Part 1 | Part 2
Functional Replacement Cost vs. Agreed Value
If you own an older commercial building, one of the most important questions you can ask yourself is,
“If this building were to be completely destroyed, what do I want to do? Rebuild? If so, with what kind of building? Or do I just want to take the money and run? Escape to Belize?”
OK, that’s more than one question. But you get the idea. Should your building be destroyed, what do you want to happen?
Many clients have told us, “This old structure is great, but it would cost way too much to rebuild. I’d just replace it with a modern equivalent.” Another said they wouldn’t rebuild, but just wanted enough money to pay off the mortgage. Whatever your desire, your answer will influence how to value the building on your insurance policy. If done properly, it can save money and avoid a co-insurance claim penalty.
In an earlier post, we discussed how to properly insure older buildings utilizing Replacement Cost and Actual Cash Value. Now let’s consider two others, Functional Replacement Cost and Agreed Value.
Functional Replacement Cost (FRC)
This takes into account new construction methods which are usually less expensive. Instead of the building’s value being based on what it would cost to replace it as-is, you consider what it would cost to rebuild the structure with modern methods, but so that it serves the same function.
For example, our office is located in an old bank building from the 1920s. The original structure is three course pressed-brick. It would cost a fortune to replace, even though it is relatively small. A modern office would cost much less. FRC would allow us to assign a lower value to our building in the policy and still not get hit with a co-insurance penalty should we have a claim.
Though one of the simplest methods of valuation, it can be difficult to obtain. Many insurance companies simply don’t offer it. However, when available, it is worth consideration. In its simplest form, the building owner and the insurance company agree what the structure is worth before the policy is put in place.
As an example, consider an old church with oak pews and large stained glass windows. Value can be difficult to establish. By arriving at an agreed value ahead of time, the question is settled before a claim occurs. Thus, co-insurance does not apply.
- Replacement Cost: Most widely used. The cost to replace or rebuild using the same materials. No deduction for depreciation.
- Actual Cash Value: Second most popular. Defined as replacement cost minus depreciation. Allows a building to be insured for less than replacement cost, but can be problematic with partial loss (hurricane blows off all shingles on a roof which are ½ way through life cycle, therefore ½ depreciated, therefore claim pays ½ of roof replacement).
- Functional Replacement Cost: Cost to rebuild with lower priced, modern methods and materials.
- Agreed Value: Rarely available. Building owner and insurance company agree on building’s value before the policy is put in place.
I encourage you to ask your insurance agent about how your property is valued and ensure your policy is structured in the most beneficial manner. If you are one of our clients, opens in a new windowgive us a call. If not, give us a call anyway.
Put our experience to work for you. We insure everything from small buildings to shopping centers to factories. We are licensed in all fifty states and have insured businesses here on the Eastern Shore since 1947.
Call us at 757.442.6187 with any questions or visit our website.