The problem with property

In the p&c insurance industry, there is a always a lag period before policy changes are made at the front end by insurers and claims are made at the back end by customers. Given that most consumers don’t read their policies in detail, the changes can present an abrupt shock to those who assumed they had coverage for, say, their water logged home entertainment system in the basement.

Guess who has to explain the thorny implications of sub-limits or higher deductibles? The claims handler. In many cases, that means the independent adjuster.

That time delay is precisely what is occurring in property insurance today, as underwriters struggle to determine and limit their exposures, particularly for water damage and sewer back up losses. Adjusters say that several insurance companies have already sent out notices of policy changes on renewal of personal property policies. To control their exposures in general, insurers can increase premiums, place restrictions on underwriting, change deductibles, introduce limits (or sub-limits in specific areas), modify policy wordings and implement exclusions or endorsements.

“We have seen announcements from insurers that changes are coming,” notes Fred Plant, president of Plant Hope Adjusters Ltd. “There will be a bit of a lag as changes come into effect gradually on renewals and on specific dates for new business. The changes are coming; so too is an event where those changes will come to fruition and be magnified. We expect it wont be pleasant.”

“We are getting bulletins from insurers we work for; they have notified us of the changes they are making and how they are dealing with the issue,” says David Riddell, president of Calgary-based Canadian Claims Services. “They want to make sure everyone is aware of the changes on the new renewals, mainly for sewer back-up and hail damage.”

There are several types of specific policy amendments that adjusters are seeing on the front lines of claims handling, according to sources.

“On water damage specifically, we are receiving notifications from a number of insurers regarding some tightening of wordings and reduced sub-limits, and we are hearing indirectly from brokers and insureds about increased deductibles and premium increases,” says Jim Eso, senior vice president, property & casualty, Crawford and Company (Canada) Inc. “Sub-limits, will likely have the biggest impact. If someone’s deductible goes up from $1,000 to $2,500, it won’t necessarily influence their decision to buy coverage or perhaps to change insurance companies. However, an imposition of a $15,000 sub-limit on basement water claims is a significant issue for someone who has a home theater in their basement.”

The reaction from consumers on policy changes, whether higher deductibles, premiums or sub-limits, is predictably negative.

“Usually, it comes up when we get a new claim, we are looking through the declaration pages of the policy coverages; that is where we see any limitations or higher deductibles,” notes Lee Powell, director of property, major loss services, Cunningham Lindsey. “The statement you are hearing from insurers is that a lot of the smaller losses are getting absorbed into higher sub-limits and deductibles. The question that comes back from consumers is: ‘then, why do I have insurance in the first place, especially for water damage claims?'”

Many say that the consumer backlash against property insurance changes is in its early stages, but will likely gather momentum in the months and years ahead.

“It is really too new; there haven’t been any claims impacted by the changes yet, but it will come,” Riddell observes. “You hear informal feedback from people about new limits or capping sewer back up, higher deductibles. Anytime there is change or people get less perceived value for their insurance policy, they are not happy. Homeowners insurance is not an option for most people, as they have mortgages. This is seen as just another way for insurance companies to make more money.”

Riddell and Eso note that policy changes in Alberta involve both water damage and hail. On the latter front, homeowners insurance for older roofs may be subject to depreciation instead of replacement cost coverage.

There’s little doubt that the frequency and severity of large severe weather loss events is on the rise. The insurance industry has been pointing to telling statistics of property insurance claims growth over the past decade.

From 1983 to 2008 – 25 years – yearly natural catastrophe losses in Canada averaged around $400 million. Over the next four years, they hovered around $1 billion each year. Then came 2013 – the year of the Alberta and GTA floods and the costliest year in Canada’s catastrophic insurance loss history. Severe weather cat losses hit $3.2 billion.

“It seems to me that we are having more severe weather events,” Powell says. “Every year or other year, there is a major loss event, not just a one-in-ten or 1-in-50 scenario. That is where on the independent adjuster side we are more aligned with insurance companies. We are working more closely together as a team to handle these major events.”

What about the numbers by property lines specifically? Industry data show that despite increases in premiums and claims over time, the Canada-wide return on equity in property lines appears to be on a downward trend. The Canada 9-year average ROE for personal property from 2004-2012 was 7%, which is 4.7% below the overall p&c industry 9-year average of 11.7%.

