How Much Will Your Policy Pay in the Event of a Loss?

The amount you are reimbursed for a covered loss depends on what type of policy you have purchased. Aircraft policies, hangar and property policies and auto policies all typically have a different policy basis for how they pay a covered loss. It’s important to understand each type of loss settlement basis when you determine your values and limits of insurance as to avoid any underinsured or co-insured losses.

Aircraft Policies
Aircraft policies are typically written on an Agreed Value (also called Agreed Amount or Stated Amount) basis. This means that the amount of insurance stated on the declarations page of the policy for Physical Damage (or Hull) Coverage for the aircraft is the amount the insurer will pay in the event of a covered total loss minus any applicable deductible. The amount of insurance is agreed to by the customer and insurance company before policy inception or changed mid-term via endorsement. Underwriters will generally try and keep those values within 10-25 percent of blue book values, but most insurers will make exceptions with adequate substantiation. In the event of a covered partial loss they will pay the cost to repair the aircraft with like kind and quality. However, if when the claims adjuster adds the amount to repair the aircraft with the salvage bid and that sum is either near to or more than the insured amount, they will likely total the aircraft. This is referred to as a Constructive Total Loss. A Constructive Total Loss is more likely to happen when the aircraft has been underinsured.

Insurance, or indemnification, means that in the event of a covered loss the insurance company has a duty to restore you to where you would have been had the loss not occurred. This means that if you had high time engines or components then they are not going to pay the additional cost to put in brand new engines and components. Betterment is not allowed under Agreed Value policies.

Hangar, Buildings and Contents Policies
Property policies for hangars and buildings or homes are frequently written on a Replacement Cost basis. This means that in the event of a covered total loss, the insurer will pay the amount to actually replace the damaged physical property minus any applicable deductible. While this sounds simple, there are several considerations that must be made in order to avoid penalties or co-insurance.

First, determine if there is a co-insurance clause in the policy. When a policy is written on a Replacement Cost basis the insurance company wants you to pay premium on a limit that is as close to replacement cost as possible. A co-insurance clause basically states the required percentage of replacement cost, at the time of a covered loss, which must be carried on the policy in order to avoid paying a co-insurance penalty. These percentages are typically 80, 90, or 100 percent.

For example, if you have a policy with an 80 percent co-insurance clause and at the time of loss your property’s replacement cost is $100,000 then you must carry a minimum limit of $80,000 to avoid paying the co-insurance penalty. To demonstrate a loss that would carry a co-insurance penalty let’s revisit the previous example. The insured has an 80 percent co-insurance clause in the policy and suffers a $20,000 covered property loss. Even though this is a partial loss, the company determines that the full replacement cost of the property is $100,000. This insured only had a $40,000 loan so that is the limit he decided to purchase on the policy. At the time of the loss he should have been carrying at least $80,000 to avoid a co-insurance penalty. The insurance company will take the amount of insurance that he carried ($40,000) divided by the amount he needed to carry ($80,000) to meet the co-insurance clause and then take that result (1/2) times the amount of the loss ($20,000). The resulting figure ($10,000) is the amount that will be paid to the insured minus any applicable deductible ($1,000). In this case the insured will receive a payment of $9,000.

Amount Carried ($40,000)
Amount Should Have Carried ($80,000) = 0.5

(0.5) x Amount of Loss ($20,000) = $10,000 Recovery

Recovery ($10,000) minus the applicable deductible ($1,000) = $9,000 Paid to Insured.

As you can see it’s very important that if you have a co-insurance clause to be relatively sure what the replacement cost of your property will be during the entire policy period. One way to avoid co-insurance is to write the policy on an Agreed Value basis as previously described in the aircraft section.

Another major factor to consider when buying a property policy on a Replacement Cost basis is that the policy does not automatically include coverage for additional costs incurred by new city codes, government ordinances or law. The costs to bring your building up to code or to comply with new ordinances can be substantial, so be sure you have the Ordinance and Law Endorsement added to your property policy. This will help you avoid potentially significant uncovered costs to replace your property.

Auto Policies
Autos are usually written on an Actual Cash Value basis. Actual Cash Value is replacement cost minus depreciation. This means the insurance company will pay what the auto (or portion of the loss) is worth at the time of the covered loss minus any applicable deduction. Some property policies or various coverages on property policies (including Fine Arts) are written on an Actual Cash Value basis. Some Actual Cash Value policies may contain a co-insurance clause so be sure to check your policy.

Hopefully you now have a better idea of how you will be indemnified in the event of a loss. If you are unsure on what basis your policy is written, please check your policy or contact your agent. Knowing these issues and purchasing the appropriate limits of insurance will help reduce your risk of having co-insurance, underinsurance or a potential lack of coverage.

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