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."

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