Whose fault is it when properties are underinsured? The policyholder? The agent? The insurance carrier? That's the question we posed to NU readers following last year's California wildfires, for which many homeowners reportedly lacked adequate coverage to rebuild. NU's ethics columnist, Peter R. Kensicki, compiled the responses (many of them from readers of my blog) and came up with the following trends.
Whose Fault Is It When Properties Are Underinsured?
BY PETER R. KENSICKI
The issue of underinsured properties returned to the forefront in the wake of the November 2007 California wildfires. Some state officials suggested the problem arose from a “lack of clarity” in contract language and possible “bad advice” to consumers from agents and insurers. So we asked what National Underwriter readers what producers and insurers should ethically do to have properties properly insured.
Very few responding believed there was no ethical responsibility for producers to offer advice as to insurance-to-value. On the other hand, no one claimed there was any legal duty to do so, either.
One Illinois producer, while clearly stating there was an ethical duty for producers to advise clients about insurance to value, took issue with the industry’s critics. “Few agents give ‘bad’ advice to clients about insurance-to-value,” he said. “Policy language is not part of the problem--no one reads their contracts anyway. How could they be confused?”
Yet one Florida producer assessed part of the blame for underinsurance on producers who do not give advice. “Agents must explain the importance of good value and how that value may be calculated,” he said.
A catastrophe adjuster agreed, noting that “agents should regularly contact insureds regarding adequate values for insured property.” Another producer simply put it this way: “It’s the agent’s responsibility to remind homeowners to insure to 80 percent of replacement value.”
A compliance analyst for an insurer believes that “agents ethically must see that initial limits are adequate up front, offer an inflation guard, and tell the insured to report any changes made to the property insured.”
Another respondent said producers should “educate insureds at the time of purchase about insurance-to-value, replacement-cost provisions and options, and all available contractual automatic limit-increase options. The same service should also be offered at renewal.”
This “educate the consumer” ethical obligation was reinforced by a Kentucky producer: “Almost no insured remembers being educated by their agent. ‘Value’ has many meanings to them. Any informed buyer would want to know how their property will be valued at time of loss. However, a price-shopping insured would not care.”
A producer who was once a marketing representative for an insurer blames a lack of attention to the problem at the agency level: “Personal service and personal contact seem to have been eliminated. This is further exacerbated by a lack of follow-up at renewal to see that limits are adequate.”
An insurance executive placed the ethical and legal duties squarely on the insured: “My impression is that the law in most jurisdictions is that it is the insured’s duty to decide on coverage and limits—not the insurer or the agent. The insured knows best about the values of properties in their area.”
However, he partially exonerated the insured in catastrophe situations: “The problem with post-catastrophe loss is that replacement costs skyrocket due to cost increases from sudden demand for labor and materials.”
The Illinois producer placed no blame on insurers: “Underwriters, not living in the area, have no idea of local values.”
The Florida producer said that “insurers have no ethical duty to the insured if the insured does not seek adequate coverage.”
An extremely limited exemption to any ethical duty of an insurer was offered by the catastrophe adjuster: “If the insured is informed of policy requirements, reported changes in values and had their home inspected, the insurer should do nothing pre- or post-loss.”
The Kentucky producer cited no ethical duties, but said carriers or agents are part of the problem: “The insurance business is more concerned with selling the price of their product rather than selling their product, properly priced. Agents also tend to rely too much on the price of the product rather than the quality of the product. There is no effort to educate the public on any insurance issues.”
An Oklahoma producer indicated that the insurers he represents have already taken some action: “My companies demand a replacement-cost estimator with every replacement-cost policy, and will only allow a small variance one way or the other.”
As a side comment, he wrote: “It amazes me how we see this problem consistently on the East and West coast, but not so much in the middle of the country. Even with [Hurricane] Katrina, the question posed most often was not one of property value, but rather a wind vs. water discussion.”
The catastrophe adjuster wrote that the problem began with insurers, which “started the problem with ‘full replacement cost’ policies. They also offered an inflation guard to help with the underinsured problem.”
A New Jersey claims consultant put insurers in “good, bad and ugly” categories: “Good is requiring a full inspection at placement and follow up at renewal. They also ask adjusters for comments on property condition and values any time there is a loss. Bad is little or no inspection, or even photos. Ugly is when an insurer just accepts information on the application.”
