Cadillac Insurance for a Cadillac Price

“The man who invented the GRC should be taken out of the room and severely disciplined.”

This is perhaps the least charitable expression of a prevailing sentiment among Canadian insurers about the Guaranteed Replacement Costs (GRC) issue. The GRC debate came to a head in B. C. five years ago, when about 200 homes burned down at once during the 2003 wildfires in Kelowna, B. C. All told, the Kelowna wildfires resulted in 3,385 claims totalling Cdn$200 million, or an average of Cdn$59,084 per claim.

GRC policies pay policyholders the full replacement cost of their homes, even if the replacement costs exceed policy limits. So, for example, if a house that burns down is insured up to a limit of $300,000 and it costs the insurer $350,000 to replace it, the insurer will pay the full $350,000 under a GRC policy.

GRC is called the “Cadillac” of home insurance, since it offers the maximum protection for consumers. Insurance brokers typically defend GRC for this reason.

Insurance companies and reinsurers, on the other hand, are more inclined to see GRC as a problem. (As noted in the quote above, which was expressed, ironically enough, at an insurance brokers’ association conference held this year in Kelowna, B. C.)

Insurers face a conundrum on this issue. They risk looking miserly if they abandon the GRC altogether, and so they often fall short of publicly calling for its elimination. But certainly they face increased claims costs paying out on such policies; for this reason, many are suggesting a percentage cap be placed on GRC policies.

If insurers do in fact start capping GRC policies, the inflationary effects of demand surge on costs should be among the pricing guides used to determine the percentage of the cap.

Demand surge is typically associated with rebuilding a large number of homes at once after a natural disaster. To put it simply, a large demand at once for a shrinking pool of resources (building materials, contractors, etc.) often leads to increased costs. Material costs increase because it costs more to manufacture the resources to keep up with the demand; also, building contractors are able to charge more for their services when more people are requesting them.

The key for insurers is to ascertain from their previous claims experiences just how much “demand surge” drives up their costs, on average, in worst-case disaster scenarios. They can then use this percentage to establish a baseline for percentage caps to be applied to GRC policies.

The real question is whether such a cap is necessary at all, since the price of the insurer’s premium for a GRC policy is supposed to reflect the risk of making a potentially larger payout than indicated by the policy limit.

Insurers have suggested that since GRC policies pay the ultimate replacement cost of the home, no matter what that cost may be, consumers lack incentive to declare additions that increase the value of their homes. This contributes to the risk that the policyholder may be underinsured, thus making it harder for insurers to determine the proper insurance premium rates for the risk.

Brokers are skeptical about this argument, preferring to believe most people are honest with insurers about the value of their home.

Assuming most policyholders are honest, insurers might consider charging Cadillac rates for Cadillac GRC policies — especially if this is one way to keep GRC policies around. This logic would probably sound okay to most rational consumers: after all, in so many other financial service areas, the consumer is well aware of the dictum: You get what you pay for.

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If insurers do start capping GRC policies, the inflationary effect of demand surge should be among their pricing guides.