COMMERCIAL PROPERTY COVERAGE GAPS AND HOW TO

FILL THEM

Copyright © 2018 by International Risk Management Institute, Inc.® ALL RIGHTS RESERVED. THIS COURSE OR ANY PART THEREOF MAY NOT BE REPRODUCED IN ANY FORM OR BY ANY MEANS WITHOUT THE WRITTEN PERMISSION OF THE PUBLISHER.

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Commercial Property Coverage Gaps and How To Fill Them

Contents

Introduction 1Course Objectives...............................................................................................................................1

Chapter 1 The Role of Insurance Agents and Brokers........................................................3Chapter Objectives..............................................................................................................................3General Agency Law..........................................................................................................................3

Agency............................................................................................................................................4Agency Relationship.......................................................................................................................4Types of Authority..........................................................................................................................4Scope of Authority..........................................................................................................................4Duties Owed by Agent to Principal................................................................................................4

Application to Insurance Industry.......................................................................................................5Insurance Agents—Representatives of the Insurer.........................................................................5Insurance Brokers—Representatives of the Insured.......................................................................6Agent/Broker—Dual Agent of Both Insurer and Insured...............................................................8

Potential E&O Exposures of Agents and Brokers..............................................................................9Liability for Breach of Duty Owed to Insurer................................................................................9Liability for Breach of Duty Owed to Insured..............................................................................10

Summary of Actions Giving Rise to Claims Against Insurance Agents..........................................11Errors and Omissions That May Occur on Any Property Policy......................................................14

Incomplete or Inaccurate List of Insureds....................................................................................14Improper First Named Insured......................................................................................................15

Chapter 1 Review Questions.............................................................................................................17

Chapter 2 Direct Property E&O—Coverage Issues...........................................................20Chapter Objectives............................................................................................................................20Review of Commercial Property Coverage......................................................................................20

Covered Property..........................................................................................................................21Building Property..........................................................................................................................21Business Personal Property...........................................................................................................25Personal Property of Others..........................................................................................................26Property Not Covered...................................................................................................................27Rationale for Property Exclusions................................................................................................28Exceptions for Property Held for Sale by the Insured..................................................................28Restricted Coverage for Certain Types of Property.....................................................................29Vacancy Provisions......................................................................................................................29Covered Locations........................................................................................................................30

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Property under Construction.........................................................................................................30Failure To Cover All Locations........................................................................................................31Inadequate Sublimits for Unnamed Locations..................................................................................33Inadequately Insuring Vacant Property............................................................................................34

Endorsements Available...............................................................................................................35No Ordinance or Law Coverage.......................................................................................................36

Endorsement Available.................................................................................................................37No Flood and Earthquake Coverage.................................................................................................39

Flood Exclusions..........................................................................................................................39Flood Endorsements.....................................................................................................................39National Flood Insurance Program...............................................................................................39Earthquake Exclusions..................................................................................................................41Earthquake Endorsements............................................................................................................41Difference in Conditions Policies.................................................................................................41

No Equipment Breakdown Coverage...............................................................................................42Chapter 2 Review Questions.............................................................................................................44

Chapter 3 Direct Property E&O—Valuation Issues..........................................................47Chapter Objectives............................................................................................................................47Valuation of Covered Property.........................................................................................................47

Actual Cash Value........................................................................................................................48Replacement Cost Option.............................................................................................................49Valuation Endorsements...............................................................................................................50

Coinsurance.......................................................................................................................................51Agreed Value Coverage Option....................................................................................................53

Limits of Insurance...........................................................................................................................53Scheduled versus Blanket Limits..................................................................................................54Dealing with Fluctuation in Property Values...............................................................................57

Deductible.........................................................................................................................................59Failure To Match Limits with the Valuation Basis...........................................................................59Less than Optimal Valuation Provisions...........................................................................................60Use of Specific Limits Rather than Blanket Limits..........................................................................61Use of a Per Occurrence Limitation or Margin Clause.....................................................................62No Agreed Value Clause..................................................................................................................63Not Understanding Reporting Form Coverage.................................................................................64Not Considering Cost of Debris Removal........................................................................................66Chapter 3 Review Questions.............................................................................................................69

Chapter 4 Time Element E&O Issues..................................................................................72Chapter Objectives............................................................................................................................72Failure To Cover Time Element Exposures......................................................................................73

Loss of Income (Including Rents) Loss Exposures......................................................................73Extra Expense Loss Exposures.....................................................................................................74

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Combination Loss Exposures.......................................................................................................74Failure To Choose the Most Appropriate Time Element Insurance Coverage(s)............................76

Business Income Coverage...........................................................................................................76Business Income and Extra Expense Coverage (CP 00 30).........................................................77Business Income without Extra Expense Coverage (CP 00 32)...................................................77

Failure To Cover Rental Income Exposures.....................................................................................79Failure To Provide Leasehold Interest Coverage..............................................................................80Failure To Provide Business Income Coverage for Utility Interruption...........................................81

Endorsement.................................................................................................................................82No Coverage for Contingent Business Interruption Exposures........................................................84

Endorsements................................................................................................................................85No Extended Period of Indemnity Coverage....................................................................................86

Indemnity Period..........................................................................................................................86Indemnity Period Options.............................................................................................................87

No Time Element Ordinance or Law Coverage...............................................................................89Endorsements................................................................................................................................89

Inadequate Business Income Coverage Limits.................................................................................90Not Insuring Finished Stock on a Selling Price Basis......................................................................93

Endorsement.................................................................................................................................94Chapter 4 Review Questions.............................................................................................................95

Chapter 5 Inland Marine E&O Issues.................................................................................98Chapter Objectives............................................................................................................................98Inadequately Insuring Property under Construction.........................................................................98Not Insuring Property Shipped by Common Carrier......................................................................101No Warehouse Coverage for Property in Transit...........................................................................102No Coverage for Rented/Borrowed Equipment..............................................................................104Chapter 5 Review Questions...........................................................................................................107

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Introduction

Errors and omissions by an insurance producer can be extremely costly and damaging to the producer’s professional reputation. This course is designed to help insurance agents and brokers prevent many types of errors and omissions involving commercial property insurance. The verb prevent is used here in the risk management sense. Loss prevention seeks to reduce the frequency or likelihood of claims. Complete avoidance is impossible. An agent or broker who has handled everything properly, following every guideline within this course, may still be sued for some alleged error or omission. However, the producer who successfully completes this course is less likely to be charged with an error or omission and will probably be better able to defend himself or herself against these allegations.

Chapter 1 sets the stage for a discussion of producer errors and omissions by summarizing agency law and how it affects insurance agents’ and brokers’ duties to both insurers and their clients. The course then deals specifically with some of the more common problems associated with the following.

Commercial property insurance (Chapters 2 and 3)

Time element insurance (Chapter 4)

Inland marine insurance (Chapter 5)

This course is by no means exhaustive. No course can possibly recognize and discuss every conceivable type of error or omission an insurance agent or broker can make. However, it should at least make readers aware of many potential pitfalls and how they can be avoided.

Chapter 1 points out some traditional distinctions between insurance agents and insurance brokers. For the remainder of this course, the terms agent, broker, and producer are used interchangeably.

Course Objectives On completion of this course, you should be able to recognize and prevent many of the problems associated with selling and servicing the following.

Commercial property insurance

Equipment breakdown insurance

Business interruption and extra expense insurance

Commercial inland marine insurance

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Contents

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Chapter 1The Role of Insurance Agents and Brokers

Insurance agents and brokers facilitate the process of finding, negotiating, purchasing, and servicing insurance policies for their clients. As their name implies, agents have clearly defined legal relationships under agency law with the party for whom they work. Understanding these basic legal relationships will illuminate the duties and potential liabilities that insurance agents may have with respect to insureds and insurers. The insurance producer who breaches these duties through negligence, carelessness, lack of technical knowledge, or any other reason may face errors and omissions (E&O) claims.

The chapter concludes by mentioning two problem areas that are common to all types of property and liability insurance. Subsequent chapters examine the problem areas associated with specific types of commercial property coverage.

Chapter ObjectivesOn completion of this chapter you should be able to

describe the relationship between an agent and a principal.

explain the types of authority under which an agent may operate.

explain the legal relationships between insurance agents, insurance brokers, and insurance companies.

describe insurance agents’ and brokers’ errors and omissions (E&O) exposures arising out of their duties to the insurer and the insured.

identify the types of actions that commonly give rise to E&O claims against insurance producers.

describe the rights and duties of a policy’s first named insured.

Given appropriate information, identify the most appropriate party to list as a policy’s first named insured.

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General Agency LawThe insurance business operates within the context of general business law. Therefore, our discussion of agency begins with a brief overview of agency law.

Agency An agency is a fiduciary relationship in which one party (the agent) acts on behalf of another party (the principal) and binds that other party by words or actions.

Agency Relationship An agency relationship is created by contract. The essential elements necessary to establish an actual agency relationship are (1) acknowledgment by the principal that the agent will act for him, (2) acceptance by the agent of the undertaking, and (3) control by the principal over the agent’s actions. An exclusive agent is an agent for only one principal. If not exclusive, agents can have more than one principal. The existence and scope of the agency relationship are factual questions that can be submitted to a jury for resolution, if need be.

Types of AuthorityAn agent’s authority can either be express, implied, or apparent.

Express authority is explicitly stated by the principal, either orally or in writing.

Implied authority consists of those powers incidental and necessary to carry out a grant of express authority.

Apparent authority is not technically granted by the principal directly to the agent, but arises out of the impression the principal gives to the public at large such that the agent appears to be authorized to act a certain way. However, apparent authority cannot rest solely upon acts of agent.

Scope of AuthorityThe principal has control over the amount of authority to be vested with the agent. A principal can vest general authority with the agent to perform whatever act the principal could legally perform. This broad kind of agency arrangement is called a general agency.

An agent’s authority can also be much more limited. A principal may vest only limited authority in an agent to perform only certain designated tasks. This narrow kind of agency is called a special agency. However, third parties dealing with the agent will not be bound by any secret limitations on the agent’s authority as between the principal and agent unless those limitations are made known to the third party.

Acts of the agent that are performed within the scope of the power that has been delegated will be legally binding on the principal. For example, if a person designates an agent for purposes of making

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purchases of raw materials in a commodities market, that person will be legally bound to honor any contracts the agent makes on behalf of the principal to purchase raw materials.

The principal can be held liable to a third party if the agent uses his delegated authority to commit fraud. Since the agent is seen as legally acting on behalf of the principal, the law treats the agent’s fraud as if it were committed by the principal himself.

Duties Owed by Agent to PrincipalAn agent owes the principal a fiduciary duty to act in the best interests of the principal. An agent cannot use the powers the principal has delegated to him to benefit himself at the expense of his principal. An agent who engages in self-dealing in violation of his fiduciary duty in this regard could be held liable to the principal.

The agent’s fiduciary duty to protect the principal gives rise to a presumption that the agent will relay information that is important to the principal’s interest. The law presumes that any information known by the agent will be shared with the principal. Therefore, anything that the agent knows, or any information the agent comes by, will be imputed to the principal.

Application to Insurance IndustryThe foregoing rules of general agency law have important application to the insurance industry. In a typical insurance transaction, there may be three parties: the insurer issuing the policy, the insured purchasing the policy, and an intermediary arranging the deal. The law disregards the label that the insurance industry places on the intermediary. Therefore, it does not matter whether the intermediary is called an agent, captive agent, independent agent, managing agent, soliciting agent, recording agent, producer, insurance advisor, or broker. Instead, the pertinent question to ask is “Who is the principal?” The duties and potential liabilities of the intermediary will be determined by the legal conclusion as to whether an actual agency relationship exists between the intermediary and (a) the insurer, (b) the insured, or (c) both.

