Understanding Insurance-to-Value Challenges

Property and Casualty insurance is highly reliant on the management of risk, which by its very nature isn’t always the most predictable variable. Insurance policies cover certain risks to provide peace of mind for the homeowner or commercial policyholder. In exchange, the policyholder pays the insurance premium. It’s a quid pro quo transaction. However, both parties could encounter a nasty surprise if the coverage provided is inadequate to replace damaged or stolen property, particularly in the case of a major loss.

That’s where property insurance-to-value (ITV) comes into the conversation. It’s an important concept that is often overlooked. But faulty data used for ITV calculations can lead to inaccurate property values and eventually unprotected financial risk for both the policyholder and the insurer. It’s ultimately about being able to charge the right premiums for the amount of assumed risk. Nothing more and nothing less. Accurate assessments making all the difference.

Industry data suggests that many insurers have undervalued their coverage relative to the actual costs of reconstruction. According to CoreLogic’s Residential Cost Handbook, 64% of homeowners don’t have enough insurance, with their homes being underinsured by an average of 27%. On the commercial side, 75% of businesses in the U.S are underinsured by 40% or more. The recent surge in inflation, which has driven a drastic rise in labor and material costs, has only made this gap greater.

Insurance-to-Value Explained
ITV is the ratio between policy coverage and property value. For homeowners’ insurance, property value is based on the replacement cost, which is different than the market value. Replacement cost can be impacted by direct and indirect expenses, property age, building codes, property accessibility, and unique features. For example, $400,000 may seem like a reasonable amount of coverage for a home if that is the current market value. However, the reality is that it may cost upwards of $550,00 to rebuild the home from the ground up. So, there’s a deficit.

Therefore, inaccurate ITV calculations often result in undervaluing properties. Severe property loss for an underinsured property owner could mean paying out of pocket for expenses they simply can’t afford. It can also result in coinsurance penalties being triggered well below the standard.

Getting ITV Wrong
There are additional repercussions of getting ITV wrong on both sides of the coin. First, undervaluing property for an extensive period can cause a ripple effect quickly exhausting coverage limits when catastrophe strikes for a greater number of policyholders. An inadequate insurance valuation can also keep coverage limits artificially low not providing enough coverage to rebuild for homeowners and carriers. This in turn can lead to losing customers and negative online reviews especially if a coinsurance penalty is incurred. And then the lawyers get involved, which can lead to costly litigation and regulatory review.

The bottom line, proper premium collection is critical to the financial well-being of the insurer. Not only can undervaluing a property hurt the homeowner but the carrier also suffers. When undervalued risks accumulate within a carrier’s portfolio, low rates shortchange the insurer in terms of reinsurance programs and insufficient funding for future claims.

What can you do?
There are a few things an insurer can do to address this potential risk. We’ve broken them down into five steps:

1. Collect ITV data on new and renewal policies as part of a field underwriting inspection.
2. Select specific markets to analyze and complete a targeted field inspection review to determine if there is a broader issue.
3. Commission an audit of underwriting practices with a focus on ITV.
4. Engage a consultant to determine if there are technology solutions available to help your underwriting team with more actionable data.
5. Request ITV verification from your claims team on all property inspections.

Additional considerations should be given to annual property and equipment appraisals, improving data exchange between risk managers and brokers, and embrace AI and machine learning technology to improve property risk management practices.

Property insurance carriers can’t afford to ignore ITV. This is especially true in catastrophe prone areas. In the current inflationary environment, the expanding canyon between actual and proper values is too vast to traverse. And turning a blind eye is a slippery slope that impacts an immeasurable number of individuals and industries.

To learn more, please visit Risk & Inspection Services.