Thursday, October 24, 201911:00 AM – 12:15 PM

General Session 4

Recovering the Whole Enchilada:Matching Expectations and Contract Provisions

with Property Insurance Policies

Abe FreelandWillis Towers Watson

Nashville, TN

Janet M. JohnsonSchiff Hardin LLP

Chicago, IL

Marie A. MooreSher Garner Cahill Richter Klein

& Hilbert, L.L.C.New Orleans, LA

I. Property Insurance Basics

The main two forms that comprise a policy:

• Building and Personal Property Coverage Form (currently ISO CP 00 10 10 12)– Describes the Covered Property.

• Causes of Loss Form (for example, ISO CP 10 30 10 12) – describes the coveredtypes of loss events (Causes of Loss) covered.

Don’t call it Casualty Insurance! Call it Property Insurance.2

The other important forms:

• Declarations Page (ISO CP DS 00 10 00) – Identifies the policy, propertycovered, carriers affording coverage, effective dates of coverage, andlimits of coverage.

• Endorsement (for example ISO CP 12 19 06 07) – Adds to or subtractsfrom the coverage provided in the two main forms.

• Schedule of Forms and Endorsements – Identifies and lists the forms(including the endorsements) that together comprise the policy.

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Who promulgates most of the property policy forms?ISO - Insurance Service Office, Inc., a company that serves insurers and acts as a source ofinformation for insurers about property/liability insurance risk. ISO also promulgates forms forother types of insurance.

ISO forms are designated by letters and numbers. For example, ISO form CP 00 10 10 12, (i) thefirst letters (CP) show that it is a Commercial Property form, (ii) the second two letters (00 10)show that it is the part of the policy that describes the types of property that are covered, and(iii) the final two letters (10 12) are the date of the edition, in this case, the edition waspromulgated in October, 2012.

Also American Association of Insurance Services and ACORD. Most forms referenced in thesematerials are ISO forms.

Carrier and broker manuscript forms are also frequently used, particularly for large or complexportfolios.

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Names for the Covered Parties:• Named Insured – The party that carries the policy. This can be one entity by

itself or may include a family of affiliated entities. It will not include unrelatedentities.

• Additional Named Insured – A party that is also covered by the policy to someextent. In property insurance, additional insured status is most often used inconjunction with a premises lease agreement between the named insured as thelessee and the owner of the leased building. In these cases, the insured tenantis required to purchase insurance on the leased building and name the landlordas an Additional Named Insured on the property policy with respect to theleased building. Note: In a liability policy, the landlord should ask to be an“Additional Insured.”

• Loss Payee – The entity to whom proceeds are to be paid in the event of lossunder a property policy. Can be a mortgagee, landlord, or tenant of the NamedInsured.

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The “Covered Property” (ISO Form CP 00 10 10 12):• Real Property: The real property and related personal property, including the building,

fixtures (including outdoor fixtures), permanently installed machinery and equipment,and materials and equipment used to maintain or service the real property; and

• “Business Personal Property”: The Named Insured’s furniture and fixtures, machineryand equipment, "stock," and other personal property used in its business located onthe insured real property or to a limited extent, on the property of others (includesleasehold improvements owned by the Tenant and not otherwise included in thedefinition of Real Property if the Tenant is obligated to insure them). Can include theTenant’s use interest (declining value) in improvements, fixtures, and additions that theTenant occupies but does not own and those that the Tenant acquires or makes at itsexpense but cannot legally remove.

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NOT “Covered Property” (without a special endorsement, ifavailable):

• Loss of Business Income and Loss of Rents.

• Examples of other excluded property: electronic data (except to the extentspecifically described as covered); cost of replacing or restoring information onvaluable papers and records; land; exterior paved areas; foundations; trees,shrubs, and landscaping; piers and wharves; underground pipes, flues, or drains;vehicles or self-propelled machines licensed for use on a public road or operatedprincipally away from the insured premises (except for certain inventory itemsother than autos and other than some detached trailers); fences; and antennasand satellite dishes.

