Anderson - Insurance to Value

[Examinator]

On page 8 of this article the Agreed Amount Endorsement is discussed.

"If the property value rises during the policy period, the insurer assumes the risk of inadequate premium. If the property is insureds to the agreed amount, for example, the insurer will be liable to pay any loss up to that amount in full. The value of the property at the time of the loss is not relevant to the contract."

How could the premium be inadequate? If I have a $100,000 property, I insure it for the stated amount of $100,000, the property appreciates to $120,000, then suffer a total loss, isn't my indemnity still the $100,000 stated amount (which my premiums are adequately priced for)? Thanks.

[Avi]

IIRC, isn't this the article with GRC, Guaranteed Replacement Coverage?

[Avi]

OK, I read page 8, and IIRC here is the issue.

You are setting a value, A, for the piece of property (work of art, car, house, etc.).

The insured then buys a policy with face value = F.

The coinsurance apportionment ratio = F/A, and the Indemnity paid = L*(F/A).

Now, if the property value rises, then, in actuality, A is set too low. If so, the ratio of F/A is actually GREATER than it should be. Thus, for any Loss < (F, A), the insurer may be paying too much.

Example.

A painting's worth is set at $1,000,000 = A.

An insurance policy with a face value of $800,000 is purchased.

The apportionment ratio is .8.

The painting appreciates in value to $2,000,000.

A flood causes $500,000 in damages.

The insurer will pay .8*500,000 or $400,000.

However, if the same policy was purchased TODAY, the ratio would be .4, 800K/2M, and the insurer would only be responsible for $200,000.

Pricing the policy with a 1M value resulted in inadequate premium being collected.

Then again, it has been a while, and I could be wrong.

Hope that helps, somewhat.

[Colymbosathon ecplecticos]

On page 8 of this article the Agreed Amount Endorsement is discussed.

"If the property value rises during the policy period, the insurer assumes the risk of inadequate premium. If the property is insureds to the agreed amount, for example, the insurer will be liable to pay any loss up to that amount in full. The value of the property at the time of the loss is not relevant to the contract."

How could the premium be inadequate? If I have a $100,000 property, I insure it for the stated amount of $100,000, the property appreciates to $120,000, then suffer a total loss, isn't my indemnity still the $100,000 stated amount (which my premiums are adequately priced for)? Thanks.

If all losses were limit losses you would be right. The danger is that the partial losses increase. For example:

Suppose that a loss results in a total loss 20% of the time and a 50% loss 80% of the time. The property starts out at 1 million USD and you insure it for that. The expected loss given a loss is 200,000 + 400,000.

If the property increases in value to 1,200,000 the insured loss given a loss is:

200,000 + 480,000.

[Examinator]

Both responses make sense; thank you for the explanations. I think my question can be answered, however, by considering an appreciation in value as a reduction in coverage relative to the true value. Premiums assume that the property is insured at it's true value. If it appreciates, then the premiums should likewise adjust, and since they do not, they are no longer adequate with an agreed amount endorsement. Does that rationale make sense?

[Colymbosathon ecplecticos]

Both responses make sense; thank you for the explanations. I think my question can be answered, however, by considering an appreciation in value as a reduction in coverage relative to the true value. Premiums assume that the property is insured at it's true value. If it appreciates, then the premiums should likewise adjust, and since they do not, they are no longer adequate with an agreed amount endorsement. Does that rationale make sense?

The underlined portion is not true if all losses are total. Consider a grain silo, if you have a loss you have a total loss. Now insure it for $1 or $1 million, if you have a loss you pay the limit. Insurance to Value doesn't matter.

[Examinator]

Understood. I am thinking in general terms where losses are not all total. Your exaplanation again makes sense. Thanks.

[intelmic]

I know it's an old thread...

I bumped it to thank thread posters for this one.
Great anwsers, just what I was looking for!