Real Estate And Insurance
( Originally Published 1924 )
It has been said that insurance is but a gamble. What answer can be given to this statement? Why does insurance play such an important part in the granting of credit? Why does insurance serve to prevent fires! What are the main provisions of an insurance policy? What is meant by a "standard policy"? Explain the coinsurance clause. What are the two standard schedules for rate making? Upon what basis does each of these schedules fix the rate? What is the Fire Underwriters Association? Upon what basis is competition conducted in insurance writing? Enumerate other forms of insurance than fire. What is the peculiarity of steam boiler insurance? of plate glass insurance? of crop insurance? What are the opportunities offered to the insurance department of the real estate office?
Definition and Purpose of Insurance. Insurance has been defined as the act of indemnifying or guaranteeing against loss from a certain specified contingency. The practice arose several centuries ago, and has been common in a number of different forms, some of which were legitimate and others little less than gambling. The most common forms today are life insurance, fire insurance, and marine insurance. The first insures a person against loss due to the death of another; the second guarantees against loss by fire, and the third covers ships and cargo against loss at sea. Tornado, lightning, casuality, liability insurance, and several other forms such as credit insurance and insurance of business returns are frequently written today. The real estate dealer, how-ever, is largely interested in fire insurance, and the principles of fire insurance apply to a large degree to the other kinds. This chapter therefore will deal particularly with that branch.
Substitutes Small Known Cost for Large Uncertain Loss. The great advantage of insurance is that it substitutes for an unknown, uncertain, great loss a known, certain, and definite small loss or cost. It is a plan by which many who are eventually subject to a loss from a contingency guarantee to make it up to those upon whom the loss actually falls. Now, if all those insured had to accumulate enough of a reserve to meet the worst event, a very large amount of capital would have to be sequestrated to cover the possible losses. But in actual practice, not all those interested will suffer losses. The law of statistical regularity teaches that only a certain fairly fixed proportion of the whole group will suffer within a given length of time. Consequently a smaller proportional sum will have to be set aside to meet losses as the number of those insured increases. For example, in case of no insurance, a property owner must accumulate as rapidly as possible a sum sufficient to re-establish himself in case of loss. But if he combines with a thousand other owners, the thousand will not have to accumulate enough to cover the total value of their property, for experience will prove that not every-one of them will suffer loss during a definite reasonable length of time. As the number increases, the margin between the reserve needed and what experience teaches the actual losses will be can be reduced; the law of statistical regularity operates with increasing accuracy as the number of chances increases.
Basis of Credit.-In addition, to substituting a small certain cost for a large uncertain loss and reducing the amount necessary for effective covering, insurance per-forms a great function in serving as a basis for credit. When large credit is granted, it is usually based upon property upon tangible means of meeting the obligation incurred. If the property is subject to total or partial destruction by a single catastrophe, it could not serve as a sound basis of credit; a creditor founding his hopes upon such property might be left "holding the bag." Insurance perpetuates the safety of the creditor which formerly rested in the property. One of the foundations of credit, then, would be destroyed and credit demoralized if insurance were impossible. This has been the situation in a case or two. A few years ago the legislature of Missouri passed such stringent fire insurance laws that all except the local companies with-drew from the state. The result upon credit and general business was so great a shock that the law had to be repealed. Another similar situation arose in South Carolina from the same causes.' Insurance is obviously essential to any scientific granting of credit, and when a large proportion of business is carried on by credit, insurance becomes essential to business.
Encourages Prevention of Fires. Another great advantage which lies in fire insurance is that it provides an incentive to prevention of fires. A strikingly large proportion of losses by fire is due to carelessness, and a constant premium to pay for fire insurance serves as a persistent monitor against this carelessness. Moreover, the installation of preventive measures lowers the liability of loss and consequently the cost of insurance.
And most of all, it is the insurance companies who have been most vitally interested in the means of fighting and extinguishing fires with the inevitable result that nearly all our improvements in methods of protection against fire, such as fire companies, etc., have been originated either by the companies themselves or at their instigation.