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“Causes of Loss” Policy forms:

• Basic Form: Covers only specified Causes of Loss, including fire, lightening, vehicles,aircraft, and civil commotion (generally ISO CP 10 10 10 12).

• Broad Form: Covers the Causes of Loss specified in in the Basic Form as well asadditional listed perils like structural collapse, sprinkler leakage and losses causedby ice, sleet, or snow weight (generally ISO CP 10 20 10 12).

• Special Form: Covers “all risks of direct physical loss” (formerly “All Risk” policy)other than those perils that are specifically excluded (CP 10 30 10 12).

“Special Form” coverage is the broadest and best.8

Cause of Loss exclusions in all base forms, even Special Form:

• ordinance or law• earth movement (earthquake, landslide, and earth sinking other than sinkhole collapse)• governmental action• nuclear hazard• utility services• war and military action• water (rising water – i.e., flood -- and other water-related occurrences)• fungus (mold), wet rot, dry rot, and bacteria• mechanical breakdown, boiler explosion, or electrical current• defective design, construction, or materials

Most Property and Causes of Loss excluded from the base forms can be covered by endorsement.

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How much coverage?

• Replacement Cost: The cost of repairing and replacing the damaged property withproperty of comparable materials and quality, used for same purpose, and at samelocation (but once the amount is determined, the proceeds can be used toreconstruct at a different location).

• Actual Cash Value: Replacement Cost minus physical depreciation. Individualcomponents may be subject to their own depreciation schedules (e.g., a 50-year oldbuilding with a 2-year old roof).

Replacement cost is the best, but (1) only actual cash value will be paid if the property isnot restored, and (2) only actual cash value will be paid until restoration is complete.

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BEWARE OF THE COINSURANCE PENALTY!The coinsurance penalty reduces recovery if the insured property has been significantly underinsured.The coinsurance percentage is set out in the policy. Example of application:

Property value $5,000,000Coinsurance percentage 80%Policy limits $ 3,000,000Loss $ 1,000,000Deductible $ 10,000

The coinsurance penalty will be triggered – the owner has insured the property for less than 80% of itsinsurable replacement or reconstruction cost.

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Calculation of coinsurance penalty:(i) Multiply value of property at time of loss

by co-insurance percentage: $5,000,000 x .80 = $4,000,000

(ii) Divide stated limits of coverage by theproduct in (i): $3,000,000 ÷ $4,000,000 = 0.75

(iii) Multiply loss amount by the figurecalculated in (ii): $1,000,000 x 0.75 = $750,000

(iv) Subtract deductible from thefigure in (iii): $750,000 - $10,000 = $740,000

The insurer will then pay the lesser of $740,000 or the limits of the insurance.

The remainder of the loss amount ($260,000) will not be covered.

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Avoid the co-insurance penalty whenever possible

Obtain a policy written with either Blanket Limits or an Agreed ValueEndorsement incorporating a Statement or Schedule of Values that stipulates an“Agreed Value” for each location and suspends the coinsurance clause, but

• Be sure the insurer incorporates this Schedule of Values into the final policy;and

• Provide all required periodic appraisals and adjustments.

If the Landlord permits the Tenant to insure the Landlord’s property, the Lease shouldrequire the Tenant to maintain coverage that is not subject to coinsurance.

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Policy Insuring Loss of a Tenant’s Leasehold Interest(example: CP 00 60 06 95):Provides that if the scheduled lease terminates automatically or is terminated by the Landlord by reason of damage toproperty at that insured location caused by a covered Cause of Loss, the insurer will pay:

(i) “Net Leasehold Interest”: The difference between the present value of (x) the rental value of thepremises and (y) rent Tenant is actually paying; plus

(ii) The unamortized portion of Tenant’s improvements and betterments that are lost by reason of thetermination; plus

(iii) Any prepaid rent.

This coverage protects a Tenant (x) whose rent is below market, (y) that has made substantial improvements to thepremises that will be lost when the Lease terminates, or (z) that has prepaid a substantial amount of rent.

