Do not get blamed for your client’s underinsurance woes
External factors such as inflation and the growing disconnect between residential property prices and construction costs could be costing you and your clients in more ways than you realise. If you fail to address this mystery issue, you and your clients could end up sharing a merry dance at one of South Africa’s pro-consumer ombud schemes, so pay close attention to what follows.
From Houghton mansion to bachelor flat
The first round impacts of inflation and the house price disconnect are obvious. Inflation drives the cost of goods and services higher, increasing your clients’ cost-of-living while eroding the future buying power of their investments. And the flatlining value of that Houghton mansion means when your client eventually sells it to relocate to the Western Cape, he or she will have to settle for little more than a bachelor flat in Camps Bay. These are the household budget and investment return realities that you should be discussing with clients during your frequent broker-client interactions.
There is, however, a more sinister effect nibbling away at parts of your clients’ financial product portfolios that you seldom think about. Yes, dear reader, inflation and rising construction costs can wreak havoc on the sums insured under your short-term insurance policy by disconnecting same from reality. Underinsurance came under the spotlight during a recent presentation to Insure Talk 42. In plain language, underinsurance is a situation where a sum insured on your client’s non-life insurance policy is too low.
“The coverage provided by the policy is not sufficient to cover the full extent of the loss; [your clients] get to claim stage but the pay-out falls short of what they need to put themselves in the same position as they were in prior to the loss,” says Carolyn Thompson, Head: Retail Product, Underwriting and Pricing at Old Mutual Insure. She used an example of the natural accumulation of household goods through lifestyle changes as a typical contributor to underinsurance in the personal lines household contents context. Just think back on your evolving personal assets ‘picture’ as you moved from being a student, to being employed and renting, to owning a home.
The average clause ‘protection’
Thompson said that the difference between the sums insured on your clients’ personal lines policies and the replacement costs of these assets could be significant, and warned that this underinsurance would result in unhappiness at claims stage.
The reason is that short-term insurers deal with the risk of underinsurance by applying an average clause that is included in their policy wordings. “The principle of average is something you will find in just about every insurance policy wording; it is applied when the insured property is determined to be underinsured at the time of loss,” Thompson said. The clause exists to make sure that policyholders take adequate cover, and that they pay a premium in proportion to the risk the insurer is taking on.
To offer a practical example, consider a household contents policy with a sum insured or limit of indemnity of R100 000,00. Following a burglary on the premises, the homeowner submits a claim for R300 000,00 to replace the stolen contents. Upon assessment of this claim, the insurer determines that contents in the home should have been valued at R500 000,00. The loss suffered is restated as 60% of the fair value of the contents, and the insurer prorates the sum insured in line with this ratio. In other words, the insured in this case receives R60 000,000 only. This is an extreme example; but a neglected policy could easily result in big underinsurance gaps.
An unhappy client presents serious challenges for advisers and brokers because these clients can potentially follow the regulatory dispute channels all the way up the chain until they reach the person who advised them on their policies. It helps for brokers to consider this eventuality from the client’s perspective. “You have paid premiums for months, or years even, and at this time of need your insurer is not there to fully compensate you,” Thompson said. It turns out prevention is better than cure, and proactive brokers can sidestep the inevitable post-underinsurance FAIS Ombud visit by simply taking a higher touch approach with their clients.
Different approach to All Risks and motor
The average clause is not typically applied to the All Risks or motor sections of an insurance policy; but valuation-linked hiccups still arise. Finally, dear reader, we get to talk more about how external factors such as inflation impact on sums insured. “There was a lot of inflation in the second hand vehicle market during pandemic; and it also became difficult to get the same vehicle at claim stage following total loss events,” Thompson noted. As for All Risks, insureds need to make sure the replacement values for valuables or older commoditised items such as Garmin watches or smartphones are accurately reflected on their policy schedules.
“The insurer’s automatic inflation-linked increases [applied to motor vehicles and the sums insured on some commercial insurance sections] are not always sufficient to compensate for the inflation that we are seeing in the market,” Thompson said. This is particularly evident in the commercial insurance space where Agri-business and other industrial firms often face a combination of currency depreciation and supply chain constraints for ‘big ticket’ plants and machinery. Other contributors to underinsurance include an underestimation of risk and the non-disclosure of additions to the risk on cover, for example the installation of a solar system.
Another challenge comes in setting an adequate sum insured for a Johannesburg home where the resale value of house prices is growing far slower than the construction costs to rebuild after a total loss. Thompson shared data from Statistics South Africa to show Johannesburg’s average house price inflation at around 3.5% per annum over the past 10-years compared versus construction price inflation of around 7.5%. “Over time, it becomes more and more expensive to replace a home relative to what it costs to purchase one,” she said. In practice, this could mean that simply adjusting your house based on its resale value could leave you up to 33% under insured. You must factor in the cost of construction when insuring your buildings.
Affordability cannot trump common sense
Affordability remains a problem in the broker-client environment. “In the current economy, people are really battling with affordability; we often interact with brokers who say the sum insured has not gone up to protect their client from premium increase,” Thompson said. This is a bad, bad idea. In the aforementioned pro-consumer context, the FAIS Ombud is unlikely to view a coverage concession on the basis of affordability as sound advice. On the topic of keeping clients informed, you best take a moment or two to review the potential impact on your clients of unselected cover extensions, or new exclusions that insurers have introduced over the past few months.
The call to brokers was to pay more attention when onboarding clients, and to use the tools available to them to make accurate buildings and household contents sums insured. In the more complex commercial risk environment, it might be sensible to turn to your insurers for help with upfront survey work. As for the high value All Risks items, the best approach is to bring in valuation experts, and have an up-to-date valuation certificate.
Writer’s thoughts:
I have heard whispers that when underinsurance-related matters get taken to the FAIS Ombud, brokers usually come off second best. Have you had first-hand experience of underinsurance at claims stage? And how would you advise your clients or fellow brokers to deal with the risk of underinsurance? Please comment below, interact with us on X at @fanews_online or email us your thoughts [email protected].
