Kelly, Replacement cost, 2000 Q 25

[abc123]

I am having a hard time understanding the point of "Replacement cost coverage"
Following is 2000 Q 25 from All 10 study manual
---Question
Determine the expected net gain for the insurance when an insured increases her dwelling coverage limit as described below
1) assume that estimated replacement cost of $100000 is exactly accurate and that the policy provides replacement cost coverage
2)The insured voluntarily increases her coverage limit from 80000 to 90000
3) premium related expenses are 20% of premium
4) premium collected for the increase in coverage is $40
5) Frequency of additional claim payouts in the $80000-$90000 layer is 0.30%
6) Assume that claims in excess of $80,000 are total losses.

---Solution
1. Premium net of expense = 40*(1-0.2) = 32
2. Since the frequency is 0.3% that additional dwelling claim payouts will occur, and because all claims in excess of $80000 are total losses, the maximum estimated increase in losses for this policy is 0.003*10000=$30
3. thus expected net gain for insurance company is 32-30= $2

---My questions
1. I assume $80000/ $90000 are coverage limit amounts for Coverage A, and both meet coinsurance requirement.
2. Is the 80k~90k layer for coverage A only? If yes, why are there additional claim payouts in the 80k~90k layer? Should not "Replacement coverage cost" cover all the cost for both cases?
3. If the layer includes all other claims (coverage B,C, D), then why don't we consider the $90k~higer level layer? Increased coverage limit will increase the claims in that layer also (since 90k coverage limit is for A only).

I am very confused about this, I thank you for clearing my mind.

[KindGrind]

I think the whole reason why replacement cost coverage is not provided is because of what Kelly says:

"This policy provisions understandably requires that the policy be purchased for an amount equal to 100% of the replacement cost, because dwelling claim settlement will exceed the policy amount if the replacement cost at the time of the loss is greater than the policy amount of coverage."

This is why that insured can't benefit for replacement cost coverage.

[jk]

1. I assume $80000/ $90000 are coverage limit amounts for Coverage A, and both meet coinsurance requirement.Correct, since the question references the dwelling coverage limit.
2. Is the 80k~90k layer for coverage A only? If yes, why are there additional claim payouts in the 80k~90k layer? Should not "Replacement coverage cost" cover all the cost for both cases?No, it provides coverage only up to the policy limit. This is not to be confused with Guaranteed Replacement Cost coverage, which provides replacement cost no matter what but requires insurance to full value.
3. If the layer includes all other claims (coverage B,C, D), then why don't we consider the $90k~higer level layer? Increased coverage limit will increase the claims in that layer also (since 90k coverage limit is for A only).
It's true that limits for other coverages are usually expressed as a percentage of the Coverage A limit, and one would expect at least some total losses to reach the higher limits of the other coverages as well. However, since no information is given about these losses, I'd say that they're beyond the scope of the question. Perhaps you could clarify your answer with an assumption: "I assume that higher limits on other coverages have no effect on results."

[KindGrind]

oh you're totally right, replacement cost coverage thing only tells us that losses will be evaluated on the replacement cost value of the dwelling, rather than the actual cash value.

My bad :)

[abc123]

Thanks a lot. The statement "This is not to be confused with Guaranteed Replacement Cost coverage, which provides replacement cost no matter what but requires insurance to full value." really cleared my confusion.