BUT THE INSURER IS ONLY OBLIGATED TO MAKE THE INSURED WHOLE – NOTHING MORE.14

Insuring Loss of Business Income and Rents (examples:ISO CP 00 32 10 12 and CP 00 30 10 12)

If the insured business location is damaged by a covered “Cause ofLoss,” these endorsements cover the following “Lost BusinessIncome”:

• Net Income (net profit before taxes) that would have beenearned but for the covered Cause of Loss; plus

• Continuing normal operating expenses, including payroll, and ifthe business premises are leased, the rent that is not abated.

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Covering a Landlord’s Loss of Rents if the Landlord iscarrying the Property Insurance.The same Loss of Business Income endorsement also covers “Loss ofRental Value” if that option is elected expressly.

“Loss of Rental Value” is:

• Net profit (before taxes) that would have been earned asrental income from occupancy of the insured property bytenants; plus

• The Landlord’s continuing normal operating expenses.16

If the Landlord is insuring the Building and carries Loss ofRental Value coverage, then:

• If the Lease provides that rent abates upon an insured casualty, theLandlord has a claim for rental loss under its Loss of Rental Valuecoverage.

• But if Lease provides that rent does not abate, then (1) the Landlord’sLoss of Rental Value insurance will not cover this rent, and (2) Tenant willremain obligated to pay this rent, but if it maintains Loss of BusinessIncome coverage and has declared its rental obligations and exposures inaccordance with policy provisions, the continuing rent paymentobligation will be a “continuing normal operating expense” covered byTenant’s Loss of Business Income coverage.

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If the Tenant is insuring the Building, then the Landlord will not be able to obtainits own Loss of Rental Value coverage unless it carries contingent propertyinsurance or otherwise specifically declares and covers this exposure underLandlord’s program. The Lease should:

• Require the Tenant to carry Loss of Business Income insurance; and

• Provide that rent does not abate, so that the continuing rent paymentobligation will be a “continuing normal operating expense” covered byTenant’s Loss of Business Income coverage.

The Landlord may also require the Tenant to carry Loss of Rental Value insuranceand to name the Landlord as the loss payee, but in that case, unless the rentabates, the Loss of Rental Value insurance will not become payable.

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Limitations on Loss of Business Income and Rental ValueRecoveries:

• Not payable unless the loss was caused by a covered “Cause of Loss.”

• Limited to losses during the “period of restoration,” which is the period duringwhich business activities were slowed or stopped or the property wasuntenantable, but not longer than the period starting 72 hours after damage andending on earlier of:

- The date on which the property should have been restored; or

- The date on which the business re-opened at a permanent location.

Coverage for longer restoration periods can be obtained.19

Extra Expenses Coverage – Needed in addition to the coverage for the ContinuingNormal Operating Expenses:

• Continuing Normal Operating Expenses = the expenses that must be paidduring “period of restoration” even if the property has been damaged.

• Extra & Expediting Expenses = the necessary expenses the insured incursduring a “period of restoration” that it would not have incurred had there beenno “Cause of Loss” (e.g., rent for temporary space from which to operate) orthat the insured incurs in order to expedite restoration, to the extent itmitigates the overall loss.

Extra Expenses coverage permits recovery of, for example, moving to a temporarylocation. For coverage of both “continuing normal operating expenses” and “ExtraExpenses,” ISO CP 00 30 10 12 should be used.

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II. Coverages to Add and Limitations to AvoidAdd Ordinance or Law Coverage

Replacement Cost does not cover the cost of complying with new laws or ordinances,or the cost of demolition required by law.

• The Ordinance or Law Coverage endorsement (example: CP 04 05 10 12,Coverage C) will cover cost of adding legally-required features to thereconstructed building upon damage by a covered “Cause of Loss.”

• It can also cover the loss of value of undamaged portions of a damagedbuilding as a result of the requirement to demolish those portions and thecost of demolition to the extent required by law after a covered “Cause ofLoss” (CP 04 05 10 12, Coverage A and B).