Insurance Agents—Representatives of the InsurerExhibit 1.1

Legal Relationship of Common-Law Insurance Agent

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In the legal sense, insurance agents are defined at common law as intermediaries that have an agency relationship with the insurer. In this relationship, the intermediary is the legal agent and the insurer is the principal. The intermediary represents and acts for the insurer during the insurance transaction. The agent may perform marketing activities, take applications, and issue policies on behalf of the insurer.

Generally, the relationship between an insurance agent and an insurer can be depicted as shown in Exhibit 1.1.

In this diagram, there is no line connecting the agent and the insured. The agent would not represent the insured in this situation. Instead, the agent represents only the insurer. There are many important legal consequences of this fact, including the following.

Any act taken by the agent within the scope of his or her express, implied, or apparent authority (e.g., the acceptance of late premiums) will bind the insurer.

It is possible for the insurer to either expressly or implicitly ratify unauthorized acts taken by the agent because the insurer is the agent’s principal.

The insurer may not be permitted to rely on the agent’s misrepresentations when filling out insurance applications to cancel a policy.

Knowledge of facts that are material to the risk known by the agent are going to be automatically imputed to the insurer.

Notice regarding a loss or claim given by the insured to the agent may be treated as the equivalent of notice to the insurer.

The insurer will be liable for any fraud committed by the agent.

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Whether the agent is technically an employee or an independent contractor is irrelevant to the operation of these rules, which are a consequence of the establishment of the agency relationship itself, and which are not dependent on the agent’s technical employment status.

Varying Degrees of AuthorityThe terms of the agency relationship are normally spelled out in a written agency agreement between the insurer and the agent. Most agency agreements typically grant the agent authority to issue a “binder” before the policy is issued. A binder serves as a legally enforceable promise that the insurer is providing coverage from the time the binder is given until the time the policy is issued. It is a temporary oral policy that terminates once the insurer issues the written policy. In the absence of any special agreement as to any special terms, the binder will cover the same exposures as the insurer’s standard coverage forms. Some agency agreements go further, giving agents the discretion to countersign new policies or change the terms of existing policies.

Perhaps the most amount of authority is delegated to managing general agents (MGAs). These are insurance agents who are also given the authority to perform the services of one or more whole departments. An MGA may perform the insurer’s underwriting activities to assess risks, accept or reject applications, and actually write new or renewal business. For example, a Nevada statute defines an MGA to be one who manages all or part of the insurance business of an insurer, including the management of a separate division, department, or underwriting office, who acts as an agent for the insurer, who produces and underwrites an amount of gross premiums of 5 percent or more of the policyholder surplus, and who adjusts or pays claims.

Note that when dealing with someone outside the agency relationship, such as the insured, any restrictions on the agent’s express authority must be disclosed. Otherwise, the courts may hold that the insurer created the appearance that the agent had more authority than he or she actually did.

Insurance Brokers—Representatives of the InsuredIn the legal sense, insurance brokers are defined at common law as intermediaries that have an agency relationship with the insured. In this relationship, the intermediary is the legal agent and the insured is the principal. The intermediary represents and acts for the insured during the insurance transaction.

Generally, the relationship between a common-law insurance broker and an insured can be depicted as shown in Exhibit 1.2.

Exhibit 1.2Legal Relationship of Common-Law Insurance Broker

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In this diagram, there is no line connecting the broker and the insurer. The broker would not represent the insurer in this situation. Instead, the broker only represents the insured. There are many important legal consequences of this fact, including the following.

Nothing the broker does will bind the insurer.

Any act taken by the broker within the scope of his or her express, implied, or apparent authority (e.g., filling out an application) will be applicable to the insured.

It is not possible for the insurer to either expressly or implicitly ratify unauthorized acts taken by the broker because the insurer is not the broker’s principal.

The insurer may be permitted to rely on the broker’s misrepresentations when filling out insurance applications to cancel a policy.

The broker’s knowledge of material facts are not going to automatically be imputed to the insurer.

Notice regarding a loss or claim given by the insured to the broker is the equivalent of the insured giving notice to himself and will not be treated as the equivalent of notice to the insurer.

The insurer will not be liable for any fraud committed by the broker.

The broker does have common law fiduciary duties to act in the best interests of the insured.

Most of these consequences are detrimental to the insured. Therefore, establishing that an insurance intermediary is really a common-law broker and, thus, the legal agent of the insured, can be a powerful defense for an insurer in a coverage lawsuit. Whether an insurance intermediary is a

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common-law agent representing the insurer or a common-law broker representing the insured is a factual question that depends on the circumstances of each case.

Lay people may not fully understand the insurance intermediary with whom they are dealing may not actually be a legal agent of an insurer but are, in fact, their own agent. The confusion probably stems from the use of the term independent agent in connection with an entity that is really a common-law broker. This may lead to mistakes in the way insureds deal with an independent agent or may cause the insured to think that coverage exists when it does not.

Agent/Broker—Dual Agent of Both Insurer and InsuredThe law in many states recognizes the possibility that an insurance intermediary may serve as the legal agent of both the insurer and the insured, with respect to different aspects of the same insurance transaction. The intermediary could be the general agent of the insured for purposes of shopping for coverage, negotiating terms and premiums, and making claims under the policy. This same intermediary could be a special agent of the insurer for more limited purposes relating to servicing the policy (e.g., taking an application, collecting premiums, and issuing policy forms and notices). The dual agency relationship created by this situation can be depicted as shown in Exhibit 1.3.

Exhibit 1.3Dual Agency Relationship

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In this diagram, there are lines connecting the agent/broker to both the insured and the insurer. Both the insured and the insurer are the agent’s/broker’s principal. The agent/broker represents both. These facts give rise to a number of complex legal consequences under state law, including the following.

Any act taken by the agent/broker within the scope of his or her express, implied, or apparent authority granted by the insured (e.g., negotiating coverage terms) will bind the insured.

It is possible for the insured to either expressly or implicitly ratify unauthorized acts taken by the agent/broker because the insured is the agent’s/broker’s principal.

Any act taken by the agent/broker within the scope of his or her express, implied, or apparent authority granted by the insurer (e.g., taking an application) will bind the insurer.

It is also possible for the insurer to either expressly or implicitly ratify unauthorized acts taken by the agent/broker because the insurer is also the agent’s/broker’s principal.

The insurer may not be permitted to rely on the agent’s/broker’s misrepresentations when completing insurance applications.

The agent’s/broker’s knowledge of material facts may be imputed to the insurer, who is also a principal.

Notice regarding a loss or claim given by the insured to the agent/broker may be treated as the equivalent of notice to the insurer.

The insurer may be liable for any fraud committed by the agent/broker.

The agent/broker has common law fiduciary duties to act in the best interests of both the insured and the insurer.

Sorting out the kaleidoscope of legal relationships between insureds, insurers, and insurance intermediaries is difficult. Therefore, a good business practice for insurance agents is to clarify the party whom they represent in the transaction and to disclose the scope and limitations of their authority to minimize the potential for confusion and, ultimately, litigation.

Potential E&O Exposures of Agents and BrokersAn agent owes the principal a fiduciary duty to act in the best interests of the principal. Depending on who the principal is, agents and brokers owe different duties and may be held liable in different ways. Such individuals may be liable for breaching a duty owed to the insurer or to the insured, or for acting contrary to the interests of an insured. These types of errors may give rise to potential E&O claims on an agent’s E&O policy.

Liability for Breach of Duty Owed to InsurerA common-law agent represents the insurer and owes a fiduciary duty to act in the insurer’s best interest. A common-law agent can be held liable for breaching this duty owed to the insurer for a number of situations, including the following.

Failing to obey instructions from an insurer to cancel a policy

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Failing to obey instructions from an insurer to decline a certain category of risk

Failing to obey instructions from an insurer to reduce the amount of coverage being provided

Intentionally making misrepresentations in an application to fraudulently induce the insurer to accept a risk it otherwise would have declined or written at a higher premium

Using apparent authority to waive policy restrictions (e.g., a provision that an insurer is not liable for a fire loss occurring while any hazard was increased)

Negligently binding the insurer to coverage at a lower price than the agent was required to obtain

Failing to forward notices of claims against the insured to the insurer in a timely manner

The damages an insurance agent might owe the insurer would depend on the type of wrong he or she committed. For example, if an agent breached a duty to cancel a policy and a covered loss occurred, the agent might be liable to the insurer in the full amount of the loss that otherwise was not covered. On the other hand, if the agent negligently charged a lower premium than required, the amount of the insurer’s damages would be the difference between the actual premium charged and the full premium that was supposed to have been charged.

Liability for Breach of Duty Owed to InsuredA common-law broker represents the insured and owes a fiduciary duty to act in the insured’s best interest. Depending on individual state law, a common-law broker can be held liable for breaching this duty owed to the insured in a number of situations, including the following.

Failing to procure insurance that the insured requests

Failing to recommend specific coverages (if doing so is standard in that practice area)

Failing to advise the insured that the broker was unable to procure the coverage as requested in time for the insured to locate substitute coverage elsewhere

Negligently advising the insured as to the adequacy or scope of coverage that was obtained

Failing to advise the insured that the insurer canceled a policy in time for the insured to replace it with substitute coverage elsewhere

The damages a broker might owe to the insured depend on the nature of the breach. If the broker breaches his or her duty to inform the insured that he or she was unable to procure a policy, the broker might be liable for the entire amount of a loss that would have otherwise been covered. On the other hand, if the broker failed to advise the insured that the amount of coverage was inadequate, the broker might be liable for the difference between the amount of coverage that was actually purchased and the amount of coverage that should have been purchased.

Real Life Scenario

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Rex is an agent for XYZ Insurance Company and represents XYZ, only. He sells a commercial general liability policy to Toys Incorporated. Freda slips and falls at the Toys Incorporated store and breaks her arm. She hires a lawyer, who files suit against Toys, who in turn immediately reports the matter to Rex. Rex put the report on his desk and intended to report it to the insurer. However, it was later covered by other papers on Rex' desk, and he failed to advise XYZ of the suit. The lawsuit

Summary of Actions Giving Rise to Claims Against Insurance AgentsClaims made against insurance agents can result from a lack of technical competence and/or from errors in processing. Exhibit 1.4 lists the leading types of claims that are made against insurance agents. Such claims fall into two major categories: those made by clients and those made by insurers.

Exhibit 1.4Actions Giving Rise to Claims Against Insurance Agents

Claims Made by Clients Failure to place coverage promptly

Failure to place the type of coverage requested

Failure to increase the coverage limit or update the policy

Failure to explain limitations of coverage

Rex is an agent for XYZ Insurance Company and represents XYZ, only. He sells a commercial general liability policy to Toys Incorporated. Freda slips and falls at the Toys Incorporated store and breaks her arm. She hires a lawyer, who files suit against Toys, who in turn immediately reports the matter to Rex. Rex put the report on his desk and intended to report it to the insurer. However, it was later covered by other papers on Rex' desk, and he failed to advise XYZ of the suit. The lawsuit

Always timely report claims when received. Waiting can result in mishandling a timely made claim.

Result: The E&O insurer was able to convince the insurer to settle the claim for $100,000, arguing that Rex was their agent and hence XYZ was bound by Rex's actions—notice to Rex was notice to XYZ. However, XYZ made a claim against Rex for failing to report the matter to them and pointed to the terms of the agency agreement in place between Rex and XYZ. XYZ argued that had they been timely notified of the claim, it would have been able to be settled for much less. The E&O insurer settled with the insurer for $80,000.

