Perspectives: Telling the truth on property valuations creates trust, promotes sustainable market

It does not take a great deal of soul searching to recall the basic moral lessons many of us learned at an early age: “Don’t lie,” “don’t steal,” and “don’t cheat.” However, in today’s day and age, headlines are plagued with tales of those who have forgotten these lessons. Unfortunately, unsustainable property insurance practices implemented by a few, unintentionally impact the insurance marketplace for the many in a big way. 

This article will address the underreporting of property values and the negative impacts on the property insurance market, the importance of accurate property valuations for policyholders and steps they can take to maximize the benefits of true and accurate replacement cost valuations for best-in-class balance sheet protection. 

Unsustainable valuation practices 

Insurers rely on a diverse pool of funds covering a wide variety of insurable interests to bolster against the possibility that one of them might incur a large loss. So long as everyone is participating in good faith with true and accurate valuations, underwriters can charge appropriately to cover the risks of the broader group. Conversely, when the statement of values submitted to an underwriter does not reflect true and accurate values, the insurer is not charging enough premium to cover the risks it is assuming. 

This upsets the basic economic equilibrium of supply and demand. We reach a point where the premium dollars collected no longer accurately support the normal loss expectancy for which it was written. These premium dollars get caught up in paying out claims at levels that were not properly planned, and this decreases the supply of capital that can be deployed as limit capacity. With no change in demand for limit capacity combined with a supply shortage, we arrive at today’s pricing environment and insureds of all sizes are feeling the effects. 

Underwriters who are not confident in submitted values will resort to four strategies that make the insurance marketplace more difficult for policyholders:

1. Insurers may choose to deploy less limit capacity than they had in past years. 
2. They may ask the policyholder to assume more of the risk through increased deductibles and retentions.
3. Insurers may opt to tighten the terms and conditions under which a policy might pay out for a loss.
4. They have the option to raise rates and charge higher premiums for the same limits, deductibles, and terms and conditions. 

While underreported values are not the sole driver of difficult property market conditions, this type of corporate malfeasance directly correlates to other market-driving factors. Contractors are reporting material and labor shortages, inflation is running red hot and supply chain bottlenecks abound. All these factors are contributing to the increased cost of construction. Replacing an asset with “like kind and quality” material becomes even harder when an asset is intentionally undervalued. 

Impact on policyholders

As a policyholder, it is important to understand that insurance is an investment in the future of an organization, not a line item expense from easily replaceable vendors. Therefore, the brokers and insurers that a policyholder chooses to partner with should be integral players in the business decisions made, not an afterthought. Some policyholders may feel they are being clever and creating cost savings by underreporting values; however, as we already noted, insurers have many avenues for ensuring a risk fits within their tolerance. 

If an underwriter feels uncomfortable with the submitted valuations, it may already be charging for a level of uncertainty. Let’s use a simple numeric example on a scale of 1-10. If a policyholder submits an asset value of 6, but the underwriter believes it is closer to 8 and possibly as high as 9, it may accept a value of 6 but err on the side of caution and charge a premium associated with 9. In this case, the policyholder is not being clever, it is behaving to its detriment. Using the same example, if the policyholder were to secure a third-party appraisal that valued the property at 7 or even 8 that would remove the uncertainty gap. Thus, an increase in submitted values does not always mean a premium increase. In this example, the policyholder receives a fair and lower premium charge and the underwriter is not putting its book of business at risk.

Maximizing efficiency 

Achieving best-in-class balance sheet protection via insurance starts with a best-in-class market submission process. When a policyholder submits accurate, defensible, data-driven statements of value, and details the methodology by which the values were achieved, it removes the layers of uncertainty that may be baked into the premium it is paying. 

True and accurate property valuations start a relationship with potential insurer partners on a note of good faith. Holding yourself to a high standard of data quality will also ensure that your submission is attractive to underwriters. Underwriters receive far more submissions in a difficult market, and they will select the opportunities they feel most confident that they can win. The probability of success increases when they have the right information to decide.

Engaging a third-party appraiser is the launchpad for this process and policyholders that have already engaged a third-party appraisal service have a leg up. With a true and accurate starting point, it becomes easier to trend valuations based on industry-accepted cost indices. For policyholders that do not have a third-party appraisal as a jump-off point, the cost indices will not suffice. Trending inaccurate original values will undoubtedly turn out an inaccurate result. 

Cutting corners never pans out. Take the time to aggregate true and accurate property valuations. When we all play by the honor system, we are putting our best foot forward in maintaining a healthy underwriting ecosystem.

Alexandra Glickman is the senior managing director-practice leader for Arthur J. Gallagher & Co.’s global real estate and hospitality practices. She can be reached at [email protected]. Robby Kunz is managing director of operations for Gallagher’s global real estate and hospitality practices. He can be reached at [email protected].