September 19, 2021

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Extended Replacement Cost Coverage: A Safeguard Against Demand Surge

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An Extended Replacement Cost (“ERC”) endorsement1 can be added to a policy to increase the stated limits for your dwelling/building and potentially other structures.2 In homeowners policies, this endorsement most commonly increases the stated limits 25-50%.3 The ERC endorsement is most often found in policies of property owners in areas prone to widespread natural disasters.

If you live in California and are at risk of a wildfire loss, for instance, ERC coverage will provide you with a buffer to protect against demand surge following a loss. Even if your property was adequately assessed and valued at the time you purchased your policy (i.e., on a replacement cost basis), demand surge can leave you underinsured. The California Residential Property Insurance Disclosure not only summarizes demand surge, but also recommends extended replacement cost:

Demand Surge: After a widespread disaster, the cost of construction can increase dramatically as a result of the unusually high demand for contractors, building supplies and construction labor. This effect is known as demand surge. Demand surge can increase the cost of rebuilding your home. Consider increasing your coverage limits or purchasing Extended Replacement Cost coverage to prepare for this possibility.

Following a widespread disaster, insurance adjusters and public adjusters often flock in from other states to meet the increased needs of policyholders. If the adjuster is not from a state where these endorsements are common, additional policy benefits have an increased risk of being overlooked. Following the devastating California wildfires in the past few years, we have witnessed countless policyholders suffer total losses, get paid their full stated coverage A limits, lack the funds to properly rebuild, and have their claim closed even though their policy provided for extended coverage. Since the ERC coverage limit is often not as conspicuously listed as the stated coverage A limit and may even require the policyholder to do a little math, it is easily missed by unsuspecting eyes. Policyholders and policyholder advocates can add value to claims just by being aware of what to look for.

Relative to the marginal premium cost per dollar of a policy’s stated limits, ERC coverage is inexpensive. However, do not be tempted to reduce your stated estimated replacement cost coverage and use an ERC endorsement to make up the difference and reduce your premium. This practice has resulted in policyholders being vastly underinsured for two primary reasons. First, other policy coverages may be calculated using the stated coverage A limit. Using homeowners insurance as an example, personal property is often calculated as 50% of the stated dwelling limits, and endorsed up to 75% of that amount. Without adequately stated dwelling limits, a policyholder may be inadvertently decreasing other coverage limits without proper consideration.

Second, conditions apply for a policyholder to receive the benefits of the coverage. Usually, that includes ensuring the stated dwelling coverage was equal to the estimated replacement cost. Here is an example of this condition and others that apply under a Farmers Next Generation® Homeowners Policy in California:

For this Extended Replacement Cost coverage to apply at the time of loss or damage to the dwelling, you must have complied with each of the following conditions, as applicable:

a. you must have notified us within 60 days of any inaccuracy or change in any information you have provided us regarding the physical characteristics of your dwelling;

b. you must have notified us within 60 days of any inaccuracy or change in any information we have provided to you regarding the physical characteristics of your dwelling;

c. you must have notified us within 60 days of the start of any physical changes which costs or will increase the replacement cost of your dwelling by $5,000 or more. This includes additions or remodeling;

d. you must have selected or increased the Coverage A dwelling amount to an amount at least equal to the estimated replacement cost of the dwelling, or any update thereto through application of an index or inflation factor or any other method or combination of methods; […].

If you do not comply with conditions a., b., c. and d. above prior to covered direct physical loss […] then this coverage will not apply. With respect to conditions a., b., c. and d. above, you must agree to any resulting increases in the Coverage A (Dwelling) limit and other stated limits as calculated.

Following a disaster, an ERC endorsement might be necessary to ensure you have the funds to be made whole. When obtaining a policy and attempting to purchase the appropriate amount of insurance, ERC provides an extra layer of protection for hard-to-predict price inflation factors. For policyholders and professionals new to a disaster-prone area, knowing that ERC coverage exists and reading the conditions necessary to comply are necessary first steps to protect against underinsurance. ERC coverage differs based on the type of policy, and even from carrier to carrier on similar policies. Be sure to read your own policy, or your client’s policy to obtain the appropriate benefits.
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1 This endorsement might be referred to by different names. For instance, an insurance professional may refer to it as an “extender,” or it might be a provision in your policy labeled “Option ID.” Here, it will generally be referenced as extended replacement cost, or ERC.
2 ERC coverage can be found in both homeowner and business/commercial settings. For the purpose of this blog, references are generally aimed at homeowners policies, but similar principles apply.
3 If your policy states: “Coverage A – dwelling: $200,000 Endorsements: Extended Replacement Cost – 50% ($100,000)” You have up to $300,000 to rebuild the dwelling (excluding other applicable provisions).

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