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Clerical error or misunderstanding

Oral extensions of nonexistent coverage

Inadvertent cancellation or failure to renew

Failure to advise the insured of cancellation, nonrenewal, or material restrictions in the policy

Failure to place coverage with solvent insurer

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Exhibit 1.4 (cont’d)Actions Giving Rise to Claims Against Insurance Agents

Claims Made by Insurers Failure to follow underwriting guidelines/exceeding authority

Failure to exercise reasonable diligence in discharging duties to the insurer

Failure to act in the best interests of the insurer

Failure to revise coverage on request

Failure to cancel on request

Failure to disclose material information

Real-Life Scenario

Phil is an agent for Cynthia, has no legal relationship with the ABC Insurance Company, and places coverage with them through a broker. He meets Cynthia at her home, and when he arrives, she is in the backyard, playing with her kids in their swimming pool. He asks her the questions on the application, which he has her sign. The application indicates there is no swimming pool. Phil submits the home owner's application to the insurer, who agrees to bind coverage. Six months later, a visiting child is injured when he jumps off the diving board and hits his head on the side of the pool. This child retains a lawyer, who files suit against Cynthia, and who in turn submits the claim to Phil and to ABC Insurance. ABC investigates and denies coverage due to material misrepresentation on the application due to the answer on the application about the pool. Phil reports the matter to his E&O insurer.

Result: The E&O insurer investigates and ultimately settles the entire claim for $50,000 as it is clear that Phil knew about the swimming pool, filled out the application for Cynthia, and sent it to ABC knowing the answer was wrong.

Make sure the application is accurately completed. Phil had

liability exposure because he knew or should have known Cynthia had a swimming pool at her house. The insurer did not have liability exposure in this case because of Phil's legal status—he was an agent for the customer (Cynthia) and was not an agent for ABC Insurance.

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Real Life Scenario

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Brian is an insurance agent. Lauren comes to Brian for an auto policy. Lauren asks Brian to get her complete and comprehensive coverage. Brian assures her he will get her the "best policy available." Brian secures a policy with U.S. Farm. The policy contains per person liability limits of $100,000/$300,000. Three months later, Lauren is driving her auto and pulls out from a stop sign and hits a car that had the right of way. The driver of the other car is seriously injured and hires a lawyer who makes a claim of $250,000. U.S. Farm evaluates the claim as having a settlement value of $150,000 and pays the other driver the policy limit of $100,000, but the claimant continues to make a claim against Lauren for the full $250,000. Lauren makes an E&O claim against Brian, alleging that he should have provided her with the $250,000 limit policy.

Result: Brian submits the claim to the E&O insurer. The insurer determines that U.S. Farm had an available policy with per person limits of $250,000 that Brian did not request nor obtain. The E&O insurer argues that while Lauren had a duty to read her policy, they settled for a compromised amount based on Brian's promise to get "the best coverage available." Brian admitted that he had said that to Lauren.

Avoid using absolute terms such as "the best coverage," "expert," "specialists," "best price," "most comprehensive," "fully covered," or "addressing ALL of your coverage needs" in conversations or advertising.

Share the proposal with the client and ask them to read it and state if it meets their needs. Give them coverage and limit options and allow them to choose based on their own needs.

Errors and Omissions That May Occur on Any Property PolicyThe remainder of Chapter 1 discusses errors and omissions that may occur on any type of property policy. These errors have to do with the manner in which insured parties are listed in the policy declarations. The order in which entities are listed is also important because many policies assign special duties to first named insureds.

Incomplete or Inaccurate List of Insureds The improper listing of insureds in the policy declarations is a common source of E&O claims. A party that is not listed in the declarations may be ineligible for coverage if a loss occurs.

Property policies typically cover only insureds listed in the policy declarations. However, the fact that an insured is listed in the declarations is not a guarantee of coverage. State laws typically limit property insurance coverage to those parties that have an insurable interest in the insured property. Insureds listed in the declarations of a property policy usually have an ownership interest in the property.

Insurable interest is not generally an issue with liability insurance. It is often said that “anybody can be sued,” and anybody who is the target of a suit—whether or not the allegations are reasonable or valid—needs liability insurance or some other means of defending against the claim or suit. Liability insurance policies typically cover the named insured—the person(s) and/or entities identified by name in the policy declarations—or other insureds who have insured status by virtue of some relationship to the named insured. Employees of the named insured often—but not always—fall into this category.

Named insureds generally have broader coverage than other insureds. Many liability policies cover, as named insureds (referred to as “you”), only the persons or entities listed in the declarations or in a separate named insured endorsement.

The list of insured parties should be reviewed periodically at least once a year before policies are renewed. Policies may have different rules regarding the types of entities that may be named in the declarations. For instance, workers compensation policies are subject to combinability rules that may not apply to a property policy. Nevertheless, policies should be as consistent as possible.

Real-Life Scenario

Nick meets with Jack, an insurance agent, to purchase coverage for his new house. He tells Jack that the purchase price of the house is $200,000 and that after down payment, he has

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a mortgage for $130,000 with First National Bank. Jack procures a policy for Nick through ABC Insurance. Unfortunately, Jack forgets about the bank and the policy is issued in Nick's name only. Eight months later, Nick hires his best friend to burn down the house in order to collect the insurance proceeds. ABC investigates and denies coverage to Nick based on allegations that Nick committed fraud. The bank learns of the fire and makes a claim to ABC, who refuses to pay because the bank is not an insured on the policy.

Result: The bank then makes a claim against Jack, alleging he knew they had an interest in the house, due to the mortgage, and should have included the bank as a loss payee on the policy. Jack reports the claim to his E&O insurer. The investigation shows that Jack was aware of the bank's interest and had documentation indicating that they should have been

added as a loss payee. Even though the fire was caused by Nick's fraud, the bank was an innocent party and would have recovered under the policy had they been included as loss payee. The claim with the bank was settled for the bank's interest of $130,000.

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The agent must take steps to include on the policy all appropriate parties as insureds or those parties having insurable interests in the property when they are known. The agent knew the bank had an insurable interest on the property due to the mortgage but failed to include them on the policy.

RISK CONTROL TIP

To prevent errors and omissions losses from uninsured persons or entities.

Understand the distinction between named insureds and other insureds.

Periodically (e.g., annually) review the list of insured parties.

Make sure the list of named insureds in each policy includes all entities that ought to be covered as such.

Improper First Named Insured Problems can occur if named insureds are not listed in the proper order. Many insurance policies assign special rights and duties to the first named insured. Under the Insurance Services Office, Inc. (ISO), forms, for example, no insured other than the first named insured may make changes to the policy or initiate cancellation. If the insurer cancels the policy, moreover, it will direct notification to the first named insured. Many policies render the first named insured responsible for paying premiums. First named insureds also have responsibilities related to the annual audit. Typically, these insureds must maintain records of data needed by the insurer to conduct the audit and to calculate the earned premium. If the audit results in an additional premium, the first named insured is responsible for sending payment to the insurer. If the audit results in a return premium, the excess amount is sent to the first named insured. All named insureds have obligations with regard to notifying the insurer of an occurrence, loss, or claim.

Clearly, the first named insured has important responsibilities. Thus, agents and brokers must ensure that the entity that appears first in the policy declarations is the entity that will be performing the duties.

The first named insured should be consistent on all of the insured’s policies. In the above example, suppose that Jones Inc., Jones Construction, and Jones Paving are insured under a property policy as well as a commercial auto policy. Jones Inc. should appear as the first named insured on all three policies. This ensures that all cancellation notices, audit reports, and other important insurance notifications are directed to the same entity.

RISK CONTROL TIP

To avoid errors and omissions losses resulting from improperly listing the named insureds.

Make sure the named insured whose name appears first in a client’s policy is the person or entity authorized to handle all insurance-related transactions.

Make sure the list of named insureds is the same in all of a client’s policies.

Use a broad form named insured endorsement when possible.

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Chapter 1 Review Questions1. Errors and omissions (E&O) claims against insurance agents may be made by either the

insured client or the insurer the agent represents. Insureds do not commonly make E&O claims alleging that their agent

a. did not explain coverage limitations.

This answer is incorrect. Insureds often complain of an agent’s failure to explain limitations of coverage.

b. exceeded his or her underwriting authority.

That’s correct! An insurer may claim that the agent failed to follow underwriting guidelines.

c. failed to place coverage promptly.

This answer is incorrect. Clients sometimes complain that an agent filed to place coverage promptly.

d. provided coverage that was different from what the client requested.

This answer is incorrect. Clients may complain of an agent’s failure to place the type of coverage that the client has requested.

2. Janine gave her brother Roy a personal loan that enabled him to make the down payment on the restaurant Roy now operates. Roy’s insurance agent incorrectly assumed this involved a formal agreement in which the restaurant was collateral for the loan, so the agent added Janine’s name to the restaurant policy and assured Janine that the loan gives her a right to share in any insurance proceeds that might result from damage to restaurant property. In addition to being named in the declarations of the restaurant’s insurance policy, if she wishes to share in any loss recovery, Janine should have a(n)

a. insurable interest in the damaged property.

That’s correct! State laws typically limit property insurance coverage to those parties that have an insurable interest in the insured property.

b. pre-loss waiver of subrogation.

This answer is incorrect. A pre-loss waiver of subrogation would not ensure that Janine shares in the insurance proceeds.

c. signed lease agreement with Roy.

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This answer is incorrect. The financial arrangement between Janine and Roy is not a lease-of-premises agreement.

d. verbal agreement with Roy.

This answer is incorrect. “Verbal” literally means “in words,” but the term is often misused to refer to an oral (spoken) agreement. Janine and Roy should have a written agreement that, of course, will use words. That agreement should specify that the restaurant is collateral for the loan, clarifying that it is not merely a personal loan with no collateral.

3. The declarations of an insurance policy list as named insured(s) “Orville, Paul, and Trina Hall, doing business as Hall Company.” Under the terms of a typical policy, who has a right to receive formal notice if the insurer cancels the policy?

a. Only Orville

That’s correct! If the insurer cancels the policy, it will direct notification to the first named insured—Orville.

b. Orville, Paul, and Trina

This answer is incorrect. Only one person or entity will receive the cancellation notice.

c. The agent who sold the policy

This answer is incorrect. The insurer will notify an insured.

d. Hall Company

This answer is incorrect. As the last named insured, Hall Company is not the entity to which cancellation notice will be sent.

4. Orville, Paul, and Trina Hall formed a partnership that does business as Hall Company. Their insurance broker learns that Orville handles sales, Paul handles production, and Trina handles administration. The best way to have these parties’ names listed in their insurance policy’s declarations would be

a. Hall Company.

This answer is incorrect. Important insurance-related mail that simply goes to the company might too easily be misdirected or even discarded.

b. Hall Company, a partnership owned by Orville, Paul, and Trina Hall.

This answer is incorrect. Although this description would identify all relevant entities, the sequence is not ideal.

c. Orville, Paul, and Trina Hall.

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This answer is incorrect. Since Orville handles sales, he is not the best person to list first.

d. Trina, Orville, and Paul Hall, doing business as Hall Company.

That’s correct! Since Trina handles all administration—this presumably includes insurance—she should be the person who has the rights, duties, and responsibilities of a first named insured.

