Adjusters sometimes mistakenly undervalue unique or high value items by placing a "functional equivalent" value rather than a replacement value upon the item. The most common situation is paying the lower cost of drywall when the interior of a structure is made from plaster. Absent a special statute, state law, or policy provision, the policyholder is ordinarily entitled to the replacement cost, less depreciation, as an actual cash value payment. Some state statutes and some policy forms require payment for the replacement cost immediately.
The example I like to bring this point home with is a well maintained dining room wall covering made of gold leaf. I had such a situation representing a wealthy Palm Beach client. I had no idea an individual would dare place such expensive cloth in an area where a chair, champagne spray or whatever could accidently make a meal into a ten thousand dollar event until I was retained on that case. The wall had suffered water damage. Any nice wall paper would be the functional equivalent of the gold leaf. The insurance adjuster was trying to convince me of this as well. But, the client was entitled to the replacement value of gold leaf, not Home Depot Gold Star Wall Covering.
The FC & S Bulletin recently addressed this issue in a question:
"The insured has an HO 04 90 04 91 Personal Property Replacement Cost endorsement. The insured had a collection of army knives and Japanese swords that have been damaged. How should these items be handled? Are they settled under fair market value or do we owe for basic knives? The antique cost to replace is in the hundreds of dollars whereas buying a knife of similar size could be done for about $25.00."
The answer:
"Unless they’re specifically scheduled, they’re paid at actual cash value. Actual cash value is replacement cost less depreciation. This is different than buying a new knife of the same size; that’s more of a functional replacement rather than actual cash value. Functional replacement cost is when you replace something that serves the same function but is less valuable; for example replacing plaster with drywall. They serve the same function, but the drywall costs much less. You can’t replace a diamond with a cubic zirconia; likewise you can’t replace an antique knife with a Wal-Mart special that happens to be the same length. If it’s the same kind of knife fine. You first need to see documentation that the insured had authentic antiques and not museum replicas; replicas are readily available and much cheaper than the actual antique items. There are no special limits on antique knives; guns and jewelry have limits, but not knives. They’re paid at actual cash value."
Please note that some older buildings should be insured at a functional equivalent basis. Older buildings can often be built for in a different manner with modern methods of construction and design for far less than rebuilding to a replacement cost standard. This can save the policyholder premium dollars. In those instances, I suggest that risk managers and brokers raise the issue of insuring on a "functionally equivalent" basis.
