E&O Insights: What Could Go Wrong When Insuring Habitational?

Insuring habitational risks has generated more than its fair share of errors and omissions (E&O) claims. While there are a host of issues, consider these specific ones: valuation, ordinance or law coverage and flood.

Valuation

A significant number of E&O claims dealing with property involve the issue of valuation. The economy has contributed to this issue as clients may be able to buy property (at market value) for less than the replacement cost amount. As a result, education dealing with the concepts of market value and replacement cost is extremely important. On your property proposals containing co-insurance, look to include a claim example to illustrate the significance of this clause, how it works and the importance of insurance to value. Also look to include definitions of some key terms, such as “actual cash value” or “replacement cost,” based on the specifics of your proposal.

The valuation amount is potentially a sticky issue. Technically in most, if not all, states, the agent has no duty to determine this number. Thus, if the agent comes up with an incorrect number, he or she is likely to be blamed if a loss occurs. If the agent performs the calculation, he or she should ensure the necessary detail – square footage, construction type, etc. – is secured and correct.

Most of the carrier approximator tools can be a great starting point, and proper use should result in a quality output. Unfortunately, these calculations can often be inaccurate. In essence, the quality of the output is directly attributable to the quality of the input. Take the time to ensure you have full and accurate information. If possible, visit the property personally or have someone knowledgeable in property insurance visit the location to ask any necessary questions. There are typically various questions on most of the approximators addressing issues such as quality of construction. How you answer these will directly impact the final value, so be sure to have the correct answers.

There have been many E&O claims where the calculation did not even have the correct square footage or construction type. The agency staff member simply took the customer’s word for it. If the customer provides the agency with the information, include a disclaimer on the proposal noting that the limit calculated was based on information provided, and the agency cannot attest that this limit will be sufficient at the time of a loss. It is also highly recommended that agents protect themselves by informing all customers in writing whenever the agent comes up with the number; the limits are an approximation using the available information. A licensed insurance appraiser would need to render an opinion to ensure a risk is properly insured.

Ordinance or Law Coverage

While most insurance consumers probably have a good understanding of how their personal or commercial property insurance addresses damage done by a covered peril, to what degree do those same consumers understand how their insurance addresses the undamaged portion of the risk if it needs to be torn down or modified due to a change in the municipal codes?

This is where ordinance or law coverage comes into play. How many of your customers have this coverage? If a customer has it, is the limit, usually expressed as a percentage, going to be sufficient?

Ordinance or law coverage is designed to pay for:

• Loss of the value of the undamaged portion of a building when it must be torn down to meet code requirements.
• Cost of the demolition and removal of the debris of undamaged portions of the structure that must be torn down or modified. (Debris removal for the damaged property is covered. Debris removal for the undamaged property is typically excluded.)
• Increased cost of reconstruction, that is, the added cost to repair or rebuild in accordance with the current code. This may include issues such as adding more electrical outlets, installing a sprinkler system, redesigning to meet earthquake/hurricane resistant standards, etc.

The dollars associated with any of these items could be costly – but how many consumers are familiar with the various local and state building and zoning laws? To avoid creating a duty, it is best for an agent to explain the coverage and suggest that the client contact the zoning board if the client has questions.

Sample questions a client should ask include:

• Do any existing codes prohibit rebuilding with present construction, occupancy, or size of location, or require demolition if more than a given percentage of the building is damaged? If so, what is that percentage?
• Since the building was constructed, have there been any changes to any of the codes that could adversely affect the property? If so, what have those changes been and what would be the effect?

Normally, the focus will be on homes/buildings built many years ago. Yet agents and customers must realize that there could even be code changes for a home built 20 years ago or less.

Flood

Super Storm Sandy seemed to highlight a host of issues pertaining to flood insurance. These issues include:

• Lack of knowledge of the 30-day waiting period.
• Lack of knowledge on exactly what coverage was provided by the flood policy. While many consumers had flood coverage, there appeared to be an overall lack of understanding on exactly what coverage was provided. Some consumers did not understand that while they had a flood policy, that policy only covered the building, not contents.

Many consumers seemed to only insure their property to the extent of the mortgage. When the storm occurred, they then realized that the limit was not adequate to cover the full amount of the property.

Consider the following flood-loss example (unassociated with Sandy).

The agent wrote coverage for a condominium association on an apartment building being converted to condos. The FEMA policy was written on a standard building form, with a $250,000 limit. After that, the apartments were being converted to condos, and some of the condos remained as the property of the client. The $250,000 limit remained on the policy. The policy was never converted to a FEMA condo policy.

A flood loss occurred and initially the servicing carrier denied coverage because the flood policy was written on the wrong form. The carrier then reformed the policy to a condo policy. Unfortunately, the limit remained at $250,000. Following the carrier’s inspection of the loss, it determined the value of the condo property, including common areas and condos owned by the association, to be $2.2 million. The FEMA policy applies 80 percent coinsurance if the maximum coverage available – $500,000 – is not purchased. The loss of $290,000 was reduced to $26,000 by the carrier due to coinsurance, leaving an unpaid loss of around $260,000. The agent should have had the full available limit of $500,000 in coverage for the building and condos. The claim settled for $200,000.

Knowledge of the exposure and applicable coverages is the best way to minimize the potential of your insurance agency facing some type of errors and omissions litigation.