5. Orville, Paul, and Trina Hall formed a partnership that does business as Hall Company. The company’s vehicles are titled in the company name, and their business auto policy lists “Hall Company, a partnership of Trina, Orville, and Paul Hall” as the named insured. However, the declarations of their commercial property policy list as named insureds “Trina, Orville, and Paul Hall, doing business as Hall Company.” Is this the best way to set up their policies?

a. No; a business entity cannot be the named insured because the business itself cannot sign or endorse premium payment or refund checks.

This answer is incorrect. Business checks are signed by an authorized employee of that business.

b. No; the list of named insureds in the auto policy should also be used in the commercial property policy.

This answer is incorrect. Because the first named insured has more duties and responsibilities than other named insureds, the list in the commercial property policy is probably better. This assumes Trina is the individual who handles Hall Company’s insurance matters.

c. No; the list of named insureds should be the same in all the insured’s policies.

That’s correct! The list of named insureds should be the same in all the insured’s policies, and the first name on the list should be the individual or entity to whom premium notices and premium refunds should be addressed.

d. Yes; the auto policy reflects the ownership of the auto, and the commercial property policies reflects the ownership of other business property.

This answer is incorrect. More important than reflecting the way in which property is titled is identifying the first named insured as the party who handles the firm’s insurance matters.

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Chapter 2Direct Property E&O—Coverage Issues

This is the first of two chapters dealing with preventing the errors and omissions (E&O) that commonly occur in connection with commercial property insurance. Chapter 2 focuses on coverage issues, where Chapter 3 focuses on valuation issues. Various policy terms are reviewed in order to highlight potential problem areas, but this is not a complete policy analysis. It is assumed that the reader has previously taken other courses in commercial property coverage.

Chapter ObjectivesOn completion of this chapter, you should be able to

prevent problems by recognizing what property the commercial property policy does and does not cover.

prevent problems by making sure coverage with adequate limits applies to each insured’s property at all locations where that property might be found.

prevent problems associated with insurance on vacant property by recognizing property that is vacant and adding an appropriate endorsement to the commercial property policy.

prevent problems resulting from the effect of building ordinances or laws by recognizing ordinance or law exposures and adding the ordinance or law coverage endorsement with adequate limits to cover them.

prevent problems resulting from uninsured flood and earthquake losses by offering coverage or ensuring that the client is aware that these perils are uninsured.

prevent problems associated with excluded equipment breakdown claims by supplementing commercial property policies with equipment breakdown coverage.

Review of Commercial Property Coverage

Commercial property policies specify what types of property are covered and what types of property are not covered. Agents and brokers face potential E&O claims when an unhappy client suffers a loss to property that has not been properly covered. Before examining specific issues, it is necessary to review the ways in which commercial property policies address properties that are and are not

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covered. The discussion here generally applies to commercial property forms, such as the Insurance Services Office, Inc. (ISO), building and personal property coverage form.

Most commercial property forms cover most types of property typically owned by a business. However, it is important to remember that coverage specifics will vary from one policy to the next. Nevertheless, it is important to review the covered and excluded property provisions carefully, with the needs of the organization in question firmly in mind. The discussion that follows deals only with covered property; it does not address covered perils or other aspects of these forms’ coverage.

Covered Property A standard commercial property policy provides fairly detailed descriptions of covered property. The covered property provision of the ISO building and personal property coverage form (CP 00 10) establishes three categories of covered property.

Building property

Business personal property

Personal property of others

Coverage for any or all of these property categories is “activated” when a limit of insurance (or a notation such as “Included”) is shown for that category on the policy declarations page. If no entry is made in the declarations, that means there is no coverage for that category of property. This should only happen when the insured clearly has no need for coverage on a particular property category. For example, a building owner who leases the entire building to a tenant might have no need for coverage on business personal property.

Building PropertyThe building property category includes not only the building(s) identified in the policy declarations, but a number of other types of property as well. Exhibit 2.1 summarizes the property that qualifies for coverage under the building property category.

Exhibit 2.1Covered Building Property

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Buildings and structures identified in the declarations

Completed additions

Fixtures, including outdoor fixtures

Permanently installed machinery and equipment

Owned personal property used to service and maintain the building and premises

Additions under construction, alterations, and repairs to the building or structure, if not covered by other insurance

Materials, equipment, supplies, and temporary structures within 100 feet of the premises that are used in making the additions, alterations, or repairs

Buildings and StructuresFirst of all, the building property category applies to the buildings and structures that are identified in the policy declarations. While the words building and structure are not defined in the policy, a building is generally thought of as a walled, roofed structure, and a structure may be thought of as property permanently attached to land that is not walled and roofed. For example, a picnic shelter and a water tower would not ordinarily be thought of as buildings, but they would nevertheless be insurable as structures.

Coverage is limited to buildings and structures that are described in the declarations. It is therefore important that the description includes all locations for which coverage is intended, either by listing them or by some other appropriately inclusive reference (such as “all locations shown on the statement of values on file with the insurer”) so that no gaps in coverage result.

How the covered buildings and structures are described on the declarations page may ultimately prove to be important in the event of a dispute between the insurer and the insured. For example, if the description is simply a street address, and there is more than one building at that address, the covered building property provision would automatically extend coverage to apply to all buildings at that address. As a practical matter, the insurer normally is aware of the existence and nature of all of the insured’s buildings at the street address(es) shown in the declarations.

Completed Additions The building property category includes additions to covered buildings and structures that are complete as of the time of the loss.

Courts have taken several approaches in deciding what qualifies as an addition. In Joseph E. Bennett Co., Inc. v. Fireman’s Fund Ins. Co., 344 Mass. 99, 181 N.E.2d 557 (1962), the court held that “the term ‘addition’ most aptly describes an enlargement of what previously existed by a piece of construction of the same general character, having some definite connection and community of use with the basic building.” Under that standard, the court concluded that an in-ground swimming pool that was only tenuously connected to the clubhouse at a golf course was not an “addition.” The pool was situated on a separate terrace connected to the concrete apron around the clubhouse only by a set

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of stairs, and the manner of use of the pool was substantially different than the manner of use of the clubhouse. (In dicta, the court commented that “an open, uncovered swimming pool may be a ‘structure’” though.)

In Rahrig v. Lamse, 2000 Mich. App. LEXIS 619 (Mich. Ct. App. June 9, 2000), the court focused on a physical connection between the addition and the main building. In that case, the court held that since the phrase “completed addition” modifies the term “building,” the policy impliedly required that the addition be physically attached to the insured building. The court, therefore, held that the policy did not cover a loss to a detached gazebo that was not described in the declarations.

However, the court in Atlas Pallet, Inc. v. Gallagher, 725 F.2d 131 (1st Cir. R.I. 1984), ignored the physical connection and focused on the operational interdependence of the addition and the main building. In that case, part of the foundation of the insured’s manufacturing facility extended 40 feet into a river. Attached to the foundation was a milldam that extended all the way across to the other side of the river. The purpose of the milldam was to dam up and divert water into a “watercrib” (i.e., a container) in the basement to raise the water pressure for a gravity-fed sprinkler system. When the river flooded, the milldam collapsed, the building’s foundation and watercrib sustained damage, and the gravity-fed sprinkler system was inoperable. The Atlas Pallet court held that, in order to be covered as an addition, the milldam would have had to have been “indispensably connected or related to the purpose or use of the manufacturing facility.” In the court’s view, the milldam did not qualify under this test, reasoning that “Important though the function of the dam was—in providing a positive head of water for the sprinkler system—that function was not indispensably related to the use of appellant’s building for manufacturing and storing purposes. That is, the milldam was not involved in any way in the manufacturing, reconditioning or storing of wooden pallets, which were, and presumably still are, the uses to which appellant’s building was put.”

In Japour v. Ed Ryan & Sons Agency, 215 A.D.2d 817, 625 N.Y.S.2d 750 (N.Y. App. Div. 3d Dep’t 1995), the court did not require that the addition be physically connected to the main building, nor that it be indispensable to the operation of the main building. Instead, the court equated the word “addition” to the legal term “appurtenance,” which, in this context, are outbuildings located in physical proximity to the main building that are legally annexed to the owner’s title and that merely supplement the owner’s use and enjoyment of the premises. On this basis, a detached three-car garage qualified as a completed addition to the main apartment building.

FixturesThe building property category includes both indoor and outdoor fixtures. The term fixture is not defined in the building and personal property coverage form. In real estate law, a fixture is generally understood as an item that has been physically attached to land or to a building or structure in such a manner as to evidence an intent that it remain part of the real property. Thus, a fire escape bolted to the side of a building would qualify as a fixture, but a ladder leaned up against the outside of a building would not. Other examples of fixtures would include indoor light fixtures, signs attached to buildings, a flagpole cemented into the ground on the insured’s premises, and light poles in the parking lot.

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The building and personal property coverage form includes fixtures in the building property category of covered property. They are also included in the business personal property category of covered property. Including fixtures in both categories is clearly deliberate. Further, there is no language that limits or makes any distinction between the items of property that may be insured as fixtures under either category. (There is one possible exception. It might be argued that the specific mention of outdoor fixtures under the building property category, combined with the lack of specific mention of outdoor fixtures under the business personal property category, suggest that perhaps outdoor fixtures, such as light poles, are covered only as building property.) Therefore, the inclusion of fixtures in the description of both covered building property and covered business personal property would—presumably—allow the insured to insure its fixtures under either category. For example, it would allow a landlord with no personal property other than fixtures to ensure them as building property. (Building insurance rates are normally lower than the rates for personal property in that building.) Likewise, it would allow a tenant with no real property other than fixtures to ensure them as business personal property.

There is no requirement that fixtures (generally, or outdoor fixtures in particular) be specifically described in the declarations for coverage to apply. In fact, the only building property that must be described for coverage to apply is the covered building or structure.

However, if the covered buildings are specifically enumerated in the schedule, courts may hold that the policy covers outdoor fixtures that are physically attached to the scheduled buildings, but not outdoor fixtures attached to the land elsewhere at that location.

Using the definition given earlier of the term fixture from Black’s Law Dictionary, which says that it is an item of personal property that is attached either to land or a building, it would seem indisputable that a light pole qualifies for coverage as a fixture. The specific mention of outdoor fixtures in the phrase “fixtures, including outdoor fixtures” seems to evidence an intent on the part of the form drafters to make it clear that fixtures attached to the land are included. Otherwise, there would be no need to mention outdoor fixtures, since there is no disagreement on the fact that personal property attached to a building qualifies as a fixture.

However, some insurers may interpret the term “fixtures” as attachments to covered buildings only. Further, the court decisions in these cases suggest that a court might uphold this very narrow interpretation of the term if, as is often the case, the description of the covered locations on the declarations page describes and identifies the covered buildings without making any mention of the grounds. This is unfortunate, since insurers rarely make any mention of the grounds at the insured locations on the declarations page of a commercial property policy to avoid giving the impression that coverage applies to the land itself.

One of the most common methods of describing covered property on the declarations page of a commercial property policy is to simply list the street address(es). It is possible that using this type of description on the declarations page would make it more likely that a court would rule in favor of coverage for outdoor fixtures attached to land in the event of a dispute over this issue. However, it might be wisest to avoid any possibility of dispute by discussing the need for coverage on outdoor

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fixtures attached to land (such as light poles and gas pumps) when arranging coverage and obtaining written confirmation that they are covered.

Permanently Installed Machinery and EquipmentPermanently installed machinery and equipment are included under the building property category. The phrase “permanently installed” is not explained or defined in ISO commercial property forms, and few, if any, states impose a technical meaning on this phrase. Some insurers might consider machinery and equipment as permanently installed if it is bolted to the floor. Others might assert that bolting to the floor is insufficient to establish that the property is permanently installed.

