OK, I’ll apologize in advance for the length of this post (almost 2,000 words). I try to limit most blog posts to 500-750 words to make them a quick read, but this issue is so important, I believe it warrants a longer post that I recommend you share with your entire staff.

Today I got the Skype message in the image above from Tim Dodge at the Big I of NY. A NY agent is quoting a residential property in Maryland. The insurer he has in mind has an endorsement that will give the insured 25% on top of the dwelling limit for a total loss. The agent’s question is whether he can reduce the Coverage A HO policy limit by 25% so he will be more competitive with his quote while putting the Coverage A + 25% figure on a certificate of insurance.

Aside from the bad math (reducing a number by 25% then increasing the result by 25% does not get you back to the original number but rather to a lesser number), this tells me that the agent likely does not know how the loss settlement provision of most HO policies works, especially with regard to partial losses. More on this below.

This was the second such question I got within a few days. Earlier, I got an email from a Nebraska agent. He had run into a couple of agents in Omaha that were quoting HO business with Coverage A limits far below the actual replacement cost of the homes. For example, he recently lost a client’s HO policy to one of these agents who quoted Coverage A at $680,000. The home was currently insured for $1,100,000 based on two replacement cost estimates, the lowest being $1,000,000.

The agent that took the business from this agent quoted a Coverage A limit of $680,000 on an HO policy that included an Extended Replacement Cost endorsement of 50%. The new agent told the customer that the house was really insured for $1,020,000 ($680,000 X 1.50) with the endorsement. So the customer gets the “same coverage” at a significantly reduced premium. Is this correct?

My guess is that the carrier does not know what the agent is doing. This is not the purpose of these types of endorsements. They exist to recognize that valuation is not an exact science AND that, in the event of a natural disaster, reconstruction costs can skyrocket. They serve as a safety net. They aren’t designed for the purpose for which this new agent is using them.

As in the example from Tim Dodge, is this a case of an agent being ignorant of what he’s doing or is it something more nefarious, bordering on unethical and perhaps even fraudulent. One way to find out is for the customer to ask the agent to put his explanation IN WRITING and copy the insurer. If he refuses, you probably have an answer to that question.

If he does refuse, someone should let the carrier know, as well as the DOI. This is certainly not ethical behavior and likely not legal behavior and it needs to be stopped and communicated by the carrier to all of its agents and the DOI to all industry participants in the state.

So, what’s the problem with this practice? Well, there are many. One is the likelihood that the practice is in violation of the insurer’s DOI rates and rules filing for their HO program. Another is the possibility that the practice violates state laws or regulations, from unfair trade practices to potentially fraudulent behavior. And perhaps the most important problem is that this won’t work…the insured is likely still underinsured (at least for partial losses) and even if they sue the agent for such inadequately covered losses (or outright denials by the insurer), the agent’s E&O policy could very well exclude the claim or suit.

The agent who made the inquiry did not have a copy of the endorsement being used by the competing agent, but he did provide copies of three endorsements used by carriers his agency represents. This is my take on the three endorsements:

  1. Dwelling Replacement Cost endorsement 12567A (03-05)
    “In return for your having…furnished us accurate information for replacement cost estimation…insured your dwelling to at least 100% of its replacement cost…we will settle covered losses to the dwelling under Coverage A, up to 150% of the limit of liability shown in the Declarations for Coverage A….”
  2. Extended Replacement Cost – Coverage A endorsement FF-159 EX (1-98)
    “If you have complied with all of the following…Insured your dwelling at 100% of its replacement cost as determined by us in accordance with accepted standard industry practices…And if the cost to replace or repair exceeds the limit of liability for any listed dwelling(s) below, we will pay for covered loss without regard to the limit of liability applying to the dwelling.”
  3. Additional Replacement Cost Protection endorsement HO-420 (06-06)
    “(Applies only when loss to dwelling exceeds the Coverage A Limit of Liability shown in the Declarations)”

Endorsement #1 implies that the increase only applies if the dwelling is insured to at least 100% of its replacement cost as identified as “the limit of liability shown in the Declarations for Coverage A.” This is true of most of these types of endorsements and, when Coverage A is something less than that, the insurance is not in compliance with the form language requirement that triggers coverage under the endorsement. As a result, failure to insure 100% of replacement cost at policy inception likely results in the endorsement not applying to any losses.

Endorsement #2 clearly says that the endorsement doesn’t apply unless “the cost to replace or repair exceeds the limit of liability” shown. So, take a home valued at $1,000,000 but insured for $680,000. If the loss is less than or equal to $680,000 as the vast majority of losses would likely be, then the insured would have an insurance-to-value penalty.

