There Are Parts I, II, and III

Part I is not just a foundation but a crucial one.  It equips property owners, borrowers, and insurance professionals with a comprehensive understanding of general insurance concepts   This knowledge is informative and empowering as it facilitates informed decisions and instills a sense of control over your insurance need It’st’s the starting point that sets the stage for parts II and III, which delve into the specifics of real estate insurance, providing a deeper understanding of this complex subject and further boosting your confidence.

Introduction:

Insurance companies play a pivotal role in our lives, safeguarding our assets and providing security and peace of mind. Their primary function is to amass premiums and utilize them to compensate for covered insurance claims.  This business model, which aims to collect more premiums than pay out claims, ensures the company’s and its shareholders’ profitability.  The insurance industry operates on a national and global scale, underscoring the significant role it plays in the economy.

Real Estate insurance is a complex subject, intricately woven with many subsets: property, business, and personal coverages.  The sheer breadth of real estate insurance categories, including homeowners, condominiums, co-ops, commercial property, renters, mobile and manufactured homes, liability, and personal property, underscores the need for a comprehensive understanding of these areas.  This thorough understanding is crucial, as it enables property owners, borrowers, and insurance professionals to feel more informed and prepared.

A ‘peril’ is an event that causes property damage or destruction.  These can include natural disasters, such as fire, windstorms, hail, and earthquakes, as well as human-caused events like theft and vandalism.  The specific risks covered by insurance are known as ‘insured perils ‘.

The covered claims are made because the damage is caused by sudden and fortuitous events that occur by chance.  Insurance does not cover property damage that occurs over time due to a lack of timely maintenance, wear and tear, deterioration, or faulty quality.  Insurance companies calculate the probabilities of claims and losses and issue coverage accordingly. Profit is motivation.

A few shady insured parties will file claims for reimbursement resulting from their negligence or failure to maintain timely property upkeep.  A few even intentionally caused damage to collect on the insurance claim.  I once worked as a private investigator, investigating allegations of fraud, organized theft, and arson.  Insurance companies and their adjusters are experienced and intelligent people.  They know when claims are accurate and when they are fraudulent.

Non-covered perils, such as flooding, earthquakes, riots, etc., require additional coverage in the form of riders or endorsements.  This knowledge empowers property owners to make informed decisions about their insurance coverage, ensuring they are prepared for any eventuality.

One crucial element of insurance is that the insured party cannot assume any event is covered unless they comprehensively review the coverage and the insurance policy explicitly states so.  This thorough review is not just a step in the insurance process, but a proactive measure that empowers the insured party, ensuring they understand and can make informed decisions about their coverage.  Few insured parties thoroughly read and comprehend the substance of their policies; however, this is a critical and responsible step in the insurance process.

Insurance company executives are not fools. Their business model, which involves providing hazard insurance cover, is designed to maximize the insurer’s profits.  Their premiums are heavily invested in the securities market, typically yielding a substantial profit.  High-risk exposures include highly leveraged securities investments, such as derivatives contracts.  Insurance companies are significant holders of loan portfolios for large office buildings,  which are now in considerable decline.  The losses will be substantial.  The federal government will always bail them out with taxpayer dollars, allowing them to suffer significant economic losses.

Insurers will insure anything for a fee.  They will cover the continued vitality of an opera singer’s voice, the hands of a professional golfer, the health of a 3-million-dollar racehorse, or the potential loss of a derivatives contract.  Sometimes, insurers will insure something that they do not understand.  The motivation is always profit.

At one time, American International Group, Inc. (AIG) was the largest property and casualty insurer in the world.  It was also the largest provider of retirement savings investments for primary and secondary teachers and healthcare workers.   IG has 71 separate U.S.-based insurance companies and 176 other financial services subsidiaries worldwide.

AIG miscalculated the risks associated with insuring derivatives and was bailed out by taxpayers in April 2009.

• AIG did not understand the risks for which they were insured.
• The taxpayer bailout was a substantial sum of $185 billion due to derivatives losses.
• The U.S. Treasury sold its final shares of AIG in December 2012, recouping all losses.  AIG is now a smaller and wiser company.

