I received the following text the other day about a spirited discussion between Harvey Goodman, one of the country’s most respected public adjusters, and Derek Chaiken in our Los Angeles office:
I have spent the last hour fighting with Derek as to whether a replacement cost policy is a betterment policy or policy of indemnity—we’re still on the call.
My first thought was that these two bright insurance minds could probably find something a lot more constructive to fight about. So, I sent Derek this response:
I think you guys could find something else to fight about which is a lot more constructive and I have no idea why you would want to fight with Harvey about this issue which does not matter. I think the insurance treatises answer this debate pretty clearly. Replacement cost insurance is still a policy of indemnity. It simply changes the measure of indemnity by eliminating depreciation after the property is actually repaired or replaced. Calling it a ‘betterment policy’ misses why replacement cost coverage was created. The purpose wasn’t to make insureds better off. Instead, it was to allow them to be made whole so they could pay for the repair or replacement. Any ‘betterment’ comes from receiving new materials in place of old ones, which is unavoidable when restoring damaged property. That’s also why replacement cost policies typically require repair or replacement before paying the depreciation holdback. If the goal were betterment rather than indemnity, that condition wouldn’t exist. Maybe the Chubb, PURE, and Lex Preferred policies which pay RCV right away could be considered more of a betterment policy. But, why the two of you would argue theory over something that does not matter baffles me. If it were me, I would say, ‘Harvey, how do you see it?’ And then, if I agree I would say, ‘I agree.’ If I disagreed, I may say, ‘Hmm, never looked at it that way. I may have to change my view.’ It matters about as much as how much it snowed in the Alps last year. However, if I wrote a blog with the title asking this question, a hundred people would get all excited about it.
Well, here we are. I am writing that blog.
The reality is that the insurance literature settled this question decades ago. Replacement cost insurance did not evolve because insurers wanted to give policyholders a windfall. It evolved because actual cash value settlements often left policyholders without enough money to rebuild. A depreciated payment on a destroyed roof or kitchen frequently meant the insured simply could not restore the property. Replacement cost coverage solved that problem.
The underlying principle remained indemnity. The method of measuring it changed.
This is why replacement cost policies generally require the insured to actually repair or replace the damaged property before recovering the depreciation holdback. If replacement cost insurance were truly a “betterment policy,” there would be no reason to impose that condition. The policy would simply hand over the full replacement cost regardless of whether the property was ever restored.
Instead, replacement cost insurance recognizes an unavoidable reality. A fifty-year-old roof cannot be replaced with another fifty-year-old roof. A ten-year-old carpet cannot be replaced with another ten-year-old carpet. The replacement will be new. The “betterment” is incidental to restoring the insured’s property, not the objective of the coverage.
There are, however, some interesting policy forms that blur the line. Certain high-end homeowners policies issued by companies such as Chubb, PURE, and Lexington Preferred provide replacement cost benefits immediately, without requiring the insured to complete repairs first. Indeed, there is a standard endorsement that policyholders can purchase which provides immediate payment of replacement cost value without depreciation. One could argue those policies and endorsements move somewhat closer to providing a benefit beyond traditional indemnity because they eliminate one of the historic safeguards against overpayment. Even then, I would still describe them as indemnity policies with more generous valuation provisions rather than true “betterment policies.”
At the end of the day, I suspect Harvey and Derek each learned something from the discussion. That’s never a bad outcome.
As for me, I still think there are more important issues facing policyholders and the insurance industry than debating labels that the treatises have already answered. But if the discussion gets people thinking more carefully about why replacement cost coverage exists and how indemnity actually works, perhaps it wasn’t such a pointless argument after all.
I have written extensively on the theory of actual cash value and replacement cost coverage. Two blog posts in particular may add some additional nerdy understanding to this topic or may simply help you get to sleep if you are having those issues. I suggest reading Does a Structure Have a Market Value? Arriving at Actual Cash Value In Partial Loss Situations Before Replacement Cost Policies Existed and Actual Cash Value and Indemnity.
Thought For The Day
“The important thing is not to stop questioning. Curiosity has its own reason for existing.”
— Albert Einstein