Machinery and equipment are also included under the business personal property category. Therefore, if the machinery and equipment in question do not qualify as being permanently installed, it would still be covered as business personal property, assuming that the policy provides coverage for business personal property. However, if separate limits of insurance apply to building property and business personal property, and the insured has included the value of the machinery and equipment in the limit for building property rather than business personal property, the limit of insurance for business personal property might be inadequate.

If the insured intends to cover machinery and equipment under the building property category, it would be wise to confirm during the coverage arranging process that the insurer agrees that it qualifies as being permanently installed and to obtain written confirmation to that effect. Another way to avoid this problem is to arrange for a blanket limit that applies to both building and business personal property.

Personal Property Used To Service the BuildingThe building category also includes personal property that is used to service the building, such as fire extinguishing equipment, outdoor furniture, floor coverings, refrigerators, dishwashers, and laundering appliances. Including personal property that is used to service the building in the building property category allows a landlord with no other personal property at that facility to insure all of its property under the building property category.

Additions under Construction, Alterations, Repairs, and Related MaterialsAdditions under construction, alterations, and repairs to the buildings and structures identified in the policy declarations also qualify as covered building property, provided that they are not covered by other insurance.

The same is true of materials, equipment, supplies, and temporary structures (like scaffolding) that are used to make additions, alterations, or repairs to covered buildings or structures. However, this coverage applies only while the materials, equipment, supplies, and temporary structures are on, or within 100 feet of, the described premises, and only if they are not covered by other insurance.

The coverage provided by a standard commercial property policy for property in the course of construction is not necessarily an adequate substitute for a builders risk policy. One problem is that a standard commercial property policy does not provide coverage for property in transit, except to the

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extent of the limited transit coverage provided in the special causes of loss form, if the special causes of loss form applies. Another problem is that a standard commercial property policy does not provide coverage for offsite storage of building materials and supplies, except in the form of a $10,000 coverage extension for property temporarily off premises at a location not owned, leased, or operated by the insured.

Business Personal Property The business personal property category applies to business personal property that is located at the premises described in the declarations. This includes property in the open or in a vehicle within 100 feet of the described premises or the building, whichever distance is greater. Coverage applies not only to furniture and fixtures, machinery and equipment, and stock, but also to “all other personal property owned by the insured and used in the business.”

The business personal property category is summarized in Exhibit 2.2.

Exhibit 2.2Covered Business Personal Property

Business personal property located on or in the premises or in the open or a vehicle within 100 feet of the described premises, as follows:

Furniture and fixtures

Machinery and equipment

Stock

All other personal property owned by the insured and used in the business

Labor, materials, or services furnished or arranged by the insured on personal property of others

Improvements and betterments made by the insured as a tenant

Leased personal property that the insured is contractually obligated to insure (unless provided for under the personal property of others category)

As mentioned earlier, there is some overlap between the building property category and the business personal property category. For example, fixtures are specifically included under both categories. Similarly, the business personal property category specifically includes furniture, and the building property category specifically includes outdoor furniture. Machinery and equipment also is included under both categories; the only distinction is that the building property category specifically applies to “permanently installed” machinery and equipment, whereas the personal property category does not impose this requirement. Including certain types of property in both categories allows the coverage to be arranged under whichever category makes sense for the insured. For example, an insured tenant with no building to insure could cover its machinery and equipment under the business personal property category, thus eliminating the need to determine and declare a separate limit for machinery and equipment under the building property category.

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StockThe business personal property coverage category specifically includes stock. Stock is a defined term that means (1) merchandise held in storage for sale, (2) raw materials used for manufacturing, (3) in-process or finished goods, and (4) supplies used for packing or shipping finished goods. Although the policy does not define the word merchandise, that term is ordinarily understood to mean “the commodities or goods that are bought and sold in business.”

The Value of LaborThe business personal property category also includes the value of work (i.e., labor, materials, and services) performed or arranged by the insured on personal property of others. For example, suppose the insured business is a dry cleaning service that offers garment alteration services as well. If a fire at the insured’s facility damages a number of customer’s garments that have been cleaned by the insured and altered by an independent contractor retained by the insured, the value of the dry cleaning services performed by the insured and the alteration services performed on behalf of the insured would qualify as covered business personal property under the policy.

Tenant’s Use Interest in Improvements and BettermentsAlso included in the business personal property category is the insured’s use interest as a tenant in improvements and betterments. Improvements and betterments are defined as fixtures, alterations, installations, or additions that are made a part of a building or structure that the insured occupies but does not own, and are acquired or made at the insured’s expense but cannot legally be removed. Suppose, for example, that an insured retailer leases space at a shopping mall and adds interior walls, carpeting, light fixtures, and a sound system at its own expense. If the lease does not permit the insured to remove these items at the end of the lease, they qualify as improvements and betterments, and their value is insurable under the business personal property category of covered property.

Leased Personal Property the Insured Is Contractually Obligated To InsureFinally, the business personal property category includes leased personal property that the insured is contractually obligated to insure. For example, many businesses lease photocopiers and other office equipment. When the equipment lease requires the insured business to maintain insurance on the leased equipment, it qualifies for coverage under the business personal property category. This is another example of deliberate overlapping of covered property categories. Leased personal property that the insured is contractually obligated to insure would also qualify for coverage under the third category of covered property—personal property of others. However, including it in the business personal property category allows an insured business to meet its contractual obligation to insure leased personal property without necessarily having to determine and purchase a separate limit of insurance for personal property of others.

Personal Property of OthersThe third and final category of covered property is personal property of others in the insured’s care, custody, or control. This applies to such property while located on or in the premises, or in the open

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or a vehicle within 100 feet of the described premises or the building, whichever distance is greater. Personal property of others would include the following.

Property that the insured leases from others (regardless of whether the insured is contractually obligated to insured it)

Property loaned to the insured

Property of visitors

Property of employees

As with the other two categories of covered property, a limit of insurance for personal property of others must be shown in the declarations in order for coverage to apply. This limit may be a separate limit applicable only to personal property of others, or it may be a blanket limit applicable to more than one of the three categories of covered property.

Property Not CoveredExhibit 2.3

Property Not Covered

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Accounts, bills, currency, food stamps, money, notes, and securities (but lottery tickets held for sale are not considered securities)

Animals, except as stock while inside buildings, and animals owned by others and boarded by the insured

Automobiles held for sale

Bridges, roads, walks, patios, and other paved surfaces

Bulkheads, pilings, piers, wharves, or docks

Retaining walls that are not part of a building

Foundations of buildings, structures, and machinery if below the lowest basement flood or the surface of the ground

Underground pipes, flues, or drains

Land, water, growing crops, and lawns (except lawns that are part of a vegetated roof)

Cost of grading, excavation, or filling

Vehicles or self-propelled machines, including watercraft, and aircraft that are licensed for use on public roads or are operated principally away from the described premises, except

o Vehicles and self-propelled machines manufactured, processed, warehoused by the insured or (other than autos) held for sale by the insured

o Rowboats or canoes out of water at the described premises

o Trailers, to the extent of coverage provided in the Non-Owned Detached Trailers Coverage Extension

Although standard commercial property policies cover most of the types of property typically owned by a business, there are certain types of property for which no coverage is provided. These excluded property types are identified in the “Property Not Covered” provision. Exhibit 2.3 summarizes the excluded property categories of a standard commercial property policy.

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Exhibit 2.3 (cont’d)Property Not Covered

Personal property while airborne or waterborne

Electronic data, other than prepackaged software held for sale by the insured and electronic data that is integrated in and controls the building’s elevator, lighting, heating ventilation, air conditioning, or security system, except as provided under the Electronic Data Additional Coverage

Valuable papers and records, except as provided by the Valuable Papers and Records (Other than Electronic Data) Coverage Extension

While outside of buildings: crops; fences; antennas (including satellite dishes); and trees, shrubs, or plants, other than as part of a vegetated roof or the insured’s stock; except as provided in the Outdoor Property Coverage Extension

Property in the course of illegal transportation or trade

Property insured more specifically under another policy, except for the excess of the amount due (whether collectible or not)

Rationale for Property ExclusionsSome of the types of property that are not covered are excluded because they are customarily insured under other, more specialized policies. Aircraft and watercraft are excluded for this reason. Automobiles are typically insured, for physical damage as well as legal liability, under automobile insurance policies. Bridges, roadways, piers, wharves, and docks are normally subjects for inland marine insurance. Coverage for money and securities is available under a commercial crime policy.

Of course, there are other reasons for excluding certain types of property. Underground pipes, flues, drains, and underground foundations are excluded because they are relatively unsusceptible to damage by the causes of loss that are covered in a standard commercial property policy. The same is true of retaining walls that are not attached to buildings; walks and other paved surfaces; and the cost of excavations, grading, and backfilling. Most businesses have not wanted to include and pay premium on these types of property, since the likelihood of covered loss is significantly less than for other types of property.

The exclusion of certain types of property while outside of buildings is imposed for the opposite reason—because they are especially susceptible to loss caused by exposure to the elements. The exclusion of property more specifically described and insured elsewhere is intended to prevent multiple recoveries for a single loss. Contraband or property in the course of illegal transportation or trade is uninsurable because of its illegal purpose.

Exceptions for Property Held for Sale by the InsuredThere are exceptions to a number of excluded property types for property that is held for sale by the insured (or that otherwise meets the policy’s definition of stock).

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The exclusions pertaining to animals, plants, and vehicles and self-propelled machines other than autos contain exceptions that preserve coverage for these types of property when held for sale by the insured.

The exclusion of money and securities stipulates that lottery tickets held for sale by the insured are not considered securities.

The electronic data exclusion specifies that it does not apply to prepackaged computer software held for sale by the insured.

Note, however, that autos held for sale by the insured are expressly excluded from coverage.

Restricted Coverage for Certain Types of PropertyFour of the excluded property categories contain exceptions that refer to other policy provisions. They state that a certain type of property is not covered, “except as provided in” a coverage extension or additional coverage provision elsewhere in the policy. This has the effect of restricting the coverage on these property types rather than excluding them from coverage altogether. The four property types that are excluded from coverage except as provided in a coverage extension or additional coverage are as follows.

Non-owned detached trailers

Valuable papers and records

Certain property while outside of buildings (crops; fences; antennas including satellite dishes; and trees, shrubs, or plants, other than as part of a vegetated roof or the insured’s stock)

Electronic data, other than prepackaged software held for sale by the insured and electronic data that is integrated in and controls the building’s elevator, lighting, heating ventilation, air conditioning, or security system

Vacancy ProvisionsVacancy of a building increases the likelihood of loss to property, unless special precautions are taken to prevent vacancy-related losses. Losses that do occur to vacant property also tend to be more severe, since delays in discovery often allow deterioration after the initial damage. For these reasons, standard commercial property policies contain vacancy provisions to protect the insurer against this significant increase in hazard, which presumably would not have been contemplated by the insurer in the underwriting and rating process.

The vacancy loss condition in the building and personal property coverage form severely restricts coverage on buildings that have been vacant for more than 60 consecutive days. Losses arising from the following are not covered at all if the building where the loss occurs has been vacant for more than 60 consecutive days before the loss.

Vandalism

Sprinkler leakage (unless the system has been protected from freezing)

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Building glass breakage

Theft or attempted theft

Recovery for other insured losses is reduced by 15 percent under the same circumstances (that is, if the building where the loss occurs has been vacant for more than 60 consecutive days before the loss).