Derivatives are highly leveraged, interest-rate-sensitive hedging bets in the financial market.  There are currently $610 trillion of notional value outstanding derivatives in the U.S. alone.  Derivative risks of loss for any insurance carrier are a financial ticking time bomb, as they were in 2008 and remain today in 2022.

Insurance policies are written legal contracts between two principal parties: the insurer and the insured.

In real estate, the lender is a third party with a security interest in the property and a financial interest in the insurance policy.  However, they are not a principal to the insurance contract.  This means they have a stake in the insurance policy but are not directly involved in the contract itself.

• Insurance company (the insurer)
• The Insured party Borrower) may be an individual, trust, business, or entity (the insured).
• The lender has a security interest in an insured property and is referred to as an additional insured.
• These three parties willingly enter into an insurance contract that includes coverages, exclusions, policy limits, and limitations of coverage, such as personal property, as well as considerations regarding the parties’ obligations, rights, and responsibilities.
• The Borrower and the lender are principals; the insurer is not.  Although not a principal in a loan contract, the lender requires protection of its security interest rights.

https://www.investopedia.com/terms/p/property-insurance.asp

The insurance industry is like a cartel:

The Department of Insurance regulates the industry in various states (the California Department of Insurance or similar state agencies for other states.  Only a few companies are allowed, and admitted members draft regulations in their favor.

Insurance brokers are dual agents who represent both the company and the insured. General agents are agents of insurance companies, rather than the policyholders themselves. Failing to adequately counsel clients regarding the proper insurance products, alternative insurance products, and corresponding add-on endorsements or riders is a breach of fiduciary duty.

When there is controversy over whether the insurance company is willing to cover the loss, negotiating a claim to the insured party’s reasonable satisfaction may require that the insured party hire an independent insurance adjuster representing their interests, not the insurance company’s interests. An insured party may be required to pay legal costs and experience a delay in reconstructing the building for an extended period.  The alternative is to engage in arbitration or expensive litigation against mammoth-sized companies with seemingly bottomless pockets. His potential for conflict underscores the importance of preparing for potential challenges in the insurance process.

While completing the loan application, the Borrower or agent may object to the lender’s requirement that insurance cover the total 100% replacement cost of the building, including appurtenant structures.  The Borrower may suggest coverage of 50% of the replacement cost, as the property’s value may not accurately reflect the replacement cost of the improvements.  However, it’s important to remember that underinsurance can lead to significant financial risks in the event of a claim, making it crucial to ensure adequate coverage.

From a lender’s perspective, insurance should be sufficient to recoup the principal balance, accrued interest, and expenses in the event of a claim.  Borrowers should consult with their insurance broker’s counsel to guide them in making informed decisions regarding the types and amounts of coverage, alternative coverages, and applicable endorsements.

Inflationary pressures cause insurance premiums to rise faster:

Inflation directly results from the government’s continuous injections of new fiat currency into the economic system, which creates a corresponding future debt to taxpayers.  Our future sovereign debt, of course, is a systemic fraud because the Federal Reserve and the leaders of this country never plan to pay the debt off or even reduce it. As the Federal Reserve pumps more money into the economic system, there is a corresponding reduction in the dollar’s purchasing power (debasement).  Debasing the dollar assumes repayments of reduced value (cheaper dollars).   Goods, services, and construction cost incrementally more.

Real estate may benefit from inflation because values increase, but the glee quickly decreases when everything costs incrementally more.  Each dollar becomes worth less and less.

Insurance markets have remained stable over the past decade, with little indication of inflationary pressures.  Over the last four years, we have been in an accelerated speed trap, attempting to keep up with a race between increased premiums and costs, all related to inflationary pressures caused by our current administration. The taxpaying consumers are the losers.

During inflationary times, there is constant pressure on the rising prices of original construction, repair, and maintenance costs, as well as regulatory compliance, and the increasing cost of required building enhancements.