Extent of the Necessity for the Insurance Business in the United States. The extent of the fire insurance business alone in the United States is enormous. The amount of property thus protected has been estimated at a hundred billion dollars by a special committee of the Chamber of Commerce of the United States. The premiums collected every year reach beyond a billion dollars, and the losses paid are more than $750,000,000.
But the value of fire insurance companies to the country is not measured solely by these figures ; they exert a tremendous influence upon the reduction of fire losses. Notwithstanding all they do in that respect, in 1920 and 1921, according to President Mallieu, of the National Fire Prevention Association, the loss by fire in the United States was over $1,000,000,000. Sixty-seven per cent of these fires were preventable. It is staggering to think what the figures would be were it not for the efforts of the fire insurance companies in this Association! And it is still more staggering to think what uncertainty would result in business and in industry in the absence of some means of insuring this risk.
The Fire Insurance Policy. In most states of the Union, a standard fire policy is prescribed, which must be used in every case. The states have passed a law requiring a uniform policy in order to protect the rights of both the company and the insured. It is very easy for an insurance company to be defrauded. The property covered by an insurance policy is left in the hands of the insured and wholly subject to his acts. Upon his honesty and good faith a great deal of the extent of the risk depends. Consequently it is necessary for the insurance company to protect itself as far as possible from imposition. On the other hand, the usual insured person is unfamiliar with the technical terminology and forms of insurance and it is very easy for him to be swindled by a dishonest and careless company or agent through the writing of a policy which leaves too many loopholes for the company. In order to protect both these interests, the states have prescribed the definite wording in which an insurance contract shall be written. Such a contract is called a "standard policy."
The following are the chief provisions of such a policy:" (I) the consideration, (2) the liability assumed by the company, (3) the term of its policy, (4) location of property, (5) signatures. In addition, the back of the policy contains stipulations concerning the following points, all of which are a part of the contract : (I ) voidance of policy in case of fraud or misrepresentation, (2) uninsurable and excepted articles and hazards, (3) provisions regarding ownership the non-compliance with which will void the policy, (4) other conditions which would void the policy, (5) waiver clauses, (6) cancellation clause, (7) definition of the term "noon," (8) "mortgagee clause," (9) requirements and procedure in case of loss.
The insurance agent should familiarize himself with every provision in the standard policy of his state and be sure when writing a policy that the insured understands each one. Negligence in calling attention to and explaining the provisions of the policy may result in loss to the insured, and it ought to be the aim of an agent to protect the interests of his customer in every respect. The customer commits his interests to the agent; they should be in no way neglected or abused.
Special Features of the Policy. One of the points the agent should guard against is describing the property insured in such a way as to fail to include it all. It is better to use general rather than specific language in this connection; for the general includes the specific, while the specific may by inference exclude what is not mentioned. It is better, for example, to say, "On household furniture and other personal property usual to a dwelling" than to try to enumerate all the articles covered. Special care must also be observed in specifying where the property is located. Few policies (known as "floating policies") are written that cover property which is not located in a specific place designated in the policy. In case of removal on account of danger from fire, a short time is given for readjustment. The location determines the risk, and it would be neither fair nor scientific for a company to cover property upon which the risk had been increased by its removal into a location in which the hazard was increased.
Insurable Interest. Another point that must be safe-guarded is the careful designation of the "insurable interest" of the insured in the property covered. An insurable interest may be any of a number of kinds, such as that of sole owner, mortgagee, etc., but it must be clear what that interest is. If there were no interest in the property insured, the policy would really be a gamble —the insurance company would be betting that the property would not be destroyed by fire; the policy holder that it would. It is clear how much the hazard would be increased by such a situation.
The Mortgagee Clause. Special attention should be called here to what is known as the "mortgagee clause." This is a clause which is endorsed on the contract for the protection of the person who owns a mortgage on the property insured. The importance of this clause is evident at once. While the owner of property is protected by his insurance, the man who has taken a mortgage may be defrauded in case of loss. He wants also to know that at all times the property upon which he holds a mortgage is covered by adequate insurance. A default in the payment of premium, for example, might leave the property unprotected.