The Florida producer supported the consultant’s position: “Companies must get realistic values, use inflation guard as part of the policy--or at least as an option--and use renewal questionnaires to get value information.” He also--as did most respondents--put part of the responsibility on the consumer.
The compliance officer believes “insureds must report changes to the property, have an agent physically review a renewal, and call for an update when needed.” This was supported by the Illinois producer, who suggested that the “principal cause of underinsurance is the failure of the insured to report improvements.”
Another producer noted a problem in dealing with insureds: “Getting a homeowner to accept suggested limits or do an appraisal is like pulling teeth, only the sound is worse!”
Another adjuster summed up all comments toward insurers and insureds: “Insurance is like the police--you don’t want to deal with them until you need them. People refuse coverage increase suggestions and under-report square footage. Insurance companies do not go out and look at properties”
A loss control executive echoed the adjuster’s comments by asking: “Why haven’t insureds increased limits after all the stories on the news about underinsurance were trumpeted in the press? Did they pinch pennies? Did they say, ‘It will never happen to me?’ Why didn’t insurers inspect to see if homes were insured for value?”
In summary, those commenting on the ethical duties of producers uniformly agree that valuation methods must be explained to insureds, automatic coverage increase options should be offered, and insureds must be instructed to report changes made to properties that affect values.
Insurers should require some verification of values, with appraisals the best option. Insurers should also offer automatic value increases.
Ethically, consumers must give accurate information about their properties and, if needed, seek assistance in helping determine values.
(Peter R. Kensicki is a professor of insurance at Eastern Kentucky University in Richmond, Ky., as well as a member of the Ethics Committee of the CPCU Society in Malvern, Pa. He may be reached at ethics@eku.edu.)
Comments (16)
The answer to your question is found in Everett v. State Farm General Insurance Co, published April 29, 2008, where the California Court of Appeal applied the terms of the contract after the insured complained she did not have enough insurance and could not replace her house after a loss. The court said:
"Here, State Farm provided Everett with more than sufficient notice of the changes in her policy. According to the record, State Farm mailed to its insureds, including Everett, a notice informing them of the reduction in coverage. Specifically, the notice informed Everett that the "Guaranteed Replacement Cost Coverage" was being eliminated. Nonetheless, Everett maintains that the notice failed to "clearly explain" that there was a limit on the amount of coverage. We disagree. The notice stated: "Your policy now has a stated limit of liability under Coverage A that reflects the maximum that will be paid in case of loss."
If Everett did not understand what was being changed with respect to her coverage, she could have called her agent, or State Farm directly, for clarification. She did not do so. Based on the above, Everett's assertion that she did not get sufficient notification of the changes in her policy fails.
* * *
"The fact that Everett did not understand the 1997 notice informing her that her guaranteed replacement cost coverage was being eliminated is her fault. State Farm did not misrepresent anything regarding Everett's insurance policy.
Thus, Everett is unable to show how the defect in her pleadings can be cured by amendment. As such, we find no abuse of discretion in the trial court's decision to grant State Farm's motion for judgment on the pleadings as to Everett's claim for reformation."
Perhaps more people will read their insurance contracts and stop bringing suits that they believe will succeed because the defendant is an insurance company.
Posted by Barry Zalma | May 1, 2008 12:17 PM
Posted on May 1, 2008 12:17
In 2006, Marshall & Swift/Boeckh, a leading provider of building cost information, reported that as many as 58 percent of U.S. homes were underinsured by an average of 21 percent.
In the aftermath of a catastrophe, such as a hurricane or sildfire, the news media and certain consumer groups try to place blame on insurance companies and agents for not making sure the homes were adequately insured. The harsh reality is that policyholders are ultimately responsible for properly insuring their homes.
One of the current challenges in obtaining proper “insurance to value” is that the general public does not seem to understand the difference between the real estate value of their home, versus its replacement cost (what it will cost to rebuild). The rebuilding cost can be significantly higher than the market value of a home. For example, if a policyholder purchased a newly constructed home in a subdivision for $200,000, the original builder had economies of scale when he built several similar homes. Now, it may take $225,000 to rebuild that one home.”
