The Borrower Objected to Paying for Adequate Property Insurance By Dan Harkey

What is property hazard insurance?

Insurance is a form of protection whereby insurance companies collect premiums en masse and use those premiums to reimburse accidental damages. The business strategy is to collect more premiums and pay out fewer claims! The purpose is to make a profit for the company and its stockholders. The insurance industry is systematically regulated and operates nationally and worldwide. There are many types of coverage and policies to insure for different risks.

Real Property insurance is a complex subject because there are many subsets of residential, commercial, business, and personal coverages. The insured categories include homeowners, condo/co-op, commercial property, renters, mobile and manufactured homes, liability, and personal property.

Covered events are called perils.  A peril is an event that causes damage or destruction to a home or property.   Insured perils are fire, windstorms, hail, theft, vandalism, and earthquakes.

Insurance is not for property damage that occurs over time due to lack of timely maintenance, wear and tear deterioration, or faulty quality.  The covered claims are due to damage caused by sudden and fortuitous events that occur by chance. Understanding this concept can enlighten you about the nature of insurance and how it operates.  Insurance companies calculate the probabilities of claims and losses and issue coverage accordingly.  Profits are the motivation.

Non-covered perils, such as flooding, earthquakes, riots, etc., require additional coverage known as 'riders or special endorsements.' These are add-ons to your standard policy, providing extra protection for specific risks. In such cases, the guidance of a knowledgeable commercial lines insurance broker is indispensable, providing you with the necessary expertise and reassurance that you are in good hands.

The most crucial element of insurance is understanding your policy. By reading and understanding the insurance contract, you can empower yourself with knowledge about your coverage. It's surprising how few people have read their policy, and this lack of understanding often leads to disappointment when a claim is denied. Understanding your policy can give you a sense of control and empowerment in the face of potential claims.

The underinsurance speed trap with devastating consequences:

In the past ten years, markets have been stable with little notice of inflationary pressures.  We are now in an accelerated speed trap, a term used to describe the rapid increase in building costs and insurance premiums. This is due to a race between increased premiums and building costs, all related to inflationary pressures.  During inflationary times, there is constant pressure on rising prices of original construction, regulatory compliance, and the rising cost of required building enhancements.

A borrower may be focused on saving money but should be advised of the adverse financial consequences of recovering losses in a claim when the property is grossly underinsured.  If the borrower follows the recommendations of his qualified insurance agent, good things may happen.  What happens when a property owner experiences a hazard loss, tenders a claim to the insurance company, and discovers the condition of massive under-insurance?  Blaming others is the answer, of course.

Because of policy limits, the insurance company fully knows they have no liability for this under-insurance problem.

Inflation causes prices of building materials, appliances, heating and air conditioning, municipal approvals, including revised building codes, and labor costs to go up substantially; over time, this process compounds prices.

Whether intentional, uninformed, or negligent by the borrower’s insurance agent, real estate agent, or mortgage broker, the insured parties may find themselves underinsured and must pay a portion of the repairs and reconstruction costs for the loss.  Many owners may not have the financial strength to pay for the shortage.  The consequence may be to walk away from the property and hand the keys to the lender. This highlights the urgent need to address the issue of underinsurance to avoid such dire financial consequences, instilling a sense of caution in the audience.

The problem of underinsurance is a nationwide catastrophe that is currently occurring.  No one even talks about it.  I don’t think that property insurance industry participants, including insurance agents/brokers and real estate agents/brokers, are vocal enough about the magnitude of this national problem!  But, as accusations fly, Mr. Fiduciary, you should have told me that I was underinsured; the lawyer community will high-five with delight.

The Borrower’s Loan Broker

“My client is objecting to paying premiums for full replacement coverage.  He is a general contractor and states that he can repair damage for a much lower price than quoted by the insurance carrier.  Besides, he contends that the land will not burn down.  Please reduce his replacement cost from $2,000,000 down to $1,000,000.  He is hell-bent on saving insurance premium money.”

After consulting a knowledgeable insurance broker who arranged the coverage, the lenders' response underscores the crucial role of insurance brokers. Their advice on adequate coverage is invaluable, providing a sense of reassurance in the often complex world of property insurance. It's essential to seek professional advice when dealing with property insurance, and their guidance can be instrumental in ensuring you have the right coverage for your property, empowering you with the knowledge to make informed decisions.

“Under-insurance is more prevalent now than in the past because of the upward cost pressure caused by inflationary increases in construction costs.  For example, lumber prices and other materials and labor have increased dramatically.  Municipal approvals and building standards/codes are much more stringent.  Add-on municipal fees (taxes) have gone up.

The owner, playing contractor, may use substandard workers, operate without adequate insurance, and skate from building and zoning compliance.  The property owner may calculate $200 per square foot for replacement.  However, in the retail market, where the insurance company is contemplating hiring a third-party contractor, the exact replacement cost is $400-$500 per square foot.  These figures are for entry-level and production homes.  High-end custom homes can be $1,000 to $2,000 per square foot or higher.

Lenders and mortgage companies may want to audit their loan portfolios to ensure that property coverage adequately offsets inflation.  Lenders should review and discuss methods and data sources for calculating replacement costs.  Most insurers and appraisers use Marshall & Swift cost data to estimate the construction cost.  Marshall & Swift monitors the factors that drive the cost of construction and the actual building component costs of the tracts.  Marshall Valuation Service reflects data in hundreds of locations throughout the U.S. and Canada.

We are sorry, Mr. Borrower, but your insurance coverage must equal or exceed the loan amount and cover the replacement cost of the dwelling and appurtenant structures. 

The current state of the Insurance industry in California:

Carriers are suffering a triple whammy of negative factors.  There are current historic increases in construction costs, outpacing inflation, and an expanding number of catastrophic events (natural disasters).  Additionally, the reinsurance market has collapsed.  Companies have sent “notices of non-renewal” to current policyholders and declined to approve new insurance policies.  State Farm is keeping its recent book of insurance active.

AIG and Chubb are canceling or cutting back on insurance coverage for homeowners and businesses. State Farm and Allstate, America’s most significant personal-lined insurers, ceased accepting new applications for business, personal lines, and casualty insurance. Catastrophic events, including wildfire exposure, severe storms, hurricanes, tornadoes, floods, earthquake exposure, water damage, and automobile accidents, have become unmanageable without drastically increasing policy premiums.

State Farm suffered a record $13 billion underwriting losses in 2022, with $4.7 billion in losses the year before.  Allstate lost $3.11 billion in 2022.  Liberty Mutual Holding Co lost $3.55 billion, and Berkshire Hathaway lost $3.10 billion.  Chubb lost $2.182 billion in 2022.  The Travelers lost $1.877 billion in 2022.  Progressive lost $1.66 Billion.

Currently, rates are skyrocketing, sometimes doubling or tripling. Yesterday, coverage was $3,000 annually; today, it may be $9,000. Paying the additional premiums significantly dent the average family’s monthly cash flow.

Also, there will be more pressure on California’s Fair Plan, a state-run substandard carrier for those who cannot find coverage elsewhere. Everyone knows what happens when the government operates a business enterprise. Inefficiency and decay set in.

Thank you,

Dan Harkey

Educator & Private Money Lending Consultant

949 533 8315 dan@danharkey.com

Visit www.danharkey.com