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Add Coverage for Increased Cost of ConstructionExpenses and Extended Restoration Period

• The Increase in Rebuilding Expenses Following Disaster endorsement (See CP 04 0910 12) and other similar forms (generally known as “Increased Cost ofConstruction”) provides coverage for additional expenses up to a specifiedadditional expense percentage when there is a declared state of disaster thatcauses the expense of labor or materials to increase beyond the applicable limits,the insured actually replaces the building, and the insured notifies the insurerwithin 30 days of all improvements that increase the replacement cost by 5% ormore.

• Coverage can also be obtained for business losses sustained during an extendedperiod of restoration caused by having to comply with ordinance or law (see CP 1531 10 12). 22

Add Coverage for Equipment Breakdown (formerly boilerand machinery coverage)

• Provides coverage if artificially generated electrical energy (power surge),mechanical breakdown, or explosion of steam boilers, pipes, engines orturbines causes loss or damage (CP 10 46 10 12).

• Covers direct physical loss to buildings or other improvements, and if Loss ofBusiness Income coverage is part of the coverage package, it will cover lostBusiness Income (and Extra Expenses if that coverage was otherwise elected).

• Will cover other breakdowns caused by the covered mechanical or equipmentbreakdown.

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Delete Policy Provisions (e.g., Vacancy) and Endorsements (e.g.,Protective Safeguard) that protect only Insurers:

• Vacancy. Forms provide that if a building has been vacant (less than 31% of its squarefootage occupied) for longer than a certain period (generally 60 days), the insurer canrefuse to pay for part or all of damage.

• Protective Safeguard. This endorsement added by insurers permits the insurer todeny coverage unless a sprinkler, burglar alarm system, or other protective safeguardis installed and working at time of loss.

The insured must (i) notify the insurer when the insured building will be vacant or when asprinkler or other protective system will not be operating and (ii) obtain the insurer’s waiver ofthese conditions during those periods.

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Other Coverages/Limitations to Consider:

• Damage Caused by Loss of Utility Services. Coverage can be obtained for damagecaused by loss of business caused by loss of utility equipment outside of insuredproperty, but only if the damage is caused by a covered “Cause of Loss” (damage todistribution lines is generally excluded, with carve-backs often available for lines withina certain distance of a covered location – e.g., 1,000 feet).

• Contingent Business Income Insurance. Coverage can be obtained for business lossessuffered by reason of damage to an anchor store or other specifically designated keyproperty if that damage is caused by a “Cause of Loss” covered under the insured’spolicy.

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Add Flood CoverageStandard “Causes of Loss” policies exclude damage caused by flood, surface water, waves, tidal water,overflow of a body of water, and spray from any of these, whether or not driven by wind (excludes damagecaused by storm surge).

National Flood Insurance Program (NFIP) has kept flood insurance affordable, but:

• Low Maximum Limits: $500,000 for a commercial building and $500,000 for contents.• Wind-driven rain and storm surge are not covered.• Only Actual Cash Value is covered.• A separate policy is required for each location.• Loss of Business Income and Rental Value are excluded.

NFIP Coverage has been extended only through November 21, 2019. Non-NFIP Coverage is available on theprivate market, though it usually has a $500,000 minimum deductible.

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Add Terrorism CoverageTerrorism Risk Insurance Program Reauthorization Act (“TRIA”) of 2007was extended retroactively in January 2015 - Federal terrorism coveragelegislation now expires on December 31, 2020.

Federal terrorism coverage is limited:

• Only acts certified as acts of terrorism by Secretary of theTreasury after consultation with Secretary of HomelandSecurity and U.S. Attorney General trigger payment; and

• Then only if property losses (excluding health or life risks)exceed $5,000,000.

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III. Making the Parties’ Restoration Obligations MatchTheir InsuranceWho Should Carry the Property Insurance?

• Normally, the party that owns the building should carry the property insurance.

• Normally, the party that carries the property insurance should be the one obligated torestore the insured building.

• If the party with the obligation to restore is not the party carrying the property insurance,the Lease should provide that (i) the restoring party is not obligated to begin restoringuntil it has received the proceeds, (ii) its restoration obligations are limited to theproceeds it receives, (iii) it must be a loss payee and additional named insured on theinsurance, and (iv) the party that carries the insurance must pay the restoring party alldeductibles/self-insured amounts.

