Risk Management for Homeowners Chapter 15

Chapter Objectives • List the basic coverages in a homeowner’s policy and the limits of liability for each • Identify property that is excluded from the homeowners’ policy and the special dollar limits for certain types of property • Describe how additional living expense losses are determined and how the loss settlement clause in the homeowners’ policy operates • Explain the doctrine of concurrent causation and its role in property insurance policies • Identify the perils insured in homeowners’ policies • Identify and explain optional endorsements to the homeowners’ policy • List the coverages in the comprehensive personal liability section of the homeowners’ policy and identify the major exclusions • Determine appropriate insurance coverages for a personal risk management program

Introduction • Traditionally, homeowners’ insurance has been a very stable branch of the insurance industry • Premiums tend to increase each year at a moderate rate • This line of insurance is not as sensitive to losses as personal auto • However, occasionally events occur that dramatically impact homeowners’ insurance, as in 1992 • Hurrican Andrew: Over $19 billion in losses • Hurricane Iniki quickly followed • Hailstorms in Texas and Oklahoma: $450 million in damages • Los Angeles riotL: $500 million in damages • Losses combined push the combined ratio of (losses plus expenses) ÷ premiums from an average of 111 to 156 • Dozens of insurers went bankrupt

Introduction • The homeowners’ sector still not fully recovered from the setback • For all practical purposes, homeowners’ insurance is a necessity • You cannot obtain a mortgage to purchase a home unless you can prove that you have a valid homeowner’s policy • You must maintain that policy or a similar one • Homeowners in southern Florida and Hawaii have had availability problems • Florida: new laws passed to make insurance available in coastal areas

Introduction • Table 15-1 shows 10 most costly catastrophes from insured losses in U.S. history • These losses are all quite recent • Six are wind related • All but the terrorist attacks of 9/11 are primarily losses to residential property • Thus, are paid mostly by homeowners’ insurance

Table 15-1: Ten Most Costly U.S. Catastrophes

Homeowners’ Program: Development • The most comprehensive protection for owner-occupied, one- to four-family residences is found in the homeowners’ program • An outgrowth of several attempts by the insurance industry to develop policies to provide a more balanced and adequate program of insurance for the average homeowner • At lower cost than will be available if the coverages were purchased separately • Homeowners’ policy was developed in 1958 by the Multi-Peril Insurance Conference • Major revisions have resulted in today’s homeowners’ policy: • Is written in easy-to-understand English • Is multiple-line • Requires a minimum amount of coverage to be purchased • Costs less than if coverages are purchased separately

Concise Language • The current version of the homeowners’ policy is much easier to read than earlier versions • Today’s version is 40% shorter and much easier to understand • Even the size of the print has been increased 25% so that it is easier to read

Multiple-Line • A basic objective of the homeowners’ program • To provide an opportunity for the homeowner to purchase in one policy any of the many variations of coverage • Coverage is provided for • Both the home and personal property • Broad named-perils or open-perils protection is offered • Coverages such as personal liability and medical payments to other persons are included

Minimum Amount of Coverage • Provides a definite minimum amount of coverage acceptable to the user • A single indivisible premium is charged • The insured cannot pick and choose among specific coverages

Lower Cost • Because the insured is buying a package of coverages, costs are lower • The savings results from a broader range of perils being insured • Which gives the insurer a better spread of loss exposures and lower administrative expenses • Allows insurers to charge substantially less for the total package than if the coverages were purchased separately

Outline of Homeowners’ Coverages • Certain coverages are mandatory in the homeowners’ program, but • Sufficient flexibility still exists in the amounts required to fit the needs of most people • Basic coverages of the homeowners’ program are

Outline of Homeowners’ Coverages • Table 15-2 summarizes the coverage offered by most of the primary homeowners’ forms • Designated HO-2, HO-3, HO-4, HO-5, HO-6, and HO-8 • A dwelling must be owner-occupied to qualify for dwelling coverage in this program • Minimum dwelling coverage as specified by the insurer must be purchased • The term limited named perils means • Fire, lightning, windstorm, hail, explosion, riot, civil commotion, aircraft, vehicles, smoke, vandalism and malicious mischief, theft, and volcanic eruption • Open perils is the new name for what used to be called all-risk coverage • Coverage is for any direct loss to property except for certain losses specifically excluded in the policy

