Chapter 15 Quiz: Homeowners Underwriting

Twenty questions — fifteen multiple choice and five short answer. Answers and brief explanations are in the collapsed key at the bottom. All figures are illustrative.

Multiple Choice

1. The defining feature of the HO-3 form is that it covers: - A) the dwelling and contents both on a named-peril basis - B) the dwelling on an open-peril basis and the contents on a named-peril basis - C) the dwelling and contents both on an open-peril basis - D) only the interior of a condominium unit

2. Under open-peril (special form) coverage, at claim time: - A) the insured must prove the loss was caused by a listed peril - B) the loss is covered unless the insurer can point to an exclusion - C) only perils named in the declarations are covered - D) depreciation is always deducted

3. Replacement cost differs from actual cash value (ACV) in that replacement cost: - A) deducts depreciation; ACV does not - B) pays market value; ACV pays rebuild cost - C) pays to rebuild with no deduction for depreciation; ACV deducts depreciation - D) applies only to contents, never the dwelling

4. A roof costs \$30,000 new, is 60% depreciated, and is destroyed by a covered windstorm. The ACV settlement is approximately: - A) \$30,000 - B) \$18,000 - C) \$12,000 - D) \$0

5. Insurance to value (ITV) requires the dwelling limit (Coverage A) to be based on: - A) the home's purchase price - B) the home's current market value - C) the full cost to rebuild the home - D) the outstanding mortgage balance

6. A dwelling with a full replacement cost of \$500,000 carries an 80% coinsurance requirement and Coverage A of \$300,000. On a \$100,000 partial loss, the coinsurance-reduced recovery (before deductible) is: - A) \$100,000 - B) \$80,000 - C) \$75,000 - D) \$60,000

7. Which of the four catastrophe perils is excluded from every standard homeowners policy without exception? - A) hurricane wind - B) wildfire - C) flood - D) lightning

8. A named-storm/wind deductible is typically expressed as: - A) a flat dollar amount - B) a percentage of the dwelling limit - C) a percentage of the loss - D) a multiple of the all-other-perils deductible

9. The NFIP was created in 1968 primarily because: - A) the private market wrote flood too cheaply - B) the private market historically would not write flood, which fails several insurability criteria - C) earthquakes were uninsurable - D) homeowners policies already covered flood and needed a backstop

10. In a hurricane that both blows the roof off and floods the lower floor of an unscheduled home with no separate flood policy, under a standard HO-3: - A) both the wind and the flood damage are covered - B) the wind damage is covered; the flood (surge) damage is excluded - C) neither is covered - D) the flood is covered but the wind is excluded

11. Earthquake coverage on a home is typically provided by: - A) the standard homeowners policy at no extra charge - B) the NFIP - C) a separate policy or endorsement, usually with a large percentage deductible - D) the federal government's flood program

12. Which rating-factor family is the most powerful in homeowners and the main reason the line is harder to write than personal auto? - A) dwelling characteristics - B) credit - C) claims history - D) location

13. A carrier facing a hardening catastrophe market is least likely to: - A) raise the named-storm deductible - B) lower rates to grow market share in the most exposed zone - C) tighten new-business eligibility - D) non-renew the highest-hazard policies

14. A state-run FAIR Plan or coastal residual market functions as: - A) a reinsurer for private carriers - B) the insurer of last resort for risks the private market will not write - C) the federal flood program - D) a rating bureau

15. Endorsing an aging roof down to ACV rather than replacement cost is best understood as: - A) an arbitrary cost-saving measure - B) applying the insurability principle that insurance covers fortuitous loss, not expected deterioration - C) a violation of the policy's good-faith duty - D) a way to avoid filing the rate with the state

Short Answer

16. Explain, in two or three sentences, why a catastrophe peril breaks the law of large numbers when ordinary perils such as kitchen fires do not. Use the word correlated.

17. A homeowner insists the amount of insurance on their house should equal what they paid for it. In two or three sentences, explain why that is the wrong number and what the right number is.

18. Describe the coinsurance penalty: what triggers it, what it does to a partial-loss settlement, and why the clause exists.

19. Name the four levers a carrier pulls when a catastrophe-exposed homeowners market hardens, and state the social-function tension that the most drastic lever creates.

20. The Harbor Steel owner's coastal home is described as "the catastrophe problem in miniature." Explain in two or three sentences what makes the home's catastrophe risk identical in logic to the commercial plant's, and name the single peril that is the most probable total-loss scenario yet is excluded from the standard policy.

