LEGAL CORNER: The California Wildfires Effect on the Real Estate and Insurance Industries

This past week, Los Angeles and the surrounding communities were struck by the most destructive wildfires in U.S. history. These wildfires have destroyed and continue to destroy thousands of homes, commercial properties, schools, places of worship and public buildings, leaving horrific death and destruction in its path. As of Monday morning, Jan. 13th, the death toll was at 25 [see https://bit.ly/40inCUC]. Our thoughts and prayers go out to all of those who lost their lives and loved ones. While the wildfires in California are not directly affecting our communities, now more than ever, it is imperative that we all pray for and provide support to our West Coast “neighbors” and “family.”

The Economic Effects on the Insurance and Real Estate Industries

The economic repercussions caused by these wildfires will undoubtedly have dramatic effects on the real estate and casualty insurance industry in California and throughout the U.S. It will take decades and billions of dollars to rebuild what was lost in these communities.

The insurance industry will certainly bear a substantial brunt of the cost for rebuilding all of the properties destroyed in the wildfires. Unfortunately, as a result, many insurance companies will consider pulling out of these markets and substantial increases in premiums are inevitable. The California Insurance Commissioner [see https://bit.ly/4ji1wKA] has at least provided some short-term protections for homeowners by implementing a one-year moratorium and ban on cancellations and non-renewals in the affected areas.

However, this temporary action will likely not stop large nationwide companies from raising rates or from leaving this and other markets entirely. The New York Post reported in April 2024 [see https://bit.ly/40uXzLo] that California “which has seen costs soar due to natural disasters like wildfires, has had seven of its top 12 home insurers—including Farmers Insurance, State Farm and Allstate—pause or restrict coverage, saying they can’t afford to take on new clients.”

NAR Provides Guidance Regarding Insurance Coverage

It is important for real estate agents, attorneys, and other real estate professionals to be familiar with the issues involving homeowner’s insurance and to advise their buyer clients of the many issues relating to same. The National Association of Realtors recently made available the “Consumer Guide: Homeowners Insurance” (“Guidance”) [see https://bit.ly/4jdBDMa], which practitioners should utilize and provide to their buyer clients when they are first engaged. As NAR’s Guidance explains, “Homeowners insurance covers you for unexpected losses at your home or property. It can include provisions to repair or rebuild the property, replace assets within the home, cover accidents that happen to you or someone else on the property, or even pay for living expenses if a covered incident forces you to live elsewhere temporarily.”

Purchasing Property on an ‘All Cash’ Basis

As NAR points out in its guidance, homeowner’s insurance is not always required particularly when there is no lender or financing being obtained in connection with a purchase. When a buyer is purchasing a property on an “all cash” basis, there is no legal requirement that homeowner’s insurance coverage be put in place prior to a closing. Therefore, it is imperative to inform buyers who are purchasing a property on an “all cash” basis to begin researching insurance coverage options as early as the acceptance of an offer by the seller. When there is no lender, it is up to the real estate agent and attorney to inform their clients about obtaining homeowner’s insurance on the premises.

The Cost of Homeowner’s Insurance:
An Important Consideration When Purchasing

As NAR explains, “The cost of homeowners insurance depends on several factors, including your credit history (in some states), the house’s age, square footage, condition of the property, and location.” These various factors may make it difficult, and sometimes even impossible, for buyers to obtain insurance coverage, or at least coverage that is affordable. Many buyers and real estate practitioners focus on the usual expenses when purchasing a home, such as the interest rates, monthly mortgage payments and real estate taxes. In most instances, buyers fail to consider the cost of homeowner’s insurance, which can be several thousands of dollars annually and which can increase the monthly payments significantly.

It is also important for real estate attorneys to take these factors into account and consider including provisions in the contract of sale allowing a purchaser to cancel the contract if the purchaser is unable to obtain insurance coverage due to reasons beyond the purchaser’s control. Events like the wildfires in California, and other severe weather events such as hurricanes and storms like the ones that hit Rockland and Westchester counties in 2023 and New York City in 2021, have inevitably led to an increase in rates and difficulty in obtaining coverage on homes located in these areas. It is important for attorneys to include protections and contingencies in the contract in the event a buyer is unable to obtain coverage for any reason.

Consideration of Lender Requirements When Obtaining Insurance

When a lender is involved in providing financing for a real estate transaction, it is recommended that buyers check with their lenders to make certain that they do not have any unexpected or overly burdensome requirements. It is common for lenders to require that certain coverages be obtained. Lenders may also restrict the homeowner’s ability to choose a higher deductible in an attempt to reduce the annual premium. As previously mentioned, properties may also be located in areas where insurance companies have deemed to be high-risk locations and may have certain restrictions and/or added costs for those areas, or may simply not provide coverage at all in those areas.