The data for commercial property is better, with a 9-year ROE average of 13.6%; however, the downward trend is also seen here, with 2011 being the least profitable year with an ROE of only 4.8% Powell notes that “on the commercial side, we have not seen as much in terms of limiting coverage; we have, however, seen higher deductibles for flood and sewer back-up.”

Some regions, such as Alberta and the Maritime provinces have fared particularly poorly in personal property insurance results. Over the period 2004-2012, Alberta only had one year of positive ROE (2006), with 2011 showing the worst result at a staggering -51.8% ROE. The average ROE over that period in personal property was -17%. The Maritime provinces also posted a substantial negative ROE in personal property in 2009 (-17.1%), with the 9-year average at a mere 4.6%

While there are many sources of property insurance claims, water damage is singled out as the major factor behind the increase in losses and the pressure on insurer financial results. Insurance companies in Canada, such as Aviva, have shown that just over half of all property claims involved water damage. For Aviva Canada the figure for water-related losses in 2013 was $190 million. (Other insurers have reported similar ratios of water damage claims to overall property losses).

In February 2014, the Canadian Institute of Actuaries released a report called “Water Damage Risk and Canadian Property Insurance Pricing.” The study, prepared by KPMG, included a survey of insurance companies on trends in water-related losses.

It found that “the majority of respondents answered water claims were roughly 40% or more of total claims. For some insurers, water damage claims range from 60% to 70% for Ontario and western regions. Condominium water claims comprise a much larger percentage of total claims relative to homeowners and commercial multi-peril policies; many of the respondents indicated claims from 60% to 90%. Not only are water damage claims a large proportion of total claims, at least 90% of exposures are subject to water damage, depending on perils covered in the standard policy and what optional coverages are offered.”

The CIA study found that losses due to water are becoming a challenge in accurate pricing and reserving. “The increasing trends seen in the number of water damage claims (i.e., frequency of claims) as well as in the costs of claims (i.e., severity of claims) are alarming to many in the P&C industry. Trends in frequency are often attributed to…
climate change, aging and inadequate infrastructure, and lifestyle changes. The reasons for increasing severities include but are not limited to the costs in addressing mould remediation as well as the costs required to address any concerns about the presence of asbestos in old drywall.”

The report also noted that insurance companies have some work to do to get a more accurate risk assessment of the threat of future water damage. “Currently, most P&C insurers have not captured all of the data (about either the properties or the local environments) required for detailed actuarial analyses of the risk of water damage. To move to a good-practice state with respect to data will require considerable investment of personnel, IT, and human resources,” the CIA study noted.

In the face of this uncertainty, insurers are increasing premiums – a trend borne out in a J.D. Power Canadian Home Insurance Study. The report, released in June, discovered that 45% of customers indicated they received a premium increase in 2014. It also noted a 10-point increase in the price index on a national level. Year over year, the number of weather-related insurance claims in Canada has increased by 32%, according to J.D. Power. The study is based on responses from 7,092 home insurance customers, collected March through April 2014.

Increased rates, higher deductibles and new sub-limits for water-damage coverage are only part of the insurer response to heightened property insurance exposures. Modified wordings are also being considered or implemented, particularly for sewer back-up coverage. Insurance Bureau of Canada recently released a new limited sewer backup endorsement advisory wording designed to clarify what is and what is not covered in a flood-type situation. While not binding, these advisory wordings are often used as the basis for insurance companies to develop their own policy terms and conditions.

Independent adjusters note that many insurance companies already had clear policy language and contract wordings in place that distinguished between overland flood and sewer back-up. However, in situations such as the Alberta floods and, to a lesser degree, the GTA water losses, insurers often changed their coverage interpretation to include certain claims.

“There were wordings that existed in relation to the (Alberta) floods last year that specifically excluded sewer back-up if it happened preceding or at the same time of an overland flood,” Riddell says. “Some of the insurers relied upon that wording at first to deny claims and then ultimately reversed their positions due to public pressure.”

Whether modified policy wordings will clarify matters during a major loss event is an unanswered question for claims handlers. Sources say that independent adjusters will have to be aware and proactive on any property insurance changes and how they affect the end consumer.

