Consumers who experience a loss involving the failure of one of the many mechanical and electrical systems in their residences are often surprised to learn such losses are commonly excluded under the standard homeowners policy. With constantly evolving home systems, it is important to anticipate that a breakdown to a home's mechanical and electrical systems can result in numerous opportunities for consumers to experience uncovered losses. Integrating coverage solutions available in the market to manage this risk can help risk advisers avoid hearing the dreaded words "no one ever told me that was not covered" from the consumers they serve.1
Common exclusions in standard homeowners policies that deny coverage for physical loss or damage to the many mechanical and electric systems comprising a home's infrastructure are unambiguous and well known to risk advisers. Meanwhile, they are often viewed by consumers who experience an uncovered loss as an example of "insurance policy fine print" used to deny coverage for losses that many home owners assume should be covered. As a reminder, standard homeowners insurance policy exclusions often preclude coverage for physical loss or damage to critical home systems that are a result of the following.
Wear and tear
As every house contains significant and meaningful mechanical and electrical systems, physical loss or damage to these systems presents a significant coverage gap that leaves an insured with a large financial exposure. This article will explore the importance of helping consumers to understand this risk and the risk management solutions available to manage it.
Understanding the Evolving Residential Infrastructure
Even for owners of historic homes, gone are the days when a home's infrastructure was comprised of a furnace, hot water heater, and a few ancillary systems. The mechanical and electrical systems and equipment in many homes today are comprised of a number of systems vulnerable to a wider range of risks. Consider the following components that constitute the infrastructure of many homes, large and small.
Heating, ventilation, and air conditioning (HVAC)
Hot water heating/wells/water filtration
Green systems, including solar, geothermal, heat pumps, hybrid fuel boilers, and home batteries
Kitchen and laundry appliances
Pool pumps and associated systems
Networked/smart/connected home systems and their associated equipment
Listing all the systems that may exist would be a difficult exercise, as there are too many, and more are being developed at a rapid pace with the explosion in the Internet of Things (IoT) devices and systems. A good rule of thumb for risk advisers is that the mechanical and electrical systems comprising a home's infrastructure can represent up to 20 percent of the replacement cost of any house. This applies across personal lines segments—middle market, affluent, and high net worth. For example, risk advisers may include a warning about such systems similar to the following.
"Proceeding with the clear understanding that significant and costly systems exist in almost every house, it is important to make consumers aware that, should a system break down as a result of any of the aforementioned exclusions, the expense to repair or replace the failed system falls squarely on the home owner."
Risk Management Options
Having performed the first step in risk management planning by identifying the risk and before recommending the solution of transferring the risk, advisers should first make clients aware that there are a number of steps that can be taken to reduce their exposure to losses to their residential systems. Scheduling professional maintenance, installing protective devices, understanding the proper use of each of the systems, and replacing dated systems are all examples of strategies to reduce the risk of loss.
Of course, these measures require the clients to be sufficiently knowledgeable to craft the required steps and then diligently execute their best laid preventive plans. Meanwhile, be mindful that many home owners do not know what maintenance steps are needed, and the preventive steps that are available, nor do they understand the life expectancies of their home's various systems. While transferring this risk is not the only risk management technique, it is quite often the most practical one.
Risk Transfer Options
Supplementing any measures to reduce the risk of loss with a contractual risk transfer strategy is an option well worth examining, and there are several different risk transfer solutions available.
These coverages are usually very limited in the scope of covered equipment, as they specifically list covered systems, have specified limits by covered components, can exclude common home systems, have loss settlement provisions that allow for reconditioned or remanufactured parts, require the use of a vendor network for maximum benefit, cannot be purchased for every size home, and are generally expensive.
Service Protection Plans/Individual Item Warranties
Typically secured at the time of purchase, these, like whole-home warranties, are usually very limited in coverage, cover only the item purchased, and are typically limited to the amount originally spent.
Homeowners Insurance Equipment Breakdown Coverage
Added as part of a quality homeowners insurance policy, this addition usually provides coverages such as additional living expenses; spoilage; and expediting costs, generous limits, and replacement cost loss settlement provisions, and is easily attached to homeowners insurance policies as a clear insurance product. This coverage offers consumers a number of advantages over other transfer options, given the broader protection and the many limitations of the other transfer options.
What Is Covered?
Naturally, there are a variety of different homeowners equipment breakdown coverages. The information that follows depicts the coverage provided by one of the broadest coverage forms available among dozens of homeowners insurance companies. Backed by Hartford Steam Boiler, the current version eliminates the often problematic wear and tear exclusion in favor of providing coverage for loss caused by sudden and accidental mechanical or electrical breakdown, or bursting, cracking, or splitting of a broad category of equipment. Naturally, when reviewing other coverage forms, it is essential to understand how coverage differs from the details that follow.
It is helpful to recall the earlier discussion on the various systems that exist in a home. Subject to some specific noncovered equipment, covered equipment typically follows the definition of Coverage A and B that meets either of the following two criteria.
Uses, generates, or transmits energy
Operates under vacuum or pressure
More precisely, a standard definition of covered equipment under a homeowners equipment breakdown coverage extension is as follows.
Standard Definition of Covered Equipment
"Covered home equipment"
a. "Covered home equipment" means property covered under Coverage A—Dwelling, Coverage B—Other Structures or Coverage C—Personal Property:
(1) That generates, transmits or utilizes energy; or
(2) Which, during normal usage, operates under vacuum or pressure, other than the weight of its contents.
