using functional replacement cost, it allows them to purchase enough coverage to rebuild a one story, 3,000 square foot building at the time of a total loss.
Functional replacement cost could also be used when insuring an older building with unique or obsolete features. For example, plaster and lath walls would be replaced with drywall, shingles are used instead of clay roofing tiles and elaborate woodwork and ornamental fixtures are replaced with a basic design. In the event of a partial loss, the insurance company will pay to replace damaged property with less expensive and modern-day materials that provide the same functionality. Property replaced using functionally equivalent materials and products are less expensive and require less time for the reconstruction. Since materials are modern day, they are easier to find and work with during a loss.
Offering the insured the option of a lower building value (for the cost to replace the current building with a new smaller, or less ornate, building) results in a lower premium versus insuring the current building with a higher limit on an actual cash value or replacement cost basis. An insurance company would most likely not offer replacement cost and is hesitant to offer actual cash value because of the potential moral hazard.
FUNCTIONAL REPLACEMENT COST ENDORSEMENT FEATURES
• No coinsurance clause
• Building Ordinance coverage included. However, it should be noted that the building limit must include the cost to rebuild the building, the cost to demolish undamaged portions of the building and the cost to rebuild the property, subject to current ordinance or laws. • If the loss is partial, valuation is the lesser of:
o The limit of insurance
o The cost to repair or replace the damaged portion of the building with less costly construction materials, in the same architectural style that existed before the loss. An allowance is also deducted for “physical deterioration and depreciation”.
o This is an important factor to consider because you may reach your limit of insurance before the repairs are complete
• If the insured does not actually make the repairs, valuation is the lesser of:
o The limit of insurance that applies to the building that was damaged
o The building’s market value (prior to the damage), not including the value of the land
o The cost to repair or replace in the same architectural style but with less costly materials if available, reduced by an appropriate deduction for physical deterioration depreciation
QUESTIONS TO ASK YOUR INSURED WHEN CONSIDERING FUNCTIONAL REPLACEMENT COST
•Will you rebuild in the event of a total loss?
•Will you rebuild the same type or size of building (square footage, construction type, etc.)?
•Will you want to stay in the same location?
• How important are the materials and more expensive features and details of your building?
• Are you required to keep the structural integrity due to city or town requirements (same square footage, plaster, paint color, time period wallpaper, etc.)?
•What changes would be required by ordinance or law if you rebuilt, such as ADA requirements, automatic sprinklers, etc.?
If you determine that functional replacement cost is the proper coverage for your insured, RMIC will require a cost estimator be completed for the type of building the insured would build to replace the current building.
We’re here to help you navigate your commercial risks. Be sure to contact your RMIC Underwriter with any questions about coverages, endorsements, enhancements and more. Together, we can build the perfect policy for your insureds.
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