Table 15-2: Basic Coverages of Homeowners’ Program

Outline of Homeowners’ Coverages • HO-2, HO-3 and HO-5 forms are all for owner-occupants and differ primarily in terms of the perils they cover • HO-4 form is for tenants • Commonly called renter’s insurance • HO-8 form was developed because many people are moving back into older neighborhoods and renovating houses • The market value of the home might be $100,000, but its replacement cost could be twice that • The standard homeowners’ policy would encourage the policyholder to insure at least 80% of replacement value • However, insurance companies were reluctant to do this because of the potential moral hazard, so coverage was unavailable for such older dwellings • Insureds cannot collect on a replacement cost basis—instead they collect on a cost-to-repair basis • No deduction is made for depreciation, and repairs may not be made with like labor and material • The rates are high compared to other forms • The insured must pay more for less coverage, but they have homeowners’ insurance available where previously it was not

HO-3 Coverage A—Dwelling • Coverage A is for the dwelling on what the policy calls the residence premises • The one- to four-family dwelling where you reside, other structures and grounds of that location, or that part of any other building where you reside and that is shown as the residence premises in the declarations • Includes structures attached to dwelling • Such as a patio roof, a carport or an attached greenhouse • Dwelling coverage also involves materials and supplies located on or next to the residence premises • For use in the construction, alteration, or repair of the dwelling or of other structures on the residence premises

HO-3 Coverage B—Other Structures • Other structures are defined as those separated from the dwelling by clear space or connected by only a fence or utility line • A garage that is not attached to the dwelling is an example of such a structure • As is a greenhouse or a tool shed • Coverage B is designed for structures for personal use • Other structures used for business purposes or held for rental are not protected

HO-3 Coverage C—Unscheduled Personal Property • Covers personal property owned or used by an insured while anywhere in the world • Subject to exclusions • Types of property protected include such items as • Jewelry, kitchen appliances, furniture, clothes, stereos, video cassette recorders, televisions, currency, guns, and bicycles • Besides the insured’s property, property of others while on the residence premises is protected • If the insured requests it

HO-3 Coverage C—Unscheduled Personal Property • Personal property that is taken to a secondary residence while the insured is temporarily residing there is insured for the full limit of Coverage C • For most families, Coverage C does not have to be modified when one or more children go to college • Each child’s property would be covered for 10% of the Coverage C amount • Certain types of personal property are excluded and others have dollar limitations

HO-3—Property Excluded • Articles separately described and specially insured in this or any other insurance (Such as an expensive camera, watch, or a diamond ring) • Animals, including birds and fish • Motorized land vehicles (Except those not licensed for road use that service an insured’s residence or assist the handicapped) • Sound equipment while in an automobile • Aircraft and hovercraft and their parts • Property of roomers, boarders, and other tenants (Except those related to an insured) • Property contained in an apartment regularly rented or held for rental • Property rented or held for rental to others away from the residence premises • Books of account, drawings, or other paper records, or electronic data processing tapes, wires, records, desks, or other software media containing business data

HO-3 Coverage D—Additional Living Expenses • Covers the increased cost of living that results from an insured peril damaging the residence premises and making them uninhabitable • The insured is allowed to maintain his or her normal standard of living • However, only the increased cost of living is covered • Table 15-3 shows an example

Table 15-3: Additional Living Expense Example

HO-3 Coverage D—Additional Living Expenses • Pays for loss of rental income less rental expenses • This lost income would arise from a situation in which the insured rented a basement room to someone and fire made it uninhabitable • For many home owners in south Florida, coverage D limits were exhausted after Hurricane Andrew • Little rental property was available and what could be found was expensive • Repair time was much longer than normal because the demand for repair was much greater than the supply

