Actuarial Notes

HO-3 Property Conditions

Study guide: Exam DISC-IA

HO-3 Property Conditions are the Section I conditions of the ISO Homeowners 3 – Special Form (HO 00 03, 05 11 edition): the rules that decide how much a covered property loss is worth and how it is paid. They cover insurable interest, the deductible, the insured's duties after a loss, loss settlement including the 80% replacement cost rule, pairs and sets, appraisal, other insurance, suits against the insurer, the mortgage clause and the other conditions that finish Section I.

\text{Paid}_{\ge 80\%} = \min(L,\ \text{RC}_{\text{loss}},\ \text{Spent})

\begin{aligned} \text{Paid}_{<80\%} = \min\Big(L,\ \max\big(&\text{ACV}_{\text{loss}}, \\ &\tfrac{I}{0.8\,\text{RC}}\,\text{RC}_{\text{loss}}\big)\Big) \end{aligned}

\text{Share} = \frac{L}{\sum_k L_k}

  • Symbols: The first formula applies when I \ge 0.8\,\text{RC} and the second when I < 0.8\,\text{RC}. I is the amount of insurance on the damaged building, RC the full replacement cost of the building immediately before the loss, L the limit of liability that applies to it, \text{RC}_{\text{loss}} the cost to repair or replace the damaged part with material of like kind and quality for like use, Spent the amount actually and necessarily spent to repair it, and \text{ACV}_{\text{loss}} the actual cash value of the damaged part. In the other insurance share, L_k is the limit of policy k covering the loss. The deductible comes off after these amounts.
  • Insurable interest and limit: However many people have an interest in the property, the insurer pays no insured more than that insured's interest at the time of loss, and no more than the limit.
  • Deductible: Unless the policy says otherwise, the insurer pays only the part of the total of all loss payable from one loss that exceeds the deductible, subject to the limit. If two or more deductibles apply, only the highest applies.
  • Duties after loss: The insurer has no duty to provide coverage if failing to perform these is prejudicial to it. The named insured, an insured seeking coverage or a representative must: give prompt notice; notify the police of a theft; notify the card company for a credit card loss; protect the property from further damage, making reasonable and necessary repairs and keeping a record of their cost; cooperate in the investigation; prepare an inventory of damaged personal property with quantity, description, actual cash value and amount of loss, with bills and receipts; as often as reasonably required, show the damaged property, provide records and submit to examination under oath outside the presence of other insureds; and within 60 days after the insurer's request send a signed, sworn proof of loss.
  • Loss settlement at actual cash value: Personal property, awnings, carpeting, household appliances, outdoor antennas and equipment, structures that are not buildings, and grave markers are settled at actual cash value at the time of loss, but not more than the cost to repair or replace.
  • Loss settlement at replacement cost: Buildings under Coverage A or B are settled at replacement cost without deduction for depreciation if the insurance on the building is at least 80% of its full replacement cost immediately before the loss (Insurance to Value). Below 80%, the insurer pays the greater of the actual cash value of the damage and the proportion of the replacement cost of the damage that the insurance bears to 80% of the building's replacement cost, up to the limit. Excavations, foundations and supports below the lowest basement floor or below ground, and underground flues, pipes, wiring and drains, are left out of the replacement cost when testing the 80%.
  • Until the repair is done: The insurer pays no more than actual cash value until the repair or replacement is complete, unless the cost is both less than 5% of the insurance on the building and less than $2,500. The insured may claim on an actual cash value basis first and then claim the rest, as long as it notifies the insurer within 180 days after the loss of its intent to repair or replace. A building rebuilt somewhere else is paid no more than rebuilding at the original premises would cost, and the increased cost of complying with an ordinance or law is paid only under the ordinance or law additional coverage.
  • Loss to a pair or set: The insurer may repair or replace any part to restore the pair or set to its value before the loss, or pay the difference between its actual cash value before and after the loss.
  • Appraisal: If the insured and insurer disagree on the amount of loss, either may demand appraisal. Each chooses a competent and impartial appraiser within 20 days of a written request; the appraisers choose an umpire, and a judge does if they can't agree within 15 days. Each appraiser sets the loss separately, an agreement between the two or a decision by any two of the three sets the amount, and each party pays its own appraiser and shares the umpire's and other costs.
  • Other insurance and service agreements: When other insurance covers the loss, the insurer pays the proportion its limit bears to all the insurance covering it. The policy is excess over a service agreement, such as a home warranty or a property restoration plan.
  • Suit against us: No action can be brought unless the insured has fully complied with Section I and it is started within two years after the date of loss.
  • Our option, loss payment and abandonment: With written notice within 30 days after receiving the sworn proof of loss, the insurer may repair or replace with property of like kind and quality. It adjusts losses with the named insured, pays the named insured unless someone else is named or entitled, and pays within 60 days after the proof of loss once there is an agreement, a final judgment or an appraisal award. It need not accept property an insured abandons.
  • Mortgage clause: A Coverage A or B loss is paid to the named mortgagee and the named insured as interests appear, mortgagees in order of precedence. If the insurer denies the insured's claim, the denial doesn't apply to the mortgagee if it reports changes in ownership, occupancy or substantial change in risk that it knows of, pays premium due when the insured hasn't, and submits a sworn statement of loss within 60 days after notice of the insured's failure to. The mortgagee gets at least 10 days' notice of cancellation or nonrenewal. If the insurer pays the mortgagee and denies the insured, it is subrogated to the mortgagee's rights, or may pay off the mortgage and take an assignment of it.
  • The rest of Section I: The insurance does not benefit a bailee holding, storing or moving property for a fee. Nuclear hazard is not treated as fire, explosion or smoke, but direct loss by fire resulting from it is covered. Recovered property may be returned to the insured with the payment adjusted, or kept by the insurer. Volcanic eruptions within 72 hours are one eruption. The policy covers only losses during the policy period. If any insured intentionally concealed or misrepresented a material fact, engaged in fraudulent conduct or made false statements relating to the insurance, before or after a loss, no insured is covered under Section I. A loss payee shown for listed personal property is an insured for that property and is notified of cancellation or nonrenewal.

