We’ve all seen the ads for insurance saying things like “buy only what you need” or offers to let insureds “name their price”. But for insureds who’ve never read their policy and don’t work in the industry, how do they know what they need? How do insureds know what coverages they do and don’t need, and what constitutes a fair price? Insurance is complicated even for the professionals, and nonprofessionals are often at a loss.
While a good agent will explain coverages to an insured, many insureds’ eyes will glaze over once the explanation begins. They don’t want to sit through a lengthy explanation of the law of large numbers and coverages and exclusions and exceptions to exclusions. So how do we as professionals quickly explain a complicated issue in a way most insureds will understand? We start with the basics and provide a brief overview.
Insurance works by pooling risks - risks with similar characteristics will be “pooled”, or grouped together and charged a premium that reflects the risk of loss. Someone with multiple speeding tickets is more apt to have an accident than someone with no speeding tickets, so those people are put into separate groups. Likewise, those who have filed multiple claims on their property policy are put into a different group than those who have never filed a claim. Location is also a factor - certain areas are more prone to floods, wildfires, tornadoes, and other climate hazards. Insureds with similar characteristics are clumped together. So a neighbor’s premium might be different, even though the houses are similar, due to other factors.
Pooling and why it’s needed are difficult concepts to understand for an insured unfamiliar with insurance rating. It may be helpful to explain that without pooling, the insured could not pay enough in premiums individually to cover the cost of totally replacing their home or vehicle. And moreso, if all the homes on a city block were to be damaged by a fire or tornado, or the insured had more than a single accident in any given year. So even though an insured may not have had a claim, the company needs to take in enough premium dollars from all of their insureds to pay for the worst case scenario. There are industry and state guidelines that require companies to take in enough premiums to make sure they can pay all of their losses on the basis of the worst case scenario.
Next, we need to explain the policy. Insurance is an agreement between the insurer and the insured. In exchange for the premium, the insurer agrees to provide certain protections to the insured. Every policy has things that are not covered in a section called exclusions. Exclusions are things that can be expected to happen, such as wear and tear, deterioration, rust, and similar events that happen over a longer period of time. Insurance is designed for sudden or catastrophic losses, not maintenance. If a roof is 25 years old and needs replacing, that’s just the joys of property ownership. In general, if the damage is due to wear over time, the loss will be excluded.
Another policy feature to be aware of is special limits for certain types of property. For example, in a homeowners, tenants, or condo policy, special limits apply to a variety of personal property including watercraft, jewelry, watches, furs, precious stones, silverware, portable electrical equipment, property used in business, money, bank notes, and other property. These restrictions should be pointed out to an insured so they understand how the policy works with certain property and whether they would like to purchase more coverage for certain items.
The difference between open perils and named perils is important to explain to an insured. These are terms specific to insurance and not used by others. Again, using the standard homeowners policy as an example, the coverage for the house itself and other structures is open perils, which means that unless something is excluded, like an earthquake or war, there is coverage. Personal property, however, is named perils, which means that the peril, or cause of loss, must be specifically listed in the policy in order for the damage to be covered. So the sofa must be damaged by one of the listed perils, such as fire, lightning, theft, vandalism, accidental discharge or overflow of water or steam, and others. If the sofa is damaged by something not listed, then there is no coverage.
Each policy also has a section titled “Duties After a Loss.” It’s a good idea to advise the insured of what these duties are, at least briefly. Prompt notice is critically important, as is preserving damaged property for the insured to show the adjuster. Documentation of all damaged property, as well as providing the insurer notice if suit papers have been received, are important parts of an insured’s duties. It is also a good idea to explain that nonfulfillment of some of these duties may result in a claim denial.
How a loss will be settled is another section that should be explained. The difference between actual cash value and replacement cost is significant, and most insureds aren’t familiar with how their losses will be handled. Explaining this difference up front can make it easier on the insured in event of a loss.
When an insured is pressed for time or unwilling to sit for a lengthy explanation of how insurance works and what they need to know, a brief overview may give them enough information to begin to understand what they need to know and what questions to ask. It’s not ideal by any means, but some knowledge is better than no knowledge, and if it gets an insured to stop and think a minute before buying the very cheapest policy that really won’t protect them, then the mission is accomplished.
Christine G. Barlow, CPCU
Christine G. Barlow, CPCU, is Executive Editor of FC&S Expert Coverage Interpretation, a division of National Underwriter Company and ALM. Christine has over thirty years’ experience in the insurance industry, beginning as a claims adjuster then working as an underwriter and underwriting supervisor handling personal lines. Christine regularly presents and moderates webinars on a variety of topics and is an experienced presenter.