South Carolina Personal Lines Practice Exam

Which method of loss valuation contradicts the principle of indemnity?

1. Actual cash value

2. Replacement cost

3. Market value

4. Agreed value

The correct answer is: Replacement cost

The method of loss valuation that contradicts the principle of indemnity is replacement cost. The principle of indemnity is designed to ensure that an insured is compensated only for the actual financial loss incurred, thus preventing the insured from profiting from a loss. Replacement cost refers to the amount it would take to replace an asset with a new one of similar kind and quality at current prices, without factoring in depreciation. Under this method, if an insured property is lost or damaged, the insurer pays the cost to replace it rather than the value accounting for depreciation, which may result in the insured receiving more than the financial loss sustained. This can potentially lead to an unjust enrichment of the insured, as they may receive a higher payout than necessary to restore them to their pre-loss financial position. In contrast, methods such as actual cash value, market value, and agreed value tend to align more closely with the principle of indemnity as they seek to reflect a more accurate valuation in terms of actual loss or prior agreements.