The End of Insurance as We Know It

by Rob Galbraith

  Even if a claim does result from a covered peril, a customer could be in for a surprise when they realize that the economic cost to remedy the damage is not fully covered. Take for example a hail claim for roof damage that is covered, but a 2% wind/hail deductible applies, and the roof is covered on an Actual Cash Value (ACV) basis, not Replacement Cost (RC) for the homeowners policy. A hypothetical roof replacement claim may be adjusted as follows:

  •Dwelling (Coverage A) limit on homeowners policy: $300,000

  •Wind/hail deductible: 2% of Coverage A limit (which is $6,000)

  •All other peril deductible: $1,000

  •Cost to replace roof: $20,000

  •Age of roof: 10 years old

  •Claims settlement amount (ACV basis): $10,000

  •Less wind/hail deductible: $6,000

  •Total claims payout$4,000

  •Cost to replace roof$20,000

  •Remaining cost not covered by insurance$16,000

  •Percent of roof replacement paid by insurance: 20%

  From a consumer’s point of view, a claims settlement of $4,000 in order to cover a roof replacement that costs $20,000 is not a compelling value proposition. In this scenario, the policyholder is left having to fund the remaining $16,000 or 80% of the cost on their own (likely through a home equity loan, raiding college or retirement savings, and/or using credit cards). In fact, depending on the nature of the hail damage, an insured might be tempted simply to pocket the cash they initially receive for their roof damage and not get it replaced, taking a risk of suffering future losses due to a roof that is in poor condition and unable to withstand severe wind, rain or hail. Changing the scenario slightly, if the damage to the roof was less severe and only required the replacement of a few shingles rather than an outright replacement of the entire roof, the cost of the claim is greatly reduced. However, if the estimate to replace the missing shingles comes to $5,000, the policyholder is going to end up with no payout from the carrier because they did not exceed their 2% wind/hail deductible threshold of $6,000.

  Percentage deductibles are used by carriers to place some of the cost burden for claims on insureds which helps reduce premiums. They can appear to be an attractive proposition on the surface as consumers can save a substantial amount of money on their homeowners policy premium by selecting a higher percentage deductible such as 3%, 4% or even 5%. The difference between these deductibles of 1% or 2% does not sound like very much; in the event of a total loss, the carrier is still paying the vast majority of the loss (95% or more.) The important point that is lost on many consumers is that the vast majority of losses are not total losses, but are instead much lower. A 5% deductible applied to a home with a dwelling limit of $300,000 as in the above example results in a deductible of $15,000, which is a much higher threshold to pierce after a loss event than a $6,000 deductible set at 2% of the dwelling limit.

  The chart below shows what the claims payouts of a $10,000 claim would be at different percent deductibles applied to a dwelling limit of $300,000. Note that as the percent deductible goes up, the amount of claims payout rapidly declines and results in zero payout at the 4% and 5% deductible levels.

  Percent deductible

  Dollar deductible for a $300,000 dwelling limit

  Payout for $10,000

  claim estimate

  1%

  $3,000

  $7,000

  2%

  $6,000

  $4,000

  3%

  $9,000

  $1,000

  4%

  $12,000

  none

  5%

  $15,000

  none

  Auto deductibles are a bit more straightforward as they are only expressed in dollar terms, usually $250, $500 or $1,000. However, they apply to each vehicle on the policy separately. If a hail storm damages 2 or more vehicles for a family that carries $1,000 comprehensive deductible on each auto, they will be paying $2,000 or more to repair all of the damage to their vehicles. Additionally, in auto insurance, similar to the example of the hail claim for roof damage that is settled on an ACV basis, vehicles that are damaged in accidents may be totaled out by the insurance company. This means that the insured is paid the depreciated amount of what their auto is worth today and not:

  •what they originally paid for it

  •the amount remaining on their auto loan to the bank

  •the cost of purchasing a new model of the same or similar vehicle.

  Many people are “upside down” on their auto loans, meaning that they owe more money to the bank than they would get if they sold their vehicle as used. For consumers who are looking to hold onto their vehicles for a long time or trade them in to upgrade to a more expensive vehicle, this does not present a major financial hardship. However, if the vehicle is suddenly damaged, and it is less expensive for carrier to total the vehicle than to replace it, the consumer is negatively impacted because their settlement amount does not fully cover their auto loan nor the cost of equivalent transportation.

  AREN’T YOU SPECIAL?

