The replacement cost endorsement dilemma

Replacement cost endorsements help homeowners protect the full value of their home and personal property. However, after a loss, most homeowners discover this coverage is not sufficient to replace like-items or restore unique features in their homes.

In the current economic environment, many homeowners are not carrying adequate insurance, and carriers have problems honoring replacement cost endorsements. About 63% of insured homeowners say they haven’t factored annual inflation into their coverage amounts, according to the American Property Casualty Insurers Association, and about two-thirds of respondents said they may not have opted for extended replacement cost insurance coverage either.

The U.S. Bureau of Labor Statistics saw U.S. year-over-year inflation register at 3% in June. That percentage has trended down from the previous year, but higher prices continue to affect homeowners who bought homes or items, which may cost more to replace.

Inflation also has impacted building costs. To illustrate, plastic and copper plumbing in 2023 increased 35% over 2022 levels. Drywall has risen 19%. These prices force the cost of home repairs upward in luxury dwellings with unique fit and finishes.

Supply and demand are also a factor. Even with higher interest rates, buyers seek new homes and home equity loans. Multifamily dwelling construction reached unprecedented levels while home improvements press on. A shortage of about 2.2 million skilled construction workers has seen labor costs grow, which pushes up the price of constructing or reconstructing a home.

Contents coverage poses dilemmas for underwriters. The process involves more than replacing floors and carpet, for instance. This is because homeowners might not regularly track home upgrades or significant purchases. Smart home systems, for example, cost thousands of dollars to buy and install. Replacing that feature in luxury homes increases the insurance claims cost.

Inflation and demand aren’t the only variables in the replacement cost conundrum. Carrier loss ratios suffer because of national weather and climate events. In 2022, the property/casualty insurance industry witnessed the third-highest number of billion-dollar disasters, according to Chubb. Between 2020 and 2022, losses amounted to more than $275 billion, the highest figure seen by insurance carriers in any consecutive three-year period.

Improving unfavorable loss ratios

Unprofitable claims occurrences require ending or radically changing the practice of issuing replacement cost endorsements. Also, current market conditions render replacement values unequal to the cost a homeowner originally paid to build and furnish. This trend is particularly true for upscale homes with one-of-a-kind items and features.

There are more influences on the current replacement cost endorsement dilemma.

• Owners don’t notify insurers of new additions to the home or personal property.
• Most upscale homes include custom features or valuable collectibles.
• Rebuilding to satisfy updated local code specifications costs more.
• New environmental regulations increase the cost of reconstruction.

Rebuilding or replacing unique items after a claim is more expensive than original acquisition costs. As a consequence, homeowner’s coverage and carrier loss ratios deteriorate.

Higher rates don’t sufficiently bolster the bottom lines of insurers. Therefore, we must seek solutions to protect homeowner value and insurer margins.

One answer could be modified replacement value coverage. This entails replacing unique features of older high-end homes with materials available today. An ornate mahogany staircase in a 110-year-old home is impossible to duplicate. Modified replacement value coverage would allow carriers to pay for materials and construction closest to the staircase’s original rendition, with the balance of expense incurred by the homeowner.

Solving replacement cost dilemmas

Agents and brokers should educate policyholders on replacement cost concepts to close coverage gaps.

Here are four ways agents and brokers can mitigate the problem.

• Convey changes to replacement cost endorsements.
  With rising inflation, escalating construction costs and accumulating losses, replacement cost endorsement status is tenuous. Two things may happen. These endorsements may not apply to new and renewal business, or the endorsements will become much costlier. In either case, educating clients helps them make appropriate coverage decisions.
• Revamp yearly reviews.
  Many clients won’t disclose home improvements and new household purchases. Nominal inflation increases built into policies to combat rising prices may not be adequate for homes and personal property. Explaining the replacement cost endorsement and asking pointed questions might help reveal how protections need to increase.
• Clarify replacement and purchase values.

Brokers and agents understand how upgrades and purchases affect replacement value. So it must be the advisor who helps configure replacement value by asking probing questions. Explaining the concept in its simplest form may be beneficial: Replacement cost helps make the customer whole by restoring a property to the same condition it existed in before a loss. Client homes may be significantly undervalued because of inflation, but you can be the agent of change to remedy underinsurance issues.

• Gain trust.

When you’re a trusted advisor, policyholders look to you to assess appreciation of home values and unique items listed on a policy. An agent or broker exhibits knowledge of policy provisions, and it’s easier to help clients understand adjustments in homeowners’ coverage. Inflation presents obstacles such as untracked spikes in home values. Annual policy reviews help, but coverage may require more frequent readjustments in hot real estate markets.

Other endorsements help close underinsurance gaps within traditional insurance policies. Find out if the following options apply to your clients:

• Additional living expense endorsements. Helps pay for increased costs incurred if you are temporarily unable to live in your home due to a covered loss. It could include food, lodging and other expenses that you have due to the loss of use of your home.
• Extended replacement cost coverage. Pays for repairs during “demand surges” in areas affected by natural disasters. An endorsement on your homeowner’s policy can extend dwelling coverage by 10% to 50% of the cost to rebuild your home.
• Ordinance and law coverage. Ensures rebuilds comply with new laws levied by municipalities to address new building codes.

Navigating the replacement cost landscape requires education, communication and cooperation. As changing economic circumstances force insurance carriers’ hands, it’s critical to keep high net worth homeowners in the loop about dynamic policy values that help protect their financial interests. When you do this, you’ll be seen as a true partner and trusted advisor — and that is the ultimate goal.

Robb Lanham is chief sales officer for HUB International Personal Insurance. He may be contacted at [email protected].

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