Insurers push back on bad property estimates

Posted On: Feb. 1, 2020 12:00 AM CST Claire Wilkinson

Commercial property valuations in insurance contracts are garnering heightened scrutiny in a hardening market as insurers burned by unexpectedly large claims in recent catastrophes seek to tighten underwriting standards, according to industry experts.

As part of their increased diligence around valuations, property insurers are sometimes applying “onerous” terms and conditions to policies when they feel a policyholder’s valuations are too low, brokers and risk managers say.

“We see common examples where the values reported at a location were perhaps different to how the claim actually begins getting adjusted,” said Jeffrey J. Beauman, vice president, chief underwriter for Johnston, Rhode Island-based FM Global. “We know this valuation challenge is a fairly common issue across a broad swatch of industries and clients,” Mr. Beauman said.

The focus on values results from a combination of factors, according to experts.

One of the challenges for insurers at Jan. 1 renewals was obtaining correctly scheduled values, according to Michele Sansone, president of the North America property insurance business for Axa XL, a unit of Axa SA, in New York.

“We’ve seen numerous instances where we’ve gotten claims and the values are a lot higher than what was submitted as part of the schedule,” she said.

“That’s really disturbing because we set lines on those, we base our engineering surveys on those and we’re obviously charging based on those, Ms. Sansone said. “It’s very concerning, and nobody seems to know why … We are really going to be paying close attention to that in 2020,” she said.

Gary Marchitello, chairperson of Willis Towers Watson PLC’s North American property team in New York, said in underinsuring actual values hits underwriters hard when a loss occurs.

“Let’s just say the loss is $10 million at a particular building and … it’s a total loss,” he said. “The insurance company has to write a $10 million check and the value that has been reported is $5 million so that’s the rate base at which the premium was derived.”

“That is a circumstance where senior executives at insurers pull their hair out and the ultimate consequence could be as extreme as firing the underwriter that didn’t spot that that particular building was undervalued,” he added.

Hardening market Recent catastrophic events may have prompted insurers to revisit valuations, though no single catastrophe is responsible for the heightened scrutiny, brokers say.

“Throughout 2017 and 2018 where we had back-to-back years of significant catastrophe losses whether it was hurricanes Harvey, Irma, Maria, or hurricanes Florence and Michael in 2018, there were a couple of very notable claims that were out there where the marketplace ended up paying hundreds of millions of dollars in claims on accounts where values were half of that amount,” said Ryan Barber, New York-based U.S. property practice real estate leader at Marsh LLC.

This led to some litigation and questions about misrepresentation and as a result, insurers are being “increasingly diligent about values and more are applying underwriting guidelines,” Mr. Barber said.

For example, an insurance coverage dispute related to property damage and business income loss arose between CBI Acquisitions LLC, the owner of U.S. Virgin Islands resort Caneel Bay and its insurers in the wake of hurricanes Irma and Maria in 2017.

The hardening market is another contributing factor, said Lori Seidenberg, New York-based global director of real assets insurance for BlackRock Inc.

“There shouldn’t be a correlation but now that the market is hardening the carriers are making sure they are collecting every little bit of premium they can to offset their losses in the future,” she said.

Insurers want to narrow the gap between what they may lose on an account and what they are collecting in premium, Ms. Seidenberg said.

“Property premium is derived by rate times value. If the values are understated, even if the rates go up it’s going to produce an inadequate premium. So, every time there’s a hard market there’s a renewed scrutiny of the accuracy of the values reported,” Mr. Marchitello said.

Cutting costs A market where rates and premiums are increasing has led some policyholders to understate values to cut insurance costs, some risk managers and brokers say, though there is no consensus on this issue.

“I would like to believe insureds are not intentionally underreporting for purposes of manipulating premium, but I can’t tell you it’s not being done out there,” said Mr. Barber, adding: “We remind insureds of their obligations under a policy and the need to represent what you believe to be 100% of value. If you knowingly underreport, an insurer can cite misrepresentation as grounds to deny a claim.”

