Filed Under:Markets, Personal Lines

Interpreting Functional Replacement Cost (FRC) insurance

Coverage Q&A

The standard homeowners' insurance settlement provision property will be repaired or replaced without deduction for depreciation costs. (Photo:
The standard homeowners' insurance settlement provision property will be repaired or replaced without deduction for depreciation costs. (Photo:

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Question: My question is in regards to Functional Replacement Cost (FRC). The definition refers to "obsolete, antique or custom construction."  What happens when the damage is to a roof that is 8 years old, which is not obsolete, antique or custom construction? 

For example, the insured purchased the FRC endorsement due the home's construction year being 1910. Then, he had a loss to the roof, which had 35-year shingles that were only 8 years old. Could claims replace the roof with 25-year shingles? Does this truly meet the definition of FRC?

Also, what happens when the kitchen in this same house has a fire loss to cabinets? Let's say that are 12 years old, standard cabinets, nothing fancy, not custom, etc. What should be the replacement cabinet they receive? A lower grade cabinet then what they had damaged in the fire?

I understand when the damage is done to items that fall under those described in the FRC definition. But what happens when they don't fall within that definition? What is paid?

 Michigan Subscriber

Answer: When the functional replacement cost endorsement does not apply, for example to your roof or kitchen cabinets, then the standard settlement provisions of the policy apply. In the ISO HO 00 03, these provisions are that property will be repaired or replaced at replacement cost without deduction for depreciation. The policy pays the lesser of the limit of liability, the replacement cost of that part of the building with like kind and quality, or the necessary amount actually spent to repair or replace the damage.

In your situation, if you're dealing with the HO 00 03 or a similar policy, the roof and cabinets would be repaired/replaced on this basis. The functional endorsement only applies to those items that meet the definition of obsolete, antique or custom construction. If the insured still had horsehair plaster walls then that would be replaced with standard drywall.

Related: How to accurately calculate repair, replacement costs

Valuation differences

 Is there a difference between agreed value and functional building valuation. Which is better?

Insured has four-story building. If loss occurred, he would want only a two-story building.

What form will provide better coverage?

— Pennsylvania Subscriber

Answer: Functional building valuation allows the insurer to pay the least of the following for the repair or replacement of the building: the limit shown in the schedule; in the event of a total loss, the cost to replace the damaged building on the same site, or a different site if required by an ordinance or law, with a less costly building that is functionally equivalent to the damaged building. In the event of a partial loss, the cost to repair or replace the damaged portion of the building with less costly material, if available, in the architectural style that existed before the loss or damage occurred and the amount the insured actually spends to demolish and clear the site of undamaged parts of the building; or the amount actually spent to repair or replace the lost or damaged building with less costly material if available to demolish and clear the site of undamaged parts of the building. (As specified on the ISO Functional Building Valuation form, CP 04 38). 

Agreed value is usually an optional coverage on a commercial property form that provides an amount that the insured and insurer agree the property is worth. This requires a submission of a statement of values on an annual basis. This option is often used to avoid coinsurance penalties.

The functional building valuation option may be better if the insured would want to replace his existing building with a less costly one.

Related: A look at replacement cost value vs. actual cash value

Functional Replacement Cost and property damage

 We have a large commercial claim in which the insurance carrier has put a functional replacement cost type of policy on the property. The building has custom interior window trim, custom wood windows, ornate crown trim, oversized base trim, special milled door trim and so forth. The majority of this trim is restorable. The insurance carrier wants to replace some of the materials with a lesser quality of materials where it will not match the existing materials that are now there.

We can restore 95 percent of this trim by removing it, restoring the trim elsewhere, and reinstalling all above mentioned trim throughout the entire home. The cost of this may exceed the replacement cost of the other lesser quality of trim the carrier wants to replace it with. My position is that this trim is not damaged but just in the way when it comes time to remove the plaster walls and then replacing the walls with sheetrock. The trim work that is irreplaceable can be restored and cosmetically returned to its prior condition. My question is since this trim is only in the way, not really structurally damaged just cosmetically in need of restoring and can be saved, can the insurance carrier say that it owes the lesser of the two: the repair or replacement cost whichever is less?

— Indiana Subscriber

Answer: While it does depend on the policy wording, if the policy has ISO wording or similar, the insurer does have the option to replace the lost or damaged property with other property used for the same purpose if that is the lowest cost option of the three listed. If the trim is not damaged but will become damaged in the repair of the building, that can still be considered part of the cost of repair.

Insureds generally carry functional replacement cost insurance when they want lower limits and the materials or property can be replaced with cheaper materials. If the cost to repair the trim (or any other features of the building)  is more than the cost to replace it with functional replacements, and the insured wants that type of replacement as opposed to functional, then the building should not be insured on a functional replacement cost basis.

Related: 4 commercial real estate coverage enhancements that really matter

What about a partial building loss?

We have written an old church on a standard ISO form with a Functional Building Evaluation endorsement, CP 04 38 10 00. The building value is a fraction of what it would cost to be replaced but the limit is sufficient to put up a building of the same square footage that would be functional.

The insured suffered a partial wind damage loss. We adjusted the loss based on replacement cost less depreciation and offered that amount.

The insured's agent is demanding that the partial loss be paid without the depreciation, at full replacement cost. Can you please advise if we are entitled to depreciate the loss because it is the smaller amount to settle the claim?

— Connecticut Subscriber

Answer: It is our opinion that you are not entitled to depreciate the loss. The CP 04 38 states that the insured will receive the cost to repair or replace the damaged portion of the building with less costly material, if available, in the architectural style that existed before the loss or damage occurred. This is not the same thing as receiving a depreciated amount, but is less than the full replacement cost because less costly materials are used.

Related: Time is of the essence: Repairing, replacing damaged property

On-site building replacement

Our client owns a two-story commercial building that is insured on an ISO commercial property form. There are offices on the first floor and apartments on the second.

If this building were destroyed, the owner would rebuild it in a different location without the apartment buildings. To reflect this, we've attached the functional building valuation endorsement [IDL:CP 04 38 10 00pdf^CP 04 38 10 00^CP 04 38 10 00] and selected a $500,000 limit, which is enough to replace the building without the apartments.

I'm concerned that the functional building valuation endorsement requires same-site replacement. Does it?

— Wisconsin Subscriber

Answer: The endorsement does not require that the structure be rebuilt at the same location. The endorsement deletes the coinsurance clause of the policy. It also provides that, in the event of a total loss, the insured may receive the smallest of the limit of insurance or the cost to replace the damaged building on the same site (or on a different site if relocation is required by ordinance or law) with a less costly building that is functionally equivalent to it.

After the loss, the cost to reconstruct the building at the current location would be established. The insured would be paid the lesser of the $500,000 limit or the cost of rebuilding at the same site. In other words, it may cost $425,000 to reconstruct the building at its current location. Identical reconstruction at a different location might be $475,000 because of bedrock or foundation requirements. The insured would be provided the lesser of these, or $425,000. However, if an ordinance or law required that a new site be used, the insured might qualify for the $475,000 settlement.

You may also wish to be sure that the underwriter agrees that rebuilding the structure without the apartments is functionally equivalent to the insured structure.

See also:

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