Endorsement #3 is similar to #2 in that coverage is only triggered when a loss “exceeds the Coverage A Limit of Liability shown in the Declarations.” This language tracks that in ISO’s HO 04 20 and HO 04 11 endorsements

So, at a bare minimum, if there is a partial loss, at least two of the endorsements won’t be triggered and the insurance-to-value clause in the policy (assuming ISO language) means that the insured will only be paid a percentage of the loss or the ACV of the damage, whichever is greater. In the example, for a $500,000 loss (forgetting the deductible), the insured would be paid $425,000 and responsible for $75,000 out of pocket.

So what happens if a significant uncovered claim happens? First of all, the insured is going to have, at best, an out-of-pocket payment in addition to the deductible and, at worst, a complete claim denial by the insurer based on noncompliance with policy language or even misrepresentation or fraud. Second, the agent is almost certainly going to be sued. Presumably, the agent has E&O coverage, but does it apply? Quite possibly not if it has a provision like this one found in the most used E&O policy in the country:

INTENTIONAL ACTS. Any “claim” for Intentional acts, including but not limited to acts of dishonesty, fraud, criminal conduct, malice, or assault and battery.

The only issue is whether the agent is abjectly ignorant or something worse. Is what the agent did “dishonest”? If I’m the E&O adjuster, I’d say so given the facts of a case like the one cited above. Did the agent commit fraud? If the insurer is not aware of what is going on, I would venture to guess that the adjuster would consider that claim to have arisen from fraud.

What other issues could be related to this? Quite possibly what the agent did violates the rate and rules filing of the insurer, so there could be regulatory penalties. What the agent did (if the carrier is not complicit) is also likely a violation of the agency/company agreement, so the agent could have contractual liability, especially if the carrier is stuck paying the claim. In that case, the E&O claim would likely come from the insurer rather than the insured (or in addition to the insured).

There could also be other laws involved such as fraud, unfair trade practices, deceptive business practices, and on and on. A loss of license is likely and there could possibly be significant civil, if not criminal, penalties including jail time (up to 20 years in at least one state). Here is an except found in many state fraud statutes:

“It is a crime to knowingly provide false, incomplete or misleading information to an insurance company for the purpose of defrauding the company. Penalties include imprisonment, fines and denial of insurance benefits.”

This is from the Nebraska DOI:

Insurance fraud is any deliberate deception committed against or by an insurance company, insurance agent, or consumer for the purpose of unjustified financial gain. This occurs during the process of buying, using, selling and underwriting insurance.

Some states may address the valuation issue directly. For example, California (10 CCR § 2695.183) now includes “Valuation of Homes” under it’s Unfair or Deceptive Acts or Practices in the Business of Insurance and makes it clear that communicating an estimate of replacement value that isn’t compliant with the regulation “constitutes making a statement with respect to the business of insurance which misleading and which by the exercise of reasonable care should be known to be misleading….”

I conducted some unscientific research on this in 2015 for a convention panel I was on that led me to believe that agents deliberately underinsuring homes in order to underbid other agents was uncommon but far from rare. Few would argue that deliberate conduct of this type is unethical. Most would probably consider it to be dishonest, if not fraudulent and criminal. If I was aware of such conduct, I wouldn’t hesitate to report it to the authorities. The agent in this case may not only be engaging in an unethical practice, but his ignorance of insurance (either not realizing that partial losses are definitely not fully covered by the sample endorsements or gambling that no loss will occur) puts the consumer at risk of significant loss if the endorsement is not triggered.

This type of activity was allegedly rampant years ago when “guaranteed” RC first came out, especially with direct writers. So the true “guaranteed” endorsements disappeared. Even in commercial lines, this has been a problem in the area of blanket insurance to the point that many carriers now use margin clauses to limit coverage, reputedly because too many agents were undervaluing individual buildings, knowing that the blanket limit would be available.

This is just another adverse response to industry price competition. Those who buy on price, may die on price. There are all kinds of examples of agent malfeasance to reduce premiums in order to land an account. For example, click here for an article about deliberately failing to disclose teen drivers in order to reduce auto premiums.

Just last week, I heard from someone who became aware of an NFIP flood account where the property was shown to be a Primary Residence rather than a vacation home. Why? Because the subsidized premium was $2,000 and the actuarially sound premium was over $20,000. The home was misrepresented to save an annual 25% premium increase. In addition to voiding the policy, such misrepresentation/fraud may result in the banishment of insured and agent from the NFIP program, along with even more severe federal penalties.

Do you have examples of your own? Have you encountered deliberate misrepresentation in personal or commercial lines in order for a quote to be more competitive? What did you do when you became aware of it? Are you aware of uncovered or inadequately covered claims resulting from this behavior or even sanctions against agents or insurers? If so, please Comment below.

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Bill Wilson

Founder at InsuranceCommentary.com
One of the premier insurance educators in America on form, coverage, and technical issues; Founder and director of the Big “I” Virtual University; Retired Assoc. VP of Education and Research from Independent Insurance Agents & Brokers of America. Reprint Request Information