Valued Policy Law

People who have been around the insurance business for a while should be familiar with the concept of indemnity – that is, the insured should be put back in the same financial position as before an insured loss. One exception to that theory is the “valued policy law.”

This law has been on the books for decades – as Insurance Code Article 6.13 (Policy a Liquidated Demand) until it was re-codified as Section 862.053 (Fire Insurance: Total Loss of Real Property) in the new Insurance Code. The purpose of the law is to prevent insurers from overinsuring property to collect more premium, and then refusing to pay the limit when the property is totally destroyed.

The law reads as follows: “(a) A fire insurance policy, in case of a total loss by fire of property insured, shall be held and considered to be a liquidated demand against the company for the full amount of such policy. This subsection does not apply to personal property. (b) An insurance company shall incorporate verbatim the provisions of Subsection (a) in each fire insurance policy issued as coverage on real property in this state.”

On policies that were formerly promulgated by the Texas Department of Insurance such as Texas homeowners and dwelling policies, the required wording is found in the Insurable Interest and Limit of Liability condition of the policy. On ISO and company-specific policies, the wording is usually found in a Texas amendatory endorsement. It means what it says. If insured real property is rendered a total loss by fire, the limit of insurance on that property is paid even if the limit exceeds the value or even replacement cost of that property.

Texas courts have determined that the test for “total loss” is whether a reasonably prudent owner, uninsured, desiring to rebuild, would have used the damaged remnant for restoring the building. If so, the building is not a total loss.

Surplus Lines

Does the valued policy law apply to fire policies issued by surplus lines companies in Texas? We tend to believe that it does, although we are not aware of any court decision that has addressed this question.

In 1985, the Texas Supreme Court ruled that the valued policy law applies to farm mutual insurance companies, despite a provision in the law that exempts farm mutuals from laws that don’t specifically apply to them. (Hochheim Prairie vs. Burnett)

In it’s decision, the Court looked at the wording of the law – “it applies to 'each and every' fire insurance policy issued as coverage on real property in Texas” – and declined to make an exception. The wording of the law has changed since that time, but it appears the intent is the same.

Reduction of Limit After Loss

Closely related to the valued policy law is a clause found in TDI-promulgated property policies just prior to the valued policy wording.

This clause reads as follows: “Each time there is a loss to an insured building, the amount of insurance applicable to that building for loss by fire will be reduced by the amount of the loss. As repairs are made, the amount of insurance will be reinstated up to the limit of liability shown on the declarations page.”

For example, if a windstorm rips the roof from a building, the insurer is obligated to pay the value of the loss. If the building were totally destroyed by fire before the repairs are complete, the insurer is obligated to pay the full limit of liability due to the valued policy law, except that now the limit of insurance on the building has been reduced by this automatic reduction clause.

The drafters of this clause reasoned that an insured should not collect more than the limit of insurance – a partial amount for the value of the prior loss and then the limit of insurance for a subsequent total fire loss. The automatic limit reduction isn’t needed for causes of loss other than fire, because the valued policy law applies only to fire losses. For other losses, the actual cash value of the building is less because the loss has reduced the value, and the valuation provision in the policy will only permit payment up to the actual cash value of the building.

This provision isn’t found in ISO or company-specific policy forms.