The Great Calculator Debate

Collecting adequate premiums based on accurate replacement cost is the cornerstone of the Canadian property insurance industry. For Canadian consumers however, the concepts of construction cost, replacement cost, market value and assessed values are neither clearly defined nor understood. Although construction costs can yield substantial savings when building several homes of similar design and finishing, there are no such economies of scale available at the time of a loss. Market supply and demand forces further accelerate replacement variances during catastrophic loss.

Many brokers are increasingly concerned about the differences between replacement costs assessments derived in their offices and those derived by independent loss control inspection firms. The insurance industry currently supports several different versions of calculation engines, clouding this picture even further. If an insurance company, broker and loss control firm is each using a different replacement cost tool, an “apples-to-apples” comparison is impossible.

Accurate data collection is crucial to generating replacement cost. Information can vastly differ, however, depending on how it is collected: information gathered by means of an interview with an insured, for example, will be different than that obtained onsite at the time of a physical inspection. Brokers are looking for solutions that drive efficiencies in their offices, protect their reputations with their clients and assure accurate insurance to value.

The question must be asked: “Does the process of deriving accurate replacement cost values need to be this complicated?”

THE GREAT CALCULATOR DEBATE

In 2002, Marshall Swift and Boeckh (MSB) launched their new Residential Component Technology system known more commonly as RCT. This kicked off a debate within the property underwriting community about the difference between this new product and the former Boeckh calculation system. Perhaps more importantly, it also created a focus on the uniqueness of competing products, namely RS Means and Powersoft.

Brokers’ concern focused on their customers’ inevitable increased home insurance premiums and retention. Insurance companies, meanwhile, wrestled to determine which calculator was best suited to their business practice. The debate concluded with an industry agreement to accept all three versions of replacement cost calculators, even though significant variances were noted between the three products.

INSPECTOR’S REALITY

Insurance inspections are designed to protect consumers against losses that would be of great life-altering consequence and the insurance industry from potential fire, water loss and liability exposures. The inspection process is the best way to establish the most accurate replacement cost value. Independent inspection firms put their reputation on the line each and every time they visit a home. If a claim occurs, subrogation undoubtedly follows even if the inspections are significantly outdated. The industry’s current catch-phrase, “getting it right the first time,” is the focus of any loss control firm. While consumers may be uncomfortable with an insurance assessment and potential premium increases that may result, a key role of loss prevention is to ensure accurate insurance to value.

WHEN CATASTROPHE STRIKES

Statistics suggest about 70% of residential properties are underinsured by 30%. If nothing else, these statistics show how insurance to value is often overlooked until a disaster occurs. The forest fires in Kelowna, B.C are a prime example. In the Kelowna situation, a majority of insurance adjusters dealt with the reality that the policy Coverage A did not adequately cover the guaranteed replacement cost on the losses. In particular, a July 19, 2004 Globe and Mail article highlighted the woes of Elton Ash. A reported CD$210,000 variance between Coverage A and Ash’s assessed replacement cost led the local real estate broker to sell his lot and buy a house in a nearby subdivision. Ash told the Globe he could have avoided most of the stress if he’d only paid more attention to updating his policy over the years. “If anybody ought to have known how to insure their house, it should have been me,” the real estate executive is quoted as saying.

EXPLAINING GAPS

Overwhelmingly, the majority of residential inspections in Canada are calculated using RCT. The most common variances in replacement cost between brokerage firms and loss control companies occur in the following data input fields:

* Year built.

* Square footage.

* Standard vs Pre-1930 construction.

* Standard vs Pre-194O construction. * Basic, builders, custom or designer grade kitchens and bathrooms.

Incorrect data entry in any of these fields might dramatically alter the replacement cost of a dwelling. Brokers typically use versions of replacement cost calculators such as Compu-Quote’s EvaluRater RCT program, which commonly default to basic and builder grades. Inspection firms use a more detailed version of the RCT application when creating property valuations. It is therefore little wonder that, in many cases, a gap exists between the value a broker calculates and the value derived by a loss control firm.

THE ROAD AHEAD

CGI has been working with industry stakeholders to address this issue head-on. Most recently, CompuQuote, RS Means, the Insurance Brokers Association of Ontario (IBAO) and CGI have met to discuss these issues and reach common sense solutions to this problem.

CompuQuote has agreed to offer the RS Means replacement cost calculator through its broker interface, giving brokers more flexibility and choice. Moreover, CompuQuote, RS Means and CGI are collectively building EASY ITV, a broker-friendly, insurance-to-value tool. EASY ITV is designed to help the broker quickly and accurately assess replacement costs on properties under $400,000.

CGI has integrated the RS Means Calculator into its inspection portal, allowing brokers and companies to select RCT or RS Means to derive replacement cost values. Compu-Quote and CGI are also working to develop communication protocols that would allow brokers to order, track or ask questions about inspections completed by CGI. This would be done directly through the Compu-Quote interface, without having to leave a broker management system. If desired, the interface can:

* Automate the inspection ordering process based on an insurance company’s unique ordering criteria.

* Generate a customer notification letter.

* Provide CGI inspectors with accurate contact information.

In partnership with IBAO, we can centralize a communication and education strategy to give brokers the information they need to better assist their customer and the insurer. Together we can streamline this process, assure accurate insurance to value, minimize exposure and thus protect the industry and the consumer.