The building and personal property coverage form contains specific definitions of vacancy for insureds that are landlords, general lessees, and tenants.

If the insured is a building owner or a general lessee, a building is considered vacant unless at least 31 percent of its total square footage is used by the building owner, a lessee, or a sub-lessee to conduct their customary operations.

If the insured is a tenant, the vacancy provision applies only to the unit or suite rented to the insured, and this space is considered vacant when it does not have enough contents for the insured to carry on normal business operations.

Two endorsements discussed later in this chapter can be used to modify or eliminate the vacancy provision.

Covered LocationsStandard commercial property insurance policies are basically designed to cover property that is at—or within 100 feet of—locations that are described (or scheduled) in the policy as covered locations. Only very limited coverage is provided on property that is at other locations. The key extensions of coverage for property at unscheduled locations are summarized below.

The newly acquired or constructed property coverage extension grants 30 days of temporary coverage for newly acquired buildings and personal property at newly acquired locations within the policy territory. The limits are $250,000 on newly acquired buildings and $100,000 on personal property at newly acquired locations.

The property off-premises coverage extension provides $10,000 of coverage on personal property away from scheduled locations within the policy territory.

If the policy is written on an all risks basis, the property in transit coverage extension in the special causes of loss form provides $5,000 of coverage for personal property transported by a motor vehicle owned, leased, or operated by the insured. Covered causes of loss for this extension are limited to fire; lightning; explosion; windstorm or hail; riot or civil commotion; vandalism; collision; upset or overturn; and theft of an entire bale, case, or package, as evidenced by visible signs of forced entry.

The commercial property forms provide very limited coverage on property in transit. Even though paragraph 2.i. excludes only airborne or waterborne property, the covered property provision establishes that business personal property is covered only while it is within 100 feet of the premises. The special causes of loss form contains a $5,000 coverage extension that applies to personal property transported by a motor vehicle owned, leased, or operated by the insured. However, this limit would be inadequate for many organizations. Also, coverage under the property in transit coverage

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extension in the special causes of loss form applies only to loss from fire; lightning; explosion; windstorm or hail; riot or civil commotion; vandalism; collision; upset or overturn; and theft of an entire bale, case, or package, as evidenced by visible signs of forced entry. Full coverage for property in transit is available under an inland marine transportation policy.

Property under ConstructionCommercial property policies are basically designed to cover completed occupied buildings and their contents. A standard commercial property policy covers additions, alterations, and repairs to covered buildings. It also provides temporary coverage for new structures under construction at covered locations. However, this limited coverage generally is not an adequate substitute for a builders risk policy. One of the major problems is that the coverage for property in transit and off-site storage of building materials is very limited. While it may be possible to address these and other limitations by endorsement, specialized inland marine builders risk policies usually provide broader coverage for property under construction.

Failure To Cover All LocationsFailing to provide coverage for all locations where the insured has property exposures can create big problems, not only for the insured, but also for the agent or broker who should have included coverage for property at those locations.

As mentioned earlier, commercial property insurance policies are generally designed to cover property at locations listed (or scheduled) in the policy as covered locations. Usually, the covered locations are listed on the declarations page or, if there are too many to list there, in a separate schedule of covered locations. Many policies provide very little coverage for property at unscheduled locations.

In addition to the insured’s primary location, other locations will likely require coverage as well because property at those locations is also exposed to loss. For example, the insured may acquire additional locations or use some locations for temporary storage. It is essential to ensure that all locations, scheduled and unscheduled, are covered.

Most policies provide limited coverage for property that is not at a specified location. For example, property that is in the open or in a vehicle is typically covered only if it is situated within a specified number of feet from the premises. The specified distance ranges from 100 to 500 feet (although a few forms cover up to 1,000 feet). While most policies afford no coverage for unscheduled buildings (except temporary coverage on newly acquired buildings), they usually do provide a limited amount of coverage (such as $10,000) on personal property at unscheduled locations that are within the policy territory. If a policy does not cover personal property at unscheduled locations, the insurer may be willing to add coverage for “any other location,” subject to a particular sublimit. An “any other location” limit is sometimes referred to as an “open limit.” An open limit generally applies to personal property at a location other than those described in the schedule of covered locations. Open

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limits can be very useful for businesses that often use temporary locations, perhaps to store supplies or merchandise.

Most commercial property policies provide temporary coverage (typically for up to 90 days) for newly acquired property. Many policies cover newly acquired buildings and personal property under the following conditions.

buildings while being built at an existing scheduled location or when acquired at a new location if intended for use as a warehouse or in a manner similar to described buildings

personal property at a newly acquired location, at a newly constructed or acquired building at a scheduled location, or at an existing location

Limits vary from $250,000 to $1 million for newly acquired buildings and from $100,000 to $500,000 for newly acquired personal property. To be covered, property must be situated in the coverage territory. Note that most property policies do not cover buildings in the course of construction at unscheduled locations. Construction projects away from the insured’s described premises should be covered under a builders risk policy.

Because commercial property insurance policies are intended to cover property at designated locations, they usually provide very limited, if any, coverage for property in transit. If the insured has more than an incidental exposure, transit coverage should be purchased via an endorsement.

Finally, any other additional locations (e.g., fairs or exhibitions) should be evaluated. If the policy does not already cover property at such locations, coverage should be arranged.

Real Life Scenario

Fred owns a lawn care business and meets with Al, an insurance agent, to obtain commercial property coverage with XYZ Insurer for his office, located at 25 W. Maple. Al procures coverage for this office building. Fred subsequently buys a second building, located at 35 Popular Street in order to house his mowers and other property. He does not specifically tell Al about this purchase, but Al procures coverage for the equipment, which lists the Poplar address as where the equipment is stored. There is a hail loss to the 35 Poplar building, and Fred makes a claim to XYZ for the damage, estimated at $75,000. XYZ denies coverage to Fred because the building is not on the commercial property policy. Fred files an E&O claim against Al, who reports it to his insurer.

Result: The E&O insurer was able to convince XYZ to pay part of the settlement, arguing the insurer should have known about the additional location since it was described in the application for the inland marine policy for the equipment. The E&O insurer was also able to argue that Fred should have read his policy. However, Al had some exposure in this matter because he failed to add the location to the policy. The E&O insurer eventually settles with Fred for $30,000 after getting a $15,000 contribution from the insurer.37

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RISK CONTROL TIP

Do the following to prevent problems caused by failure to cover property at all locations.

Make sure all locations owned or leased by the insured are listed in the declarations or, if necessary, in a separate schedule.

Determine whether coverage is required at locations other than the insured’s primary location (e.g., the location used for temporary storage).

Determine whether coverage is needed and included for personal property in the open, on a vehicle, or more than a specified distance from the insured’s building or premises.

If an exposure might exist or develop, ask the insurer to provide “any other location” coverage, subject to an open limit.

Be aware of the limits on newly acquired buildings and personal property.

Arrange transit coverage if a more-than-incidental exposure exists.

Fred owns a lawn care business and meets with Al, an insurance agent, to obtain commercial property coverage with XYZ Insurer for his office, located at 25 W. Maple. Al procures coverage for this office building. Fred subsequently buys a second building, located at 35 Popular Street in order to house his mowers and other property. He does not specifically tell Al about this purchase, but Al procures coverage for the equipment, which lists the Poplar address as where the equipment is stored. There is a hail loss to the 35 Poplar building, and Fred makes a claim to XYZ for the damage, estimated at $75,000. XYZ denies coverage to Fred because the building is not on the commercial property policy. Fred files an E&O claim against Al, who reports it to his insurer.

Result: The E&O insurer was able to convince XYZ to pay part of the settlement, arguing the insurer should have known about the additional location since it was described in the application for the inland marine policy for the equipment. The E&O insurer was also able to argue that Fred should have read his policy. However, Al had some exposure in this matter because he failed to add the location to the policy. The E&O insurer eventually settles with Fred for $30,000 after getting a $15,000 contribution from the insurer.

In this case, the agent was aware of the new location since the equipment was being stored there. Al should have asked Fred if he owned the building that the equipment was being stored in, thereby gaining an opportunity to (1) provide additional coverage for the new location and (2) avoid an E&O claim.

Inadequate Sublimits for Unnamed Locations

Some insureds frequently move personal property to temporary locations not scheduled on the policy. For example, property may be stored at a job site, a temporary warehouse, a trade show, a customer’s location, or even an employee’s home. Coverage gaps may occur if the “any other location” limit or “unscheduled locations” limit is inadequate to meet the insured’s needs.

An “any other location” limit is sometimes referred to as an open limit and may be described in the policy as an “open limit, applicable to personal property at a location other than those described in this schedule.” An open limit can be very useful for contractors or other insureds whose operations involve frequent use of temporary locations, perhaps to store materials or supplies. The sublimit on the policy may need to be increased to cover the maximum value of property the insured may have at any one location.

RISK CONTROL TIP

To prevent problems caused by inadequate sublimits for unnamed locations

Make sure the insured’s open limit (i.e., “any other location” limit) is high enough to cover the maximum exposure at any one location.

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Inadequately Insuring Vacant Property Vacant buildings create headaches for insurance agents and brokers, especially when the vacancy develops during the policy term and when the insured is not aware that this creates a coverage problem and does not notify the producer. A vacant building is especially susceptible to loss by vandalism and other causes.

Many property policies, including the ISO property form, contain a clause that limits coverage for vacant buildings. The vacancy clause appears in the loss conditions section of the form. It begins by defining vacant and building. The meanings of these terms vary depending on whether the policyholder is a tenant or a building owner. When the policy has been issued to a tenant, building means the unit or suite rented or leased to the tenant. Such a building is deemed vacant when it does not contain enough business personal property to conduct normal operations. When the policy has been issued to the owner or the general lessee of a building, building means the entire building. Such a building is vacant unless one or both of the following is true.

At least 31 percent of its total square footage is rented to a lessee or sub-lessee and used by the lessee or sub-lessee to conduct its customary operations

At least 31 percent of its total square footage is used by the building owner to conduct customary operations

Buildings under construction or renovation are not considered vacant.

The vacancy limitation applies only when a building has been damaged or destroyed and when the building was vacant for more than 60 days before the loss or damage occurred. In that event, the insurer will not pay for any loss or damage caused by any of the following, even if they are covered causes of loss.

Vandalism Sprinkler leakage (unless the insured has protected the system against freezing) Building glass breakage Water damage Theft Attempted theft

If the building has been damaged by a covered cause of loss other than those listed above, the insurer will reduce the amount it would otherwise pay for the loss or damage by 15 percent.

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Endorsements AvailableTwo endorsements can be used to alter the vacancy provision. The vacancy changes endorsement (CP 04 60) allows the 31-percent square footage use requirement to be replaced by a lower percentage specified in the endorsement schedule. ISO’s Commercial Lines Manual suggests the use of this endorsement only in situations where a use level lower than 31 percent does not present the hazards associated with vacancy.

Another endorsement, the vacancy permit endorsement (CP 04 50), can be used to rescind the vacancy provisions of the form. Under this endorsement, vacancy is permitted at the locations and during the time periods specified in the endorsement. The endorsement also allows for exclusions with respect to vandalism or sprinkler leakage, or both. When the exclusions apply, an “X” appears in the endorsement schedule.

Real Life Scenario

Burt has a snow removal company in northern Minnesota. He meets with Sally to procure coverage for his office building. Sally obtains commercial property coverage with ABC insurer. Burt also has a summer job as a baseball umpire for a semiprofessional baseball league, and Sally is aware of this. He closes his snow removal business every April 1 and reopens the following October. The office remains vacant between April 1 and October 1. On July 18, vandals break into the office building and "trash" the inside of the building, causing damages of $35,000. The claim is submitted to ABC, who disclaims coverage based on the vacancy exclusion, as the building was vacant more than 60 days at the time of the vandalism. Burt files suit against ABC and Sally, who reports the claim to her E&O insurer.

