The recently released report of the Cayman Islands Monetary Authority recommends indexing home insurance to reflect rising building costs as a way of preventing averaged settlements caused by under-insurance.
The report, titled ‘Review of the Domestic Insurance Industry Post Ivan’ detailed many of the insurance-related problems experienced in the Cayman Islands after the hurricane, and recommended ways of avoiding those problems in the future.
The report was prepared by CIMA director Sir Alan Traill, Terence Fairs of Fairs Reinsurance Consulting and members of CIMA’s Insurance Division.
Under-insurance was one of the most prevalent problems with insurance claims after Ivan, the report noted.
‘As the loss adjusting/claims settlement process got under way, policyholder complaints started to be made as to unfair treatment by insurers,’ the report stated. ‘These seem to have largely been prompted by the application of the average clause in cases of alleged under-insurance.’
Under-insurance was created when owners insured their homes for less than the rebuilding cost, which rises with inflation.
The concept of insurance settlement averaging seeks to put all insured policyholders on a level playing field, whereby those who insure to a level below replacement value only receive that level, in terms of percentage, of any claim they make.
The report finds the concept of averaging acceptable.
‘It would be grossly inequitable for the policyholder who had paid only a proportion of his premium in relation to others to get his claims paid in full up to the policy limit,’ the report states.
The vast majority of property insurance policies on Cayman prior to Hurricane Ivan were subject to some sort of averaging provision, yet the application of averaged settlements came as a surprise to many policyholders, the report stated.
There were several reasons cited for policyholders not recognising the need to keep sums insured in line with increased building costs.
Those reasons included, among several others, un-familiarity with claims procedures due to the long length of time since a similar catastrophe occurred here; having insurers not explain the consequences of underinsurance well enough or not requesting sufficient information to advise clients on the adequate level of insurance; and mortgage providers only requiring their loan amounts be covered.
The report asserts that indexing could eliminate the need for average clauses in policies by ensuring there is adequate coverage to rebuild.
‘Even assuming a sum insured is fixed at the correct level at commencement, it is clear that, with the passage of time, it will, unless regularly reviewed, quickly become out of date,’ the report said. ‘The only alternative is for sums insured to be indexed.
‘This may be achieved either through the application of an arbitrary annual percentage adjustment reflecting changes to reinstatement costs, or more preferably, through linkage to an appropriate index.
‘For example, in the case of buildings insurance, the relative cost (taking account of both labour and materials) of rebuilding properties, and in the case of contents, a consumer price index.’
The report notes that insurers received claims on as many as 90 per cent of their policies after Hurricane Ivan.
‘Assuming it was necessary for most, if not all, of these to be assessed by loss adjusters, insurers now have in their possession up-to-date rebuilding valuations on the bulk of their portfolio.
‘Now is, therefore, an excellent time for them to ensure that, on renewal, respective sums insured are pitched at realistic levels.
‘It is also the perfect time to introduce an index-linked product, as, providing the underwriter is satisfied that the sum insured is correct, there would be no need for an average clause.’
Bryan Murphy, CEO of Island Heritage Insurance, said some sort of indexation was a probably a good idea.
‘It’s very commonly used in Europe,’ he said. ‘But we must have a reliable index to work with.’
The basic consumer price index would not be adequate, Mr. Murphy said.
‘It would have to be a construction cost index.’
Mr. Murphy thought the private sector could get together to make recommendations to government on establishing such a construction cost index.
Overall, Mr. Murphy found CIMA’s report to be fair, although he did not agree that insurers had up-to-date rebuilding valuations on the bulk of their portfolio as the report suggested.
‘There were estimates done on many of the properties, and we certainly have better data than we did before, but it’s not the same as a proper evaluation,’ he said.
Mr. Murphy said Island Heritage had launched a campaign in cooperation with local experts to provide accurate rebuilding cost evaluations for its customers.
Under-insurance was not a big issue with Island Heritage claims after Hurricane Ivan, Mr. Murphy said.
‘We saw very little of it,’ he said.
One contributing reason for the few instances of under-insurance with Island Heritage’s Ivan claims was its policy of using an 85 per cent averaging provision, which means averaging was not triggered unless the amount insured was less than 85 per cent of the rebuilding cost.
‘We find that to be fair,’ said Mr. Murphy.
The CIMA report agreed.
‘While full average is not an unusual policy feature, its application gives more scope, depending upon how strictly applied, for policyholder dissatisfaction,’ the report stated.
‘We feel, therefore, that consideration should be given to incorporating a margin, of say 15 per cent, in the average clauses of all policies issued to non-commercial policyholders.’
Danny Scott, president and CEO of Cayman General Insurance, said his company had some policies written with 85 per cent averaging provisions and some that had full averaging provision.
But Mr. Scott likes the idea of the 85 per cent policy going into the future.
‘It makes sure no one falls between the cracks,’ he said.
Mr. Scott also thinks indexing policies is a good idea, but that it must be used in conjunction with regular rebuilding cost evaluations.
‘We’re going to have to find a way to re-look at each cover,’ he said. ‘But it would be too costly to have evaluations every year.’
Mr. Scott suggested using some sort of indexing over five year periods and then having a full rebuilding cost evaluation done again after five years.
‘You can’t just depend on indexing alone,’ he said.
Both Mr. Murphy and Mr. Scott said the insurance industry had learned a lot from its experiences with Hurricane Ivan.
Mr. Scott said the industry wants to find the best way forward.
‘From a personal standpoint, I do not ever wish to be in a situation where I have to sit down with my customers, who are my own people, and tell them the don’t have enough insurance.’