HO-3 Additional Coverages • Debris removal • Included in the limit of liability • However, when the limit has been exhausted, an additional 5% may be used to pay for debris removal • Reasonable repairs • Repairs made by the insured to protect the property from further loss, after loss from an insured peril has occurred • Are covered by the policy • However, this provision does not increase the insured’s limit • Trees, shrubs, and other plants • Up to 5% of the coverage A limit can be used to pay for loss to trees, shrubs, and other plants • Subject to a limit of $500 for any one item

HO-3 Additional Coverages • Fire department service charge • In situations where the insured lives in a rural area and a city fire department makes a charge for responding to a call • The policy will pay up to $500 for such charges • The charge must resolve from an insured peril, and no deductible applies to the coverage • Removed property • If property must be removed from the premises due to an insured peril • The removed property provision gives all-risk coverage during removal and 30 days thereafter

HO-3 Additional Coverages • Credit card, electronic funds transfer card, forgery and counterfeit money • Although federal law limits a person’s liability to $50 per lost credit card • A stolen or missing wallet full of cards can lead to loss of several hundred dollars • However, if the unauthorized user is a member of the insured’s household, no coverage exists • Coverage exists for forged or altered checks, fund-transfer cards, and counterfeit money accepted in good faith • No deductible applies to any of these items • The insurer will pay defense costs for court suits brought against the insured under the credit card or forgery coverage

HO-3 Additional Coverages • Collapse • Covered if resulting from • The perils insured against in coverage C, personal property • Hidden decay and hidden insect or vermin damage • The weight of contents, equipment, animals, or people • The weight of rain that collects on the roof • The use of defective materials or methods in construction or remodeling • If the collapse occurs during remodeling • Collapse caused by an earthquake, mudslide, or flood are not covered • Glass or safety glazing material replacement • Provides coverage for breakage of glass or safety glazing material (safety glass) of a covered building, storm door, or storm window

HO-3 Additional Coverages • Landlord’s furnishings • If the insured rents out part of the residence premises as an apartment • The insured’s appliances, carpeting, and other furnishings in the apartment are covered for the coverage C perils, except theft • Loss assessment • Provides the insured $1,000 of coverage if he or she is assessed for damage to property that is owned by an association of property owners of which the insured is a member • The damaged property must be collectively owned by all members of the owners’ association • The peril causing the loss must be covered under coverage A

HO-3 Additional Coverages • Ordinance or law • Up to 10% of the limit for coverage A is provided as additional insurance for increased costs resulting from an ordinance or law related to repair of a covered structured damage by a covered peril • Grave markers • Policy will pay up to $5,000 for loss to grave markers on or away from the residence premises • As long as the loss is caused by a coverage C peril

Loss Settlement Clause • Determines how the items will be valued for adjustment purposes • The homeowners’ policy provides replacement cost coverage on the dwelling and actual cash value (ACV) coverage for personal property • The law settlement clause helps classify certain items as to whether recovery is on an ACV basis or on a replacement cost basis

Loss Settlement Clause • When a loss occurs to a building or other structure under coverage A or B • The insured can make a claim on either an ACV or replacement cost basis • It may sometimes be to the insured’s advantage to collect on an ACV basis because of the policy’s coinsurance clause • If the claim is filed on a replacement cost basis, then an 80% coinsurance requirement applies • The insured can choose the basis of the claim after the loss occurs

Pair-and-Set Clause • When part of a set or one of a pair is lost, this clause is used to determine the loss payment • The insurance company will pay only for the difference between the ACV of the item before and after the loss • The loss of one of a pair of items, such as diamond earrings, is not a total loss • Only the difference in value of the earrings before and after the loss is paid • In many cases an insurance company will take possession of the remaining item and pay a total loss or replace the item

Perils Covered in Homeowners’ Insurance • HO-3 gives • Open-perils coverage on the dwelling and other structures • Broad named-perils coverage on unscheduled personal property

Open-Perils Dwelling Exclusions • Open-perils coverage includes all physical losses except certain specifically excluded losses • To determine what is insured, you must investigate the exclusions • Homeowners’ policies with open-perils coverage contain a number of exclusions

