If the pattern of the “early returns” holds up, the small but growing trend to offer “green” property insurance products will be more than a passing fad.
Demand has been strong for the “Green Coverage Endorsements” offered by Fireman’s Fund, says product executive Steven Bushnell. Those endorsements pay to replace insured property damaged by a covered loss with components deemed to be more environmentally sound or energy efficient.
According to Bushnell, nearly 400 commercial policyholders purchased Green Coverage Endorsements in 2007, the first year they were available. Fireman’s Fund equaled that total in the first quarter of 2008, and expects to sell at least 1,000 of the endorsements this year.
“The customers who buy the product are located all over the U.S. and range in size and complexity from single location accounts to real estate investment trusts with hundreds of locations,” Bushnell says.
David Valzania, vice president of personal lines for Lexington Ins. Co., a Boston-based AIG company, reports similar success for Lexington’s “Upgrade to Green” residential property policy, introduced in November 2007.
“The response has been truly fantastic,” he says. According to Valzania, Lexington had sold more than 1,200 “Upgrade to Green” policies through May 2008.
Liberty Mutual this year introduced a green homeowners policy, and other national and regional carriers have indicated that they plan to introduce policies that restore property with “green” enhancements following a covered loss.
While reflecting a growing environmental consciousness among property owners, “green” upgrade coverage also marks an important step in the evolution of property insurance.
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Among the earliest “green” products introduced in property insurance were two types of green endorsements filed by Fireman’s Fund in commercial lines:
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“Green Upgrade Coverage” pays to replace covered property (including machinery and equipment) with property that is certified by a federal government agency or industry organization as environmentally sound and/or energy efficient.
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“Certified Green Building Coverage” pays to restore a building to the level of certification it had prior to a covered loss, or one level higher, under the Leadership in Energy and Environmental Design (LEED) Green Building Rating SystemTM, a program sponsored by the U.S. Green Building Council.
Each of the Fireman’s Fund endorsements includes several coverage extensions for the additional expense of achieving or maintaining certification of a structure as a green building.
The covered expenses include the costs of hiring LEED-accredited engineers and design consultants, (re-)applying for certification, recycling renewable debris, flushing out reconstructed space with outside air, restoring roof vegetation (installed to reduce “heat island” effect), and compensating the insured for any loss of favorable tax, utility, and/or loan rates.
Fireman’s Fund also has a green builders’ risk policy that, among other things, includes coverage for environmental recertification expenses in its “soft costs” coverage. The Fund recently introduced a green homeowners policy that pays to upgrade damaged property and fixtures with environmentally certified alternatives.
Similarly, Lexington Ins. Co.’s “Upgrade to Green” property policies pay for the insured to purchase materials and services that meet standards for energy efficiency under the federal government’s “Energy Star” program, as well as to meet other environmental objectives.
“Upgrade to Green” policies are available for both residential and commercial policies, and the green coverages under both types are triggered by partial or total losses.
Also, Lexington has introduced its LexElite Eco-HomeownerSM policy for homeowners who generate their own electrical power using geothermal, solar, or wind systems.
The Eco-Homeowner policy compensates insureds for income lost when they are prevented by a covered loss from selling surplus power to the local electrical grid; it also covers the extra expense incurred to purchase replacement electricity.
In addition, Lexington’s Eco-Homeowner provides coverage for replacement of “eco-landscaping,” described as plantings that provide shade or direct wind to reduce heating and cooling costs. The eco-landscaping coverage effectively provides extended limits over standard homeowners policy limits for plants, trees, and shrubs.
There is no upgrade feature in the coverage provided by the Eco-Homeowner policy, however; the insured features must be in place and damaged by a covered peril to trigger coverage under the policy. |
Traditionally, property insurance has operated according to the “principle of indemnity,” which holds that “insurance contracts should confer a benefit no greater in value than the loss suffered by an insured.”1
Clearly, however, at least some of the new green coverages are being marketed as products designed to replace damaged property with property that is better for the insured.
“The specific intent of the Upgrade to Green product is to improve the condition of the house, improve its energy efficiency, improve its sustainability,” says Valzania at Lexington.
Through the first half of the 20th century, actual cash value loss settlements were “the historic measure of indemnity,” says Thomas Mallin, president of the Property Loss Research Bureau (PLRB). An insured was generally paid the estimated value of the damaged property.
That changed about 50 years ago, Mallin says, with the implementation of replacement cost coverage and later with the introduction of additional insurance for “increased costs—ordinance or law.”
(Replacement cost coverage pays the cost of replacing damaged property with new property, even if the new property is worth more than the value of the damaged property. Coverage for increased cost—ordinance or law pays the additional expenses incurred to meet building code standards and similar requirements when repairing or replacing damaged property, including undamaged parts of a structure.)
Mallin says that, at the time replacement cost coverage was introduced, “there was a lot of hand-wringing and concern about moral hazard, but I think those concerns were dealt with by the restrictions placed on replacement cost coverage.”
Those restrictions included high insurance-to-value requirements, requirements that the insured actually rebuild before collecting from the insurer, and, later, percentage limits on recoveries (now commonly imposed on guaranteed replacement cost coverage).
