Insurance has a language all its own, and translating insurance-speak so the average person can understand it has long been a challenge for insurance agents, claims adjusters and underwriters. But that translation is extremely important. Without it, customers may not understand what they're buying or may even develop negative perceptions of the insurance industry.
We wrote today's post to help. We provide basic definitions of commonly misunderstood insurance terms that you can use when working with your customers. Also included are examples you can use to make the terms easier to understand. If you'd like us to add a term to this guide, contact us and let us know.
Why insurance is sometimes so confusing
Insurance policies are contracts, and many customers see them as overly complicated by legalese that helps insurers avoid paying claims. Our industry is dedicated to fulfilling our promises to policyholders and claimants, and the contracts define the specific terms of those promises. Insurers use those contracts to plan for the future and ensure they'll have enough money to pay claims.
When customers fully understand important terms, they can make better decisions about which coverage to purchase and what mitigation steps they might take on their own. Helping customers understand their policies also enhances the public's perception of our industry.
All risk and all perils
Predominantly, this wording is used for homeowners policies, and it creates a false sense of comfort in many people. This term covers a great deal of potential harm that can occur, but these types of policies have a lengthy section of exclusions (see below) that remove coverage for certain perils, including disasters, such as earthquakes, landslides and floods. It is imperative that we help our customers assess what real risks they have and encourage them to purchase appropriate coverage.
These are risks that either require specific types of additional policies or are considered uninsurable, such as war, nuclear hazard and government action. In some cases, exclusions can give partial payment on a claim up to a certain amount. Ensure your customers have read the exclusions section. Asking questions about the excluded items will help you to confirm they understand their coverage.
Earthquake property damage is often excluded from standard policies.
Replacement cost typically relates to property, such as homeowners or commercial lines property policies and can cover the building or the contents owned by the policyholder. Replacement cost is often confused with market value. Imagine a 2,500 square foot house in Seattle, and the cost to rebuild completely might be $500,000, but the sale price might hit $1,000,000. Insurance is focused on the replacement of the home, so the policy would pay the $500,000 rebuilding costs, not the market value, and would charge a much lower premium accordingly.
Contents coverage that has replacement cost is an excellent value because your clothes, electronics, appliances and all other affected possessions will be replaced, brand new, regardless of their age or condition before the loss. Determining the right replacement values for your customer’s building and contents is very important, and your expertise is essential in ensuring your client is properly covered.
Actual cash value
Contrasted with replacement cost, actual cash value pays after the value of depreciation is determined. In the same example above, if the customer purchased an actual cash value policy on the same home of $500,000, but it is 50 years old and not in great shape when it is completely destroyed in a fire, depreciation could reduce the claim payment significantly. The same can happen on contents. If your customer has a 2003 laptop or 1995 clothes dryer, your customer will get the value of what they are worth today, not the amount necessary to replace them with new items.
Deductible and Self-Insured Retention
A deductible is the amount a policyholder is required to pay out of pocket before the insurer will cover the remaining claim costs. Customers can pick their deductible based on their comfort level and, depending on the insurance company, may see significant savings by increasing the deductible. Most companies will offer deductibles down to $100 and up into the thousands of dollars. Agents and brokers can help customers determine the best deductible for them based on their financial tolerance.
A self-insured retention is a fancier term for deductible, typically found in personal excess or umbrella policies. These are normally set at $250.
Co-insurance might be the most confusing term in insurance and is found in many insurance policies. (Here, we are defining the term as it relates to property insurance, such as homeowners or commercial property, as opposed to healthcare co-pays.) Homeowners aren’t the only ones confused by co-insurance. Many underwriters and claims adjusters struggle to explain it adequately. Property co-insurance is a percentage that is set by the insurance company to determine what percentage of the value of the property must be insured so the policyholder can be fully reimbursed for a covered loss.
Confused yet? Let’s simplify with an example. A homeowners policy has an 80% co-insurance clause and the home value is $400,000. That means the policyholder is required to insure the home for at least 80%, or $320,000, per the co-insurance clause. If, at the time of loss, the policyholder has 80% of the home value insured, the claim is paid in full minus the deductible. However, if the customer has $160,000 in coverage at the time of the claim, which is only 50% of the required $320,000, the claim payment is reduced by 50% minus the deductible.
Co-insurance isn’t for everyone, and it’s important for customers to know how their policy works. For example, home and commercial property values change over time, and some — but not all — policies account for that.
Co-insurance could affect policyholders whose homes are damaged by wildfire,
or a number of other perils.
Betterment is one of the foundations of insurance. The purpose of insuring property or a vehicle is to financially restore the policyholder to the same position they were in before the loss or damage to the property or vehicle. Theoretically, policyholders should not end up in a better position than they were in before the loss or damage. In other words, an insurer should not provide compensation for more than the value of the insured property or vehicle because insurance is there to make the policyholder whole.
Related to betterment is the concept of diminished value. The best way to describe it is by using vehicle valuations as an example. If a policyholder is in a major accident, there is a direct impact on the value of the post-accident car. Vehicles that have been in major accidents are worth less than those that have never been in such an accident, even with quality repairs and with original equipment manufacturer parts, also called OEM parts or non-aftermarket parts.
More and more often today, car owners are making claims for the difference between the pre-accident and post-accident value, which makes sense because insurance should restore policyholders to where they were before the loss. Whether the insurance company is willing to pay for diminished value depends on a number of factors, including policy language, who is to blame for the accident and the age of the vehicle. Usually, the policyholder is responsible for proving there is diminished value by getting a value assessment completed.
So far, diminished value claims are most commonly made on cars, but a case can also be made for property-related diminished value claims, depending on the type of claim. Time will tell if this starts to occur.