Consequently, the mortgagee clause has come into general use. This clause contains two principal provisions. First, the insurance upon the property which is the basis of the mortgage cannot be invalidated so far as the interests of the owner of the mortgage are concerned, by any act of the mortgagor. Regardless of what the mortgagor may do, the mortgagee is protected. Secondly, when the mortgagor defaults in payment of premiums, the holder of the mortgage undertakes to pay them. In-stead of the policy's being cancelled upon default in premium payments by the mortgagor, the mortgagee is called upon to pay them and the policy remains in effect.
There are other considerations of less importance. The mortgagee is obliged to report to the insurer, as soon as they come to his attention, any changes in ownership or location of the property or any other factors which might increase the risk. And payments made to the holder of the mortgage entitle the insurer to a claim in the mortgage to the extent of such payments. The holder of the mortgage could otherwise collect from the insurance company and then benefit as far as possible from any foreclosure he desired to make.
The Coinsurance Clause. The "coinsurance clause" is one that is frequently used, and frequently misunderstood or not understood at all. Yet it is not difficult to understand. It is the result of an effort to equalize the cost of insurance to all policy holders, and arises from the fact that in a large majority of cases loss from fire is not total but partial. Suppose that the average loss from fire is fifty per cent of the value of the property. The merchant, for example, could then carry insurance for fifty per cent of the value of his stock, and collect full damages in case of the average loss from fire. But he would be paying only half the premium that a merchant carrying insurance for the full value of his stock would pay. This would be plainly unfair. Consequently, nearly all mercantile policies (this clause does not apply to dwellings) carry the coinsurance clause. This clause provides that the property covered must be insured for a certain precentage of its value, usually eighty per cent. If everyone carried the same percentage of coverage, rates could be assessed upon an equitable basis. In case the property is not covered to the extent mentioned in the coinsurance clause, the insured is considered as him-self assuming enough of the risk to make the total equal to that mentioned in the clause.' An example will make this clear. Suppose the policy covering a $100,000 stock of merchandise carries an eighty per cent coinsurance clause. The stock would then, in order to cover completely any partial loss by fire, be insured for at least $8o,000, and being so covered, any loss up to the total value of the policy would be completely recoverable. But if the owner carried only $70,000, he would be considered as coinsurer for the difference between $70,000 and $80,000, or one-eighth of the amount specified in the coinsurance clause. In case of a partial loss he could not recover full damages but only seven-eighths, that proportion of the full loss that the actual insurance bears to eighty per cent of the total value of the stock. If the loss were $40,000, for example, he would recover only $35,000; he would, as coinsurer, have to bear one-eighth of the loss—$5,000.
Other Special Conditions. The policy holder should also be reminded that any change in the nature of the property, the character of the building such as addition of floors or increase in number of tenants, and any other change that would affect the nature of the risk should be reported to the company for a readjustment of rates. In case such is not done, the policy holder may suffer at least some loss in case of fire. The amount of the insurance will be reduced to that which the premium actually paid would buy under the increased rate. When the change is one which would effect a decrease in rate, the customer should be promptly notified so that he may receive immediate benefit from the improvement.
Rate Making. Rate making for fire insurance is a very complicated problem and one whose scientific solution is not completely realized. It is an effort to distribute cost of insurance exactly in proportion to the risk involved. But there are no two identical risks. The risk of insurance is of two kinds, the external risk and the moral.
The external risk, such as exposure to other buildings, likelihood of fire from furnaces, etc., can be fairly measured; but the moral risk, depending as it does upon human factors, varies with each individual policy. It is increased by any condition which might make a fire desired by the insured, or cause him to decrease his vigilance. To a certain extent all insurance increases the moral hazard, for it does cause a decrease in care; the results from a fire cannot be so disastrous, and less attention is paid to hazards. Overinsurance, heavy financial losses, mortgages, these and many other factors which must be judged separately in each case increase the moral risk involved in insurance.
