The Cheap Policy is very alluring to real estate investors because it is as advertised – cheap. We know there are a lot of uncontrollables that affect profit margins, things like property taxes and surprise repairs. So it is understandable that expenses such as insurance are often examined to ensure you are not overpaying. The Cheap Policy though doesn’t explain to you though that its cheap because it doesn’t do much for you.
To be transparent our agency owes a lot of its growth to The Cheap Policy. Not because we write them, but because we specialize in fixing portfolios that have been adversely affected by them. The glamour of The Cheap Policy quickly fades when you are coming out of pocket thousands of dollars at claim time. However, we do not want you to learn the hard way and so this month we are going to walk through a claim scenario and illustrate how the policies function differently when there is a claim.
Policy 1: Dwelling Basic Policy – $60,000 Dwelling coverage – Actual Cash Value – 80% Coinsurance – $2,500 Ded
Policy 2: Dwelling Special Policy – $75,000 Dwelling Coverage – Replacement Cost – No Coinsurance – $2,500 Ded
Property Details: Single Family Home – Built 1930 – $1,000 Square Feet – Market Value $52,000
Claim: Kitchen Fire
Amount of Damage: 37,000
“The Cheap Policy”
Since the cause of the loss is Fire this is a covered claim. Since this policy has an actual cash value endorsement the items affected by the claim are paid out based on depreciation. The Depreciation due to the age of the Kitchen is $11,100. The true replacement cost of the home is $150,000 which means to not receive a coinsurance penalty the home needs to be insured for at least $120,000. Since the home is insured for half that amount there is a Co-Insurance penalty. The penalty reduces the claim by the percentage the building was underinsured which brings the co-insurance penalty to $22,200. Then the Deductible of $2,500 is applied. Factoring in depreciation, Co-Insurance, and Deductible the The Cheap Policy will pay the insured $1,200 to cover the $37,000 loss
Since the cause of the loss is fire this is a covered claim. Since the policy has a replacement cost endorsement the items affected by the claim are not depreciated. The policy also does no have a coinsurance clause so there is no penalty for being underinsured. The $2,500 deductible still applies. Factoring in the same variables our recommended policy will pay the insured $34,500.
This is why policy language is important and why we work so hard to make sure your policy is more than a line item on an expense report. And the honest truth is on average the recommended policy and The Cheap Policy differ by $10 a month or less.
So let us help make sure you are not allured into a false sense of security by the tempting Cheap Policy.