There are a number of additional reasons why a home may be underinsured:
• As home prices have declined over the past year, it may cost more to rebuild the home today than it can be sold for.
• The cost of building materials has been rising faster than inflation. For the past three years, material costs have increased by six percent or more each year. Material prices can rise even higher after a catastrophe due to increased demand.
• When a home is partially, but significantly damaged, the specialized skills needed to repair it may cost more than typical new construction costs.
• When purchasing insurance, the homeowner may not have mentioned expensive features within the home, such as a finished basement, granite counter tops, custom cabinetry or upgraded wall finishes or flooring.
• Oftentimes, people forget to inform their insurer about home improvements that have been made, such as a new addition, a remodeled kitchen, bath, sun room or a built-in home theater entertainment center.
• Due to financial constraints, some homeowners buy less insurance than needed because it’s all they can afford. Other homeowners may simply want to economize and keep their premiums low.
Most insurance companies and their agents take a variety of steps to help ensure that policyholders’ homes are adequately insured. During the application process, for instance, an automated home cost estimator is typically used to develop an appropriate replacement cost based upon the information supplied by the applicant.
At each renewal, dwelling coverage limits are adjusted to reflect changes in building costs. Coverage limits are clearly displayed on the renewal declarations page. Often agents will contact their policyholders on a regular basis to inquire about their changing needs.
It is in their mutual interest for both companies and policyholders to have homes insured correctly.
Companies and their agents do their best to assist each policyholder in determining an estimated replacement cost for their home. However, they still need to rely on the information the customer provides to them. If the information they receive during the application process is accurate and the insured keeps them informed about changes, the home’s replacement cost amounts should keep up with the current rate of inflation and rising construction costs.
Posted by Tom Icatar | May 1, 2008 1:36 PM
Posted on May 1, 2008 13:36
Suggestions for follow-up columns...
It would be interesting to see how the responses differed if the respondents were policyholders and their representatives rather than insurers and producers...who both have a vested economic interest in not being legally responsible.
It would also be interesting to hear what the original respondents think ought to happen to the insurers and producers who fail to fulfil their ethical (though not, legal) obligations.
Posted by John Ference | May 1, 2008 6:50 PM
Posted on May 1, 2008 18:50
As Tom Icatar points out, there are many reasons homes are underinsured and, also, undervalued. In 40 years of service I found that relying on the valuation services, underwriters had a very poor representation of what the actual value of a building was.
No matter how you apply the various factors, the values come up as "averages" and do not accurately represent the actual building you are looking at, whether industrial, commercial or residential.
I had many conversations with home office personnel regarding their various electronic and online systems that we used, as well as that of other valuation services, and we never came to a solid conclusion that true value would be obtained using the calculators. So, a ballpark value, at best, is what you'll get. And that can be a very BIG ballpark!
I might be accused of favoritism here, but the Auto Club (AAA) in Southern California sends out a detailed questionaire about your home on a regular basis, asking about construction details, interior finish, floor coverings, and details about each room, ceiling heights (cathedral ceilings), fireplaces, built-in appliances, upgrades to the original home, heating/cooling, plumbing, garages, outbuildings, and other upgrades etc.
They then use that in figuring value increases for the renewal policies, even though many of their policies do include guaranteed replacement costs, either with or without code and ordinance upgrade coverage.
Personally, I think that places the onus on the homeowner to complete the form and spell out the details. Certainly not as good as a professional home appraisal, but they do sign and state the information provided is true to the best of their knowledge. It at least makes them cognizant of what they have and maybe a party to improved coverage for their homes.
If you look at the record, AAA was one of the few companies who had an exemplary record following both of the past wildfires in San Diego County. They must be doing something right.
Posted by BJ | May 1, 2008 8:39 PM
Posted on May 1, 2008 20:39
Here is a specific problem that the Consumer Federation of America is very worried about for consumers living in catastrophe-prone areas.
Most homeowners insurance policies now contain a provision that limits the replacement cost coverage for a dwelling to the stated amount in the limits of liability section of the policy--or some percentage, such as 25 percent, above the stated amount.
This relatively new approach to determining replacement value, usually called “Extended Replacement Cost” or something similar, has replaced the “Guaranteed Replacement Cost” in use previously on most homeowners insurance policies.