There is some variation in the external risk, but it can be much more nearly approximated than the moral. It is easy enough to see from casual observation that different kinds of buildings and the different uses to which they are put carry different fire risks. But this fact, simple enough once it is observed, was for a long time not recognized by insurance companies. It is said that some one once asked the president of an insurance company whether his company made any money by insuring paper mills. 1 This question started the president to classifying the risks and led to the present system of rate making. The principle had been very crudely recognized long before by one of the earliest companies to be organized in America. It was known as the Contributionship. One of the conditions of membership in this society was that within six months all trees standing in front of the house within a certain distance should be cut down.' Trees were supposed to interfere with fighting fires. Some of the members, chafing against this restriction, withdrew and formed their own mutual company known as the Green Tree. Their risks were divided into two classes—those having trees in front and those that did not have.
Rates today are very rapidly being standardized. In that state of Wisconsin they are standardized for all licensed companies in the state by a state insurance bureau. When an agent writes a policy, he submits it to this bureau for assignment of rate. The expense of the bureau is maintained by a tax upon the gross business of each licensed company. In other states and in most of our cities, the rate is designated by a board of underwriters—that is, a common association of all the companies. It is generally recognized that cut-rate competition leads to disaster and to great iniquities nowhere more than in the writing of insurance. The basis upon which the rates are fixed is, first, the class of building and, second, the purpose for which it is used. Some classes, such as private dwellings, are insured under what is known as "minimum rates." These rates are applied as blanket rates according to the type of structure, the number of occupants, etc., without any attempt to distinguish between members within the class.
More complicated and more hazardous risks are rated only after inspection and the application of specific rates to the individual case. Specific rates are established upon the basis of long experience and careful rating of every factor of risk involved. This includes fire prevention or extinction equipment, the exposure to other buildings and means employed to protect against fires in other buildings, the number of occupants and the nature of their occupancy, and any other factors in connection with the specific building examined which might have an influence upon the amount of risk involved. In order to secure a basic rate. a standard has to be determined upon. This standard is first established in connection with the city. An ideal—or perhaps more accurately, an average city is determined upon as a standard. It is equipped with a certain amount of fire-fighting apparatus, a definitely efficient water system and so on. The basic rate established for any city reflects the degree to which the city examined measures up to the standard city. If its equipment is the equivalent of that in the standard city, the basic rate is the same; if it is poorer, a higher rate is established, so that the lack of equipment is penalized; and if better than the standard city, a lower than standard rate is established. The same procedure is taken in case of every building in the city. A standard building is first established, of a definite height, with a specified number of occupants, an adequate sprinkler, and other forms of protection. Every building is rated according to its approximation to this standard.
There are two schedules according to which this procedure is carried out. One is known as the Universal Mercantile Schedule, and the other as the Analytical Schedule. The former establishes definite charges—so many cents for each hundred dollars of insurance against the various risk factors, and deducts a percentage of the total rate for "credits." The analytical schedule divides all cities into seven classes and establishes a basic rate for each class. Every risk is charged a percentage of this basic rate instead of a flat dollars and cents charge. When fire-fighting apparatus is improved, the city moves up into a better class, but the percentage of the basic rate charged for additional risk remains the same. It will be seen that this system adds a double penalty for the poorly equipped city a penalty assigned' in the basic rate and one in the percentages of this rate assigned to every additional hazard.
Basis of Competition in Fire Insurance. With standardized policies offering to customers exactly the same conditions and standardized rates under which the price is uniform in all companies, the basis for competition in writing insurance has changed radically from what it was in the days of rate-cutting and special clauses in special cases. Every real estate dealer who writes insurance ought to realize this and organize his insurance department in such a way as to take advantage of it. The competition today is obviously on the basis of service, not price or special favors. But service is a much abused word; it has to be defined before it can carry any definite meaning. In writing insurance it means attention to the interests of the insured. Some of the ways in which this can be manifested have already been pointed out: the insured should be informed regarding the provisions of his policy and what acts of his might vitiate it and cause a loss to him. A prompt report in case changes have been made that justify a lower rate on the policy; promptness in reporting losses and securing adjustments; timely notification before the expiration of a policy so that it can be renewed these are some of the bases for soliciting insurance business when competition is no longer desirable or possible in price and conditions. Service can also be rendered when a policy is written. There are frequently conditions which, with but a little expenditure, could be enormously improved so that a different classification in rates can be secured with a consequent saving to the policy holder. The agent should be thoroughly familiar with these factors in the establishment of the rate so as to be able to give advice to his customer that will result in saving him money. The addition of a sprinkler system, standardization of skylight or chimney, an increase in the height of fire walls or other alterations may frequently be recommended by the man who knows his business. The insurance agent should not be content to write policies; he ought to be an expert consultant on fire risks.
