A Borrower Objects to Paying for Adequate Property Insurance

By Dan Harkey, Educator, and Private Money Lending Consultant

949 533 8315, dan@danharkey.com, Website www.danharkey.com

Real-life example- #18 of 25

A borrower, who is typically responsible for securing and maintaining adequate property hazard insurance to cover replacement costs and meet the lender’s requirements, objects to this financial obligation.

The Loan Broker said….

Let's consider a real-life example. A client, who is a general contractor, is objecting to paying premiums for full replacement coverage.  He believes he can repair damage for a much lower price than quoted by the insurance carrier. He also argues that the land will not burn down. He requests to reduce his replacement cost from $2,000,000 to $1,000,000.  He is determined to save on insurance premium costs.

The knowledgeable lenders responded, providing valuable insights into the insurance industry's current state and the potential risks of underinsurance.

“Under-insurance is more prevalent now than in the past because of the upward cost pressure caused by inflationary increases in construction costs.  For example, lumber prices and 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.

The owner, playing contractor, may use substandard workers, operate without adequate insurance, and skate from building and zoning compliance.  The property owner may calculate $200 per square foot for replacement.  However, in the retail market, where the insurance company is contemplating hiring a third-party contractor, the exact replacement cost is $400-$500 per square foot.  These figures are for entry-level and production homes.  High-end custom homes can be $1,000 to $2,000 per square foot or higher.

Many insurance policies have coinsurance provisions that penalize the insured’s loss recovery by limiting the claim payout for underinsurance to an amount not equal to or greater than a specified insurance amount, such as 70-80% of the loss recovery.

Lenders and mortgage companies may want to audit their loan portfolios to ensure that property coverage adequately offsets inflation.  Lenders should review and discuss methods and data sources for calculating replacement costs.  Most insurers and appraisers use Marshall & Swift cost data to estimate the construction cost.  Marshall & Swift monitors the factors that drive the cost of construction and the actual building component costs of the tracts.  Marshall Valuation Service reflects data in hundreds of locations throughout the U.S. and Canada.

We are sorry, Mr. Borrower, but your insurance coverage must equal or exceed the loan amount and cover the replacement cost of the dwelling and appurtenant structures. 

The current state of the Insurance industry in California:

Carriers are suffering a triple whammy of negative factors.  There are current historic increases in construction costs, outpacing inflation, and an expanding number of catastrophic events (natural disasters).  Additionally, the reinsurance market has collapsed.  Companies have sent “notices of non-renewal” to current policyholders and declined to approve new insurance policies.  State Farm is keeping its recent book of insurance active.

AIG and Chubb are canceling or cutting back on insurance coverage for homeowners and businesses. State Farm and Allstate, America’s most significant personal-lined insurers, ceased accepting new applications for business, personal lines, and casualty insurance. Catastrophic events, including wildfire exposure, severe storms, hurricanes, tornadoes, floods, earthquake exposure, water damage, and automobile accidents, have become unmanageable without drastically increasing policy premiums.

State Farm, one of the largest insurers, suffered a record $13 billion underwriting losses in 2022, with $4.7 billion in losses the year before.  Allstate lost $3.11 billion in 2022.  Liberty Mutual Holding Co lost $3.55 billion, and Berkshire Hathaway lost $3.10 billion.  Chubb lost $2.182 billion in 2022.  The Travelers lost $1.877 billion in 2022.  Progressive lost $1.66 Billion. These significant financial losses highlight the challenges insurers are facing.

Also, there will be more pressure on California’s Fair Plan, a state-run substandard carrier for those who cannot find coverage elsewhere. The Fair Plan is designed to provide basic property insurance to homeowners who cannot obtain coverage in the standard insurance market. This increased pressure on the Fair Plan reflects the challenges in the insurance industry.

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Thank You

Dan Harkey