Calif. Offers Regulation As Solution To Underinsurance

by Zelle LLP
Contact

A wildfire ravages a community. A family’s home is among those destroyed. It is a total loss. The homeowners are eager to rebuild and turn to their homeowners’ policy. Having purchased coverage on a “replacement-cost” basis, they assume they are protected. They soon discover, however, that their policy limits are insufficient to satisfy their actual rebuilding costs, replace their personal property and meet additional living expenses. They are underinsured.

Unfortunately, this is a scenario that plays out time and again, particularly in the context of wide-scale catastrophe losses (e.g., hurricanes, floods, wildfires, etc.,) and single-risk total losses (e.g., a particularly destructive single-home fire). In 2013, one insurance industry consultant estimated that 60 percent of homes in the U.S. were undervalued by an average of 17 percent.[1] These numbers, while alarming, actually signify an incremental improvement over the previous year, and a very substantial improvement since the 1990s. However, significant room for further improvement remains, and the stakes are high.

Why are so Many Homes Underinsured?

While it easy to point the finger of blame at insurers, agents and brokers when premium paying homeowners come up short after a devastating property loss, underinsurance is a complex problem that often begins with using an improper basis for the amount of insurance limit purchased. Real property is generally insured at replacement cost value. Therefore, to ensure that property is sufficiently insured, the actual, current 100 percent RCV must be used as the basis for selecting the limit of coverage to be purchased. However, rather than using a property’s current 100 percent RCV, the amount of the mortgage remaining on a property or its acquisition cost, are sometimes used, to the insured’s detriment in the event of a catastrophic loss. It is easy to see how using these less-than-full replacement values, which seem like an attractive option for insureds looking to save a few dollars on insurance premiums, can leave homeowners without sufficient resources to undertake a complete, like-kind replacement. For instance, a homeowner who insures her home for the value remaining on her mortgage (e.g., $150,000) could face financially crippling out-of-pocket costs if it takes $250,000 to rebuild her home.

Insureds may also fail to appreciate and account for market forces that operate in a post-catastrophe environment. Demand surge for labor and materials, paired with strained supply following a catastrophe loss, drive skyward the costs to repair or replace property. Relatedly, the extended time it may take to make repairs or complete a property replacement following a catastrophe puts pressure on additional living expenses or business interruption coverage limits (in the case of commercial insureds), and policyholders may face cash constraints before the repairs or replacement are complete. Additionally, costly code improvements (e.g., raising the elevation of a flood damaged home) may further drive up repair/replacement costs versus the policy limits purchased.

Because catastrophe losses are more likely to be total losses (as opposed to partial losses), underinsured homeowners and businesses may also face coinsurance penalties. Coinsurance formulas used to calculate loss payments take into account the amount of insurance actually purchased and compare it with the amount that should have been purchased. The larger the discrepancy is between the amount of coverage purchased and the amount of insurance that should have been purchased, the smaller the loss payment amount will be.

Is Regulation the Answer?

The insurance industry has taken a number of steps to address the underinsurance issue, including introducing policies that offer “extended replacement” coverage. These types of policies pay up to a specified percentage above the policy limit in order to account for post-catastrophe demand surges and other unforeseen costs. However, by themselves, these measures have clearly not solved the underinsurance problem entirely. Further, while insureds can take steps to reduce their risk of being underinsured, including regularly reviewing and updating policies to reflect the actual replacement cost values, it is unrealistic to expect that all homeowners will invest the time and effort required to do so. In recent years, some states, including California, have therefore turned to regulation as a way of curbing the catastrophic consequences of underinsurance.

After years of wildfire losses drove the underinsurance problem to the surface in California, insurance regulators adopted a series of regulations aimed at improving the quality of replacement cost estimates for homes. As the California Department of Insurance explained in a Nov. 20, 2012, memorandum submitted in connection with a public hearing on catastrophic claims before the National Association of Insurance Commissioners:

In 2011, CDI adopted regulations that provide more comprehensive and reliable estimates of what it might cost to completely rebuild a destroyed home. Such estimates were previously unregulated, and led homeowners to believe they needed less coverage than they truly did in the event of a disaster.

The 2011 regulations placed a number of new requirements on California insurers and producers. Specifically, they mandated standards and training for insurance brokers and agents with respect to estimating replacement cost value and required improved documentation of persons making replacement cost estimates. The most extensive change, however, came with the introduction of standards for estimates of replacement value, which were codified within the subchapter of the California Code addressing “Unfair or Deceptive Acts or Practices in the Business of Insurance.”[2] Among other things, the regulation requires those estimating replacement cost values to consider specific features of the insured structure, including the types of materials used and the “[g]eographic location of the property.” It also prescribes detailed procedures for communicating replacement cost estimates to insureds and insurance applicants.

Not everyone, however, has embraced California’s efforts to solve the underinsurance problem through regulation. In fact, the insurance industry has mounted a fierce legal challenge to Section 2695.183, the meatiest of the regulations adopted in 2011. The Association of California Insurance Companies sued the Commissioner of the CDI, seeking that the court declare the regulation invalid. In the litigation, the ACIC argued that the commissioner lacked the requisite authority to promulgate a regulation that defines a new unfair practice under the Unfair Insurance Practice Act by mandating how insurance licensees produce and provide replacement cost estimates to homeowners. They also contended that the regulation infringed on insurance licensees’ commercial speech rights. On March 25, 2013, a California trial court sided with the ACIC and declared the regulation invalid, reasoning that the commissioner had indeed exceeded his authority. Because the case is currently on appeal to the California Court of Appeal, the future of Section 2695.183 remains uncertain.

While Section 2695.183 was invalidated on technical, legal grounds, the insurance industry’s real issues with the regulation appear to be its rigidity and its potential to interfere with the underwriting process. In the event that the commissioner loses the pending appeal, California will be forced to return to the drawing board.

Where do we go from Here?

While California has encountered significant difficulty in its attempt to address the underinsurance problem through regulation, that does not mean that a regulatory approach cannot be part of the solution. Underinsurance is a complex problem that calls out for creative, multifaceted solutions that involve insureds, insurers, producers and regulators. In order to be successful, regulatory efforts should allow for a certain amount of flexibility in the process, while providing guidelines that will be effective in allowing insureds to obtain the most accurate and useful replacement cost estimates. In the meantime, however, policyholders should not just sit back and wait for a regulatory solution. They should be proactive in reviewing their coverage to make sure they have purchased an adequate amount of insurance in the event of a catastrophic property loss.

Insurance Law360
June 25, 2014

[1] Insurance Industry’s Property Undervaluation Issue Continues to Improve According to Marshall & Swift/Boeckh, PR NEWSWIRE, Aug. 7, 2013.

[2] Cal. Code Regs. tit. 10, § 2695.183 (2014).

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Zelle LLP | Attorney Advertising

Written by:

Zelle  LLP
Contact
more
less

Zelle LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.