  Another common insurance policy feature is a sublimit or specific coverage limit that is lower than the stated general policy limit for a subcategory of items. Sublimits vary by policy, so agents and consumers need to pay attention and determine whether or not additional insurance coverage is needed. For auto insurance, liability coverage limits are generally more apparent as each coverage typically has its own stated limit. Here is an example from my own personal auto policy in Texas:

  Coverage

  Bodily Injury (BI)$500,000 per person/ $1,000,000 per accident

  Property Damage (PD)$100,000 per accident

  Personal Injury Protection (PIP)$100,000 per person

  Uninsured/Underinsured Motorist$500,000 per person/ $1,000,000 per accident

  In theory, each of these coverage limits could be different amounts so depending on which coverage I needed to “use” in an accident, I may or may not have enough coverage to meet my obligations. For example, if I cause a severe auto accident and people riding in another car or truck that I hit are seriously hurt, my auto policy will pay up to $500,000 per person or a total of $1,000,000 per accident. If there are four people injured, my policy would not provide enough coverage if each of them sustained injuries of $300,000 each, even though this is well below the per person limit, because the total amount owed is $1.2 million or $200,000 over my policy limit for a single accident.

  Next, consider possible injuries to passengers in my vehicle. If I were involved in this serious accident carrying one of my children and two of their friends, I only have enough coverage to pay up to $100,000 for each person’s injuries, far less than the up to $500,000 in coverage that I have for injuries sustained in another vehicle. As it turns out, I cannot select a higher PIP limit than $100,000 with my insurance carrier. While I may be fortunate enough to have good health insurance that covers myself and my child, the other two children may or may not have health insurance, and that insurance may not be sufficient to cover their injuries if they are serious.

  On the property side, most homeowners and renters insurance policies have sublimits for certain items that are far below the policy limits for contents coverage (which is typically capped at 50% of the dwelling limit). In fact, these are commonly referred to as special limits when they are, from the consumer’s perspective, decidedly not so special. Items such as jewelry, cash, fine art, firearms, business property and silverware (!) are subject to lower limits. A standard HO-3 form contains the following sublimits that most consumers are not aware of (Note: This list is not all-inclusive.):[61]

  •$200 on money, bank notes, bullion, gold other than goldware, silver other than silverware, platinum other than platinumware, coins, medals, scrip, stored value cards and smart cards.

  •$1,500 on securities, accounts, deeds, evidences of debt, letters of credit, notes other than bank notes, manuscripts, personal records, passports, tickets and stamps. This dollar limit
applies to these categories regardless of the medium (such as paper or computer software) on which the material exists.

  •$1,500 on watercraft of all types, including their trailers, furnishings, equipment and outboard engines or motors.

  •$1,500 on trailers or semi-trailers not used with watercraft of all types.

  •$1,500 for loss by theft of jewelry, watches, furs, precious and semiprecious stones.

  •$2,500 for loss by theft of firearms and related equipment

  •$2,500 for loss by theft of silverware, silver- plated ware, goldware, gold-plated ware, platinumware, platinum-plated ware and pewterware. This includes flatware, hollow-ware, tea sets, trays and trophies made of or including silver, gold or pewter.

  •$2,500 on property, on the "residence premises", used primarily for "business" purposes.

  •$500 on property, away from the "residence premises", used primarily for "business" purposes.

  Some of these coverage limitations can be mitigated by purchasing one or more coverage endorsements that amend the policy to provide broader coverage or by purchasing a companion product such as a “floater” policy where individual items can be scheduled based on their appraised value.[62]

  Similar to deductibles, coverage limits and sublimits are a way for insurance companies to limit their exposure and keep the cost of premiums affordable. The downside is these limits and sublimits transfer that exposure back onto consumers who 1) may not be aware that these gaps in their coverage exist and 2) may not be in a position to cover these gaps out of pocket. Some limits are clearly stated when purchasing coverage and on the declarations page of a policy at each renewal, but others are buried in the policy language that is generally only provided at the policy inception date.

  MAINTAINING HOPE

  There is a set of perils that are generally considered to be purely the responsibility of the insured by traditional insurers and are typically not covered by standard personal lines policies. Traditional insurers believe that if the insured is covered by insurance for losses that arise from the improper upkeep and maintenance of their assets (auto, home, business property, etc.), then they will have no incentive to perform these duties. When insureds lack sufficient motivation to properly maintain their auto or property, it is called morale hazard. Put another way, these everyday losses that occur with regularity can be prevented by proper maintenance by the insured and thus should not be paid out as insurance losses on the policy. If claims due to improper maintenance were to be paid out by insurers, the result would be a large increase in paid losses in total and a resulting large increase in policy premiums that all insureds would ultimately pay. Classic examples of this type of damage that are not covered by a standard policy include replacing a car battery or tires, home appliance failures and personal electronic devices such as gaming systems, smart phones and more.

  P&C carriers are typically fairly strict in not providing coverage for what are deemed to be losses which could (in theory at least) be prevented by proper maintenance. The question is: how are insureds responding? Consumers typically respond in 3 main ways, all of which are result in large missed market opportunities for insurance carriers:

  1.Consumers use their credit cards to pay for needed repairs or replacement parts and pay interest over the course of months or years to pay off the incurred debt.

  2.Consumers purchase warranty products such as home warranties, service contracts and/or extended warranties on larger purchases that go beyond a standard manufacturer product warranty.