Even without those restrictions, replacement cost and ordinance/law coverage
would not violate the principle of indemnity, says Mallin,
because they protect policyholders from losses they would necessarily incur.
It is often impossible or wholly impractical to replace older structures with the type of components they were originally built with. Similarly, updated building code requirements generally cannot be avoided.
“It’s not a violation of the principle of indemnity to avoid having the insured dig into his own pocket,” Mallin says.
Green coverage upgrades are different. For the time being, at least, they pay for
optional improvements to property that often provide direct economic benefit to property owners through enhanced energy use.
“The green upgrade coverages are going one step further than replacement cost coverage,” says Jeff Kerensky, vice president of property legal services at the PLRB. “It’s not only that you’re getting something new, but you’re getting something you never had before and is not legally required.”
While the introduction of replacement cost coverage required changes in statutes in certain states, “there’s nothing in the law today that prohibits insurers from contracting to provide insureds with better property after a loss,” says Joseph Gerber, a member (partner) in the Philadelphia office of Cozen O’Connor, a leading insurance law firm.
Green coverage updates differ from replacement cost and ordinance/law coverage in other respects, as well.
Part of the motivation for introducing replacement cost and ordinance/law coverage was to simplify loss settlement. The insurer simply pays for conventional or mandatory repairs to covered property, and seeks to avoid contentious negotiations over the value of damaged property.
Loss settlement could be more complicated under green policies, however. Green coverage is generally marketed on the assumption that green repair and replacement will be more costly than conventional repair and replacement. If not, why buy the green coverage?
But, “environmentally sound features and materials may not always be more costly, especially as they become more conventional,” says Susan Luecke, AAIS assistant vice president of personal lines.
How, then, will insureds react if they learn that they paid additional premium to replace damaged property with property that is less valuable? Will they insist on actual cash value or replacement cost settlement?
The introduction of green coverage raises other questions, as well.
For one, how will green coverage apply to partial losses and to undamaged property? Will a carrier be expected to pay for renovation of undamaged property to realize the environmental benefits of green replacement property?
“If an air conditioner goes down, you don’t want to have to replace the windows and floor coverings,” says Michael Fusselbaugh, senior vice president for strategic business development at The Hartford Steam Boiler Inspection and Insurance Co. (HSB), Hartford, Conn.
HSB is a leading insurer of equipment breakdown, and for more than 10 years it has made coverage available that will pay the additional cost to replace equipment damaged by a covered loss with equipment that is more energy efficient and environmentally safer.
That approach is entirely appropriate for a carrier that specializes in technology and loss control, Fusselbaugh says. “In many cases, you can no longer buy parts for old equipment,” he says. “You have to upgrade.
“As far as functionality is concerned, the insured is made whole, but the energy use is lower, the cost [of energy] is lower, and the environmental impact is less. The public wants to see companies move in that direction.”
Yet, there is an enduring need to draw a line between indemnity and betterment, Fusselbaugh adds.
Also, very little is known about the potential impact of green upgrade insurance on loss of use coverage in personal lines and business income coverage in commercial lines.
“We’re in uncharted waters,” says Valzania at Lexington.
Given all that, the companies marketing green coverage upgrades are mindful of the potential for moral and morale hazard they may represent.
(“Moral hazard” is a condition where the presence of insurance creates an incentive for an insured to induce a loss; “morale hazard” is a condition where the presence of insurance leads an insured to be indifferent about preventing a loss.)
“We could be putting the insured in a better position than before a loss,” Valzania says. “While that is the intent of the product, it is a concern and we will be watching it.”
Valzania adds, however, that Lexington’s “green” products appeal to “environmentally-minded homeowners” who are conscientious and unlikely to cause a loss or neglect their properties.
“The potential for moral and morale hazard was considered as we developed the product,” says Bushnell at Fireman’s Fund. “We believe that our strong underwriting practices will uncover insureds with financial issues. To date, we have had no suspicious losses.”
While the potential for moral hazard associated with “green” upgrade insurance is acknowledged, it is considered to be remote, and there appears to be strong support for the concept.
A May 2008 report by a climate change task force of the National Association of Insurance Commissioners (NAIC) touted the Lexington and Fireman’s Fund products, stating, among other things, that “green” buildings generally presented less risk of loss than conventionally-constructed ones.
In any event, the current distinction between “green” coverages and replacement cost and ordinance/law coverage may soon become moot.
“‘Going green’ may eventually make its way into building codes,” says Kerensky at the PLRB, “As these building techniques become more accepted they will become more and more a part of building codes.”
If that happens, “green upgrades” will potentially fall under ordinance/law coverage. That could vary widely among states and municipalities, however, depending on their climatic conditions and political environments.
For the time being, however, carriers are advised not to plunge into providing “green” coverage without thorough consideration of its implications.
“You really have to think this out,” says Gerber. “You don’t want to rush to market.”
1Wiening, Eric; Foundations of Risk Management and Insurance;
American Institute for CPCU, Malvern, Pa., 2002; p 8.5
The greening of 