Open-perils Dwelling Exclusions • Freezing • Loss caused by freezing of plumbing, heating, or air conditioning systems is excluded • While the dwelling is vacant, unoccupied, or under construction • Unless heat is maintained or the water system is shut off and the water pipes are drained • Fences, pavement, patios, and similar structures • When fences, pavement, patios, swimming pools, foundations, retaining walls, bulkheads, piers, wharves, or docks are damaged by freezing, falling, or the weight of ice or snow, no coverage exists

Open-Perils Dwelling Exclusions • Buildings under construction • No theft coverage exist for materials and supplies • Coverage begins when the dwelling is completed and occupied • Vacancy beyond 60 days • When a building is vacant for more than 60 days, coverage for vandalism, malicious mischief, breakage of glass, and safety glazing materials is suspended • For the purposes of this coverage, a dwelling under construction is not considered vacant • Mold, fungus, or wet rot • Generally excluded • However, an exception provides coverage for mold, fungus, or wet rot that is hidden within the walls, floors, or ceilings of a structure • If the loss results from water or steam from a plumbing, heating, or air conditioning system, or a household appliance

General Open-Perils Exclusion • Open-peril contracts have one exclusion provision that is almost universal to such coverage • Excluded by this clause are such things as • Wear and tear • Inherent vice • Latent defect • Mechanical breakdown • Rust, mold, and wet or dry rot • Contamination • Smog • Smoke from agricultural smudging or industrial operation • Settling, cracking, shrinking, bulging, or expansion of pavements, patios, foundations, walls, floors, roofs, or ceilings • Loss due to birds, vermin, rodents, insects, or domestic animals

All-Property Exclusions • Several general exclusions apply to all property including • Earth movement • Flood and several other types of water damage • War • Intentional loss • Neglect by the insured to protect the insured property from loss at and after the time of loss • Spoilage • Spoilage resulting from the interruption of electrical power or other utility service caused by an off-premises event is not covered • However, if lightning strikes the power line pole on the premises and causes power interruption • Then the policy will pay for the ensuing loss

Concurrent Causation • This doctrine greatly expanded coverage under open-perils insurance policies • So that if a peril is not excluded, it is covered • The courts held that even if an excluded peril such as flood, earthquake, or contamination occurred • Coverage would exist if a concurrent event occurred and that concurrent event was not excluded • Because of the court’s decision on concurrent causation and a similar decision on the collapse peril • Today’s insurance policies have a rather lengthy exclusion with respect to events that might result from concurrent causation

Named-Perils Protection • Fire and lightning • The fire must be a hostile fire • Outside normal confines • Direct loss caused by fire also includes such losses as damage from water or chemicals used to fight the fire and broken windows or holes chopped into the roof by firefighters • Windstorm and hail • Certain types of property are excluded such as • Watercraft and their trailers, furnishings, equipment, and outboard motors except when inside a fully enclosed building • When windstorms as such as Hurricane Andrew occur, insureds may seem helpless • However, as citizens, insureds can require strong enforcement of building codes • Much of the damage from Andrew could have been prevented if existing building codes had been enforced

Named-Perils Protection • Explosion • The term explosion is undefined in the policy and thus is broadly interpreted by the courts (It would include a natural gas explosion as well as a sonic boom) • Riot and civil commotion, aircraft, and vehicles • These terms are undefined in the HO-3 form • Damage to trees, shrubs, and plants by a vehicle driven or owned by a resident of the residence premises is excluded • Aircraft include self-propelled missiles and space craft • Smoke • This peril only includes sudden and accidental damage from smoke • Loss caused by smoke from agricultural smudging or industrial operations is excluded • Vandalism or malicious mischief • Typically involves the concept of willful intent to damage the property • However, the HO-3 form does not mention this limitation (So a liberal definition of the term can be assumed)

Named-Perils Protection • Theft • The policy states that the theft peril “includes attempted theft and loss of property from a known location when it is likely that the property has been stolen” • In the case of loss, the police must be notified if the insured expects to collect under the policy • The insured is required only to show that theft of the item is a reasonable explanation of the loss • It is not the intent of the insured to pay for property that the insured simply loses • No coverage exists if any insured steals the property • Limitations on the premises • Any materials or supplies used in the construction of a dwelling are not covered for theft until the building is completed and occupied • No coverage is available for any property in that part of the residence premises rented by the insured to another unless they are an adult relative • Off-premises limitations • Restrictions exist involving trailers and campers, watercraft, secondary residents, and student property

