The Hurdle of Replacement Cost Value (RCV) to Building Back Better

• Emily Stock, lawyer, Monaghan Reain Lui Taylor LLP

When we discuss the concept of building back better, we all agree that it is great.  Who can oppose making our communities, infrastructure and people more resilient to catastrophes.  We also recognize that there are a multitude of hurdles to consider, and that underlying many of those hurdles is an often inflexible legal regime.

Understanding property insurance coverages is significant to any policy for building back better.  Typically property insurance policies provide for some combination of Actual Cash Value and Replacement Cost Value, depending on a variety of criteria.

Actual Cash Value (ACV) is also sometimes referred to as market value.  It is intended to be the dollar amount you could expect to receive for the item if you sold it in the marketplace.  It thus takes into account depreciation of the property.  An insurance company determines the depreciation based on a combination of objective criteria (a formula considering the category and age) and a subjective assessment in the marketplace.  The result is that if a homeowner receives ACV they technically receive exactly what they lost (i.e. the value of an old house); however they cannot afford to replace their property (i.e. build a new house).

Replacement Cost Value (RCV) is the cost to replace the property.  It insures the depreciation of the property, so that the homeowner receives the cost to build a new house similar to the house they lost.  When we talk about building back better, the homeowner can typically only afford to rebuild if they are able to obtain RCV.

The difficulty in obtaining RCV is that it is typically only available where the rebuild is:

(a)        at the same site or location; and,

(b)        uses materials of “like kind and quality.”

But what if being at the same location, or building the like kind and quality, is not building back better?  Consider if the insured event is a flood in an area that is now prone to flood zones.  We don’t want to encourage that homeowner to rebuild in the same location, despite there being significant financial incentive for them to do so.  Similarly if the event is a fire, we know that we don’t want to require that the rebuild use the same non-fire resistance materials (i.e. siding, roofing materials), or even to rebuild the same type of structure which may have been inappropriate for the location recognizing the changing environment.

Although we recognize that the wording of the policy must define the rights of the homeowner, and the monetary obligation of the insurer, I expect we would also agree that it seems unfair to require the homeowner to rebuild at the same site, or use materials of like kind and quality, where such is contrary to the principles of building back better.

In considering this conundrum, it is helpful to consider the rationale for RCV, as recently articulated by the Ontario Court of Appeal in Carter v. Intact.  After recognizing that replacement cost insurance is justifiable even though it provides the policyholder with greater value than what they lost, the Court explained the following as to why the limitations on RCV are reasonable and required:

… allowing insureds to replace old with new raises a concern for the insurance industry. The concern is moral hazard: the possibility that insureds will intentionally destroy their property in order to profit from their insurance; or the possibility that insureds will be careless about preventing insured losses because they will be better off financially after a loss.

To put a brake on moral hazard, insurers will typically only offer replacement cost coverage if insureds actually repair or replace their damaged or destroyed property. If they do not, they will receive only the actual cash value of their insured property.

It is clear from this reasoning that there is little to no risk of the moral hazard in catastrophic insured events.  There is similarly no risk of the moral hazard where an insured homeowner does not want to comply with one or both of the criteria to receive RCV, same location and/or like kind and quality, because of a desire to build back better.

As an advocate for encouraging the insurance industry to build back better, we therefore advocate thoughtfully reducing the two criteria for building back better.  This could be done proactively by deleting the same location requirement in policies in flood or other risk zones.  The like kind and quality criteria should also be carefully examined for certain types of insured events (i.e. fires), so that more appropriate materials can be agreed upon before the event as acceptable under the policy.

An important step to reducing these types of hurdles is to continue and develop the conversation, which I look forward to doing at the CATIQ Canadian Catastrophe Conference in 2018, and beyond.