"Covered home equipment" may utilize conventional design and technology or new or newly commercialized design and technology.
This broad language is generally narrowed for the purpose of carving out certain exposures that the standard homeowners policy is usually intended to cover, such as the following.
The structure/enclosure the item is built in (i.e., the house)
The domestic water lines, except for those attached to a boiler
Septic tanks and leaching fields
Fire protection systems
Riding lawn tractors/mowers
The following examples illustrate the types of home systems that could qualify for coverage under the Hartford homeowners equipment breakdown coverage, unless the cause of loss is specifically excluded.
Gas-fired furnace. It uses electricity and natural or liquid propane gas and operates with pressurized gases (covered equipment).
Hot water heater. It uses electricity (covered equipment).
Solar panels. In converting light to power, the system transmits electricity (covered equipment).
Well pump motor. It uses electricity to spin (covered equipment).
Central air-conditioning. The entire system uses both electricity and pressurized refrigerant (covered equipment).
Central vacuum system. It operates under a vacuum (covered equipment).
In contrast, these types of items would usually not qualify for coverage under homeowners equipment breakdown coverage.
Water piping to second floor (not covered equipment)
Knowing what property is covered, the question becomes what types of losses are covered? Under the broadened Hartford Steam Boiler coverage form, the usual and customary exclusions for wear and tear and mechanical breakdown with respect to covered equipment are generally eliminated by the following coverage grant.
"We will pay for direct physical damage to 'covered home equipment' that is the result of a 'home system breakdown' that occurs on or off the 'residence premises.'"
A "home system breakdown" is broadly defined as direct physical damage to covered home equipment from sudden and accidental
electrical breakdown; or
bursting, cracking, or splitting
that requires repair or replacement of all or part of the damaged covered home equipment. Basic exclusions within the endorsement include the following.
Rust, corrosion, erosion, deterioration or gradual loss of efficiency or functionality of "covered home equipment";
Leakage or seepage at or from any connection, valve, fitting, shaft, or seal;
Any programming error, programming limitation, computer virus, malicious code, loss of data, loss of access, loss of use, loss of functionality or other condition within or involving data or media of any kind;
Complete or partial interruption of electrical power, fuel or water supply, whether deliberate or accidental;
Any condition which can be corrected by resetting, recalibrating, or by the performance of maintenance; or
Cosmetic or other damage that does not impair functionality.
To understand the many protection benefits available to consumers who have access to broadened mechanical equipment breakdown coverage, the following are examples of the types of losses that could be covered by homeowners equipment breakdown coverage and their approximate costs.
Cracked heat exchanger in forced hot air furnace—$7,500
Well motor pump windings melted and shorted out—$12,000
Gas hot water heater tank ruptured—$4,850
Propane generator crankshaft seized—$11,000
High-end refrigerator compressor seized—$7,500
Freon line ruptured in air-conditioning coils—$6,000
Obstacles More Perceived Than Real
It is worth examining how some underwriters and risk advisers perceive the obstacles associated with introducing this form of protection. As reviewed in below, there are solutions to the reasons commonly cited for not making this coverage more widely available.
Table 1. Obstacles to Equipment Breakdown Coverage
Common Risk Adviser Concerns
Common Insurer Concerns
Perceived Obstacle: Claims can negatively impact future renewals for home owners who have had claim(s).
Perceived Obstacle: We don't need to offer this coverage.
Consider: When coverage is endorsed by the homeowners insurer via a reinsurance treaty with a third-party provider, equipment breakdown claims may not be factored into the renewal premium.
Consider: Recognize an increasing number of companies are offering this coverage enhancement, and risk advisers are considering availability when placing their best clients in all market segments.
Perceived Obstacle: Wear and tear will preclude loss payments.
Perceived Obstacle: It will render our pricing uncompetitive.
Consider: Some broadly written homeowners endorsements cover a wide range of physical loss and damage—some go so far as to remove the wear and tear exclusion.
Consider: Pricing for homeowners equipment breakdown coverage varies from company to company, based on sizes of homes, geography, and other risk characteristics. Endorsements can be as low as $30 per home, annually.
Perceived Obstacle: Claims for older systems will not be paid.
Perceived Obstacle: Claims handling will be challenging.
Consider: Age is not a factor in determining liability.
Consider: Partner with a third-party provider that specializes in the handling of homeowners equipment breakdown claims and can customize claims handling processes to support your claims philosophy.
With risk transfer solutions available to help insurers and risk advisers protect consumers from having to absorb losses involving the sudden and accidental breakdown of one of the many mechanical and electrical systems in their residences, electing to simply not make them available to consumers represents a remarkably missed opportunity to enhance the customer experience and positively differentiate the risk solutions offered. Insurers that are uncomfortable with making this coverage available directly should strongly consider the many benefits and ease of working with an expert third-party provider. The following are important factors for risk advisers to consider adopting when counseling consumers.
Help your clients to assess the risk and rewards of self-insuring and transferring the risk of failure to one or more of the many mechanical and electrical systems in their homes.
Providing solutions to address the commonly overlooked failure of a home's many systems can strengthen your differentiated value proposition and better position you as a personal risk adviser.
Explore this option with an appreciation for the specific risk characteristics of each client. Owners of newly constructed homes are less vulnerable than owners of older homes who have no builder warranties.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
1 The author would like to thank and acknowledge the contributions to this Commentary by Jed Usich, Vice President, Personal Lines Marketing, The Hartford Steam Boiler Inspection and Insurance Company.