Named-Perils Protection • Falling objects • Falling objects does not pertain to property inside the building unless the roof or an exterior wall is first damaged by the falling object • Weight of ice, snow, or sleet • Coverage applies only to contents inside the dwelling • The roof would have to collapse from the weight of ice and snow, and then the contents would have to be damaged, for coverage to exist • Accidental discharge or overflow of water or steam • The overflow or accident must come from within a plumbing, heating, or air-conditioning system or from within a household appliance • Coverage does not exist for the appliance from which the steam or water escaped nor for loss due to freezing, overflow, or discharge that occurs off the residence premise

Named-Perils Protection • Sudden and accidental tearing apart, cracking, burning, or bulging of a steam, hot water, or air-conditioning system or an appliance for heating water • The obvious example of this peril is a water heater that explodes • No coverage for freezing is provided under this peril • Freezing • Covers freezing of a plumbing, heating, or air-conditioning system or a household appliance • No coverage exists if a dwelling is unoccupied • Unless the insured takes reasonable care to maintain heat in the building or shuts off the water supply and drains the system and appliances of water • Many people might expect to see most of this type of damage in the northern part of the United States • However, much of the destruction occurs in the South as the buildings are not designed for freezing temperatures

Named-Perils Protection • Sudden and accidental damage from artificially generated electrical current • An air conditioner damaged by a power surge would be covered by this peril • However, the policy specifically excludes loss to a tube, transistor, or similar electronic component • Stereos, televisions, and PCs are the main targets of this exclusion • Volcanic eruption • A fairly new coverage for the homeowners’ program • Addresses problems that arose after the eruption of Mount Saint Helens • Loss caused by earthquake, land shock waves, or tremors is not covered

Optional Property Endorsements to Homeowners’ Policies • Many property endorsements are available • Personal risk managers must decide which, if any, of these endorsements are appropriate for their circumstances

Earthquake • The peril of the earthquake is catastrophic in nature • However its frequency is so low that few people purchase the coverage even though they should • The endorsement eliminates a loss from flood or tidal wave cause by an earthquake and loss to exterior masonry veneer • Two earthquake deduction endorsements are available • A 5% deductible • A 10% deductible • Most often found in the western states where earthquakes are most likely • On a dwelling with a replacement cost of $150,000 the deductible would be $15,000 • Perhaps this is why some people do not purchase earthquake insurance

Inflation Guard • When inflation occurs at a rapid pace, the problem of maintaining adequate property limits has to be addressed • It as not uncommon for construction costs to rise 10% per year • When replacement cost protection is desired, an 80% coinsurance clause must be maintained • And policy limits need to be adjusted periodically • However, if one adjusts only once a year • Problems can arise because the loss may occur right before it is time to increase the policyholder’s limit • The inflation guard endorsement is a partial solution • A person’s limit is raised a set percentage every three months

Guaranteed Replacement Cost • Applies to the dwelling and provides the policyholder with full replacement cost at the time of the loss • The policyholder is required to insure 100% to value when the policy is purchased • And increase the stated value as requested by the insurer • Most versions of this endorsement limit the policy to 125 to 150 percent of the stated value • May or may not increase the limits for coverages B, C, and D • An attractive endorsement and a good way to eliminate the potential coinsurance problem that can occur when a hurricane or tornadoes strikes a city and building costs explode during the rebuilding period

Personal Property Replacement Cost • Before 1980 an individual could not purchase replacement cost coverage on an unscheduled basis on personal property in the homeowners’ program • In 1980 a new endorsement was introduced • The insured could collect the smallest of four amounts for personal property • Replacement cost at the time of loss • Full repair costs of the time of loss • Any special limits of liability pertaining to coverage C • The limit of liability for unscheduled personal property and coverage C • Which is usually 50% of the dwelling coverage

Risk Management for Homeowners Chapter 15