Your Level Of Coverage
There are three levels of coverage that determine the amount of money to be paid to cover the cost of the loss or damage to your property. It is critical to understand these three levels of coverage and their respective benefits. The three types of coverage are:
- Guaranteed Replacement Cost: This premium level of protection is standard on the REIN Investor Guard policy. The Guaranteed Replacement Cost provision offers the highest level of protection as it pays whatever it costs to rebuild your building as it was before the loss or damage—even if it exceeds the total dollar value of the policy limit. This gives you protection against increases in construction costs and peace of mind.For example, assume you own a home that is insured for $200,000. It burns to the ground, but the cost to rebuild your home is $300,00 due to significantly increased labour and material costs. If you have Guaranteed Replacement coverage the insurance company commits to rebuilding your home without further costs to you; they pay the $300,000 even though the policy premium was calculated at a price for rebuilding your home at $200,000!Generally, the “Guaranteed Replacement Cost” coverage is rarely available for investment properties, rented dwellings, and commercial buildings over 30 years old.However, the REIN Investor Guard policy provides Guaranteed Replacement Cost coverage at no extra charge!
- Replacement Cost: This is the standard level of coverage provided by most insurers. This coverage ensures that your rental building is repaired or rebuilt at the actual cost to replace it. It is important to note that the repairs or rebuilding costs covered are only up to the sum that your policy specifies.
Using the same example as above, assume your policy limit is $200,000, but at today’s construction prices it costs $300,000 to rebuild your building. With a Replacement Cost policy the maximum payout by the insurance company would be $200,000.
In addition, you can only collect the face value of the policy if you rebuild the building. Assuming once again that in your policy the building is valued at $200,000. It burns to the ground. The insurer will pay up to $200,000 to rebuild it—but you must rebuild it to collect the $200,000. However, at today’s construction prices it costs $300,000 to rebuild it. Now, you have two options:
- Decide to rebuild; collect the $200,000 and pay the $100,000 difference yourself
- Decide not to rebuild the building, or at least not to its original size and purpose, and accept a claim settlement based on the Actual Cost Value (ACV) of the original building. In most cases, this would be far less than the amount of the insurance you carry. You are still required to pay for debris removal and site clearing out of your settlement money.
- Actual Cash Value (ACV): This type of policy pays to repair damages or replace your building or your possessions—minus a deduction for depreciation. “Actual Cash Value” is often offered at a lower price, but is a poor choice because construction expenses continually rise, and the actual cash value of your property will be lower than its replacement cost, requiring you to pay the difference, which could be a substantial amount.(Sometimes this level of coverage is offered by insurers for properties that are considered “sub-standard.”) This is not a recommended level of coverage.
The co-insurance clause is a critical part of any discussion on insurance coverage. The co-insurance clause allows insurance companies to reduce the coverage of your claim if you do not insure to the full value of the property equal to today’s rebuilding costs.
When only a portion of a building is damaged by an insured loss (i.e. fire in the kitchen), and your building is not insured to the full replacement value, the insurer will apply a financial penalty against your claim. A simple way to describe this penalty is if you are only insured for half the replacement value, the insurance company will only pay half of the cost to make repairs and you will have to pay the difference yourself.
To protect yourself fully against such an event you can increase the value of your coverage or buy a Guaranteed Replacement Cost policy.
To avoid any unpleasant surprises you should have the rebuilding cost (including demolition and debris removal), estimated, and then increase your coverage accordingly. Ultimately it is up to you to decide on the amount of insurance to carry.
Note: It is important to note that the majority of investors do not have enough insurance to replace their buildings at today’s construction costs. Although it costs more initially it always saves big-time when you need to file a claim.
Construction Rebuilding Costs
The reality of constantly changing cost of labour and materials should prompt every investment property owner to ask three questions:
- What would it cost to rebuild my investment property at today’s construction costs?
- Is there a big difference between the cost of rebuilding and my current level of insurance coverage on the building?
- Can it be rebuilt and occupied within 12 months?
Sharp increases in property values and construction costs usually means that the majority of property owners are seriously under-insured. This is particularly the case where real estate investors have not had their properties valuated in the past two years and therefore, would not likely have had their coverage adjusted.
Whatever the reason for this gap in insurance protection, the result can be disastrous when the property sustains a substantial loss. Being underinsured in this
situation might be compared to a person getting a $100,000 inheritance (i.e. the increase in the value of their property in conjunction with increased construction costs), which they then leave laying around the house in cash—unprotected. To be underinsured against rising construction costs is a huge risk that all investment property owners need to consider carefully.
Also, if you anticipate that you cannot rebuild and occupy the dwelling or suite within 12 months due to the time required to secure engineering building permits and actual construction time, it then becomes important to extend the indemnity period on your rental income coverage. An optional 24 month period of indemnity is available, subject to an additional premium.
Call us for more details on the value of a Guaranteed Replacement Cost policy, and the option of extending your indemnity period on your rental income coverage.