House Resale Insurance

by Mr. Cheap

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This idea is targetted primarily at real estate agents.  Like many other middle-men, the Internet is destroying a previously safe and lucrative market for agents.  Either property sales will shift to be predominantly for-sale-by-owner, or agents are going to have to start adding more value to their role in the process.  This is one way they could do so.

This would be an insurance product, that would guarantee the value of residential real estate.  Agents would use it (in part) to sell their services to customers as a guarantee that they would be able to re-sell the house they are buying for at least what they paid for it.  In order to claim this, they would have to list the house with the original agent, give her a reasonable period of time to sell it, at which point if it hadn’t sold the agent would buy it from them herself (less her commission).   In reality, it would be the insurance company who is purchasing the property (and probably the agent would lose out on her commission).

This is obviously reassuring to the buyer, as it’s a guarantee they won’t lose money on the purchase.  It’s good for the agent, as it guarantees them repeat business (previous clients will want to list with them in order to be protected by the guarantee, if the agents sells for MORE than it was originally bought at, it’s gravy for everyone).

In the current market I can see why people would think that either insurance companies would be crazy to offer policies along these lines, or that the premiums would be outrageously expensive, but I don’t think either would necessarily be the case.

Typically house prices go up or plateau (stay the same).  Sharp dives, like we’ve recently experienced, are fairly rare (leading to the now obviously debunked myth that real estate always goes up).  In normal environments, policy premiums will be pure profit, with few or no payouts from the insurance company.  From one perspective, each year the owners are in the property inflation decreases the insurance company’s liability (since the dollar value of the property is worth less in the future than it is today).  Even in the case of a sharp drop, there would be a number of properties that have increased enough in value that they wouldn’t drop back to their purchase price, and there would be owners who just don’t want to sell.  A market like we’re currently in, where interest would be highest in such an insurance product, would probably be the safest time to offer a product like this (how much further can values drop?).

It’s also important to remember, in the worst case they’re only going to cover the DIFFERENCE between the lower sale price and the original purchase price, not the full value of the house.  Also, there should also be exclusions for major changes to the property (such as it being burnt down in a fire) which would be covered by other insurance, not by this.

If agents (or brokerages) bought this as a blanket coverage for all transactions they’re engaged in, I suspect the insurance could be offered to them at a fraction of a percent of the purchase price (perhaps Riscario can comment on whether my intuition is correct on this).

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{ 8 comments… read them below or add one }

1 Potato

I’m not sure if this type of insurance would lead to rampant housing speculation, or if the very fact that it’s offered would cement in people’s heads that real estate is not a one-way journey to riches, pouffy hair, and bad reality TV shows. It might help stop ridiculous bidding wars if agents had to live in fear of losing their commission (and then some) to the insurance premium of selling a house far over market!

In reality, this type of insurance probably would be quite expensive (I’m not an insurance actuary, but maybe something about systematic risk requiring a huge cushion?). CMHC essentially provides this insurance for the bank, but with the added condition that the borrower can’t pay the mortgage, and that costs in the neighbourhood of 2%. For the homeowner to be able to call it whenever they want would add extra risk for the insurer (though they would be less likely to reduce the property value non-systematically by punching holes in the walls and absconding with the copper plumbing before a foreclosure).

2 Four Pillars

What if the home owner does major renos to the property after purchasing? How would that factor in?

3 Charles in Vancouver

What if it could be purchased all at once? Like buying a protective put option on your house. And subsequently, at your discretion, you may ask the put holder to buy your house at the strike price ;)

4 Al

Odds are most people wouldn’t require the insurance because their house would have gone up in value (nominally at least). If they did need it, the only way they would collect is if the government bailed out the insurance company. By today’s standards, I’d call that a business model.

5 Mr. Cheap

Potato: Yes, in a way it would be legitimizing the old “real estate only goes up”, or at least providing insurance that would stay true. I think there are restrictions the insurance company could put in place that WOULD lead to the agents being more realistic (which would also be a good thing).

Mike: Either that would invalidate the policy (if someone tears up the place and then tries to sell it), or would provide an extra cushion for the insurance company.

Charles: That’d be interesting as well. I’d be willing to sell puts on one or two properties in this market…

Al: That’s true as well! One of the big potential problems with this (in addition to the premiums perhaps costing more than I suspect, as Potato points out) is that the insurance companies would have to prove adequete reserves to deal with a large market drop. As you say, if they didn’t, then it would really be the GOVERNMENT providing the insurance (and the insurance company just collecting the premiums – now why does that sound familiar? ;-) ).

6 Thicken My Wallet

This is known as residual value insurance and it is done in the commerical real estate sector but more typically for large cap ex assets like ships or aircrafts.

The premiums in this context, as Potato points out, would be very high since the time between the underwriting and potential claim is very short (working on the same principle that someone older would have to pay a higher life insurance premium because the insurance company does not have as long to invest the premium and make a return to pay out the potential claim).

7 Mr. Cheap

TMW: I assumed something like this must exist. I’ll have a look at “residual value insurance” on the intrawebs. Thanks!

I wonder if putting a minimum time between purchase and sale might allow lower premiums…

8 Take Notes

Read Shiller and then look at the CME futures one can sell to hedge out property in large US cities. One can also buy those instruments if one thinks property is going up. Insurance companies WITHOUT government money would ultimately have to go to an exchange and sell those contracts to back any policy they issue. Unfortunately banks are not forced to clear and mark to market these mortgages in a forum like the CME where they would be subject to daily price discovery… and you see what happened finally to insurers taking these risks from banks in the back room with OTC swaps. The problem is that people buying property these days are in fact informal speculators. If everything was cleared on exchanges prices would quickly shake out the idiots and home ownership loans would only be available to those who could truly afford to own. Ultimately, society has to decide if the home ownership entitlement of the mortgage/banking system should even exist today. I say renters should rent. If renters want to speculate, they ought to open a trading account rather than trying to weasel a long real estate trade on the government’s dime through an obsolete social contract like home ownership.

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