Ignore your clients' homeowners insurance at their own peril.
Some things don't improve with age. Homeowners insurance is one of them.
It used to be that "all perils" coverage was superior to "named perils"
coverage. In the former case, all perils are covered unless
specifically excluded. In the latter case, only named perils are
covered. What's transpired over the last decade is that major insurers
now exclude so many perils-such as previously covered interior water
damage or broken pipes-that there is little difference between the two
policy forms.
In The Beginning
Says Peter Lindholm of the insurance agency bearing
his name in Albuquerque, N.M., "In the beginning, so-called 'all-risk'
policies had no exclusions except for damages attributable to war. Even
acts of God weren't excluded." According to Lindholm, several key
events started the ball rolling in the wrong direction. "Today,
homeowners policies exclude coverage for child molestation unless the
homeowner purchases an endorsement. Back about ten years ago, when this
risk wasn't excluded, attorneys realized they could get a piece of the
$100,000 or $300,000 personal liability protection each homeowner had
in his policy by encouraging child molestation claims. All the
homeowner had to do was say to his neighbor, 'Hey, I don't like the way
you're looking at my daughter,' and insurance companies were forced to
pay up."
Another cause was the mold damage controversy of 2000 that led the
state of Texas to require homeowners policies radically different from
those offered in all the other states (a sort of homeowners insurance
equivalent of California's unique auto emission control standards).
"After policies issued in Texas had long ago excluded mold damage,
Judge John Dietz overruled that practice in a high-profile case forcing
insurers to cover mold damage claims, raising the average claim from
$3,000 or $4,000 up to $15,000 to $20,000. It also gave rise to a whole
new industry: mold restoration companies. These companies would
encourage homeowners to look for mold in ductwork or mold damage to
carpets and furniture, advising them that their insurance would cover
the cost of restoring those items." Farmers Insurance, the company
Lindholm represents and the subject of the Texas case, found its losses
in that state alone outweighed its profits from the other 49 states.
Eventually, a new governor restored insurers' right to exclude mold
damage.
Of course, Hurricane Katrina provides a more recent
example of the same phenomenon. State Farm, insuring many of New
Orleans' damaged homes, denied coverage for water damage caused by the
city's broken levees; yet U.S. District Court Judge L.T. Senter
overruled the company in January 2007, saying State Farm hadn't proved
that the damage to the levees wasn't caused by the hurricane or wind-a
covered peril.
But regardless of where you stand on these rulings,
it's important to realize that, through a series of legal and economic
maneuverings, insurers have been put to the test and their efforts to
remain profitable have squeezed homeowners in ways that blindside most.
And the ignorance doesn't stop with homeowners; it's true of their
financial advisors, too.
What We Don't Know Can Hurt Us
Delia Fernandez of Fernandez Financial Advisory LLC
in Los Alamitos, Calif., was surprised to find out recently during a
discussion with her colleague that he hadn't reviewed his clients'
personal liability coverage. "And he was surprised, in turn, that I
cared so much about the issue with my middle-class clients. I consider
it one of the first types of coverage that come to mind once I see a
person's net worth. If I don't protect what they've built, how can I
help them grow future wealth without putting them in jeopardy?"
A noble sentiment, to be sure, and one validated
every day in the real world of homeowners insurance. Fernandez also
faced her own insurance issue closer to home. She says Allstate is
dropping the earthquake coverage it previously offered in Southern
California, citing the beating it took from Katrina, which presumably
has made the company reconsider its marginally profitable offerings in
non-Gulf Coast states. Fernandez says her condominium association's
Allstate earthquake coverage is no longer offered except as an
endorsement that would cost the association $15,900 a year instead of
the $4,000 they paid last year. "Our only recourse is to each purchase
supplemental coverage on our individual units, but that will only cover
us up to $50,000."
Horror stories like this one are common and varied.
In addition to insurance companies' ability to discontinue or raise
prices on coverages, they also have ways to deny claims for covered
risks. One of these is negligence, an often hazy concept.
