Insurance agents across Central and Western Massachusetts scrambled to aid their policyholders last week, dealing with hazardous roads, offices without electric power, dodgy cell phone service, and limited internet access.

But those in the industry say that they don’t expect Wednesday’s tornadoes to impact the insurance industry on anywhere near the scale of the hurricane impact on the Gulf Coast in 2005.

Robert Hartwig, president of the Insurance Information Institute, says he thinks the property and casualty insurance system will work as it is supposed to in responding to the Massachusetts disaster.

“There’s no question the market will be able to function as intended,” Hartwig, a Massachusetts resident, told Banker & Tradesman. “Tornadoes are tragic … but in terms of actual damage done, it’s very small compared to what we have seen in Missouri and Alabama.”

“Obviously, we’re getting a lot of practice this year,” he said, adding that adjusters were likely on-scene as early as Thursday afternoon.

 But what about the big picture? With replacement costs threatening to eclipse market values, will policyholders be tempted to take a cash payout instead of rebuilding?

“I doubt they’ll take the cash,” Hatwig said. “We’re not talking about communities being wiped off the map.”

James Sutton president of the James F. Sutton Agency Ltd. in East Islip, N.Y., and a member of that state’s Independent Insurance Agents and Brokers, agreed that the Massachusetts tornadoes don’t come close to the scale of the hurricane damage on the Gulf Coast.

He noted that most rebuilding policies include leeway of 25 percent above the initially-quoted rebuilding price to allow for construction cost increases during the construction period. He also said that in his experience, cash value is an older policy form that’s now used mostly on distressed properties, or as a more efficient way to determine the value of older properties with recent renovations.

Replacement Costs

Insurance companies are well aware of the depressed real estate market and the effect on market values, said Christopher Hackett, director of personal lines policy for the Property and Casualty Insurers Association of America (PCI). In his experience, he indicated, he is not aware of any companies initiating adverse actions on in-force homeowners policies based on market value changes.

Insurers review the replacement cost estimates of their policies at a 12-month renewal date. Adjustments for the amount of coverage are made to account for inflation and any regional increase in construction costs. Adjustments, and formulas for determining them, vary by company, Hacket says.

So, in today’s market, is there more incentive to rebuild or move on? Insurers will typically compare the market value of the home to the cost to replace the home at the time a homeowners insurance policy application is received, Hackett said. A moral hazard may be created if the market value of a home is significantly less than the replacement cost. Individual company underwriting guidelines vary as to how low the market value can be in relation to replacement cost.

Typically, the insurer will settle a claim for the lesser of either the limit of liability under the policy, or the cost to replace the damage with materials of similar kind and quality. A policyholder can rebuild at a new location, but coverage is limited to the amount it would have cost to rebuild at the original location, Hackett explained.  

Some companies may offer a functional replacement cost policy. For example, an older home built in the 1920s may have plaster walls, intricate wood carving, and other expensive features. Those wouldn’t be replaced under a functional replacement cost policy. Instead, it would cover modern construction materials like drywall and wood veneers.  

State and federal disaster assistance in response to a tornado would not typically provide financial help, with what’s covered in a homeowner’s policy covering a dwelling and personal property, Hackett said.

But if severe weather patterns are becoming more widespread across the state, making a wide market range of properties more disaster-prone, how will the insurance industry rethink its pricing?

This issue was first raised in Massachusetts in the middle of the last decade when increased incidences of storm damage to high-value coastal properties raised the question of whether it was feasible to rebuild. Despite those properties’ desirable status, private insurers withdrew, pushing many properties into the state’s FAIR plan, considered to be the insurer of last resort.

As of now, it’s far too soon – and far from certain – whether the June 1 tornados will continue to be a rare event in Massachusetts, or whether they will be a part of some new-weather normal. At the moment, the property and casualty insurance system is working the way it should. It may be many months before we know how long it can continue to do so under the criteria now in place.