Author: David Thompson
In 2004 Marshall & Swift/Boeckh released a study indicating that 64 percent of the homes in the U.S. were underinsured by about 27 percent. On the commercial side of the fence things were even worse with an estimated 75 percent of commercial buildings underinsured by about 40 percent. In 2010, insurance industry research(Marshall & Swift/Boeckh) indicated that 64 percent of homes were underinsured by an average of 19 percent and also stated that Americans will spend $110 billion on home improvements and additions in the year. Then in 2013, Marshall & Swift/Boeckh indicated that 60 percent of homes were underinsured by an average of 17 percent. In addition to increased construction costs many homes are not built to current building code and that fact could result in significant out of pocket costs if the appropriate building ordinance and law coverage isn't added.
Prior to a loss the policyholder cares little about being underinsured. After all, underinsurance today means lower premiums and it's not until the time of a significant loss that the problem of underinsurance rears its ugly head. It's estimated that the insurance industry loses over $8 billion a year in premiums due to the underinsurance issue.
Whose Problem is it?
When a policyholder suffers a significant property loss and finds that the building and/or personal property limit of coverage is inadequate to properly cover the loss, whose problem is it? Does the policyholder have any share in the blame? How about the agent who wrote the policy; should the blame fall on him or her? Or, what about the insurance company who issued the policy; if they are the ones to suggest the specific cost estimating software used shouldn't they bear some of the responsibility? Finally, what about other parties such as appraisers, lenders, or companies who provide replacement cost estimating software; is there a possibility that these individuals or entities should bear some responsibility? Several court cases are relevant to the issue.
In the 2005 Massachusetts case of Martinonis v. Utica National Insurance Group, a homeowners policy provided $460,000 of Coverage A and at the time of loss the damage was estimated at over $1.1 million. The trial court found for the agency/company but the insured appealed. The policyholder had been a customer of the agent for nearly 10 years. The agency had previously advised the policyholder that their contents limit was inadequate and on the agent's advice the policy was increased. The policyholder expressed concern about the adequacy of their building limit but the agency assured him the coverage was adequate. On appeal the court found in favor of the policyholder stating, in part, the following: "There is no general duty of an insurance agent to ensure that insurance policies procured by him provide coverage that is adequate for the needs of the insured…[however] in an action against the agent for negligence, the insured may show that special circumstances prevailed that gave rise to a duty on the part of the agent to ensure that adequate insurance was obtained." In short, because the agency represented themselves as experts on building costs and assured the policyholder that coverage was adequate, the court found against them.
An interesting 2006 Florida case is AMH Appraisal Consultants, Inc. and Ann Marie McCarthy, Appellants, v. Argov Gavish Partnership, Appellee. As the building owner Argov obtained the services of AMH Appraisal Consultants to provide an appraisal on their building. The appraisal, showing a $1.6 million replacement cost, was subsequently used by the insurance agency in providing a coverage limit for building property on the insurance policy. After a total loss it was determined that the policy limit was inadequate. Argov brought suit against AMH alleging an inadequate appraisal. The trial court found AMH liable, and they appealed. On appeal the appraiser alleged that the insurance agent was negligent in not knowing the appraisal showed an inadequate replacement cost figure. The appeals court upheld the decision of the trial court against the appraiser and stated: "It is the position of the appraiser in this case that the insurance agent should have scrutinized the appraisal and recognized that it was too low. Given that appraising requires expertise, and that the insurance agent did not have thatIn the 2004 Georgia case, MacIntyre & Edwards Inc. v. Rich a homeowners policy had been issued by the agent to the plaintiff in 2000. The policy included a provision providing an unlimited amount of "Coverage A" if the rebuilding cost exceeded what was provided in the policy. In 2001 the policy renewed with a cap of 125 percent on this additional coverage. The plaintiff acknowledged receiving the change notice, but stated he never read it. After a fire in 2001 both the agent and the claims adjuster assured the plaintiff that his policy provided unlimited Coverage A after it was clear that the policy limit was inadequate. The adjuster later contacted the plaintiff to correct his earlier statement and to advise him of the 125 percent cap. The court found against the plaintiff and stated, in part, the following: "In general, an insured has an obligation to read and examine an insurance policy to determine whether the coverage desired has been furnished. Scott Rich says he relied upon the agent's word that he had unlimited replacement coverage. But even if he did, that would not absolve him of his responsibility. In other words, if it is readily apparent that the insured did not get the coverage he requested, the duty to read will still bar a lawsuit against the agent even if the insured relied upon the agent's expertise. The Riches have not shown that they relied upon the agent's expertise. To show reliance, the Riches would have to show that the agent performed expert services on their behalf under circumstances in which they had to rely on the expertise of the agent to identify and procure the correct amount of insurance."
In the 1992 California case of Free v. Republic the court stated, in part, the following: "Generally, the duty of care owed by an agent did not require the agent to advise the homeowners regarding sufficiency of limits."
In the 2009 Washington State case of Peterson vs. Big Bend Insurance Agency & Grange Insurance Association the insured had a homeowners policy providing $193,000 of dwelling coverage. The house was totally destroyed and the carrier paid the policy limit. The cost to replace the house was, however, $328, 843. Investigation showed that the agency incorrectly completed a replacement cost estimator and had they correctly use the program the replacement cost would have been estimated at $240,000. Because the agency did not properly use the replacement cost estimator, the court awarded $240,000 to the customer. The point to be noted in this case is that agency personnel should accurately and completely utilize the features of replacement cost estimating software.
