In: Operations Management
Mark has a Homeowners 3 (special form) policy that provides $120,000 of insurance on his dwelling and $100,000 on personal property. The replacement cost of the home is $200,000. Assume the coinsurance requirement is 80% and ignore any deductible. Treat each case separately.
1. If the dwelling is damaged by a covered peril, would the insurer pay replacement cost for the damage? (circle one) Yes No Explain why or why not:
1. Answer: No
The insurer will not pay the replacement cost for the damage because there is a coinsurance requirement of 80%. Hence Mark has to insure the property upto 80% of its value to recover any loss upto the face amount of the property. Here the house is insured for $120,000. The replacement cost of the home is $200,000.
80% of $200,000= $160,000
Mark has to insure the property for $160,000 to cover the replacement cost for the damage. But Mark has insured only for $120,000. Hence the insurance will not cover the replacement cost and Mark is also a coinsurer who has to cover a proportionate share of the loss.
Amount of recovery= Lossx[Amount of insurance coverage/(coinsurance percentage*property value)
= lossx[120,000/(0.8*200,000)]= 0.75x loss
Hence the insurance policy would cover only 75% of replacement cost of the damage. Mark has to cover the remaining loss.