The purpose of the change was to allow insurers to limit the amount they paid out should a home not be insured for its appropriate value when a total loss occurred.
This is understandable in some instances, such as where an addition was added to a home and the insurer was not notified, or where an insured customer simply understated the amount of insurance to save money on premiums.
However, there are instances where the use of this provision is very dangerous for consumers.
Take, for instance, a large event such as a hurricane or wildfire, where many homes are damaged and/or destroyed. Suppose an insured party does all that is possible to properly determine the replacement cost of his or her home, including paying for an appraisal and discussing the value calculations with the insurance company. Suppose further that everyone agrees that the value to replace that home is $200,000 and the policy covering that home has an extended replacement cost clause that would pay up to 25 percent over the stated amount, or $250,000.
This is an example of a consumer who has done everything in his or her power to properly evaluate the replacement cost.
Then the hurricane or wildfire happens. Many homes, including the properly valued home mentioned above, are destroyed. Everyone seeks contractors to restore their homes.
The high demand causes a “demand surge” in prices for materials and labor to restore homes to their original state. Suppose the cost escalates by 50 percent, which is what happened in some areas after the 2004 and 2005 hurricanes.
Our hypothetical insured homeowner now requires $300,000 to rebuild the destroyed home as it was. But the insurance will only cover $250,000 (or only $200,000 on those policies that offer no extension).
This situation is not acceptable for consumers. This is a shift of risk from insurers to consumers that have done the right thing and their very best at buying insurance to value.
We believe that insurers should take the demand surge risk.
Posted by Bob Hunter | May 2, 2008 8:33 AM
Posted on May 2, 2008 08:33
In my experience, I found the policyholder was the driver in underreporting of inventories and personal property, subject to coinsurance requirements.
Conversely, when it came to structures, especially dwellings, I'd have to point to the agent. If he or she went out and did the basic measurement and cost approach, it is hard to see how the coverage could be inadequate from the start.
Posted by Bill Brauer | May 2, 2008 12:04 PM
Posted on May 2, 2008 12:04
In response to Bill Bauer:
I do not hold a Contractor's, HVAC or Master Plumber's license. I am provided by the carrier a very simple and inaccurate program to establish a STARTING point for replacement costs.
The same program can vary dramatically from each carrier depending upon their factors. Agents have a financial stake in each customer being insured to value.
P.S. I do not practice law, marriage counseling or child-rearing practices. I am just the dumb old insurance agent.
Posted by Anonymous Agent | May 2, 2008 2:24 PM
Posted on May 2, 2008 14:24
Surely, someone out there has a professional obligation to his or her customer. Is this not the entire reason industry professionals obtain at least one if not any number of insurance designations, including the CIC (Certified Insurance Counselor)?
Call me mad-capped, but the word counselor sticks in my mind. Working at the company level, it is amazing to read the comments made by the various respondents.
Is it my understanding that I am to believe these agents get a signed release from their customer stating they understand the valuation of their property may not meet the requirements of the policy and accept the penalty?
Am I missing the whole "errors and omissions" thing or doesn't that come into play here?
Regardless, it is still amazing... This industry has certainly taken a turn for the worse over the past 20 years if the only thing an agent is worried about is their commission and not their customer.
Posted by Curious Company Comment | May 2, 2008 3:02 PM
Posted on May 2, 2008 15:02
It is the agent's responsibility to make sure the insured understands the valuation the policy requires?
No matter how good the explanation, most homeowners are reluctant to pay additional premiums.
I recently added a sunroom and, amazingly, was very hesitant to advise my insurer. I did, and I didn't like the additional premium. If I, an insurance professional who explains this stuff all the time, am so hesitant when it's my own money involved, just imagine the average insured.
Yet the basic concept of market value vs. replacement cost value is still grossly misunderstood by insureds.
The Miami Herald just published a letter that said:
"When you purchase a new home, you're forced to carry insurance equal to the purchase price. Why?
"I'm quite certain that if it (a shack on a large parcel of ground where she had purportedly been forced to insure for the amount of the mortgage) had burned to the ground, I wouldn't have been compensated for more than the value of the structure.
"I'm sure the insurance industry wants no part of this kind of thinking, but I'll bet my fellow Floridians sure would".