“I think the important question is whether policyholders have firstly read (in the case of direct written policies) and secondly truly understood (in the case of brokered policies) the implication to their own potential situation in the event of a loss,” Eso observes. “The tendency may be that in the face of increasing premiums, policyholders are accepting reductions in coverage in order to minimize premium increases. They (may not have) full understanding of the impact various scenarios such as a major water loss or total roof loss in a hail storm could mean to them if coverage is not full replacement coverage to full policy limit. The lack of complete awareness becomes reality only when a loss occurs, which can make the claim settlement more challenging.”

“Adjusters will have to be vigilant in ensuring they have the current wording in-hand before making any comment or commitment on coverage,” Plant notes. “Actually, that is the way it should be all the time; however, practice does not always follow protocol. Those adjusters who are not careful may end up digging into their pockets.”

In the short to medium term, more and more insurers will likely continue to control the frequency of water damage claims through measures like higher deductibles and sub-limits.

“Insurance has always been – ‘what is our risk?'” Riddell says. “When (insurers) are trying to place a value on what their potential exposure is versus the premium collected, they are always going to be looking at ways to mitigate their exposure, whether that is capping certain levels of coverage or raising deductibles. This absolutely reduces claims. If consumers have the financial wherewithal to do it, many will just absorb the smaller claims, even for sewer back-up. They don’t want to be rated, they don’t want an increase going through next year.”

Eso notes that insurance brokers will typically have the best “line of sight” into how many customers decline to submit claims due to these policy changes. He adds that Crawford and Company’s after-hours Claims Alert Call centre has witnessed some signs of this activity.

“What we do see… is a higher number of claims that are either withdrawn or simply cashed out due to a combination of higher deductible and lower sub-limit coverage,” Eso says. “In some of those situations, proceeding with full repair through a specialist contractor is simply not financially feasible for an insured whose policy is subject to sublimit, depreciation or a high deductible. Any one of those may be the tipping point that strains an insured’s financial resources beyond their ability to proceed with full repair.”

Plant says that brokers will also have a strong role to play in consumer education. “The most common recurring claim is water-related so there will be more people who will have had a claim adjudicated based on one wording and then find their second (or third) claim more restricted,” he notes. “Brokers will play an important part in lessening coverage-shock by fully explaining coverage changes on renewals or restrictions on new business.”

How much the actual “savings” or “efficiency gains” accrue to insurance companies from their policy revisions is an open issue subject to many variables, including the role of contractors in the repair work process. Some sources argue that exposures like mould could become a major problem if sub-limits reduce the amount of coverage and repair work done on a water-damaged property. After the gains in mould remediation in recent years, it may be “two steps forward, one step back” if the changes in property policies become fully embraced by the p&c industry.

“What will insurers do now in those cases where they do not control the remediation of the damage due to water because of a limitation of coverage?” Plant asks. “A $50,0000 repair is only covered to a limit of $20,000. Will insurers be content to simply write the limit cheque and walk away? They will likely want or should want some sort of release so that an improper clean-up is not their responsibility. That is a deviation from the current trend of the insurer dispatching a contractor to do the job and if something happens later the contractor has to come good for it.”

Plant adds that “contractors are likely to feel the pinch on this even more than field adjusters. Insurers will not be so keen to simply send their contractor over to do the job, although some insurers may leave the henhouse keys where they are. Those insurers may not see much change in payouts. Perhaps there will now be a need to have a proper and independent (of the contractor) assessment of the cause and the application of coverage in the circumstances.”

Eso observes that insurance companies have spent years developing comprehensive property policies on an all risk, replacement cost and high limit basis for most personal property insurance policies. They have also created preferred construction networks to handle the vast majority of claims through a direct repair process. He calls this the existing “Canadian claims model.”

“Changes that increase claim costs to the homeowner to the extent that larger numbers of files do not go through a managed rep
air process is a significant issue I think to the Canadian claims model,” he observes.

In the end, the problem with property is two-fold: will the policy changes truly achieve the right effect for the insurance industry of limiting exposures? And how well will the changes be communicated to clients to avoid the “sticker shock” of diluted coverage?

“I think the issue that the property insurers will wrestle with for awhile is the impact of the tightening of coverages and payouts available as they try to find the right balance,” Eso concludes “The challenge will be finding a balance that maintains customer satisfaction and underwriting confidence, while controlling or limiting repair cost and allowing for competitive premium pricing. Time will tell whether current policy changes have struck that balance or gone too far.”