  3.Consumers are willing to pay higher prices for replacement parts or labor that provides long guarantees that result in cost avoidance for damage caused by the same peril and/or to the same item.

  On the last point, companies often provide long guarantees on replacement parts such as tires, home repairs, etc. for long periods of time such as 5+ years all the way up to the lifetime of the damaged item so that consumers do not have to incur repeated costs to fix the same damage multiple times. Some of these warranties can even be transferred to the next owner.

  FEELING LEFT OUT

  Sometimes, consumers must feel that insurance is a game of trivia where the answers they think are correct end up being wrong. A classic example is when items are stolen out of your vehicle. Almost everyone would likely tell you this loss is covered by their auto insurance policy - but it is not. It is, however, covered under a renters or homeowners policy. Of course as has been illustrated in this chapter, depending on the policy deductible, a claim still may not result in a payout.

  What are the consequences when there is no insurance coverage available for property and liability? And how quickly can the traditional marketplace respond to meet evolving consumer needs? The next chapter explores the rise of ride sharing and the gig economy as well as the broader question of risks in general that are completely uncovered by insurance.

  1

  CHAPTER 9 - A WORLD WITHOUT INSURANCE

  HITCH A RIDE

  It was a cloudy evening on New Year’s Eve 2013 in San Francisco when a mother and her two young children were crossing the street near the Civic Center. Without warning, a distracted driver on his smartphone ran through the crosswalk, striking the family. The crash resulted in the death of 6-year old Sonia Liu and injuries to her mother and 5-year old brother.[63] A wrongful death lawsuit was subsequently filed against the driver, Syed Muzzafar, for his negligence as well as Uber, the ride-sharing company that he drove for. The lawsuit alleged that Muzaffar was distracted because he was checking the Uber app on his smartphone in order to locate a passenger to provide a ride for. Uber denied responsibility, claiming that Muzaffar was a contractor who did not have an active fare when the incident occurred.[64]

  If a traditional taxi had been involved in the crash, liability coverage would clearly exist for the driver and taxi cab company. However, most ride-sharing firms such as Uber or Lyft hire drivers as contractors who use their own personal vehicles to provide the service. This created a gray area of legal responsibility for insurance carriers as most standard personal lines auto policies specifically deny coverage when a vehicle is being used to carry passengers or cargo for compensation[65] (except for share-the-expense carpools). When Muzzafar was driving his vehicle for personal use, he had coverage through his personal auto policy. When Muzzafar had one or more passengers in his car driving for Uber, he was covered by an E&S commercial auto policy written to insure Uber as a business entity.[66] The ride-sharing coverage gap occurred when Muzzafar had his Uber app on and was actively looking to pick up a fare as well as when the app had matched him with a rider but the rider had not yet entered the vehicle. Both the personal lines carrier and E&S commercial carrier denied coverage, claiming this period was not covered under their policy. This gap led to a lack of compensation to the Liu family for the injuries sustained and the tragic loss of little Sonia’s life (the case was ultimately settled out of court).[67]

  The tragic case of Sonia Liu along with the explosive growth of ride sharing services provide an interesting case study in the responsiveness of the traditional P&C insurance marketplace to support emerging risks. The resulting media attention surrounding the Liu case throughout 2014, along with a host of contentious political and regulatory issues related to ride sharing in general highlighted the need for clarity with regards to insurance coverage for ride sharing activities.

  Through the leadership of the National Association of Insurance Commissioners (NAIC) along with two leading industry trade associations and several leading P&C insurance carriers, a TNC compromise was agreed upon in March 2015 that provided a roadmap for the regulation of insurance requirements for ride sharing companies and drivers.[68] What was most notable about this compromise is that industry players had divergent views on how to approach ride sharing - some saw it as a risky activity that should be excluded from coverage while others saw it as an emerging market opportunity to write new business. The compromise allowed insurance carriers the flexibility to write or
deny coverage while providing ride sharing drivers and passengers some much needed clarity regarding the exposure faced by each party.

  However, while the TNC compromise represented a breakthrough after a year of uncertainty following the Liu incident, the actual implementation of changes in regulation has taken a while and not all issues are resolved even five years later. The TNC compromise led to a TNC Model Bill that the NAIC developed as a compromise. This TNC Model Bill then led to a model act that was developed by the National Conference of Insurance Legislators (NCOIL) which incorporated some changes. The vast majority of states have now passed legislation governing the insurance requirements for ride sharing activities and at least 25 state insurance regulators and the NAIC have issued bulletins cautioning consumers about the potential limitations of insurance coverage for ride sharing activities. Even as recently as March of 2018, the NAIC states:

  “The risks associated with participating in ride-sharing services are not yet completely understood and do not fit neatly into insurers current risk-pooling models, raising numerous insurance related questions. Specifically, there is increasing concern over the potential gaps in insurance coverage in the unfortunate event of an accident or injury. “[69]