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IV. Waiver of Claims/Waiver of Subrogation

• Each party should insure its own property (except when the Tenantinsures the leased building, but that’s risky).

• Subrogation permits the insurer to stand in the shoes of its insured and sue theperson that caused the damage for the amount paid by the insurer.

– The Landlord’s insurer can sue the Tenant for damage to the buildingcaused by the Tenant.

– The Tenant’s insurer can sue the Landlord for damage to the Tenant’s FF&Ecaused by the Landlord (for example, by a defect in the building or itssystems).

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A Waiver of Claims and Subrogation by each party is needed to avoid this result.

• Each party should include in the Lease a waiver of claims for its property damage orloss that are insured or could have been insured by a Special Causes of Loss policy ofproperty insurance.

• Many property policies permit a waiver of claims by the Named Insured to bind theinsurer provided this waiver is agreed in writing prior to a loss; for example, in a Lease,an endorsement is needed if the policy does not expressly permit this waiver.

• In some cases, courts have held that if the Tenant has paid for the Landlord’s propertyinsurance policy by reimbursements to Landlord (or in other circumstances), theinsurer is not entitled to a right of subrogation, but the safest course is to include anexpress waiver of claims in the Lease.

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Example of Mutual Waiver of Claims: Tenant and Landlord each hereby releases andrelieves the other and waives its entire right of recovery against the other (and in the case ofTenant, against Landlord’s property manager), for any and all loss of or damage to property,including, (i) in the case of Landlord, the Building and Landlord’s loss of rents, and (ii) in the case ofTenant, the Improvements, all other property located in or about the Premises, all property ofTenant located elsewhere on the Property, and Tenant’s loss of business income, in each case,arising out of or incident to perils insured against or that could have been insured against by a“special causes of loss” form policy of property insurance or any other policy of insurance requiredunder this Lease insuring property loss or damage, even if this loss or damage is caused by thenegligence of Landlord, Tenant, or their respective invitees. This waiver includes a waiver by eachparty of all rights of subrogation that its insurers may have against the other party. If a propertyinsurance policy carried by either party does not permit the insured to waive the insurer’s rights ofsubrogation, then that policy shall contain an endorsement in which the insurer waives all of itsrights of subrogation against the party that is not the insured party (and in the case of Tenant’spolicies, against the Landlord’s property manager). 31

V. The Risks of Relying on the Tenant to Insure the Landlord’sBuilding

When the Tenant insures Landlord’s building,

• Landlord does not control the insurance placement or compliance with itsLender’s obligations

• Landlord might be subject to cancellation of the policy caused by Tenantviolations

• Landlord will not receive notice of cancellation (without a special endorsement)• Landlord may have difficulty negotiating a claim adjustment directly• Landlord will have to review Tenant’s policy every year• Landlord should consider maintaining its own contingent (back-up) property

policy with Loss of Rental Value coverage, which can increase overall insuranceexpense

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When the Landlord must let Tenant insure the Landlord’sbuilding, the Lease should require the Tenant to:

• Maintain a policy of “Special Causes of Loss” form property insurance as well as floodinsurance, terrorism insurance, and other insurance important to the Landlord, covering allbuildings and other improvements.

• Ensure that the aggregated sublimits and special limits for catastrophic perils areappropriate compared to the insured exposures.

• Insure the property for its full Replacement Cost, with low or no deductibles.• Maintain Agreed Value coverage or limits that are high enough to avoid co-insurance.• Continue to pay rent after a casualty (no abatement) – Tenant’s Loss of Business Income

insurance should cover rent during reconstruction.• Have the policy endorsed to require notice of cancellation to Landlord.• Name the Landlord as Loss Payee and Additional Named Insured.

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Loss Payee, Additional Named Insured, or both? Both ifpossible.

• Landlord as Loss Payee: Building claims should be adjusted with the Landlord only and theimprovements & betterments claim should be adjusted with the Tenant (unless the Leaseprovides otherwise), but in practice, losses are generally adjusted only with the first namedinsured (lender rights may have priority).