Given that few, if any, insurance agency personnel are experts in building costs, it is in the best interest of the agency to not claim to be construction experts. By its very nature the construction of buildings is not an exact science. Five different builders would have five different estimates for the construction of a building. Agency personnel should refrain from assuring policyholders that an amount of insurance will definitely be adequate to rebuild a building or replace personal property after a loss. Making assurances that "this is the exact amount of coverage you need to rebuild" will likely create the very "special circumstance" referred to in the Martinonis case and has the end result of holding the agency to a higher duty of care.
An agency may wish to consider a waiver to be used with customers in order to help make it clear that the agency does not guarantee the policy coverages will be adequate. FAIA's E&O carrier has approved the following wording for a waiver:
Building and personal property coverage limits are estimates only and were arrived at based on information provided by the policyholder and/or industry standard software used to estimate replacement costs. The actual cost to rebuild the structure or replace the personal property may exceed the policy limits, especially in circumstances where a catastrophic event has disrupted the normal supply of materials, labor, and resources. The agency makes no assurances or guarantees that the policy limits provided will be adequate to rebuild the structure or replace personal property. If there is doubt about the adequacy of the policy limits, the policyholder should obtain a professional appraisal or obtain the services of a qualified company or builder who is able to provide replacement cost estimates.
Agency Procedures in Determining an Estimated Replacement Cost
There are a variety of tools available to an agency to assist in developing an estimated replacement cost of a structure. Additionally, various procedures can help keep policy limits up to date.
Cost Estimators: Absent any other better data, a properly completed cost estimator is the best tool an agency can use to determine an estimated replacement cost. It's important to note the title of these documents: cost estimators, not cost actuators. Cost estimators were never intended to provide THE replacement cost of a structure, just the estimate of a replacement cost. If an agency used three different cost estimators on a structure the result would be three different replacement cost estimates. It's important to complete the forms properly and make certain that key components like square footage are correct. Relying on the policyholder to provide an accurate square footage is dangerous since many building owners don't know the square footage. Property appraiser web sites can often provide valuable information about the building and agency staff should consider inspecting the homes to make certain that there have been no additions that are not reflected on the appraiser's web site.
Regular updates of cost estimators: Building costs increase at different rates around the country and at some point the cost estimator needs to be completed again, starting from scratch. Admittedly this requires additional work by the agency staff, but it's essential in order to best keep coverages current. Many agents have advised FAIA staff that some companies require updated cost estimators on property risks from time to time.
Surveying Customers for Additions and Upgrades: The National Association of the Remodeling Industry reported in 2006 that Americans spend over $230 billion a year remodeling and upgrading their homes. That same year the Independent Insurance Agents and Brokers of America reported that an estimated 40 percent of those who do remodel fail to consider the implications on their homeowners policy. The same could likely be said of commercial building owners too; a significant number of building owners make improvements and additions to their buildings that affect the amount of insurance needed. Since so many policyholders don't advise the agency of these building changes the agency should have some system in place to regularly contact policyholders and review coverages. It's much like an annual physical at the doctor's office where the doctor "pokes and prods" and asks numerous questions. Many agencies send out an annual questionnaire while others strive to contact every customer every year or two.
Endorsements That Provide Increased Limits of Coverage: On the personal lines side some insurers offer endorsements that provide increased amounts of Coverage A if the policy limit is inadequate. In years past these endorsements provided unlimited funds to rebuild. The Oakland fires of 1991 and Hurricane Andrew in 1992 began a trend of companies applying caps (typically an additional 20 percent, 25 percent, or 50 percent) to the coverage. Some lenders and consumers refer to these endorsements as "Guaranteed Dwelling Replacement" endorsements. Agencies should not use or acknowledge such a term since "guaranteed" does not really exist. When available these endorsements do serve the purpose of providing additional coverage when the building limit is exhausted. Not all companies offer these endorsements so it's critical to advise the customer (and lender) of its availability and conditions.
A Willing Underwriter: Some company underwriters are willing to work with the agency in determining a coverage amount. One underwriter advised FAIA that in cases where the cost estimator showed a figure that was lower than the policyholder felt was adequate she would use various methods to try to develop a higher figure. She suggested using various cost estimators to see what each came up with, requesting photos of the house along with written statements about what made the house unique, or suggesting that the policyholder obtain the services of a professional appraiser.
Builder's Estimate: It may be possible for the policyholder to have a local builder provide a detailed estimate outlining the estimated current replacement cost of the structure.
Web Resources for Cost Estimators: The web sites below provide resources for the agency to use in referring customers. Agency personnel should make certain not to recommend a specific company and should not represent that any specific web site or firm will provide "the magic number" for insurance purposes:
Marshall Swift:
Marshall & Swift® Cost Approach | CoreLogic®
Products and services are available for purchase.
Xactware: www.xactware.com
Offers replacement cost software to agencies.
Building Cost.Net: www.building-cost.net
A free web-based replacement cost estimating program.
Summary
There is no "silver bullet" when it comes to solving the insurance-to-value and underinsurance issue. Accurate replacement cost estimators, regular updates, and disclaimers are the best tools that an agency has when it comes to providing adequate coverage and avoiding the appearance of being the expert on building costs.
Copyright FAIA, 8/19/13, David Thompson
Last Updated: April 12, 2024