Cinco de Mayo, the “sub-lime” crisis … and your homeowners policy

Carbone-WilliamMany Cinco de Mayo revelers will be affected by the great lime crisis of 2014. As lime prices climb, restaurants and bars have passed the costs on to customers ordering margaritas, fish tacos, or simply a lime wedge in their cerveza. Others have taken to using lemons as a substitute for limes in recipes, although we haven’t seen the key lemon pie yet. The increased prices are driven by the laws of supply and demand. While demand has increased quite significantly in recent years, the dramatic increase in price this year is due to a shortage in the supply. Poor weather in Mexico’s lime-growing regions and crop disease have severely reduced the supply, and cartel activity has exacerbated the situation (97% of U.S. limes are grown in Mexico). This situation is unprecedented, but the market dynamics driving it are common to the insurance world.

What is the connection between limes and insurers? Extreme weather events, such as Hurricane Katrina, Superstorm Sandy, and this week’s tornados across the southern United States, are a well-known challenge for insurers. As communities recover in the aftermath of a storm, the focus often moves to the rebuilding process—and the related cost. It’s easy to watch the price tag on building supplies, namely lumber and concrete, to see the effects of increased demand. The cost of labor is harder to monitor, and is often a bigger influence on the overall costs of the rebuilding process. Much like restaurants passing on the increased price of limes to their customers, these additional costs are often passed on to the insured.

Insurers incorporate anticipated price spikes into the price of homeowners policies. Catastrophe modeling has become standard across the industry, and these models include loads for the surging price of building materials and labor in high-demand situations. This enables insurers to set appropriate prices over an entire book and helps to keep them solvent. From the point of view of the insured, the increased costs to rebuild after a covered natural disaster may or may not be covered, depending on the policy. Most insureds have policies that cover a set dollar limit, which is usually the replacement cost or an extended replacement cost to cover inflation from the time the policy was written. The payout in these scenarios can often come up short, as out-of-date policies do not cover today’s prices or skyrocketing costs. These issues can be avoided with a guaranteed replacement cost policy, which covers the full cost of rebuilding, but these policies are more expensive and harder to obtain. In the absence of one, rebuilding homeowners may be seeing the same unexpectedly high tab that anyone ordering the ceviche will face this spring.

As the frequency of catastrophic weather events has grown, individual homeowners need to ensure that their coverage is current and that it will optimally cover them in the event of a loss, even if it is not possible to cover surging prices. After all, the last thing the victims of a natural disaster need is the added stress of finding out that their homeowners policy was a lemon.

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