While lenders require property owners to insure to 100% of the value, “if you own the building outright there’s no incentive to insure to value except in recovery,” said Ms. Seidenberg.

“I know some people in order to cut costs still underreport and hope that they never have a total loss. At BlackRock we make sure we insure at 100% because we’re an investment manager,” she said.

But Mr. Beauman said: “I don’t think clients, and certainly not brokers, are motivated to underreport their values. Ultimately, they are representing the risk through their value reports and that’s incumbent on them as they purchase the coverage to be as accurate as possible.”

During the prolonged soft market and prior to the heavy catastrophe years of 2017 and 2018, insurance to value was less of a concern, brokers say.

“I don’t think anybody intentionally did it. I just don’t think the carriers were minding the store that well,” said Brian Dove, USI Insurance Services LLC’s national real estate practice leader, based in Dallas.

Policyholders often don’t know the full value of a building until a loss occurs and they rebuild, he said.

“If they don’t have losses, they’re going to keep reporting the same values every year because nobody’s telling them anything different,” Mr. Dove said.

Subsidizing the market When insurance buyers underreport their property values, policyholders that do report to value effectively subsidize the market, some risk managers say.

“This is the crux of the relationship between the insured and insurer. If you start a relationship with someone saying it costs $100 a foot to rebuild something and I’m insuring it to $50, that would be unethical,” said Stephan Upshaw, Chicago-based vice president of risk management at apartment complex owner Equity Residential.

Policyholders have an ethical responsibility to report their values as accurately as possible, he said.

“Because I report to value, I am subsidizing those that do not,” Mr. Upshaw added.

By being honest you can be “subsidizing dishonest people or people who are not reporting correctly” but then it happens that “they have the losses and I end up paying the price because my premiums go up because other people are not profitable,” said Ms. Seidenberg.

Terms and conditions Concerns about valuations have prompted insurers to change terms and conditions on some property policies, sources say.

Many insurers will put “onerous restrictions” on a policy if they feel a policyholder’s values are too low, said Mr. Barber. Changes include, per occurrence limit of liability endorsements in contrast to blanket limits, margin clauses and co-insurance clauses, he said. Margin clauses limit the amount an insurer will pay in the event of loss to a specified percentage of the values reported by the policyholder.

In the middle market, it’s more likely that a co-insurance or a margin clause might be applied to a policy, according to Mr. Marchitello.

For larger risks, penalties are less likely to be imposed, but underwriters will question values and ask for proof that they are accurate, Mr. Marchitello said.

Anecdotally, real estate as a risk class generally has been perceived as “the most undervalued,” he said.

Kenneth Tolson, U.S. president of claims solutions at Atlanta-based Crawford & Co. said: “From a coinsurance standpoint the penalties can be quite severe for inadequate insurance. But I’d also argue that in the case of most commercial (risks) very seldom do they deal with total catastrophic loss.”

“Because it’s incumbent on both underwriters and clients to agree on values from a pure contract certainty point of view, our general mode of operation if we were to have dialogue if we believe the value is off, is to make sure there’s an agreement about that,” said Mr. Beauman.

“Then usually we can resolve that by agreeing to conduct an appraisal or figure out if it’s about how business values were interpreted,” he said.

Challenges to insuring to value While there are multiple sources used to verify and validate values, any changes in construction, equipment or labor costs can affect replacement cost values and establishing accurate values can be challenging, according to some industry experts.

For example, in mergers and acquisitions where businesses are buying and selling locations, the risk management department is dealing with information using accounting systems and sets of rules based on a different business model, said Mr. Beauman. Interpreting that information can be a challenge.

When purchasing a building, a company can either have an appraisal done to calculate values and insurable costs or use software tools that enable you to input various data points, said Ms. Seidenberg.

“There’s no standard. If everyone, if all the carriers had a standard or had the same system it would be a lot easier but it’s all self-reporting and based on your data inputs,” she said.

Published in Business Insurance – February 2020 issue