Cracking down on factors contributing to home-price escalation is a major component of the Apr. 7 federal budget document. If successful, they could affect insurers’ ability to control reconstruction costs and other claims impacts for their insureds.
Proposed budget actions include a two-year moratorium on some purchases by foreign buyers and a call to create a Home Buyers’ Bill of Rights that will end blind bidding to create price transparency. Usually, when a bid is made on a home, you include the price you’re willing to pay, as well as any conditions you have or are willing to remove (such as the home inspection or financing). A blind offer is when no one knows how much the other hopeful buyers are offering.
Since in blind bidding, no one had to disclose their offer, the bidders must guess what it takes to win the bid. And so the ‘winning’ offer may be many thousands of dollars more than it needs to be. That may inflate the reconstruction cost of the home.
Appraisals done by insurance companies for assessing valuation generally don’t focus on retail or land prices; instead, they are keyed on home replacement costs, noted Jack Mazakian, vice president and principal broker at Advocis Broker Services in Toronto.
In addition to accounting for costs to repair or replace the buildings on a site with the same features prior to the loss, “the underwriter assessment would have to include costs to adapt to new building codes,” he said.
But, Mazakian added, “the main issue in the last few years is the inflated costs and availability of materials to complete the rebuild or repair. Inflation and availability [due to supply chain issues] has pressured the price per square foot.”
Douglas Morrow, CEO and managing director at Excel Insurance Group, agreed the goal is to put the insured in the same place they were in prior to a loss. But, he added, what if the cost to repair damage, or an entire structure is more than the depreciated value of the damaged portion – or the market value of the entire structure?
He gave the example of a 20-year-old home in an established neighborhood. Since the market value in Canada is virtually always less than a brand-new home, that means the older home has depreciated.
“A small fire loss that would cost $50,000 to repair would then be settled for the depreciated value,” Morrow said, “which could mean that the homeowner is considerably short in terms of the recovery.”
The insurance industry’s solution has been to add a replacement cost endorsement to these policies, which means no depreciation would apply. Morrow added policies that offer guaranteed replacement cost are available and also solve this problem.
“The issue, though, is that the property needs to be insured not for its market value, but for its full replacement cost,” Morrow said. “The coverage has a penalty, called a co-insurance clause. What this says essentially is that the insurance company will pay replacement cost, but on the same ratio that the house was insured to its full replacement cost.”
Morrow added most co-insurance clauses are 90%, which gives the homeowner a 10% margin for error. Problem is, if the difference is more than 10%, and if the house is a total loss, the amount of insurance would simply be insufficient.
“Whenever the value of homes goes up, either or both of market value and replacement cost, it tends to make insurance more expensive,” said Morrow. “But the biggest issue is that the process…that causes large swings in value makes it harder for brokers and their clients to accurately assess and then insure property in terms of value.”
And, Mazakian noted, “larger or more expensive homes require a physical assessment by an appraiser to make sure the proper considerations have been included.”