INDEMNITY
Hello Fellow Appraisers,
There seems to be two value methodologies being taught for assignments to be used for obtaining insurance.
One trend is to report a value that is strictly based on analyzing market activity. The other is to add a fudge factor to the value - usually ten to fifteen percent. Which approach is proper?
To begin with, insurance is based on indemnity. Indemnity means that the insured will be made whole again in the event of a casualty loss. Being made whole means not making a profit or sustaining a loss but made equal to what the insured was just before the loss occurred.
Keep in mind that the insurer will use the appraisal for obtaining insurance to determine risk and set the premiums. If the item is still being sold as new, then that is the highest risk the insurer may have. Let's not get sidetracked into how to value an item as that will double this news brief.
In the event of a casualty loss, the value definition will change to actual cash value (unless it is an agreed value policy, which is very rare with jewelry). Actual cash value is defined differently in different jurisdictions. And the effective date will be the date of incident. In the Appraising Demystified website, all 51 jurisdictions are detailed for the mandatory methodology required for insurance casualty loss.
Back to the fudge factor issue. Some appraisers claim it is acceptable, when a market is rising, to add a fudge factor percentage to the value. Then wouldn't a minus fudge factor be mandatory if the market is falling? In such a situation, isn't the appraiser predicting a value? That is hypothetical with a capital H!
If one pays a higher premium due to a fudge factor and a casualty loss occurs, will they get more money? No. The value definition will change to actual cash value. And actual cash value will be determined the same way regardless of the premiums paid.
The legal requirement is for the client to be made whole again under the principle of indemnity. To have a fudge factor undermines the principle of indemnity. That is called moral hazard. Moral hazard comes into play whenever it is more tempting to sustain a loss rather than to avoid a loss. If indemnity were not the basis of insurance, it would be considered gambling. If, for example, the item is worth $100,000 and a fudge factor of fifteen percent were added to the original appraisal for obtaining insurance, the reported value would be $115,000! The insured might be very tempted not to properly protect the item since they can replace it and have money for a super vacation!
Just report a value that would achieve indemnity on the proper effective date.
Written by Bill Hoefer
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