Frank Presson of Presson Financial Associates LLC in Tucson, Ariz.,
says of the condominium he owns upstate in the Flagstaff area, "The
owner of the unit above me didn't have his utilities turned on when the
temperature dropped into the single digits while he was away last
November. His sprinkler system froze and flooded four units, mine being
the worst, suffering $44,000 of damage." The neighbor's insurer covered
his liability to Presson and the other neighbors but wouldn't cover his
own losses. Why? "The company considered his not having turned on
his utilities an act of negligence," says Presson.
In other cases, the property and casualty industry
has allegedly denied fire claims where homeowners failed to clear brush
over large areas of their property or install fireproof roofs; failed
to pay storm-related claims where homeowners did not install permanent
storm shutters; and some carriers in hurricane-prone eastern states are
declining to insure any home not built to 2001 building codes for
high-wind resistance.
Then there is the risk posed by insurers that refuse
to write new business. States can force insurance companies to remain
in a state and service old business, says Lindholm, but they can't
force them to accept new business based on old contract terms.
Steven Weydert, a partner with Bowyer, Weydert
Wealth Planning Partners Inc. in Park Ridge, Ill., says that when one
of his clients moved to Florida last year, both he and the client were
unaware that the major providers such as Allstate and State Farm were
no longer writing homeowners policies in that state. "Unbeknownst to
us," Weydert says, "our client went out and bought a homeowners policy
from a company called Vanguard Fire & Casualty.
Shortly thereafter he came home from a business trip
in the winter and found his entire house flooded due to a broken water
pipe. He moved into an apartment as contractors began mold removal, but
when he contacted Vanguard, he was notified that the company had just
been ordered into receivership. Our client will have over $150,000 of
rebuilding expenses and will pay $100,000 to $125,000 out of his own
pocket. Unreimbursed casualty losses can be written off, but we would
have much preferred that our client talk to us about the difficulty he
was having in getting coverage and we could have found a higher-rated
company from the beginning."
For those readers who don't advise on homeowners
insurance, the reasons why may be coming back to them. It's complicated
stuff that only seems simple if you don't actually read the policy.
The System Is Broken
Bottom line-the system is broken. Homeowners
policies with lists of exclusions spilling over onto additional policy
pages have become the norm. Determining the causes of and
responsibility for covered losses has become a subjective endeavor.
Insurers say they've become unduly pressured by erratic court rulings
and governmental pressures, forcing them to abandon heretofore
profitable markets. Homeowners have become highly skeptical as they pay
dramatically rising premiums for increasingly less comprehensive
coverage.
No wonder no one wants to look closely at clients'
homeowners policies; even longtime agents like Lindholm learn something
new every day about the coverages they sell. Is anyone paying attention
to this mess?
Kevin M. McCarty is. As commissioner of the Office
of Insurance Regulation for the state of Florida, McCarty's well aware
of the evolutionary path homeowners insurance has taken. "We've come
full circle," says McCarty. "In the beginning, homeowners insurance was
just for fire coverage. Then liability was added, as well as theft and
other extended coverages. These policies finally evolved into
all-perils coverage. Then, with hurricanes and other natural disasters
becoming more common, insurers have engaged in much stricter
underwriting and dramatically changed their policies so that most
policyholders-even sophisticated people-would be surprised to find they
don't have the coverages they used to have."
McCarty, long a defender of seniors and minorities, understands both sides of the issue. "Companies are looking at how they calibrate their book of business, particularly after their experiences of the last few years. To preserve their return on investment, they're having to shift away from insuring older buildings and coastal properties."
But isn't that what the actuarial process is all about-anticipating losses based on past experience and setting premiums accordingly? Yes, but sporadic disasters undermine this process. "The worst storm in the Gulf area prior to Katrina and Rita was Camille back in 1969; [before Katrina], most people just thought they no longer needed flood insurance," says McCarty.
What he says is needed is a model all-perils policy, available in every
state, that truly is for all perils, so policyholders and insurers
don't have to establish what peril their damage was caused by. "When a
house is completely wiped out, it's hard to determine if the wind blew
the house down before the water came along to damage it further,"
McCarthy says. Such a policy would exist in the context of a strategic
national catastrophe plan, he says, that would require local
governments to prepare a plan for disaster, establish a prefunding
mechanism for uninsured losses and require uniform building codes. Adds
McCarty, "There is no uniformity of disaster preparedness among the
states. Instead, the federal government just opens its checkbook when
disasters come along."
