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Student Question of the Week: Insurance

Student Question from: Bill M.
Course:  Insurance – Replacement Cost

Student Question:

I don’t understand Question 2. Why does the client have 97.2% of the coverage he needs? Doesn’t he have $14,000,000 in coverage? I thought he just had 77.7% of the required coverage. Where am I messing up?

Peter purchased an apartment building for $15,000,000 five years ago. The apartments were appraised a few months ago for $19,500,000 (market value). The building has depreciated by $2,250,000. Peter has the apartment building insured for $14,000,000 on a replacement cost basis. The replacement cost is currently estimated at $18,000,000. The insurer requires 80% coverage for full replacement cost coverage. Recently, a fire damaged the top floor of the building and water damage to the next two floors. It will cost $4,000,000 to restore the building to its former condition. How much of the $4,000,000 replacement cost will the insurer pay?

Instructor Response:

This is a really good question.  Students are often confused about this. You are correct that he’s underinsured and that the percentage is 77%.  So now we know he’s not getting full reimbursement.  How do we determine what percent he gets?  We take what he has ($14,000,000) and divide by what he SHOULD HAVE ($14,400,000).  That’s where we get the 97.2%.

In case you’re wondering, the $14,400,000 is 80% of $18,000,000.