Agents are more frequently encountering the Modified Functional Replacement Cost Loss Settlement endorsement. Sometimes, policies, such as an HO 3, with this endorsement are the only ones available for clients, including for those with high-value historic homes. The agents are finding the language in the endorsement to be vague. The Modified Functional Replacement Cost Loss Settlement endorsement defines functional replacement cost as:

"Functional replacement cost" means the amount which it would cost to repair or replace the damaged building with less costly common construction materials and methods which are functionally equivalent to obsolete, antique or custom construction materials and methods used in the original construction of the building.

Q: What is an appropriate disclaimer to explain this to our clients? 

Response 1: Ask your agency's lawyer about legal disclaimer language. To inform and educate the clients, you could point out the policy language that concerns you and provide a list of markets you approached, along with the market responses. Tell them you have no other options and they are welcome to explore the marketplace. 

If their property is on the National Register of Historic Places or a state or local registry, you could suggest the clients confer with their lawyers to understand what a destructive loss could entail and how their insurance would respond. 

Response 2: I think the endorsement is designed to prevent underinsurance of historic properties. I would expect that if the underwriter and the insured agreed on a replacement cost value that incorporated the historic features and materials the endorsement would not be attached.

If that is the case, you are tasked with educating your insured on insurance to value. An educated insured can make informed decisions about the valuation of their property. Offering disclaimers does not provide the insured with anything and allowing an insured to make an uninformed decision is unwise.

Offer the insured options to include replacement cost using values that the underwriter is willing to accept, as well as functional replacement cost. Address the introduction of coinsurance into the equation if the Modified Functional Replacement Cost Loss Settlement endorsement is attached.

If you provide the options and ensure that the insured understands the differences, then the insured's informed decision and sign off on their decision should eliminate the need for a disclaimer.

Response 3: Since this is a diminishment of coverage in almost all cases, the carriers for standard lines must send out a notice 30 days or more before the renewal date, per state law, to the client if they are changing the policy at renewal. If that notice is not being sent, then you should get the carrier to renew without the endorsement.

If the carriers are sending the proper legal notice, then you should do your best—which I know might be very difficult—to find a regular replacement cost policy. 

Some clients may actually prefer the functional replacement cost because the limit and the premium will be lower. However, other clients would likely prefer to be able to replace their home as close as possible to its original style and quality. Depending on what your standard carriers offer, you may have to go to the excess market to find something for those clients. 

A disclaimer is not the best way to handle this messy situation. Educating your clients on the issue, following their lead and using your markets strategically is the correct approach.

Response 4: Disclaimer wording is best left up to an attorney or a recommendation from your errors & omissions carrier. Agents are always put in a tough spot between trying to explain a particular coverage and putting themselves at risk of an E&O claim. If you feel you should explain in writing, I recommend you simply take the definition of functional replacement cost from the endorsement verbatim. 

This question was originally submitted by an agent through the Big “I" Virtual University's (VU) Ask an Expert service, with responses curated from multiple VU faculty members. Answers to other coverage questions are available on the VU website. If you need help accessing the website, request login information.

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