Now, despite the effort of diligent agents to explain how dwellings should be valued, hundreds of thousands of South Floridians now know for sure they are liars and that all insurance companies are thieves, aided and abetted by crooked agents.
The Miami Herald did a gross disservice to insureds and agents by publishing this letter without first checking out her allegation and at the very least providing a correction to go along with the letter.
But, what do they care, we're all thieves anyway, right?
Posted by Bill Lockhart | May 2, 2008 3:31 PM
Posted on May 2, 2008 15:31
Why is it that the consumer can navigate the myriad complexities inherent in the usage of computers, electronics, automobiles and the like yet fail to take the necessary steps to insure their most valuable asset? Their home?
Insurers should insist thru their selling intermediaries that a tacit acknowledgement that replacement values were discussed and agreed upon be obtained prior to policy issuance. Of course this might be too simple.
Posted by Marc Dubois | May 2, 2008 3:54 PM
Posted on May 2, 2008 15:54
After reading the many comments recorded on your blog, I will comment on only a few.
Overall, it is the insurer's responsibility to educate producers with regard to properly insuring real property.
During my time as a commercial underwriter, I had occasion to decline coverage on commercial properties that were undervalued. In each case, the producer was very unhappy and conveyed my declination to his client.
They all--every one-- agreed that their property was underinsured and was appreciative of the information. Arrangements were made for an appraisal to be made.
The insured benefitted-- the company benefitted-- the producer benefitted.
Any company that issues a policy with a Replacement Cost provision has an obligation to verify the replacement cost at the beginning of the coverage period and, at least, annually thereafter.
One producer commented that if the underwriter doesn't live in the area, how is he to know what replacement cost is? Well, it is his/her responsibility to learn this if he is going to do a professional job of underwriting.
Companies that write coverage in areas that could be subjected to catastrophic loss, need to take the potential of loss into consideration when providing coverage in that area-- or do not write there.
It is no surprise that an insurance executive would pass the responsibility for deciding what replacement cost should be to anyone else His training and experience is obviously inadequate as is the overall professional training for underwriters industrywide.
As far as stock values are concerned, agents need to confirm these values at the outset and companies need to audit the exposures annually.
Personal lines underwriters and producers should follow the same procedures to verify replacement cost for dwellings.
In addition, since mortgage companies require the Section 1 limit to equal the mortgage value, there should be a provision in policies to separate the value of land purchased with the structure(s) plus the underground pipes, and the like, that are included in the purchase price, but not included in policy coverage. A token rate should apply.
In the case of a new building, the mortgage company requirement could result in a policy limit in excess of replacement cost. The premium is also excessive.
In the case of a purchase price that is below the actual replacement cost of the dwelling ( and outbuildings), the agent is responsible for knowing the replacement cost of a dwelling of like kind.
Again, it is the responsibility of the insurer to educate the producer. otherwise, neither insurer nor producer are performing at a professional level.
In one survey, it was found that 96% of the commercial accounts were underinsured. The obvious impact is loss of premium.
What effect would this have in today's market? More money to pay catastrophe losses; better service to insureds; more commission to producers.
Win-win situation. This can be accomplished if professional standards are put into place--instead of passing the buck.
Posted by Frank Ridgway | May 2, 2008 7:29 PM
Posted on May 2, 2008 19:29
After being in the property claims end for over 30 years, I can say that it is both the carrier's and insured's fault.
When I first began, there was three ways the replacement cost was determined. Either the agent went out and did a square footage or the carrier had an ispection company go out at the application time.
If a claim occured, the adjuster did a replacement cost estimator while they were at the claim. Then every three years of so the company had an inspection company perform another to see if any changes of the property had been made.
Today, the carriers are so cost-conscious, they will not even consider spending a dime to protect themselves. They are of such a mind set on cost, that spending a dime is not in their interest, even though by spending the money, they can get a detailed description of the property.
Who knows, they might not want to write the property after seeing the photos? Better yet, it may show such pride in ownership the insured may be entitled to a discount and a risk the carrier would love to have.
Many times this industry brings problems on itself. This is one of them.
Carriers scream about retention of business as it costs so much to write new. Then make sure you do the job correctly the first time. You have to spend some money up front at times to make sure you know what you are writing.
