A recent court decision highlights why policyholders need to understand both the benefits and limitations of Inflation Guard Endorsements in their property insurance policies. While these endorsements aim to protect against underinsurance, they may not provide the complete protection many assume they do. Inflation guard endorsements automatically increase coverage limits using a formula determined by the insurance company.
As demonstrated in the recent Dixon v. Liberty Mutual case, 1 the calculation method involves an “Index Level” assigned by the insurer, which is then used to adjust the base policy limits. In the Dixon case, the policyholder discovered after a fire loss that their policy limits were insufficient to rebuild their home despite having an Inflation Guard Endorsement. The court upheld the insurer’s calculation method, noting that insurance companies have unilateral authority to select the Index Level, the specific calculation formula need not be disclosed in the policy, and that the policyholders cannot challenge the resulting coverage limit merely because it proves inadequate. Significantly, the decision stated:
Would an insured want to know exactly what their policy limit will be on any given day? Yes. Would an insured want to know exactly how the Index Level was calculated? Also, yes. But these hypotheticals represent additional terms or definitions that could have been in the Policy but are not. Instead, the Policy unambiguously provides for a procedure by which the Policy limit is calculated. And under the Policy, Liberty Personal gets to decide, unilaterally, what the Index Level will be, and, by extension, what the Policy limit will be.
Policyholders may benefit from the automatic protection coverage increases without manual intervention. These regular adjustments help account for inflation and reduce the risk of inadvertent underinsurance by failing to ask for increases in coverage at the time of renewal or during rising costs during the policy period. Insurance companies market the endorsements as financial safeguards that help maintain adequate coverage as construction costs rise and minimize the potential of coinsurance penalties caused by underinsurance.
Policyholders should be aware that the endorsement’s protection depends entirely on the insurer’s chosen “Index Level.” Depending on the index, increases may not keep pace with actual construction cost inflation, and additional coverage may be needed beyond the automatic adjustments. Further, while the endorsement typically increases premiums by 2% to 4% annually and as the Dixon case demonstrates, even with this protection, policyholders may still face coverage shortfalls. Even though the inflation factor is meant to help coverage keep pace as costs go up, it may not be enough.
Policyholders should request detailed information about how their insurer calculates the Index Level. Further, to prevent underinsurance situations, policyholders should attempt to evaluate replacement costs of the insured property and consider additional coverage options beyond the basic Inflation Guard Endorsement. In addition, policyholders should regularly review coverage limits with their insurance agent and discuss how to prevent being underinsured or subject to a coinsurance penalty.
Inflation Guard Endorsements are rarely discussed in claims decisions. Public adjusters and policyholders should always check for these when the stated policy limits are not sufficient to cover the loss. These endorsements provide valuable protection against the erosion of coverage due to inflation. However, they should not be relied upon as the sole solution for maintaining adequate coverage. The Dixon case serves as a reminder that policyholders must take additional steps to ensure their coverage truly meets their needs, as courts will likely uphold insurers’ discretion in determining coverage adjustments under these endorsements. The case highlights how policyholders may have a false sense of security because of these endorsements.
Thought For The Day
The only function of economic forecasting is to make astrology look respectable.
—John Kenneth Galbraith
1 Dixon v. Liberty Mut. Ins. Co., No. 3:23-cv-00313 (M.D. La. Nov. 19, 2024).
