Hard Market Shenanigans

by the IIABA Faculty

Several agents for an insurer have started to sell reduced Homeowners limits. They tell their insureds that because their company will pay replacement cost (RC) of up to 120%, they can take 80% of the RC and, in the event of a total loss, collect full value. For example, they’ll insure a $150,000 home for $125,000 and, in the event of a total loss, the insured will (allegedly) collect up to the $150,000 limit. These agents don’t mention that the Personal Property coverage has been reduced by about $20,000 if the home is gutted, but not destroyed. Agents are using the cap on the RC like a peak season endorsement on a Business policy.

Ironically, premiums are increasing because agents don’t insure the homes to full RC to begin with. This is an injustice to the insureds and, in the event of a catastrophic loss, it’ll give the industry and agents a black eye. This is unethical at best and not serving the public’s best interests.

I have an insured for Auto only. I tried to place his HO with the same company. He stated that he had $85,000 on a 1,450 sqaure-foot home and that his current agent told him that the guaranteed replacement cost capping out at 120% would give him an additional $17,000 coverage in the event of a total loss, for a total coverage amount of $102,000.

I told him that agents have to prove, or should prove, to the company that they have the home insured pretty close to full replacement cost value. The 120% clause responds in the event of high inflation or if construction costs go through the roof as they did when Andrew hit Florida.

I gave him a quote for $145,000 using $100 per square foot as a guideline on the home. The incumbent agent told him to insure the home for $121,500 and, with the extra 120% cap on the RC, he’d have $145,000 for a total loss. This would keep his costs down. The insured stayed with the incumbent agent.

In another case, I was working with an insured to round out the account. The insurer had $133,000 on a home that was probably in the $190,000 range. The incumbent agent argued that the $133,000 with the 120% RC would give him about $160,000 in total coverage. But if construction cost rose during the year the insured could be as much as $50,000 to $60,000 underinsured — not to mention the insufficient Personal Property coverage of $133,000. The insured realized that his agent had been short-changing him for the past 20 years. I got this account.

FACULTY RESPONSE

It would be interesting to look at the policy form for the exact wording on the guaranteed RC coverage. I’d be curious to know if the policy wording requires the home to be insured to RC in order for this coverage to respond.

FACULTY RESPONSE

Most 'guaranteed' replacement cost policies still require, in the contract wording, the home to be insured 100% to value. The 120% factor is there in the event of unanticipated cost increases. Don’t agents who deliberately circumvent this language violate the insurance laws if these policy forms are filed and approved by the department of insurance? Sounds like they’re effectively issuing orally modified contracts, probably in violation of filing requirements. Since these agents are representatives of the insurer, I suspect they’re jeopardizing the company’s certificate of authority with this practice, not to mention taking advantage of consumers to make a sale.

FACULTY RESPONSE

The 'guaranteed home replacement' endorsement goes by several names. In my experience, every company that offered it required 100% insurance-to-value to add it. It was cheap, $1.00 to $5.00 back in my days. My current HO policy offers this endorsement for about the same cost. The actual endorsement says that I agree to insure for 100% ITV and requires me to notify the company if I undertake a modification of 5% of value or more.

The idea behind the endorsement is to give some 'wiggle room' in cases where estimated replacement cost is too low, or where costs escalate after the claim. Anyone who has ever done a cost estimator knows that they’re just that — estimates. Having a policy pay 120% of the replacement cost allows for slight errors in the form. Also, anyone who has ever been in a post-catastrophe environment (hurricanes, for example) knows that costs go up after the event. Labor and materials costs climb because of supply and demand. By stripping coverage to 80% then adding the endorsement, you’ve lost any cushion and are defeating the purpose of the endorsement.

I’ll bet if the company executives knew what was going on, they’d counsel the agents in question. If I had hard data proving what the agents were doing, I’d be inclined to contact that company and report the agents. Also, in many states an agent who intentionally puts an incorrect replacement cost on an application violates the state’s unfair trade practices law. Finally, the cost to go from 80% ITV to 100% ITV just isn’t that great. Everyone thinks, 'It’ll never happen to me.' But sometimes it does.

FACULTY RESPONSE

This practice has been around in California for a number of years. Unfortunately, I don’t think there’s a way to stop unscrupulous agents from engaging in this activity. Agents who come up against this objection need a way to overcome it.

I’d suggest something like, 'I know you’re concerned about the cost of your Homeowners coverage, especially with the price going up this year. But can I ask you a question? If your home were totally destroyed by fire, would the cost of your insurance be your primary concern?' Of course not. Then discuss what would happen in the unlikely event of a total loss, perhaps using specific examples from high-profile situations.

This is indeed a disturbing situation, and not an isolated example. Unfortunately, the hard market (combined with insurer concerns over mold and other issues) has a tendency to bring out the 'dark side' in some agents.