Result: The E&O insurer investigates and discovers that Sally knew the building was vacant from April 1 to October 1 but did not report that to the insurer when the coverage was placed. Had they known, the insurer would not have written the policy. The E&O insurer pays Burt the full $35,000, and the insurer pays nothing.

Since Sally was aware of the vacancy period, she should have offered Burt an endorsement to either modify or eliminate the vacancy exposure via a vacancy permit endorsement. She should have been aware that vandalism during vacancy was a realistic exposure, due to the nature of Burt's activities.

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No Ordinance or Law Coverage

Commercial property insurance is basically designed to repair or replace the property that was damaged or destroyed with similar property of like kind and quality. This might not be possible if building codes or other laws require extensive and expensive changes to comply with current requirements. The agent or broker who fails to anticipate the effect of these building ordinances or laws may be accused of an error or omission when the insured finds that substantial loss recovery costs are not covered even though they could have been covered. Let’s take a close look at the problem and how it can be addressed.

Building codes, zoning laws, the Americans with Disabilities Act (ADA), and other laws may significantly increase the cost of repairing or replacing a damaged building. Building codes may require new or alternate designs, more expensive building materials, additional features, or even a different location for buildings that have been damaged by a peril covered by the insured’s property policy. Such codes may also require buildings damaged beyond to a certain extent (such as 50 percent) to be demolished and rebuilt. Zoning and land use requirements may prohibit an insured from reconstructing a building for the same purpose as the existing one at the same site. The ADA has to do with making public and commercial buildings physically accessible for disabled persons. The changes required by the ADA apply only to certain commercial buildings and only to new buildings, and to additions and alterations to existing buildings.

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RISK CONTROL TIP

To prevent problems resulting from losses to vacant premises.

Make all insureds aware of the need to report changes in occupancy so they can be addressed.

Use the vacancy changes endorsement to modify the vacancy definition in situations where a use level lower than 31 percent does not present an increase in hazard.

Use the vacancy permit endorsement, with or without vandalism and/or sprinkler leakage exclusions, to provide coverage on vacant premises

The extra construction costs created by these building codes are excluded under all of the ISO causes of loss forms, except for a $10,000 increased cost of construction additional coverage. The ordinance or law exclusion in these forms precludes coverage for loss resulting from the enforcement of ordinances or laws that regulate construction, demolition, repair, or use of property. Thus, the insured has almost no coverage for additional cost associated with repairing the damage from a covered loss (over and above the cost that would have been incurred in the absence of these ordinances) that is incurred in order to comply with these ordinances. Unless ordinance or law coverage is added to the policy, the insured will have to pay nearly all of these costs out of pocket if a covered building is damaged and then repaired or rebuilt.

Endorsement AvailableThe ordinance or law coverage endorsement (CP 04 05) can be used to add coverage for the direct damage portion of this loss exposure. This endorsement adds three important coverages.

Coverage A—Coverage for loss to the undamaged portion of the building. This covers loss in value of the undamaged portion of the building as a consequence of enforcement of an ordinance or law that requires the demolition of undamaged parts of the same building. Coverage A is included in the limit of insurance. Note that this coverage is automatically included if the damaged property is valued according to replacement cost.

Coverage B—Demolition cost coverage. This covers the cost to demolish and clear the site of undamaged parts of the same building. (The cost to clear the site of damaged parts is covered under debris removal coverage.)

Coverage C—Increased cost of construction coverage. This covers the increased cost to repair or reconstruct damaged portions of that building and/or reconstruct or remodel undamaged portions of the building when the increased cost is a consequence of enforcement of the minimum requirements of the ordinance or law.

The limits applicable to coverages B and C for demolition and increased cost of construction, respectively, must be shown in the endorsement schedule.

Current editions of CP 04 05 state that the insurer will pay the same portion of the building ordinance loss as the ratio of the damage from covered causes to the total damage from both covered and excluded causes. For example, suppose that a hurricane destroys a covered building and that 40 percent of the damage is from wind (which is a covered cause of loss) and 60 percent of the damage is from flood (which is an excluded cause of loss). A local building ordinance requires demolition and reconstruction in accordance with current building codes whenever damage to a building is equal to or greater than 50 percent of the building’s value, regardless of the cause of the damage. The insurer will pay 40 percent of the resulting building ordinance loss, since 40 percent of the damage that triggered the building ordinance was from a covered cause of loss.

No coverage is afforded under CP 04 05 for the costs of complying with any ordinance or law requiring demolition, repair, reconstruction, etc. due to the presence of pollutants, fungus, wet or dry

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rot, or bacteria, or requiring the insured to test for or otherwise address pollutants, fungus, wet or dry rot, or bacteria.

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Real Life Scenario

Mel is an attorney in private practice. He purchases a Victorian style home to serve as the office for his law practice. He approaches Lisa to procure commercial property coverage for the law office. Lisa obtains a commercial property policy with XYZ. Six months later, a fire inflicts substantial damage to the building. While the insurer steps in and pays most of the cost to rebuild the office, there are significant additional costs to bring the office up to modern day building codes and Americans with Disabilities Act (ADA) required accessibility. These costs are $42,000, which XYZ refuses to pay, as there was no ordinance and law coverage included. Mel makes a claim against Lisa, who submits the claim to her E&O insurer.

Result: In investigating the claim, the insurer determines that Lisa did not understand that after a claim such as this, an older building may be required to have additional repairs in order to be compliant with local law. The E&O insurer settles with Mel for $33,000, arguing that as an attorney, Mel should have read the policy and known of this potential exposure. However, Lisa also should have known of the exposure, as the office building was very old. She should have alerted Mel to his potential exposure to this type of potential costs and should have offered to procure coverage to prevent or lessen the exposure.

Lisa should have offered to obtain an ordinance or law coverage endorsement that would have greatly reduced or eliminated this exposure.

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No Flood and Earthquake Coverage

When property is damaged by a flood or an earthquake, many policyholders are surprised to learn that their property insurance—even if the agent referred to it as “all risks” coverage—does not cover these perils. The producer who failed to mention these limitations and suggest alternative means of providing coverage is likely to face E&O challenges from an angry client.

Earthquakes and floods can cause catastrophic losses for business entities—both direct damage losses and time element losses. Yet, too few properties that are exposed to these risks are insured against them. Reasons include the fact that flood and earthquake insurance can be difficult to obtain, and, even if the coverage is available, the cost can be prohibitive.

Flood ExclusionsVirtually all commercial property forms contain an exclusion of flood damage and, usually, a very sweeping exclusion of most other types of water damage (such as sewer backup, seepage, and mudslide) as well.

Flood Endorsements If the flood exposure is low to moderate, some insurers will add flood coverage to the basic property policy by endorsement. An ISO flood coverage endorsement is available, but most insurers that are willing to write flood insurance do so using their own coverage endorsements.

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RISK CONTROL TIP

To prevent problems resulting from the effect of building ordinances or laws.

Become aware of ordinances or laws that might increase the insured’s costs of rebuilding a damaged structure. This is especially likely to be a problem with older structures that do not comply with current building codes, but are grandfathered.

Recognize the building and personal property policy’s limitations on coverage for additional reconstruction expenses resulting from the operation of ordinances or laws.

Where an exposure might exist, add the ordinance or law coverage endorsement with adequate limits.

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National Flood Insurance ProgramFlood coverage is available to some property owners through the National Flood Insurance Program (NFIP). Coverage may be purchased directly from the NFIP or by a commercial insurer that participates in the NFIP’s Write Your Own Program. A property owner may purchase a policy only if the property is located in a community that participates in the national flood program. The NFIP policy provides limited coverage. The maximum limits available in the regular program are currently $500,000 on commercial buildings and $500,000 on commercial contents.

Although the federal flood policy provides coverage for the peril of flood, it lacks many of the coverages and coverage enhancements that are routinely available to cover loss by other perils under commercial property policies. For example, the NFIP makes no provision for time element coverage. A property owner can assess its flood risk by examining flood maps provided by the Federal Emergency Management Agency (FEMA). The maps are generally kept in community planning or building permit departments where they should be available for review. A flood map may indicate whether a business is located in a high hazard area, called a special flood hazard area. Insureds located in such areas should purchase flood insurance. However, flooding often occurs outside these 100-year-flood plains, and insureds located outside these areas should also consider flood insurance.

Real Life Scenario

Lilly owns a gym. She meets with Stan to obtain commercial property coverage for the gym. The gym is located a quarter of a mile from the Mississippi River. Stan obtains a commercial property policy for Lisa with ABC insurer. Two years later, after several days of heavy rains, the gym sustains water damage in the amount of $225,000. ABC investigates and disclaims coverage due to a flood exclusion. Lilly files suit against Stan and ABC. Stan reports the lawsuit to his E&O insurer, who investigates and finds that Stan had documentation in his customer file offering to obtain flood coverage for Lilly through the National Flood Insurance Program (NFIP) or a commercial insurer that participates in NFIP's write-your-own program. The E&O insurer declines to make any settlement offer based on this documentation.

Result: The case is tried, and the jury finds no liability on Stan because Stan had detailed notes of his offer to Lilly and her rejection of the offer. Further, Stan had offered the coverage several times and had written to Lilly, urging her to purchase flood coverage. He sent a letter to Lilly, confirming her rejection of the offer of flood coverage. Given the gym's location, and Stan's documentation, the jury decided this situation was entirely Lilly's fault.

Flood damage is a common risk and exposure, especially in areas where a body of water is nearby. Flood coverage should be discussed with the client and offered. This offer

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Earthquake ExclusionsProperty forms generally exclude earthquake coverage via an “earth movement” exclusion. Many forms contain an exclusion similar to that found in the ISO causes of loss forms. The exclusion is very broad—it precludes earthquake; landslide; mine subsidence; and earth sinking, rising, and shifting. Also excluded are soil conditions that cause settling or cracking of foundations and contraction, expansion, freezing of soil, and the action of water under the ground surface. Fire that results from these excluded perils is covered.

Earthquake EndorsementsISO offers a few endorsements for insuring the earthquake peril, but few insurers use them. For example, CP 10 40, earthquake and volcanic eruption, covers loss from earthquake and volcanic eruption. CP 10 45 is the sublimit version of CP 10 40. CP 10 45 is used to establish earthquake or volcanic eruption limits that are lower than the limits applicable to loss from other causes.

Difference in Conditions PoliciesSince few insurers are willing to write flood and earthquake coverage, often the best solution is to buy an all risks commercial property policy from a standard lines insurer and a difference in conditions (DIC) policy from an insurer that specializes in insuring catastrophe perils. The availability of DIC coverage varies with the conditions in the commercial property insurance marketplace. When the commercial property insurance market is extremely competitive, more insurers are willing to include flood and earthquake coverage as part of the commercial property policy, and consequently, fewer DIC policies are written. There is no standard DIC coverage form. In most states, DIC coverage is considered a non-filed inland marine coverage line, and regulators do not require insurers to file DIC coverage forms and rates for approval.

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RISK CONTROL TIP

Do the following to prevent problems resulting from uninsured flood or earthquake losses.

Make it clear to policyholders that building and personal property coverage forms provide no flood or earthquake coverage.