A Borrower may be focused on saving money but needs to be more informed about, or at least aware of, the adverse financial consequences of recovering losses in a claim.  Good things may happen if the Borrower follows the recommendations of their mortgage broker or qualified insurance agent. Discovery may not occur until a time has passed with compounded inflationary pressures, when the property owner experiences a hazard loss, tenders a claim to the insurance company, and discovers the condition of massive under-insurance.  Due to policy limits, the insurance company is fentirelyawarethat it hhasno liability for tthis underinsuranceproblem.

Inflation causes the prices of building materials, appliances, heating and air conditioning, municipal approvals (including revised building codes), and labor to increase, and over time, this process compounds prices.

Whether intentional, uninformed, or negligent on the part of the Borrower's insurance agent, real estate agent, or mortgage broker, the insured parties may find themselves underinsured and must pay a portion of the repair and reconstruction costs for the loss.  Many owners may not have the financial resources to cover the shortage.  The consequence may be to walk away from the property and hand the keys to the lender.

The problem of underinsurance is a nationwide economic catastrophe in the making.  Few ever talk about it. Property insurance industry participants, including insurance agents and brokers, as well as real estate agents/brokers, are not vocal enough about the magnitude of this national problem!  The agents and brokers are fully aware of the situation in private conversations.   An underinsured party filing a claim will likely lead to accusations, Mr. Fiduciary.  It would have been best if you had told me I was underinsured.  The lawyer community will high-five with delight.

Replacement cost coverage (RCV):

RCV is the amount required to replace the damaged or destroyed property with one of the same or similar quality as initially built.  Insurance for enhancements, betterments, building codes, and current zoning ordinances will require a different form of insurance or endorsement to bring the property up to today’s standards.   The definition of insurance replacement cost does not include this form of insurance.   Upgrading a property may be tricky, if not impossible.

The insurance definition of replacement cost is hypothetical and not a reality because the same or substitute quality of materials is so radically different over an extended time that it is not economically feasible. Replacement cost insurance may be unclear to the public when it comes to life insurance, particularly when purchasing insurance policies as a protection mechanism.

The replacement cost verbiage in the insurance policy must reflect current codes, ordinances, regulations, designs, and available materials.  A property built in 1946 contemplates reconstructing the building to those same 1946 standards.  Older properties may be characterized by obsolete materials such as asbestos, galvanized, and lead-based plumbing.  An example of upgrades not covered would be replacing 1946-installed single-pane windows with aluminum frames and modern double-insulated low-E glass panes, orr upgradingtoo vinyl frames, anodized aluminum frames, or wood frames.

Structural designs, engineering requirements, building materials, and add-on standards have undergone significant changes over the last 50 years, with a notable acceleration over the previous 20 years.  Most of these new requirements are government-driven mandates, and current insurance products may not work correctly or may be inadequate.  Insurance carriers may be reluctant to write policies that cover unknown risks.

The need to invest additional capital in upgrading or bringing the property into current compliance, to raise rents and enhance value, is not part of an insurance policy.

You may visit www.insurance.ca.gov for an overview of insurance products and definitions.

Extended replacement cost coverage:

The coverage protects the insured against sudden increases in materials or construction costs.  This type of insurance is an additional, more extensive, and expensive form of protection.  Some carriers will offer extended replacement options as an endorsement that may cover a further rise of 20% to 25% of the replacement cost up to the policy limits.  However, 20% or 25% may not be sufficient to cover higher prices and new government-mandated upgrades.

Actual cash value policies (ACV):

An insured party may choose actual cash value coverage.  A loss is calculated to include the depreciated fair market value of the damaged or destroyed dwelling at a loss and up to the policy limits.  In other words, it is the replacement cost minus the depreciation of the damaged property (ACV = replacement cost less depreciation).  It represents the dollar amount you expect to receive by selling the property on the open market. This form of insurance may significantly alter the lender's underwriting.

This form of coverage is more common for older commercial and industrial properties.  An ACV policy is a bad idea in all cases.

Zoning and building ordinance Insurance:

Upgrades or updates to meet current building codes and standards require additional coverage.  Examples may include weather, fire safety, wiring, or accessibility for people with disabilities.  Some coverage endorsements are called Improvements and Betterment insurance. This form of coverage typically takes the form of policy endorsements.  These coverages vary in what is covered and what different insurers exclude.