One of the best opportunities for this type of service occurs in case of a loss. The procedure is exact and somewhat complicated. Ordinarily there is a time limit within which notification must be given and there are uniform loss-report blanks to be filled out with affidavits to accompany them. The items to be shown include the date and hour of the fire with origin if known, the value of each item lost or damaged, the policy holder's interest in the property lost or damaged, the mortgages or other incumbrances on the property at the time of loss, and a list of all insurance carried and of all the occupants of the building at the time of the fire. The agent can materially assist in the preparation of these reports.
The actual settlement is outside the activities of the agent, except in cases of small loss. It is inexcusable for him to be negligent in settling any claims over which he is given jurisdiction, and in other cases he can cooperate with the company in such a way as to expedite settlement. Most claims are very promptly settled. Insurance companies realize that litigation and trouble are business destroyers while prompt settlement builds up the good will that is essential to business. Consequently, unless there is a patent case of fraud, they usually settle in a way that is satisfactory to the policy holder. A specially trained man, known as an adjuster, is used to settle all large claims. By his wide experience he is able to judge very accurately what constitutes a fair basis for settlement and, while protecting the interests of his company at all times, he usually manifests the generous attitude that is designed to make friends for it.
Other Forms of Insurance. While fire insurance is the largest insurance interest of the real estate dealer, there are several other forms which, especially if he develops this department, he will be interested in. The most important of these are title insurance, profits and rent insurance, and some of the forms of casualty insurance. Title insurance, while of great importance to the real estate dealer, is seldom written by him; it is usually under-taken by a special company organized for the purpose. It undertakes to indemnify the purchaser of real estate against any loss sustained because of defects in the title which he receives. The title insurance company makes an expert examination of the title which the purchaser receives and, excepting such faults as it finds in the title which are enumerated as exceptions, it assumes all risk of defending that title against claims which may later arise. The premium in this case is paid all at once and has nothing to do with the difficulty of examining the title. The policies are not transferable. Such a policy is frequently considered essential when real estate is purchased, and is further discussed in Chapter X.
Occupancy, profits, and rent insurance are designed to cover the losses occasioned by a fire, but not directly attributable to it. The loss of time, which is usually accompanied by heavy overhead expenses, and the loss of business sustained while the damage done by fire is being repaired, cannot be covered by a regular fire insurance policy, but their burden, if carried by the individual concern, would frequently mean bankruptcy or serious handicap, even though all the direct loss was fully covered.
The first of these forms covers the costs of forced idleness of manufacturing plants, due to the results of a fire. The insurance company undertakes to pay to the insured the amount of overhead lost on account of the interruption. Profits insurance extends to many lines of business. It indemnifies against loss of business and consequent profits because of the damage done by fire. Rental insurance assures to the owner of a building the income which he has been receiving. When taxes and interest continue, together with a possible heavy overhead, it is important that the income from a building be guaranteed during the time it is being repaired after a fire. Several different types of coverage can be written in this connection, but the essential principle is the same in all.
Casualty insurance is of many kinds. Those in which the real estate dealer is chiefly interested are liability insurance, plate glass and boiler insurance, and crop insurance, while some offices write a large amount of automobile insurance. Liability insurance covers losses which may be sustained by the owner of a building or an employer on account of injuries received by people who are legitimately upon his premises or in his employ and for which the owner or employer may be held responsible. A common form of this is elevator insurance, covering accidents which may occur as a result of the operation of a public elevator. The prevalence of such insurance is shown by the ubiquity of the sign, "This elevator is inspected by the Casualty Company and . . . ." The premiums received for casualty insurance are said to be spent, not in the payment of losses, so much as in maintaining an adequate, thorough inspection service, of which the sign just quoted is evidence.