Use of Aerial Images to Drop Coverage

Another new phenomenon a homebuyer should be aware of is the use of aerial and satellite imaging by insurance companies to drop coverage or not allow a homeowner to renew a policy. The New York Post article [see https://bit.ly/40uXzLo] highlights the risks surrounding these practices utilized by insurance companies. As reported by the New York Post, “The Geospatial Insurance Consortium, an industry-funded group that carries out aerial surveillance missions, said it has photographed 99% of homes in the US.” The article points out that insurance companies are now using these photos to determine the condition of a roof, or to pinpoint risks that exist on the property such as trampolines, pools, tree branches and even moss, and as a result sends out non-renewal or cancelation notices to a homeowner.

It is important for purchasers to be aware of these practices and the possibility that after a closing, their insurance company may send out an unexpected cancellation or non-renewal notice if any of the conditions above are found to exist. For example, while most purchasers have a property inspected prior to entering into contract, many may choose to accept the property “as is” with respect to the condition of the roof (which may require replacement but not immediately), the existence of a trampoline, or other issue. However, after the closing an insurance company could utilize these aerial photos and require the homeowner to repair and/or replace the roof at a substantial expense (which the buyer did not expect and was not financially able to undertake right away) by a date certain or risk the cancellation of coverage.

NAR’s Guidance: Important to Understand What’s Covered

NAR’s Guidance also provides important information on the different types of coverages that are available to homebuyers. According to NAR, there are two types of coverages: (1) “Named Peril” and (2) “Open Peril.” “Named Peril” coverage “pays only if the damage is caused by a specifically named peril. The most popular policy, HO-3, covers the home structure and personal belongings for disasters including fire, hail, lightning, freezing, theft, and vandalism.” “Open Peril” coverage “pays in all instances except for when the damage is caused by an incident that is specifically excluded. HO-5 insurance policies may offer more extensive, open-peril coverage, but they often have higher premiums and more eligibility requirements.”

Important Differences in Claim Reimbursements

As NAR explains there are four different reimbursements that are available: (1) Actual Cash Value; (2) Replacement Cost Value; (3) Guaranteed Replacement Cost; or (4) Extended Replacement Cost. For policies that pay out claims based on “Actual Value” an “insurer pays out the cost to fix the home and replace your personal belongings, minus any depreciation. For example, if you bought a new table five years ago for $1,500, but due to normal wear and tear, it’s only worth $750 at the time of the covered incident, then your insurer will only pay out up to $750.” This coverage will likely cost less but may reimburse a homeowner significantly less than expected in the event of a casualty loss.

A second type of policy will reimburse a homeowner for a covered claim based on a “Replacement Cost Value” basis. This coverage “will reimburse the money needed to make repairs and/or purchase a comparable new model at today’s prices without taking depreciation into account.” As NAR points out, “In this case, even if you only paid $1,500 for the table five years ago, if a comparable model is $2,500 today, then you may be paid $2,500 to replace the damaged furniture.” This coverage is clearly more favorable and provides a homeowner with the money needed to repair the home and replace personal property at present-day value without a reduction in the reimbursement amount as a result of depreciation.

According to NAR, the best (and more expensive) available coverages are known as “Guaranteed Replacement Cost” and “Extended Replacement Cost” policies. A “guaranteed replacement policy” will reimburse the homeowner the actual cost of replacement regardless of any policy limit. An “extended replacement policy” will pay up to a certain set percentage above the policy limit contained in a policy. NAR provided examples and explained that “a home insured for $500,000 that takes $750,000 to rebuild would be completely covered with a guaranteed replacement policy. But an extended coverage policy at 20% would mean the insurer pays 120% ($600,000), or $100,000 above the limit.”

Knowledge of Insurance Issues is Critical

All real estate professionals, homeowners, and purchasers should be aware of the issues and potential pitfalls surrounding homeowner’s insurance. Knowledge of the coverage options available, the costs and the risks of non-renewal and cancellation will only serve to assist and protect homebuyers when making decisions to purchase a home in a particular area, or purchasing a home that may have certain risks associated with it. Researching the availability of the appropriate coverages and costs in advance will make the buying process smoother and less risky. Arming a buyer-client with this important information in advance will only add value to the services a real estate professional provides and will set that individual apart from the others.

Legal Column author John Dolgetta, Esq. is the principal of the law firm of Dolgetta Law, PLLC. For information about Dolgetta Law, PLLC and John Dolgetta, Esq., please visit http://www.dolgettalaw.com. The foregoing article is for informational purposes only and does not confer an attorney-client relationship and shall not be considered legal advice. The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the views or positions of HGAR, its affiliates, or any other entity.