• Landlord as Additional Named Insured: The Landlord will be an insured to the extent of itsinsurable interest in the property suffering loss. Both Landlord’s and Tenant’s names arelikely to be on the proceeds check.

In both cases: Absent a separation of Insureds clause, no protection is provided to the Landlordagainst invalidation of policy by actions of the Tenant, and no notice of cancellation will be providedto the Landlord without a special endorsement requiring that notice.

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The Landlord may be able to obtain a ContingentProperty policy with Loss of Rental Value coverage.• Locations leased to Tenants can be scheduled on the Landlord’s Master

Policy.

• Lower rates should be available since the proceeds will only be payable if theTenant’s coverage is insufficient.

• Insurer may require annual updated Evidence of Insurance for the Tenant’spolicy.

• The Landlord’s Loss of Rents can be covered (if the rent does not abate).35

VI. The Lender’s Rights and ProtectionsUnder many policies (e.g., CP 00 10 10 12), scheduled mortgage holders are covered as theirinterests may appear. Under this coverage or under a Mortgagee loss payable endorsement (forexample CP 12 18 10 12):

• The mortgagees will be paid in order of precedence as their interests may appear (themortgagee must submit a signed, sworn proof of loss within 60 days after receiving noticefrom the insurer of the insured’s failure to do so).

• This creates a separate contract between the Lender and the insurer, which means theLender will not be harmed by the insured’s violation of policy provisions (unless the Lenderknew about a change in ownership, occupancy, or risk and failed to notify the insurer).

• The insurer agrees to give prior notice of policy cancellation or non-renewal to the Lenderand the Lender is permitted to pay unpaid premiums.

Other loss payees and additional insureds do not have these rights.36

VII. The Big Concern: How Can a Party Obtain Proof ofthe Other Party’s Insurance?ACORD provides standard one-page forms considered “Proof of Insurance”:

• Certificate of Liability Insurance (ACORD 25); and

• Evidence of Commercial Property Insurance (ACORD 28).

BUT THESE FORMS SAY THAT LOSS PAYEES AND ADDITIONAL INSUREDS CANNOTRELY ON THEM.

In addition, these forms no longer require the insurer to provide the certificateholder with notice of modification or cancellation – if the policy itself is notendorsed to require this notice, then no notice.

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What can the Loss Payee or Additional Named Insureddo?

• Require the party that is contractually required to maintain the coverage to notify the partyrelying on the coverage if the policy is modified or cancelled.

• If available, obtain an endorsement in which the underwriter agrees to give notice ofcancellation to the additional named insured or loss payee party. (See, e.g., Notice ofCancellation Designated Entities.)

• In the Lease, require the party obligated to maintain coverage to provide originals of policies(or at least copies of the declarations page, the schedule of forms and endorsements, andrequired endorsements or the binder, if that is what is in effect) upon request.

• Obtain a copy of the declarations page, a copy of the schedule of forms and endorsements, anda copy of all required endorsements at least annually and review them carefully.

Always advise your landlord client to maintain its own insurance covering its own property andliability!

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VIII. Builder’s Risk Insurance• Builder’s Risk Insurance covers the building or improvements in the

course of construction – this is generally excluded in the overall PropertyPolicy.

• Examples are ISO CP 00 20 10 12 or American Association of InsuranceServices forms AAIS IM 7050 08 12, and AAIS IM 7054 08 12.

• For a single project, completed value is generally the amount of theinsurance (Replacement Cost is an option) – but the insured may need toincrease coverages to keep up with change orders and avoid coinsurancepenalties (Agreed Value coverage can be obtained).

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Additional Builder’s Risk Issues.

• Coverage ends (i) if the building or structure is occupied in whole or in partwithout the insurer’s consent, (ii) 90 days after construction is complete, or (iii)when the project is accepted – the permanent Property Policy must becomeeffective at this time.

• Insureds should include the owner, the general contractor, and thesubcontractors, and each has the right to make a claim if the owner fails to do so.

• A separation of interests endorsement is needed to protect the rights of eachinsured party.

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