As mentioned, insureds are not always going to be quite honest about the features of the house. As AAA SoCal does, ask a ton of questions, get the inspection done, follow up yearly. If you do not want to then so be it and be quiet.
Posted by J R | May 2, 2008 8:55 PM
Posted on May 2, 2008 20:55
This is an interesting and serious issue and I enjoyed reviewing the previous comments. My perspective is from the view of a personal lines producer, who occasionally writes a commercial policy.
Obviously, determining what is the right replacement cost is an art, not a science, and as soon as we arrive at the RC figure, it's outdated, just as a flood hazard map is when issued, because changes are taking place that impact the result on a daily basis.
I believe all the parties have a stake and are responsible for what winds up as the Coverage A limits.
I, as the agent writing the coverage, inspect the property, take measurements, photos and utilize the RC estimators the carriers provide to me.
Any agent who writes property coverage without locating the property on a map and visually inspecting the insured property is guilty of sloppiness and lacks the right to call themselves a professional, besides doing a disservice to his clients and the carriers he represents.
The carriers usually require we provide them with the photos we have taken and a copy of the RC Estimator results or the online results of the latter calculation.
They, also, doublecheck our work by having an inspection done so they have more than one set of eyes arriving at the RC amount.
If our figures vary, the carrier normally sends us their inspection report to review and comment on.
Our RC calculations include an estimated figure for debris removal, which can greatly impact the final figure.
There should be an industry standard for this type of activity. It's too important not to have one.
One last thought regarding the third part of this equation--the insured.
They almost always look at the bottom line--What's it going to cost me?--rather than--Am I adequately insured?
Posted by Steve Daroff | May 5, 2008 3:11 PM
Posted on May 5, 2008 15:11
Bob Hunter mentioned "demand surge," and that was one issue we faced in Florida and Southern California as well as many other areas following catstrophic losses.
However, trying to prepare and insulate against demand surge potentials is impossible, as I found given that task by our president some years back. What I found, however, was interesting.
The cost of materials surged as a result of demand, such as plywood for barricading windows prior to hurricane arrival, as well as that expected to be needed for post-storm repair and rebuilding.
In some areas, the shortages of plywood and lumber pre-storm raised the prices as much as 30-50% and a huge influx of additional supplies followed, resulting in a glut on the market of excess materials that were not needed. The cost of materials then plummeted to 20-30% under the original wholesale prices.
Cycles such as this continued in storm-prone areas (I thought everyone had enough plywood to last a lifetime) until the big storm hit and the surge demand cycle started all over again.
The facts are that there is no reasonable way to prepare for the surge demand, so the insurer, as Bob Hunter states, must be prepared to "bite the bullet" for those costs.
But, in retrospect, for homes that take many months to rebuild, and delays due to permitting processes, etc., there can be some economies realized as the demand dwindles and the costs of materials drops significantly, and the insurer should be attuned to those potentials as well.
Posted by BJ | May 5, 2008 3:59 PM
Posted on May 5, 2008 15:59
For the home's value, an up-to-date replacement cost estimate is ideal. Insurers are in the best position to confirm a value for the insurance replacement cost of the home, via inspections or other tools, given that they insure thousands upon thousands of residences.
For the personal property value, a documentation of costs paid is the best tool. Consumers that document the cost of what they own are in the best position to recover full value, come claims time--assuming, of course, proper insurance-to-value, policy provisions, etc.
The discussion about ethical, moral and legal responsibilities is vital. And in large or catastrophic loss scenarios, society and individuals want to know who's at fault, presumably to learn from mistakes and improve outcomes for the next time. And agents will always be squarely in the middle of it.
But in practical terms, it's clearly better for both agents and carriers, from a proactive customer-service perspective (read smooth claims-handling) to work before the loss in a cooperative risk management fashion with the policyholder.
Posted by Lou Granados | May 8, 2008 3:20 PM
Posted on May 8, 2008 15:20
It is amazing that the insurance contract can be incepted on "utmost good faith" but requires "utmost proof" against, under-insurance.
How has law allowed, for more than two centuries now, two different yardsticks to be applied in one contract ?
Is there any other commercial contract that permits this kind of dual yardsticks for performance ?
Posted by P.Chandrasekar | May 15, 2008 12:54 AM
Posted on May 15, 2008 00:54