The same statement is true of steam boiler insurance. Insured boilers seldom actually explode because the inspection system is so rigid that weaknesses are discovered in time to avoid the tragedies both to property and to life that inevitably follow explosions. Boiler insurance is relatively recent, having become common only within the present century.
Plate glass insurance is also a very recently developed form. It arose with the large increase in both number and size of plate glasses used in the construction of buildings. As these glasses became so large and expensive, the burden of their loss became greater and greater and the necessity for insurance more and more urgent. Losses of glass usually occur on the first floor, and are the result of external violence. Small boys and stones are said to account for a large percentage of plate glass losses, while many such losses may be ascribed to defects in construction. A peculiarity of this type of insurance is that losses are not usually paid directly but the broken glass is replaced.
Crop insurance, particularly against loss from hail, has been tried in the United States and Canada, but so far it has not made much progress. Those who have studied it recognize its value, but apparently it has been slow in developing a sound basis for the assessment of premiums. Under the influence of a central organization which has been studying and standardizing rates at a fair figure, it promises to take the place which it deserves. There is no reason why the farmer should not be protected from loss from bad weather as much as the merchant against plate glass or fire loss. One of the difficulties. which has been prominent but is rapidly disappearing with the education of farmers regarding the subject, is that false claims are made. A poor crop is reported as having been damaged severely by a storm when it really gave no promise in the beginning. But scientifically applied and honestly used, crop insurance may possibly eventually play an important part in farming.
The Insurance Department in the Real Estate Office. Insurance is written by the majority of real estate men not as an independent activity but as a supplemental one called for by the nature of their business. As a consequence it is frequently poorly done. There is no reason, however, why its commissions should not prove a valuable source of income and its opportunities a means of building business.
The insurance department ought to have the pre-eminent attitude of service. Clients will find its service a great convenience. Having placed their confidence in the dealer, they will naturally turn to him to write their insurance. The records and data available in effecting a sale or a transfer make the handling of insurance easy. Renting and appraising involves close personal relations between the dealer and the customer; that relationship makes the writing of insurance natural.
Another advantage lies in the immediate protection which can be rendered to the customer. As soon as real estate is transferred or leased, the question of insurance becomes immediately vital. The interests of the buyer may suffer by the lapse of time involved in going from one office to another, attended as such passage may be by several delays and interruptions, or conscious postponement. If there were no commissions, it would be almost necessary for the real estate dealer to write insurance in order to secure the interests of his customers.
The department has an exceptional opportunity, therefore, for building up good will for the business. Reinembering the basis of competition, it should seek to render every service that will protect the interests of customers and bind them to the firm. There will also be occasions when it can secure new customers for the other departments. An efficient insurance department is an asset to any real estate office; any other sort ought not to be tolerated.
1. Insurance is a method of distributing the losses due to a certain contingency over a group subject to that contingency.
2. Insurance serves as an essential basis of credit and acts as a deterrent to losses by fire.
3. Insurance policies are standardized in nearly every state because of the ease with which an insurance company may be defrauded and the difficulty with which the ordinary person could protect his rights in taking out a policy.
4. The special features which an insurance agent should particularly regard are using general terms instead of specific, careful specification of the place in which the property covered rests, and the exact designation of the insurable interest.
5. The mortgagee clause provides for the protection of the interests of the holder of a mortgage.
6. The coinsurance clause arises from an effort to equalize the costs of insurance. It is used because losses are usually not greater than 8o per cent of the entire value of the property.
7. Rate making attempts to fix the cost of insurance on the basis of the losses experienced on particular types of risks. Risks involve two elements, the moral hazard and the external hazard.
8. Rates are fixed either by the state or by a Board of Underwriters. They are the same for all companies operating in the same place and are based upon the Universal Mercantile Schedule or the Analytical Schedule.
9. Many real estate dealers also write profits and rent insurance and different forms of casualty insurance, including liability, plate glass, boiler, crop, and automobile insurance. Title insurance is a special form of insurance written almost solely by title insurance companies.
10. The attitude of the insurance department will determine the amount of service which it renders to the organization as a whole.