I believe that use of the wrong cost basis for insurance appraisals materially contributes to the issue of under-insurance that we see following every disaster.
If a lender/agent/property owner uses an appraiser’s market value opinion based on the “cost approach” (or any other approach for that matter) to set their insurance limits, then they’ve misused the data, and the appraiser probably has wording to that effect on their report. But, in cases where the appraiser accepts an assignment specifically for the purpose of generating an estimate of insurable value, are they changing their tools and assumptions to fit the intended purpose, or are they still generating the same estimate they would if asked to provide the “cost approach”?
Many appraisers reference Marshall & Swift cost guides and software (Swift Estimator, Commercial Estimator, and MVS Manuals) (www.marshallswft.com) when generating market value opinions based on the “cost approach”. These estimates are on a “new construction” basis, and include license restrictions prohibiting their use for insurance purposes.
Marshall & Swift / Boeckh (MSB) (www.msbinfo.com) provides different software and data to the insurance industry (RCT and BVS): these generate estimates on a “reconstruction” basis. Neither MSB, nor their competitors ISO/Xactware and E2Value (the dominant suppliers of cost data and claims analytics to the insurance industry) advocate “replacement cost new”. All use “reconstruction” basis for insurance purposes.
An individual underwriter’s willingness to accept a new construction based estimate shouldn’t be used in the defense of the practice. Typically real-estate appraisers don’t know that the insurance market uses a different tool set, and similarly the insurance underwriters don’t know the real-estate market has different tools; all either see is the term “replacement cost” or the Marshall & Swift brand name and look no further. This is not a minor issue: between the valuation basis and inappropriate deductions, I’ve seen advertised “USPAP compliant” insurance appraisals that were 30-40% below 100% replacement cost. If used for reporting values and setting limits, these values will leave the property owners in serious jeopardy of having inadequate limits and coinsurance penalties.
If the appraiser’s insurable value estimate is lower than what is needed to recover from a loss: Will their professional liability cover apply to this type of assignment (if it does, is the limit per building, per assignment, other)? What type of disclaimer should they have on their estimate (assuming the assignment is specifically for insurance purposes)?
If an appraiser has had no specific training on insurance issues, are they in violation of USPAP for accepting this type of assignment? If an appraiser uses a cost guide, that has a license restriction prohibiting its use for insurance purposes, for insurance purposes, is it USPAP compliant?
Author: John Nixon, Predident, Asperta, Ltd. - John is the founder of Asperta, an independent consulting firm focused on improving the quality of property insurance decisions by policy holders, agents, brokers, underwriters, reinsurers and investors.
He has over 20 years of experience in property insurance, including North American and International HPR loss control and underwriting; primary, E&S, reinsurance and CAT underwriting; and home office product line management, oversight and auditing.