But until we get a major overhaul of the system, presumably along lines
that look something like McCarty's proposal, what do you and your
clients do to protect themselves?
Educate, Educate, Educate
Not only are "sophisticated" consumers unfamiliar with the shortcomings of their policies, many financial advisors need to get a clue as well, says McCarty. "Most clients just buy homeowners insurance so they can close on their house; they don't know much about the coverage they have, and advisors need to play a more active role in educating them."
As a member of the National Association of Insurance Commissioners,
McCarty and other state commissioners do public outreach and consumer
alerts to get people to ask questions of their insurance agents so they
can be better versed about what's in their policies. "But Florida takes
it one step further," says McCarty. "We've developed a consumer
checklist that consumers and advisors all over the country can
use." (For your copy, visit http://www.floir.com/pcfr/HO
ChecklistRule.htm).
Yet it's a bit embarrassing that financial advisors must resort to
publicly available checklists to keep their clients safe. Aren't they
supposed to know about property/casualty insurance? The truth is, while
many advisors learn the basics of such coverage while studying for the
CFP or other professional designations, it's unusual for an advisor
whose primary business is financial planning and wealth management to
have an in-depth knowledge of the P&C market. There just aren't
enough hours in the day to be good at both planning and specialized
insurance contracts-which homeowners policies most definitely have
become.
Those In The Know
Christopher Currin of Pegasus Advisors in Dallas knows what he knows
about homeowners insurance because he worked for 12 years for a large
P&C company before starting his fee-only advisory firm. Currin has
seen his share of clients with horror stories, including those
underinsured by their failure to secure replacement cost coverage on
their homes, clients who assumed their homeowners insurance would also
cover property and liability in connection with their home businesses,
and clients who should have purchased flood insurance and didn't.
"Every time there's a hurricane, the P&C companies try to push off
as much of their losses as possible to Uncle Sam, as the sole domestic
flood insurance underwriter, or to the homeowner," Currin explains.
"Clients need to know 'the lay of the land' and purchase flood
coverage. If their home lies outside a flood hazard zone, the cost of
insurance will be very low."
Like Currin, Drew Tignanelli, president of The Financial Consulate in
Lutherville, Md., came about his knowledge of homeowners insurance
before his entry into the financial planning arena. "My father was in
the P&C industry for 62 years, so I'm pretty familiar with the way
P&C insurance works. There are all kinds of things that 90% of all
planners don't know about P&C insurance. You have to have been in
practice as a licensed P&C agent [to understand the nuances of
homeowners insurance]. Even advisors with P&C licenses are usually
too busy to ensure their clients are properly insured; you need a
specialist who can really assess your client's risk, and they're hard
to find. Since homeowners and auto insurance are required in most
states, and the supply of agents is low relative to the demand, agents
don't spend much time studying P&C risk. So just sending your
client off to an agent is usually not enough service; we need to become
more knowledgeable and really be the quarterback for our clients."
Kevin Korhorn is a knowledgeable advisor with a slightly different
view. "I didn't realize how much I didn't know about P&C until I
got licensed," says Korhorn, head of Korhorn Financial Group Inc. in
Granger, Ind. Korhorn decided to get P&C-licensed two years ago,
when he realized he didn't know much more about his clients' homeowners
and auto insurance than they did. "I thought ... if I can get great
investment returns for my client but he incurs damage to his home, the
return doesn't matter. In the big picture, as a financial advisor, we
underserve our clients if we don't examine the risks associated with
P&C coverages."
Not only did Korhorn discover how much he didn't know about P&C, he
decided licensing was critical from an implementation standpoint as
well. "We might recommend to a client he make some changes to his
insurance, like pick up umbrella coverage, only to find out he left our
office and didn't do anything. Sometimes the client will ask me to call
his agent, give him the parameters of what I want him to have, and six
months later ... still nothing has been done. I needed to be able to
control that function by being licensed, myself."