Law and Ordinance Coverage (often referred to as "Code Upgrade Coverage") can be extremely complicated for those involved in any aspect of property insurance coverage. From a policyholder’s standpoint, Law and Ordinance Coverage is a counterintuitive riddle.
It is nearly impossible for policyholders to participate in a meaningful way in the determination of how much Law and Ordinance Coverage C should be obtained. I have always thought it is unfair that most policyholders purchase Replacement Cost insurance, which typically excludes the increased costs of repair due to compliance with building laws and ordinances.
My reasoning is twofold:
1. Most policyholders are under the belief that they are purchasing enough coverage to rebuild their structures by buying a product called "Replacement Cost Coverage." Only the insurance industry would make up such a misleading name for a product which does not perform as advertised.
2. Policyholders and agents obtain estimates for the full cost of rebuilding today when determining the amount of necessary replacement cost coverage. Those cost estimates are based on current building codes, not older building codes no longer in place. I have never heard of, and I think it is nearly impossible to obtain, replacement estimates based on old codes. For instance, many older building materials have been deemed dangerous and can no longer be used. Contractors and computer cost estimating programs base estimates of labor and material costs on current building laws and regulations with legally usable materials. Yet, the insurance contract excludes increased building costs incurred by compliance with laws and regulations from replacement cost coverage. Essentially, part of the replacement values, which are reflected in premiums paid, are excluded from recovery in the small print of the policy. Sounds like a rip-off to me!
This issue was again brought to my attention during last week’s NAPIA 2012 Annual Convention. Following two separate presentations by Brent Winans, who is an insurance agent expert, and Carrol Pruitt, who is a Building Code Expert, Winans asked Pruitt about a methodology to determine the amount of Law and Ordinance Coverage C that should be purchased in an endorsement or additional coverage if true replacement coverage is to be obtained. Pruitt seemed puzzled by the question. Since most of my clients are far underinsured for increased costs to repair or replace damaged portions of a building as a result of new building codes, I was quite interested. The situation seems impossible—how do insurers expect an accurate coverage limits determination?
Christopher Boggs wrote an article, How to Calculate the Correct Amount of Ordinance or Law Coverage. Boggs raised the same question as Brent Winans. He seems inclined to my conclusion:
Where Coverage "B" involved an educated guess, Coverage "C" is devoid of any readily apparent avenues of educated information. Most replacement cost estimators develop and present the cost per square foot necessary to rebuild the building to current building code, with no method of deduction for its current "out-of-code" status. Further, the age of the building is not a reliable indicator as there may have been updates at different times throughout the years. To complicate matters further, it is not likely that any builder or contractor can provide an accurate estimate of what it might cost to rebuild the structure as it exists since all their cost estimators, like replacement cost estimators, are based on current codes. Lastly, with the time value of money and improvements in construction methods and materials, using old estimators and adjusting them to current values will not provide an accurate estimate.
Ultimately the limit chosen will be based on little more than a guess….
…Coverage "C" may be best described as a guess of irreducible complexity.
Boggs had similar concerns about the insurance industry selling a product as Replacement Coverage when it, in fact, is not:
Perhaps the insurance industry is to blame for the misunderstanding of replacement cost. In fact, the industry is almost totally to blame due to the continued misrepresentation of the definition. Insureds are routinely told that replacement cost means new for old, either directly or by implication.
"Your building is insured for replacement cost. If it burns down, the insurance company will pay to build you a new building." An over-simplified definition of replacement cost promulgated over and over.
Often an agent or broker either doesn’t know the application of the true definition or doesn’t want to complicate the conversation by providing the definition and the applicable caveats; particularly that the unendorsed policy will only pay to "replace" what was there just prior to the loss, not any additional features required by building codes. There are times, though, when the agent/broker does detail this information to the insured, but the insured does not pay attention or does not remember the conversation. The insured hears what they want to hear and they create expectations of coverage based on what they "heard."
The problem is further complicated by the number of new building laws and regulations. I have explained that there are numerous long-standing building codes in Building Codes and Ordinance – Practical Claims and Coverage Issues Explained. These wind, fire, energy, OSHA, and life safety building codes are some of the more regularly amended laws. Significant changes frequently lead to increased repair and replacement costs. Policyholders are not aware of these cost and coverage issues and are underinsured. Insurers and insurance agents are not so ignorant and, theoretically, sell a workable product that can cover these additional costs following a loss. The insurance industry needs to address this issue by having an "all in" replacement cost product or require clear disclosure and investigation of values.