DISCUSSION PAPER
ON A NEW APPROACH TO DETERMINE BUILDING LIMIT
Background
As we all know, one of the most controversial issues with regard to house insurance is the determination of the limit of the dwelling to be insured. Whilst physical inspection and appraisal would seem to be the more reliable approach, this method is neither realistic nor practical from both costing and timing point of view. Further still, appraisal by its nature is both a science and an art. Being partly an art, personal judgement steps in and expectedly, different appraisers will come up with different results when appraising the same property.
The current industrial standard is to accept evaluations made by brokers as long as they follow one of the generally accepted evaluation tools, such as Powerhouse, RCT, RSMeans, etc…
The unfortunate fact is that even for the same property, different brokers will arrive at different results applying different evaluation tools. Complicated further is the fact that even with the same tool, different ways of gathering information, interpreting information and inputting information may also result in different building values. These differences, unfortunately, may vary significantly and not surprisingly over $100,000 in value in some cases.
The result is obvious, i.e. the premium can vary significantly for the same coverage on the same risk.
For the insurer, the company may be bound with a substantially underinsured property and still have to bare the risk of GRC under the terms of the policy as long as the insured disclosed correct information about his/her house and the broker did the evaluation under one of the accepted tools.
For the broker, the agent may lose the business to competition if the client cares to shop around and get one who happens to work out a lower building value resulting in a lower premium.
For the insureds, some of them may be unknowing paying too much in premium for the same house for years if their broker being too over-cautious as to attempt to err on the high side when evaluating building values. The end result will be that the general public will gradually lose faith with the insurance brokers and the insurance companies as different brokers may have different versions of building value for the same property.
The unfortunate fact is that there is no “true and correct” building value for any property at any time.
Possible Solution
Being able to identify the cause, it should not be too difficult to find cures. The cause, as stated earlier, is the lack of a commonly accepted “standard value” for insurance purposes for each particular house. Compare with automobiles insured by ICBC, things would be very much simpler. All cars, once registered and insured in BC, will have specific values attached to each one based on its make, model, style, year, etc & etc…. Brokers selling car insurance will only have to compete for service and may be convenience as the premium for the same coverage for each car will be exactly the same with ICBC no matter where the insureds like to do business with.
The question now is “how to determine an accepted “standard value” for each house for the industry?”
The rules for finding a hypothetical standard value for a house should include at least the following:
a) The value should be based on only one of the currently generally accepted evaluation tools;
b) The building size should be based on available information from government sources (e.g. BC On-Line) supplemented with the Insured’s information, if available;
c) The evaluation should preferably be done only by one independent party instead of being dealt with by several perhaps competing parties;
d) The value should be adjusted by a common inflation/deflation factor (material/labour costs etc.) on an annual basis;
e) The same building should be re-evaluated again under the same principle once every 3 years;
As mentioned in item c) above, it would be very preferable to have only one independent partly to do the evaluation and every broker to seek such information from him over the web. By confining to only one source of information, this guarantees a common standard base for all insurance brokers, all insurance companies (save a few who do only the direct-writes) to work with.
As long as there is the “independent party” doing the job of evaluating building values for each house, and as long as it does its job properly in accordance with the above guidelines, further as long as all insurance companies honour a common accord to accept only that “standard value” for insurance purposes, everybody will be playing on the same level playing field.
For the insurance companies, they do not have to worry too much on underinsurance as the building values will be impartially evaluated by the “independent party”. The risk of houses being underinsured, if any, would be exactly the same for one company as for any other company taking the insurance for the same property. In other words, the basis of protection will be the same for every insurance company and all they need to concentrate on for competition will be service(particularly claim services), coverages and rates (“real” rates versus currently “apparent” rates as the bottom line premium being subject to the amount of the building value which at present is a variable figure). These measures can then be more easily quantified (except for service) and the actuary teams will find their lives easier to be more able to come up with “real” rates competitive enough and yet profitable.
On the broker side, things will be much more obvious. First and foremost, brokers will no longer be faced with the stressful task of evaluating dwelling limits for insurance. They no longer have to risk either a) possibility of losing customers to competition due to over-cautious assessment; or b) possibility of an E & O claim due to under-insuring the property. As far as brokers are concern, they can concentrate more on their more important roles as:
a) to explain coverages and general principles of insurance to the clients;
b) to promote the image of insurance companies and the general concepts of insurance to the public;
c) to earn the trust of the insureds to enable the business of insurance to grow;
They will find that they will be placed for the first time on the same level playing field with every other broker and compete solely on their professional knowledge, service, convenience and choice of markets.
Last and not the least, Insureds will also be greatly benefitted from the new approach. They will gradually begin to feel more comfortable with their brokers, with insurance companies and regain the faith on them at least in the aspect of the insured amount. There will never be different versions on how much their houses should be insured for. Over time, the confusion that has always been on their minds as to why different brokers can suggest different insured amounts on the same property will vanish. That would encourage insurance companies to compete more on the most basic elements in the general economic theory, i.e. pricing and service.
Would the new approach not therefore be a WIN-WIN-WIN situation for ALL?
Alternatives
I. Until such time as that “independent party” comes into being, the next alternative may perhaps be to control conflicting assessments. The industry at present seems to be heading for the wrong direction on this by accepting more and more “evaluation tools”. “Choice” is often positively received, but in this situation, more choices only give rise to more confusion. Instead of accepting more evaluation tools, the solution seems to be exactly the opposite. By restricting to accepting just one evaluation tool (as agreed by ALL insurance companies), chances of producing different spreads on the assessed value will be greatly reduced. The disparity on the bottom line premium will also be greatly minimised.
II. Back to Square One Approach – by offering an alternative for no GRC-no Single Limit policy.
The insurance companies should consider offering an alternative option to clients to insure their houses to 80% of the suggested values without the GRC and Single Limit endorsement. That way, insurance company will know fully ahead of time their maximum exposure and insureds will also know their liability in the case of total loss should they decide to take the “no-GRC” option.
FINALE
The suggestions are not meant to replace the appraisal method on high value buildings. It is also not intended to find the “true” replacement cost for every building. It is all about providing a fair and reliable common ground for the industry to concentrate on what it is expected to do best in the first place, i.e. insurance, not evaluation.
Stephen Tang AIIC CAIB January 2009