The 80% Replacement Cost Rule A house has a full replacement cost of $400,000 and is insured for $280,000 with a $1,000 deductible. A windstorm damages the roof: replacing it costs $30,000, and the damaged roof's actual cash value is $18,000. The roof is replaced. (a) What does the insurer pay? (b) What would it pay if the house were insured for $320,000?

Answer (a) $280,000 is 70% of the replacement cost, below 80%, so the insurer pays the greater of the ACV and the proportional replacement cost.

\begin{align*}
\frac{I}{0.8\,\text{RC}} &= \frac{280{,}000}{320{,}000} \\
&= 0.875 \\
\text{Proportional RC} &= 0.875 \times 30{,}000 \\
&= 26{,}250 \\
\text{Paid} &= \max(18{,}000,\ 26{,}250) - 1{,}000 \\
&= 25{,}250
\end{align*}

(b) $320,000 is exactly 80% of the replacement cost, so the roof is paid at replacement cost.

\begin{align*}
\text{Paid} &= 30{,}000 - 1{,}000 \\
&= 29{,}000
\end{align*}

Underinsuring by $40,000 cost the insured $3,750 on a partial loss.

Before the Repair Is Done A house is insured for $300,000, more than 80% of its replacement cost. (a) Hail damage costs $2,000 to repair. (b) A fire causes damage that would cost $40,000 to repair, with an actual cash value of $28,000. The insured has not yet repaired either. What can the insured collect now, before the deductible?

Answer (a) $2,000 is less than 5% of the insurance ($15,000) and less than $2,500, so the loss is settled at replacement cost now: $2,000. (b) $40,000 fails both tests, so the insurer pays only the $28,000 actual cash value until the repair is complete. The insured can collect the remaining $12,000 after repairing, provided it told the insurer within 180 days of the loss that it intended to repair.

Pairs, Mortgagees and Other Insurance (a) A fire destroys one of a pair of antique lamps. The pair's actual cash value was $1,800 and the surviving lamp alone is worth $600. (b) The named insured burns down his own house; the bank holds a mortgage and has met the mortgage clause's conditions. (c) A $50,000 Coverage A loss is covered by this policy with a $300,000 limit and another with a $200,000 limit. What does the insurer pay in each case?

Answer

  • (a) $1,200: The insurer may pay the difference between the pair's actual cash value before and after the loss, $1,800 minus $600.
  • (b) The mortgagee is paid; the insured is not. Intentional loss bars the insured, but the denial does not apply to the mortgagee's valid claim. Having paid the bank, the insurer is subrogated to the bank's rights under the mortgage against the insured.
  • (c) $30,000: The policy pays its pro rata share, $50,000 × 300/500, and the other insurer pays $20,000.

How it appears on the exam

  • DISC-IA: Section 5.5 examines the HO-3 property conditions. The applied questions give a building's replacement cost, its amount of insurance and a loss, and ask what the insurer pays under the 80% rule; others describe the insured's conduct after a loss, an appraisal, other insurance, or a mortgagee's claim.
  • Paired with Section 3: The valuation concepts behind these questions are Replacement Cost, Actual Cash Value, Insurance to Value and Coinsurance.

Exam traps

  • The greater of, not the lesser: Below 80%, the HO-3 pays the greater of ACV and the proportional replacement cost. Paying the lesser, or the proportional amount alone when the ACV is higher, understates the payment.
  • 80% of replacement cost, not of market value: The test compares the insurance with the building's replacement cost, excluding foundations below the basement floor and underground pipes.
  • Contents are ACV: The replacement cost condition is for buildings; personal property is settled at actual cash value unless endorsed.
  • Replacement cost needs the repair: Above the $2,500 / 5% thresholds, only ACV is paid until the work is complete.
  • One deductible, the highest: When two deductibles apply to one loss, only the highest is taken, not both.
  • Two years to sue: A suit over a Section I loss must start within two years after the date of loss.