Policy exclusions:

Carriers have different exclusions and what they will cover by separate policies and add-on endorsements.  Most insurance carriers have policy exclusions including but not limited to ordinance or law, tsunamis, floods, drain & sewer backups, seeping groundwater, standing water, mold, total pollution exclusion, asbestos, lead-based paint, earthquake, earth movement, acts of war, mold/mildew & fungus, acts of war, nuclear, biological, chemical, acts of terrorism, etc.  Insurance does not cover damage resulting from poor maintenance or quality, general wear & tear, pest infestations, power failures, nuclear hazards, government actions, intentional loss by the insured,  or home-based business liability.

Coinsurance provisions:

Many insurance policies, both residential and commercial, have a provision referred to as a coinsurance clause that addresses the issue of under-insurance.  A coinsurance clause requires that policyholders insure their property for a reasonable replacement cost. The insurer will receive a fair premium for the risk. A coinsurance clause will require policyholders to guarantee up to 80, 90, or 100% of the replacement cost for the structure(s) and appurtenant(s).

Coinsurance penalties will be applied to claims for underinsurance and will differ between companies and policy types.  Effectively, a coinsurance penalty triggers a contractual requirement that the insured party pay a portion or penalty of their economic loss using a calculation formula in the policy.  Some insurance companies offer step-up coverage endorsements to reflect higher replacement costs resulting from inflation.

If a policy contains a coinsurance penalty provision, a claim may reflect underinsurance.  The insurance company will pay up to the policy limit, leaving the underinsured party with significant cost overages.  The insured party may be required to pay a portion of the loss.  Their portion is part of the reconstruction cost, including betterments and enhancements.

Underinsurance is more prevalent now than before due to the upward cost pressure caused by inflationary increases in construction costs.  For example, lumber prices, other materials, and labor have increased dramatically. Municipal approvals and building standards/codes are much more stringent.  Add-on municipal fees (taxes) have gone up.

A mortgage broker, Borrower, or insurance provider who calculated $200 per square foot a few years ago may find that the replacement cost has doubled to $400 per square foot, not including the land value.  Housing replacement costs may range from $200 per square foot for entry-level production homes to $1,000 to $1,500 per square foot for high-end custom homes.

Lenders and mortgage companies may want to audit their loan portfolios to ensure that property coverages are adequate to offset inflation.  Lenders may wish to discuss methods and data sources for calculating replacement costs. Most insurers and appraisers utilize Marshall & Swift cost data to determine construction costs.

Claims department’s function:

The claims department is a vital component of the insurance industry. It has many complexities and problems.  Here are a few comments relating to the claims department’s functions.

Claims departments tend to have high turnover.

• Insurance claims are sometimes paid partly or denied.
• The insurance adjuster is an agent of the company and does not represent the insured party.
• There is always pressure on the adjuster to minimize payouts.
• There is a lack of adequate insurance adjusting capacity for significant crises, such as hurricanes, giamassiveres, floods, and building collapse, like the Florida condominium complex.
• Company strength, attitudes, and relationships with insured parties differ. When a carrier advertises that you are in good hands, the insured party may want to examine other aspects of their business.

Conclusion of Part I. Part II covers the following subjects:

• Language in deeds of trust and mortgages that require replacement cost coverage:
• Insurance binders and Certificate of Insurance.
• How do mortgage lenders protect their financial interest in the event of a reimbursable insurance claim?
• Insurance Disclosures in a Borrower's Loan Application.
• Loan processing will assist the Borrower in ordering insurance coverage.
• The Property Appraisal process:
• Types of insurance coverage and short definitions of each.

My comments are not all-encompassing, nor should parts I, II, and III be; an overview is all you should need to know.  The information contained is intended to be an educational overview only. Property insurance is a complex subject, made more complicated by regulatory infringements, economic health, inflationary pressures, and liability.  Any owner/Borrower, or lender/mortgage broker should consult with a highly competent personal or commercial insurance specialist to guide them to appropriate and contingent liability coverage. Do not forget a qualified insurance specialist lawyer.