Uncovered: Setting policy limits for insureds

When I was a young adjuster in 1971, a massive fire burned from the 405 Freeway in the San Fernando Valley across the hillsides until it reached the Pacific Ocean in Malibu.

Hundreds of homes and commercial buildings were destroyed down to bare dirt. As an adjuster, settlement with the insureds was easy because the cost to repair exceeded the policy limits by thousands of dollars. I would simply write a policy limits check to the insured and leave knowing he had inadequate funds to rebuild.

Related: Are your adjusters getting proper training?

The insurer I worked for had conducted a survey of the homes of their officers only to find that each corporate officer, allegedly insurance professionals, were underinsured in amounts as useless as 50% of the true replacement cost of their property. The insurer tried to convince its brokers that their insureds were probably under insured as well, but the brokers found their customers were unwilling to pay more for higher limits.

A previous article, “Who has the responsibility to advise insureds about policy limits” addressed liability limits on automobile policies. A reader asked about the rules that apply to homes and commercial buildings because the reader's company wanted to look at values and consider reevaluating the limits.

The primary duty of an insurance agent or broker is to fulfill the orders presented to the agent or broker by the insured. If it errs in fulfilling the order, it can be held liable. If it performs the order as requested, it has no responsibility. In Homestretch Logistical Solutions, Inc. v. Johnson Lawrence Walker Insurance Company [Court of Appeals of Kentucky, 2017 WL 729747, NO. 2014-CA-001255-MR (2/24/17)], an insurance agent was sued for doing exactly what it was asked to do by the insured that resulted — because of the insured's error — in an accident where a vehicle was uninsured.

Who sets policy limits for first-party property policies?

A reader asked: “My company is constantly bombarded with agents who refuse to look at undervalued buildings and the exposures to coinsurance penalties in the event of a loss.” The agent that does so can face an E&O exposure for ignoring what appears to be undervalued property as easily as the agent or broker can face exposure for advising an incorrect limit.

Related: Did an insurance broker have a duty to advise higher flood limits?

Insurance companies sell to the insured the coverage requested: Carriers have no obligation to force, or even advise the insured about the limits of liability of actual cash value or replacement cost value of a property. Most are not sufficiently educated on the cost of repairing or replacing a damaged structure. They rely, therefore, on what the insured tells the agent or broker is the true value of the home or commercial structure.

What should the insured do?

The appropriate advice to avoid errors and omissions claims is to serve the client properly and within your expertise. Whether you think a property is overvalued or undervalued, it is incumbent on the agent or broker to remind the applicant for insurance to set appropriate limits to avoid underinsurance or co-insurance penalties, as follows:

1. It is essential that you, as the insured, select the appropriate policy limits.

2. To do so:

   • Recognize that repair and reconstruction of structures is more expensive than new construction.

   • Recognize that you do not need to insure the full value of the property since the land is not insured, only the structure.

   • Contact a fire reconstruction contractor to advise you on the cost to replace the structure if it is destroyed by fire.

   • Contact a fair market value appraiser to advise you about the actual cash value of the property.

   • Determine from your suppliers the actual cash value and replacement value of the contents of your dwelling or commercial structure.

   • Determine the value of all product on premises.

   • Determine the value of all work in progress.

   • Report those values to your insurer so that appropriate limits can be established.

Major catastrophes like wildfires, earthquakes, floods and tornados can, and usually do, destroy real and personal property. When an insured loses everything in a catastrophe, he or she calls an insurance agent, insurance broker or insurance company to make a claim. When the claim is made, the insured is reminded of the limit of liability chosen, only to find it is inadequate to replace the house or commercial property.

The insured will be angry and unwilling to accept the fact that the inadequate policy limit is due to his or her error. Suits are filed against the insurance agent/broker and the insurer, only to find that the court will not cure the insured's mistake.

Analysis

An insurance agency, when asked to insure the contents of a property at full replacement cost, was found to have no duty to advise the insured regarding adequacy of policy limits even if the insured initially requested full replacement cost coverage in Lenz Sales & Service, Inc. v. Wilson Mut. Ins. Co., [Court of Appeals of Wisconsin, 175 Wis.2d 249, 499 N.W. 2d 229 (March 10, 1993)].

Before an agent or broker can be held liable to advise of the appropriate limits of liability, there must be a special relationship between the agent or broker and an applicant for insurance. For a special relationship to exist, the insured must show a longstanding relationship; some type of interaction on the question of coverage; and the insured's reliance on the expertise of the insurance agent to the insured's detriment when the limits are insufficient to repair or replace the property.

Related: 'Special relationships' revisited

Without a special relationship, there is no justification in the law to impose the additional burden on insurers that they anticipate and then counsel their insured on the hypothetical, collateral consequences of the coverage chosen by the insured. In 1992, the case of Free v. Republic Ins. Co., [8 Cal.App.4th 1726, 11 Cal.Rptr.2d 296 (1992)] the California Court of Appeal held an agent was involved in a special relationship so that the agent could be held liable to a client after misinforming the client that his homeowner's limits were sufficient.

It is imperative, therefore, unless there is a special relationship between the insured and the agent, that the insured do what is necessary to obtain appropriate coverage, and the agent or broker refuse to provide advice he or she is not competent to give.

When an insurance agent or broker does exactly what was asked by an insured, any suit will fail because no court will save a plaintiff from its own mistakes. The suits can be avoided by advising the insured what must be done to select appropriate limits.

Related: An alarming loss: Does a broker have a duty to recommend higher limits?

Barry Zalma, Esq., CFE, (zalma@zalma.com) has practiced law in California for more than 42 years and now serves as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud. Books in the Zalma Insurance Claims Library, can be found at www.nationalunderwriter.com/ZalmaLibrary.