A number of years ago, the Canadian insurance industry started moving towards, and standardizing on, guaranteed replacement cost within their policy products. As time went on, stakeholders within the industry started noticing significant differences between traditional valuations and the cost of reconstructing total losses under the guaranteed replacement umbrella. As a result Marshall & Swift/Boeckh (MS/B) began analyzing the data and found that a new approach to valuation was required to minimize those differences. More recent surveys in Canada have found that up to 84% of existing Canadian residences are underinsured by as much as 27%.
How could this alarming situation come to be? The spreading popularity of guaranteed replacement was only the alarm bell sending out the message that a whole new approach to valuation was needed. To address this challenge, MS/B looked to identify factors contributing to the differences that were uncovered, and test possible new approaches against carrier ‘plateline’ data.
Using actual industry loss data, the study was able to identify contributing factors rather quickly. While some factors were obvious, others were not. A high level review of some of the findings includes:
The traditional square foot valuation practice relied too heavily on an individual’s opinion of the varying grades of quality. This proved to be far too subjective with valuations varying based upon opinion rather than actual materials used. Gathering greater detail about the actual property would serve to remove the element of subjectivity from the valuation process.
The unit cost for re-construction materials and labor often proved to be much higher than those for pure new construction. The absence of volume rates and discounts and the urgency of shortening homeowner displacement always lead to higher costs.
The variance of unit costs for labor and material also varied much more than expected by location. This meant that the extensive use of location multipliers or factors would need to give way to collecting more data from more locations more frequently.
Under guaranteed replacement, materials and construction techniques used years ago would have to be duplicated. These materials and skills tended to be difficult to find and costly to employ. However, by knowing when various construction techniques changed over time, we knew that we could allow for these costs in a valuation simply by knowing the year of construction.
They study also found that debris removal and other essential architect and general contractor costs were significant contributors to the cost of re-construction.
And finally, the study confirmed that unreported remodeling continued to be a problem for the industry. The need for the ongoing maintenance of property information continues to be an industry challenge that cannot be ignored.
PUT INTO CONTEXT
These findings showed that although the traditional valuation method was correct in a simplistic sense, it did not account well enough for the context under which the valuation was going to be used. By introducing the context of one-time reconstruction into the equation, valuations would be more accurate.
Even with these study results, the industry remained skeptical that component-based valuations were more accurate than those generated using older technologies.
This skepticism prompted a ‘plateline’ study to test component-base evaluation against real Canadian loss experience. This plateline descriptor simply refers to the fact that the losses involved were total and right down to the foundation (plateline). As part of this test, a number of major Canadian carriers provided MS/B with the details of over 200 randomly chosen total property losses from all regions of Canada. This included complete pre-loss property descriptions, location data and the total costs experienced during reconstruction.
The results were convincing. Component-based valuations were within 4% of actual claims paid and in the case of one carrier they were within 1%. The accompanying graphic clearly illustrates just how accurate the new component-based approach has proven to be. And as a consequence, it cemented that fact that the industry was actually sitting on a book that was underinsured by as much as 27%.
VARIED OPINIONS
It is clear that the industry needs to address this issue as quickly as possible. But things are very rarely as straightforward as this would seem. There seem to be as many opinions on how to resolve this issue as there are stakeholders within the industry. Some of the discussion points that the property industry is still dealing with include:
Industry Education. There is a clear need to raise awareness of this issue because:
many within our industry still do not know that the majority of properties are significantly underinsured; and
many others still believe that the new valuations generated in their supposedly unique jurisdictions are incorrect, despite the fact that we collect and frequently update unit cost data from over 100 locations and sub-locations across Canada; and
the vast majority of consumers are not aware of this situation and are not ready for the correction that must take place.
Consumer Reaction. Will consumers welcome an increase in limits, along with the probable premium increase, as a valuable, proactive service provided by the industry? Or will they lump this in with their existing concerns about automobile insurance availability and cost? Will consumer reaction to the required adjustment become so great that government intervention becomes a threat? Raising limits to their proper level is the appropriate thing to do, both from a business and a consumer service perspective – with sound educational and promotional programs this challenge can be turned into a positive experience for the consumer.
Approach and Timing. The most obvious approach is to use the newer and more accurate valuation numbers, and the most appropriate timing is to correct property limits immediately or on renewal. However, that is not the only option that has been considered within the industry. Some have considered an option where in-place limits would be raised to the proper levels in stages over an extended time period of as many as two or more years. This would spread the resulting premium increases over a longer period but would also increase the legal exposure from knowingly underinsuring consumers for a period that would be longer than necessary. Raising limits immediately to where they should be is the right thing to do.
Competitive Disadvantage? The real issue surrounding approach and timing has to do with competitive fear. Many carriers fear that if they act before their competitors do they will be at a competitive disadvantage in price. That might be true if the timing were different, but it should not be because the need to act has come at the same time for everyone. To delay would be irresponsible and would bring with it additional exposures.
INDUSTRY SOLUTION
The issues are clear as are the actions required. We as an industry must become much more aware of the valuation issue and ensure that it is properly understood by the consumer. The current industry situation, where the majority of residential properties are underinsured, must be addressed as an industry “team effort” as quickly as possible. And this should be done for the benefit of consumer and for the credibility of the industry, and not for a competitive advantage over others.