Keeping Pace with Construction Values

In today’s environment, insurers face numerous challenges in their efforts to maintain a portfolio that is accurately insured-to-value. Competitive pressures, unreliable valuation techniques and out-of- date or inaccurate pricing information are all challenges insurers may need to overcome. But the most significant obstacle for insurers is the ability to keep pace with the constantly changing nature of residential construction.

According to a report by the Canadian Home Builders Association, residential remodelling has increased from less than Cdn$28 billion in 2001 to more than Cdn$42 billion in 2006. The United States is following a similar trend. U. S. residential remodeling increased from US$210 billion in 2001 to US$280 billion in 2005, according to a study by the Joint Center for Housing Studies of Harvard University. If coverage limits have not been recalculated using the latest property information and building cost data, homeowners and insurers alike are at risk for being underinsured.

Additionally, new homes are becoming larger and more complex with custom features and finishes. Almost half of all new homes built in Canada last year were fully customized, according to a 2008 survey of members of the Canadian Home Builders Association. This trend is expected to continue. Replacement cost estimates that do not accurately account for the characteristics of larger and more complex homes may lead to issues when claims are filed.

Looking toward the future, insurers are likely to face increasingly difficult challenges as they work to keep their policyholders adequately insured. New “green” building techniques and materials designed to make properties more energy-efficient are becoming increasingly prevalent in residential building construction. Insurers’ replacement cost estimators need to be regularly updated with building cost information that accounts for these latest building trends.

All of these issues are making it more difficult for insurers to maintain an up-to- date portfolio of policies in which replacement cost estimates used in underwriting are in line with the costs of claims in the event of a total loss.

As non-guaranteed replacement cost policies become the industry norm, underinsured properties often affect insurers more in the area of customer service than in finance. Having said that, replacement cost estimates that accurately match claims costs do have many financial benefits for insurers. Insurers can better anticipate future claims costs, greatly increase customer service levels, reduce back-end indemnity expenses and be more likely to collect the proper premium based on the actual risk through the life of the policy.

TECHNOLOGY SOLUTIONS

The best way for the insurance industry to overcome these obstacles is to gain access to better data. To improve insurance- to-value, insurers need localized, up-to- date and higher-quality data pertaining to the costs associated with property reconstruction and on individual properties. Insurers using high-quality reconstruction cost data and that collect better property-specific information from the insured will begin to see replacement cost estimates more in line with actual claims experience.

To this end, in the United States, the Insurance Services Office, Inc., Xactware Solutions Inc. and AIR Worldwide Corp. have jointly developed a replacement cost estimator called 360Value. The estimator uses Xactware’s industry standard building cost data for both claims and underwriting. 360Value enables insurers to bring their policyholders into the property valuation process during underwriting or at renewal for customer approval of replacement cost estimates.

The component-based replacement cost estimator uses property-specific information to create a virtual model based on sophisticated modelling algorithms developed by AIR Worldwide. Using this model, a stick-by-stick, brick-by- brick replacement cost estimate is developed using Xactware’s detailed building cost data.

BUILDING COST DATA

Xactware has been publishing building cost data for the U. S. property claims industry for more than 20 years. Today, Xactware’s claims estimation tool is used by more than 60% of insurance carriers in Canada and the United States, based on direct written premium.

Xactware has developed a system to capture and analyze active bids written by reconstruction contractors, service providers and adjusters using its claims estimating system. Thousands of estimates are returned to Xactware through this process every day, enabling “real-time” analysis of the pricing data. Every estimate is automatically audited for pricing variances. This data from the field is combined with market surveys performed regularly with other industry professionals. On average, several million unit-price data points are acquired each month using the real-time and survey data collection processes from more than 100,000 contractors, insurance carriers and independent adjusters.

Xactware also maintains an extensive independent research effort to gather the latest information on all costs associated with labour, material, equipment and other factors related to property construction. Some examples of recently added construction materials include cork floor covering, tankless water heating systems and custom timber framing (hammer beam and scissor truss systems). An average of more than 170 new unit costs is added each quarter. The research is performed daily using a database of more than 42,000 material and equipment suppliers, and more than 9,500 contractors across Canada and the United States.

A proprietary “cluster-analysis” process is used to analyze the data and provide price information for specific labor, material, equipment and other associated unit costs for a particular location. Unit cost information is published for about 470 pricing regions in the United States and Canada, and is updated quarterly in 360Value.

COLLABORATE WITH PROPERTY OWNERS

Regardless of how good the underlying building cost data is, replacement cost estimates will not match claims experience if property-specific information is unreliable. Enabling property owners to apply the detailed knowledge of their homes will go a long way towards improving the quality data used to estimate replacement costs.

Since property owners are responsible for making sure the replacement value of their property is reliable, it will be advantageous from a customer-service perspective to give them the tools to do so. 360Value includes a unique capability that enables insurers to collaborate with property owners over the Internet.

Property owners can review property information compiled by the insurer and make changes if necessary. Insurers can review and approve all changes made by the property owner before the replacement cost estimate is finalized. A record is then created of the property owner’s approval of the building characteristics and the estimated replacement costs. This improves customer satisfaction and reduces the likelihood of disputes when a loss occurs.

CONCLUSION

As residential properties continue to increase in size and evolve by incorporating new and more complex building materials and techniques, the use of high-quality data and involvement from policyholders becomes critical. Insurers using data derived from actual claims will have more reliable replacement cost estimates at underwriting. Bringing policyholders into the process will lead to fewer surprises regarding coverage in the event of a loss. State-of-the-art technology is available today that facilitates policyholder involvement and uses high-quality building cost data to ensure insurers’ portfolios are more reliably insured-to-value.