FACULTY RESPONSE

The Oakland-Berkeley Hills, CA firestorm of 1991 resulted in 3,236 total and 2,892 partial Homeowner, Renter, Condominium, Dwelling and Apartment unit losses. Several agents were undervaluing building replacement cost estimates and relying on the guaranteed replacement cost provisions to cover the difference.

The practice became evident quickly as the losses were being adjusted. The increased cost to 34 insurance companies who upgraded and reformed policies following the loss was $274,017,306. This was the sum paid in addition to benefits within their previous policy limits.

This practice might also violate the agent’s contract with their company. A number of insurers reformed their agent agreements following the Oakland-Berkeley Hills fire.

I suggest that the concerned agent document these practices and take the information to the national (not the local) office of the insurance company. I’ve done this several times and found that reporting a pattern of abusive practices can stop it on the national level. The local supervisory offices are a little less predictable. They might be aware of the abusive practices and condone them. Or they might intervene right away.

This practice can, and should, be stopped.

FACULTY RESPONSE

I can visualize such unethical practice in companies whose agents are trained as 'salespersons,' not agents. Consumers contribute to the problem by dollar shopping. They don’t want to hear the truth if it costs $10 more. They think, 'It’ll never happen to me.'

The media, with their anti-insurance company attitude, doesn’t help. They have the public convinced that the big, bad insurance industry is out to rip them off with overpriced policies while the execs line their pockets. When a practice such as this is exposed, it adds fuel to the fire.

The insurance industry could do a better job of getting the truth to the consumer. We share information among ourselves, but this only makes the ethical and professional more ethical and professional. We preach to the choir while the sinners turn a deaf ear.

I’d like to see a contract with this company to read just how the replacement cost section is worded.

FACULTY RESPONSE

This behavior isn’t new. The only good news is that their companies generally have a 20%-25% cap now, instead of selling an unlimited GRC.

Another limitation to point out to policyholders is that the increased coverage won’t apply if the homeowner fails to notify the company of substantial improvements they make to the home. One recent article indicated that 80% of those who make improvements to their home never contact their agent to discuss the need for increased coverage. One of the biggest problems I see is people adding a deck. They just never call.

FACULTY RESPONSE

Even when an insured and their agent think that the home is properly valued and insured, studies show that it probably isn’t. Here’s a quote from an article on MSN:

'A whopping three out of every four homes nationwide are underinsured, according to a survey by Marshall & Swift/Boeckh. This Princeton, N.J., company specializes in estimating construction costs, and its annual reviews of 3 million insurance policies consistently show homeowners don’t have enough coverage. We’re not talking small amounts, either. The latest survey showed the typical homeowner was underinsured by 35%.

'These figures aren’t news to the insurance industry, which has known for years that most of their customers weren’t buying enough coverage. The point was driven home again this year by the Colorado wildfires, which so far have cost insurers $79.3 million. '‘Most of the homes that were covered were underinsured,’ said Loretta Worters, spokeswoman for the Insurance Information Institute, a trade group.'

And, with regard to remodeling:

'Homeowners are remodeling like crazy. Americans spent $180 billion last year updating their homes, often boosting the value of their homes in the process. An estimated 75% of remodelers fail to update their insurance coverage to reflect those improvements,' said Bob Crine, president of Marshall & Swift, the construction estimating company.

'The company has found that homeowners consistently shortchange themselves when it comes to getting enough coverage,' Crine said. 'Homeowners have more at stake now, however, because so many insurers have capped their replacement coverage. In the past five years, the vast majority of insurers have done away with, or radically modified, their guaranteed replacement policies. Whereas once your company would rebuild your home no matter the cost, today most insurers cap how much they pay to 120% of your policy’s stated coverage amount.'

Sounds familiar, doesn’t it?

FACULTY RESPONSE

From a competitive standpoint, I think that this practice would be considered unfair and deceptive in your state and probably an unfair trade practice in most states, not to mention a possible violation of several other insurance laws.

Unfortunately, someone’s going to have to step up and file an official complaint in order for the DOI to investigate. I shudder to think what will happen to these agents and their companies in the event that a total loss (or several total losses) escalates into a full scale, possibly class action lawsuit and the media gets hold of it.

By undervaluing dwellings, these agents are commiting deliberate acts — which means that their E&O policy won’t cover them. And they know that a Personal Property claim under a total loss wouldn’t make the insured whole. These agents must be in desperate straits.

I’d write a letter to the company’s home office, outlining what’s going on and giving specific examples of properties you know are undervalued, and tell them that if they don’t take action, you’re going to take the matter to the department of insurance and call for a public hearing. It’s likely that the insurer doesn’t know what’s going on at the local level.

Sadly, some people are probably going to lose their jobs. But if the company can clean its own house, they’ll be better off than if the DOI intervenes and revokes their license — and livelihood. The saddest thing is that the well-being of innocent families is being threatened — and they don’t even know it.