Answer Key (click to expand) **1. B** — HO-3 splits the basis: open-peril on the dwelling/other structures, named-peril on the contents. That split is its defining feature and why it is the market workhorse. (§15.1) **2. B** — Open-peril flips the burden of proof: the loss is covered unless the insurer can point to an exclusion. Under named-peril, the insured must show a listed peril caused the loss. (§15.1) **3. C** — Replacement cost pays to rebuild with like kind and quality and *no* deduction for depreciation; ACV pays replacement cost *minus* depreciation. (§15.2) **4. C** — 60% depreciated means 40% of \$30,000 remains: \$12,000. The insured funds the other \$18,000 themselves under ACV. (§15.2) **5. C** — ITV is based on the full cost to *rebuild*, not the purchase price, market value, or mortgage — because the policy insures construction cost, not land or location. (§15.4) **6. C** — Recovery = loss × (carried ÷ required) = \$100,000 × (\$300,000 ÷ \$400,000) = \$100,000 × 0.75 = \$75,000. The homeowner absorbs \$25,000 they thought was covered. (§15.4) **7. C** — Flood is excluded from *every* standard homeowners policy without exception — the most consequential exclusion in personal lines. (§15.5, §15.6) **8. B** — A named-storm/wind deductible is a *percentage of the dwelling limit* (commonly 1%–5%), which both shifts catastrophe loss back to the insured and scales the retention with the value at risk. (§15.7) **9. B** — The private market would not write flood because it fails several insurability criteria (severe, correlated, concentrated, adverse-selection-prone), so a federal program had to step in. (§15.6) **10. B** — The HO-3 covers the wind damage; the storm-surge flooding is excluded as flood. With no separate flood policy, the surge loss — often the total-loss portion — is uninsured. (§15.5, §15.6) **11. C** — Earthquake is excluded from the standard policy and covered, if at all, by a separate policy or endorsement with a large percentage deductible, leaving a wide protection gap. (§15.5) **12. D** — Location, because it drives both the everyday losses (protection class, rebuild cost) *and* the catastrophe exposure that can dwarf everything else — which personal auto does not face in the same way. (§15.3) **13. B** — A hardening market raises deductibles, tightens eligibility, and non-renews; it does *not* cut rates to grow in the most exposed zone — that would worsen the very exposure it is trying to control. (§15.7) **14. B** — A FAIR Plan / residual market is the insurer of last resort for risks the private market declines; its growth signals private-market retreat and a widening protection gap. (§15.7) **15. B** — Endorsing an aging roof to ACV applies the Chapter 1 insurability principle: insurance covers *fortuitous* loss, not the *expected* wear of a component already at end of life. (§15.2; Ch. 1) **16.** A catastrophe peril causes *correlated* losses — one hurricane or wildfire strikes thousands of insureds at once, so the losses are not independent draws but a single event. The law of large numbers requires independent exposures to stabilize the aggregate; when losses are correlated, a large book is not a pool but a single enormous bet. (§15.5) **17.** The purchase price (and market value) includes the land, the location, and the neighborhood; the policy insures only the cost to *rebuild* the structure — labor and materials. The right number is the full replacement (rebuild) cost, which can be well above or below market value, which is why ITV must be estimated directly. (§15.4) **18.** The coinsurance penalty is triggered when the insured carries less than the required percentage (commonly 80%) of full replacement cost. On a *partial* loss it reduces the replacement-cost recovery by the ratio of coverage carried to coverage required, making the insured a co-insurer of their own loss. The clause exists to push back on the universal temptation to under-insure by making adequate ITV a condition of full recovery. (§15.4) **19.** (1) Raise deductibles, especially the named-storm/wind deductible; (2) narrow coverage through exclusions and endorsements (e.g., ACV on aging roofs); (3) tighten selection and restrict new business; (4) non-renew or withdraw from the market. The most drastic lever — non-renewal/withdrawal — pits the carrier's combined-ratio/solvency discipline against insurance's social function, leaving homeowners unable to find coverage. (§15.7) **20.** The home faces the *same named-storm peril* as the plant, with the *same* wind-covered / surge- excluded structure, the *same* percentage deductible, and a slice of the *same* Port Hadley accumulation — the catastrophe problem is scale-invariant. The most probable total-loss peril is flood (storm surge), which the standard policy excludes and which therefore requires a separate flood policy (NFIP or private). (The Underwriting File, §15.6)