The Office of General counsel has issued the following informal opinion on November 7, 2001, representing the position of the New York State Insurance Department.
Re: Definition of "Replacement Cost" as applied to property insurance in connection with mortgage loans.
Does the Insurance Department have any specific definition of "replacement cost" that is binding on insurers licensed by the Department to write property insurance required in conjunction with mortgage loans?
The New York Insurance Law treats the replacement value of a property as a factor to be considered in ascertaining the loss payable on a claim under a homeowners policy. It does not provide one definitive definition of the term and, in practice, insurers may "cap" their liability under such a clause by including additional provisions in the insurance policy.
The New York Insurance Law provides for a standard fire insurance policy with standard provisions and permissible variations. N.Y. Ins. Law § 3404 (McKinney 2000) establishes the "standard fire insurance policy of the state of New York." ("New York policy form"). No contract of fire insurance shall be made, issued or delivered on any property in this state unless it conforms to the provisions of the New York policy form. N.Y. Ins. Law § 3404(b)(1) (McKinney 2000). The New York policy form includes provisions regarding the limits of coverage to be provided under the policy, including a coverage provision that is commonly referred to as replacement cost. N.Y. Ins. Law § 3404(e) (McKinney 2000). The statute also permits insurers to offer policies that do not comply with the specific provisions of the New York policy form so long as the policy provides coverage provisions no less favorable to the insured. N.Y. Ins. Law § 3404(f)(1) (McKinney 2000).
N.Y. Ins. Law § 3404 (a) and (b)(1) (McKinney 2000) read, in relevant part, as follows:
(a) The printed form of a policy of fire insurance, as set forth in subsection (e) hereof, shall be known and designated as the "standard fire insurance policy of the state of New York."
(b)(1) No policy or contract of fire insurance shall be made, issued or delivered by any insurer or by any agent or representative thereof, on any property in this state, unless it shall conform as to all provisions, stipulations, agreements and conditions with such form of policy.
N.Y. Ins. Law § 3404 (e) (McKinney 2000) sets out the form and content for the New York policy form. The relevant coverage provisions provide that the insurer will provide coverage to the insured for "the lesser amount" of either:
1) The actual cash value of the property at the time of the loss, or
2) the amount which it would cost to repair or replace the property with material of like kind and quality within a reasonable time after such loss, without allowance for any increased cost of repair or reconstruction by reason of any ordinance or law regulating construction or repair, and without compensation for loss resulting from interruption of business or manufacture, or
3) to an amount not exceeding ______ dollars, but in any event for no more than the interest of the insured, against all direct loss by fire, lightning and by removal from premises endangered by the perils insured against in this policy,....
The first provision is commonly referred to as "actual cash value" coverage. Insurance Department Regulation No. 64 (N.Y. Comp. Codes R. & Regs. Tit. XI, § 216.6 (1998), entitled "Standards for prompt, fair and equitable settlements", applies to all insurers licensed to write coverage in New York, including those that write fire and homeowners insurance. Subdivision (b) of said subsection reads as follows:
"Actual cash value," unless otherwise specifically defined by law or policy, means the lesser of the amounts for which the claimant can reasonably be expected to:
(1) repair the property to its condition immediately prior to the loss; or
(2) replace it with an item substantially identical to the item damaged. Such amount shall include all monies paid or payable as sales taxes on the item repaired or replaced. This shall not be construed to prevent an insurer from issuing a policy insuring against physical damage to property, where the amount of damages to be paid in the event of a total loss to the property is a specified dollar amount.
The second standard policy provision cited above, by its plain language, measures loss as "...the amount which it would cost to repair or replace the property...." The third standard policy provision sets a maximum dollar limit for the insurer's liability under the policy. The prefatory language limiting recovery to "the lesser amount" of the three options limits all three provisions.
N.Y. Ins. Law § 3404 (d)(1) (McKinney 2000) provides as follows:
Appropriate forms of a supplemental contract or contracts or extended coverage endorsements insuring against one or more of the perils which the insurer is empowered to insure, in addition to the perils covered by such standard fire insurance policy, may be approved by the superintendent, who may authorize their use in connection with a standard fire insurance policy.
The above paragraph provides authority for insurers to issue the standard homeowners policy that mortgagees are required to obtain in conjunction with the issuance of mortgage loans. Policies may be approved providing coverage for losses due to both to fire and other appropriate risks.
N.Y. Ins. Law § 3404 (f)(1)(A) (McKinney 2000) provides as follows:
Subject to the approval of the superintendent, a policy which insures solely against the peril of fire or which insures against the peril of fire in combination with other kinds of insurance either for a divisible or indivisible premium need not comply with the provisions of subsection (e) of this section, provided:
(A) the policy contains, with respect to the peril of fire, terms and provisions no less favorable to the insured than those contained in the standard fire policy;
Pursuant to subsection (f), insurers may issue homeowners policies providing for "replacement cost guarantees" and other provisions designed to ensure that insured structures are adequately protected. Department Circular Letter No. 6 (1991), entitled "Proper amount of insurance protection on dwellings", discusses the specifics of such coverages. A replacement cost guarantee provision obligates an insurer to reimburse the insured for the full replacement cost of the insured premises even if that amount is in excess of any specified limit of coverage stated in the policy. Such a provision may include a separate "cap" on the insurer's liability, stated as a percentage of the coverage limit of the policy. For example, a guaranteed replacement cost endorsement may include a provision stating that in no event shall the insurer be liable in an amount exceeding 125% of the stated coverage limits of the policy.
While this opinion is limited to an analysis of the Insurance Law and Regulations, please note that research failed to uncover authority in the New York State Banking Law or elsewhere that would authorize lenders to require that a mortgagor secure replacement cost guarantee coverage (as it is described above) as part of the insurance policy required in order to secure a mortgage loan.
A related question was raised concerning the possibility of a mortgagor securing a homeowners insurance policy that provided coverage in excess of the value of the insured property. Such a policy would be unenforceable to the extent a claim exceeded the value of the property because the insured may only insure property that he or she holds an insurable interest in. N.Y. Ins. Law § 3401 (McKinney 2000), entitled "Insurable interest in property", reads as follows:
No contract or policy of insurance on property made or issued in this state, or made or issued upon any property in this state, shall be enforceable except for the benefit of some person having an insurable interest in the property insured. In this article, "insurable interest" shall include any lawful and substantial economic interest in the safety or preservation of property from loss, destruction or pecuniary damage.
In the future, if a factual situation develops raising related issues, you may wish to submit a separate inquiry to this office, including your analysis of the relevant facts and law.
For further information, you may contact Associate Attorney, Sam Wachtel at the New York City office.