Offer flood and earthquake coverage to policyholders

Lilly owns a gym. She meets with Stan to obtain commercial property coverage for the gym. The gym is located a quarter of a mile from the Mississippi River. Stan obtains a commercial property policy for Lisa with ABC insurer. Two years later, after several days of heavy rains, the gym sustains water damage in the amount of $225,000. ABC investigates and disclaims coverage due to a flood exclusion. Lilly files suit against Stan and ABC. Stan reports the lawsuit to his E&O insurer, who investigates and finds that Stan had documentation in his customer file offering to obtain flood coverage for Lilly through the National Flood Insurance Program (NFIP) or a commercial insurer that participates in NFIP's write-your-own program. The E&O insurer declines to make any settlement offer based on this documentation.

Result: The case is tried, and the jury finds no liability on Stan because Stan had detailed notes of his offer to Lilly and her rejection of the offer. Further, Stan had offered the coverage several times and had written to Lilly, urging her to purchase flood coverage. He sent a letter to Lilly, confirming her rejection of the offer of flood coverage. Given the gym's location, and Stan's documentation, the jury decided this situation was entirely Lilly's fault.

Flood damage is a common risk and exposure, especially in areas where a body of water is nearby. Flood coverage should be discussed with the client and offered. This offer

No Equipment Breakdown Coverage

Agents and brokers who provide building and contents coverage on property but fail to provide equipment breakdown coverage face potential E&O claims. Although these policies cover many common causes of loss, most property insurance forms exclude the following perils.

Loss or damage caused by explosion of steam boilers, steam pipes, steam engines, or steam turbines owned, leased, or operated by the insured

Loss or damage to steam boilers, steam pipes, steam engines, or steam turbines caused by or resulting from a condition or event inside this equipment (with certain exceptions)

Loss or damage to hot water boilers or other water heating equipment caused by an event within the equipment, other than an explosion

Loss or damage caused by artificially generated electric current, including electric arcing, that disturbs electrical devices, appliances, or wires

Loss or damage caused by mechanical breakdown, including rupture or bursting caused by centrifugal force

Equipment breakdown coverage is designed to cover the perils listed above. Coverage may be provided under a separate monoline policy, by endorsement to a commercial property or package policy, or under a commercial property or package policy that is designed to include equipment breakdown coverage.

Virtually all organizations own or operate some type of mechanical and electrical equipment, but only some have exposures significant enough to purchase equipment breakdown insurance. Mechanical breakdown coverage is essential to any organization that has steam equipment on its premises. Other organizations that likely have a need for it are those that own equipment that could potentially

RISK CONTROL TIP

Do the following to prevent problems resulting from uninsured flood or earthquake losses.

Make it clear to policyholders that building and personal property coverage forms provide no flood or earthquake coverage.

Offer flood and earthquake coverage to policyholders

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damage other property. Mechanical breakdown coverage should also be considered when the breakdown of equipment could result in a business income or extra expense loss.

Equipment breakdown policies may include both direct damage coverage and time element coverages. Direct damage coverage applies to the cost to repair or replace the equipment suffering the accident or breakdown, plus the cost to repair or replace other property damage by the accident or breakdown. Coverage usually applies not only to the insured’s property, but also to property of others that is in the insured’s care, custody, or control. Many policies also provide coverage for defense costs (paid in addition to the limit) in connection with damage to property of others.

Other direct damage coverages provided by equipment breakdown policies may include spoilage, ammonia contamination, hazardous substances, ordinance or law, expediting expenses, water damage, and fungus. These coverages apply to losses that occur as a consequence of breakdown to covered equipment. Spoilage coverage, which is also referred to as perishable goods or consequential damage coverage, pays for loss to perishable goods due to the breakdown of covered equipment. This coverage is important to organizations that store or process items that must be stored at a constant temperature to avoid spoilage (e.g., perishable food, medicines, or flowers). Manufacturers may also need this coverage if they use electrical power, the interruption of which may damage the product.

Time element coverages included in equipment breakdown forms include business income, contingent business income, extra expense, contingent extra expense, ordinance or law, and utility interruption.

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RISK CONTROL TIP

To prevent problems from claims that could have been covered by equipment breakdown coverage.

Recognize the perils that most property policies exclude and the perils that equipment breakdown insurance can cover.

Recommend equipment breakdown coverage against both direct and indirect losses to all commercial clients.

Chapter 2 Review Questions1. Ann Agent just completed Surrey Company’s application for property insurance, which will

be written on an ISO building and personal property coverage form with the causes of loss—broad form. She understood that all the company’s property was located at 478 Sycamore Street. The client now mentions in passing that some of its extra equipment has always been kept in a rented warehouse at 500 Elm Street. Not wanting to revise the application she already completed, Ann assures the client that nothing further needs to be done to cover the warehoused property. Which of the following statements she also made is correct?

a. Surrey’s policy limit on personal property at unscheduled locations will be $100,000.

This answer is incorrect. The limit is $10,000. A $100,000 limit applies to personal property at newly acquired locations, not one the client has always used.

b. Surrey’s policy will automatically include some coverage for building property, but not personal property, at unscheduled locations.

This answer is incorrect. There is some coverage for personal property at unscheduled locations.

c. Surrey’s policy will cover $5,000 on property in transit between the warehouse and Surrey’s main location.

This answer is incorrect. $5,000 in transit coverage, applicable only to specified perils, is included in the all risks form, not the broad form.

d. Surrey’s policy will not include coverage on property in transit.

That’s correct! Transit coverage is included in the all risks form, not the broad form.2. Rodney, a sculptor, frequently has work on display at various locations other than his primary

business address. For example, as much as $30,000 of Rodney’s property might be at a trade show, at an exhibition, at a fair, or even in the garage behind his house. Rodney’s property insurance policy currently covers property at any other location, subject to a $10,000 limit. Rodney should

a. have the any other location limit increased to at least $30,000.

That’s correct! Rodney’s open limit (any other location limit) should be set high enough to cover the maximum exposure at any one location.

b. limit the amount of personal property that is away from his primary business location at any given time.

This answer is incorrect. It is unlikely that Rodney could do business without exhibiting his work. Rather, a way needs to be found to insure the exposures associated with his business.

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c. make sure no coinsurance penalty applies to property at any other location.

This answer is incorrect. Insurance to value is the best way to avoid a coinsurance penalty.

d. reduce his exposure by covering off-premises property on a replacement cost basis.

This answer is incorrect. Replacement cost coverage probably is not suitable for unique objects of art. Moreover, changing the valuation basis in his insurance does not reduce Rodney’s exposure.

3. Kitty owns an 18-unit apartment building that is insured under a standard, unendorsed Insurance Services Office, Inc., building and personal property coverage form. All units are the same, and until recently, the building was fully occupied. However, a nearby factory recently shut down, and for the past 90 days, only 6 of Kitty’s apartments have had tenants. Now she discovers that lightning has caused $10,000 in damage to the roof. The apartment building is insured to value, so no coinsurance penalty applies to this loss. Ignoring deductibles, how much will Kitty’s insurer pay for this loss?

a. Nothing

This answer is incorrect. Even though some units are unoccupied, Kitty does have coverage for the lightning damage.

b. $3,000

This answer is incorrect. Kitty will receive more than $3,000.

c. $8,500

This answer is incorrect. The vacancy penalty does not apply to this loss.

d. $10,000

That’s correct! Because 6 of its 18 units (33.3 percent) are still occupied, Kitty’s apartment building is not vacant. The vacancy penalty does not apply to this loss, which is covered in full.

4. Eve’s Bed and Breakfast is located in a former mansion she owns that is not handicap-accessible. Her current insurance policy will pay the cost of repairing any damage to the existing building by a covered peril. However, if the building is significantly damaged, Eve will need to tear down the undamaged portion of the building and replace the entire building with a structure that complies with the American with Disabilities Act. How should Eve’s insurance coverage be arranged to deal with this exposure?

a. Write Eve’s commercial property coverage on a functional replacement cost basis.This answer is incorrect. Functional replacement cost coverage might be good for other reasons, but it will not address the ordinance or law exposure.

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b. Issue the policy on an agreed value basis to avoid a coinsurance penalty, as Eve will probably be underinsured.This answer is incorrect. Eve is probably underinsured, but agreed value coverage by itself will not pay the extra costs associated with meeting the ordinance or law requirements.

c. Increase the limits on Eve’s commercial property policy to provide enough coverage to address the building’s actual replacement cost.This answer is incorrect. Replacement cost coverage will only replace the existing structure, even if it is totally destroyed.

d. Add the endorsement or law coverage endorsement to Eve’s commercial property policy.That’s correct! The endorsement will cover (a) loss to the undamaged portion of the building, (b) the cost of demolishing the undamaged part of the building, and (c) the increased cost of rebuilding in compliance with the applicable code(s).

5. The property insurance proposal that Ginger presents to Concord Company includes coverage for flood insurance. Because the company’s property is just outside the special hazard flood area, Concord decides against buying flood insurance. What else should Ginger do?

a. Have the client sign or initial a document acknowledging that the flood insurance proposal was rejected.

That’s correct! A sign-off provides proof that the coverage was discussed; this is a potent defense against an E&O claim that the client would have had flood insurance if the agent had suggested it.

b. Issue a broad-form policy rather than the all risks (special) policy initially proposed.

This answer is incorrect. Standard all risks (special) policies on buildings and contents exclude flood coverage.

c. Issue flood insurance anyway; it’s the right thing to do.

This answer is incorrect. Countervening a client’s express request is not the right thing to do.

d. Tell Concord she agrees with this decision because less than 30 percent of all flood insurance claims come from areas outside mapped high-risk flood zones.

This answer is incorrect. More than 20 percent of all flood insurance claims come from areas outside mapped high-risk flood zones, and Concord Company is close to a flood zone. By rejecting flood insurance, Concord is exposing itself to a potential uninsured loss.

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Chapter 3Direct Property E&O—Valuation Issues

This chapter begins by reviewing the key commercial property policy provisions that establish how much the insured will recover in the event of a loss to covered property from a covered cause.

Valuation of covered property

Coinsurance and the agreed value option

Limits of insurance

Deductible

It then continues to examine various problems that can develop when these matters are not handled properly. Discussion is based on the Insurance Services Office, Inc. (ISO), building and personal property coverage form. Similar provisions are found in many other policies.

Chapter ObjectivesOn completion of this chapter, you should be able to

understand the various provisions in a commercial property policy that affect the valuation of an insured loss.

prevent problems by selecting an appropriate basis for determining the insurable value of covered property.

prevent problems by using blanket limits when insuring more than one type of property and/or property at more than one location.

prevent problems by resisting the use of limitation of liability provisions and margin clauses.

prevent coinsurance penalties by making appropriate use of agreed amount coverage.

prevent the problems associated with reporting form insurance by conveying to clients the importance of submitting timely and accurate reports of values.

prevent problems associated with the high cost of debris removal by understanding how debris removal coverage works and offering increased debris removal limits when appropriate.

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Valuation of Covered PropertyThe valuation provision in the building and personal property coverage form establishes that most covered property is valued at its actual cash value (ACV). However, the policy also contains a replacement cost coverage option that, if elected, changes the valuation of most types of covered property to replacement cost. Thus, the insured may choose to insure its property on a replacement cost basis instead of an actual cash value basis.

Actual Cash ValueUnless the replacement cost coverage option been activated, the valuation provision of the building and personal property coverage form establishes that valuation of covered property is at its ACV (subject to a few exceptions). The term actual cash value is not defined in the policy, and the courts have sometimes been called on to determine its meaning. Essentially, the courts have defined the term actual cash value in three ways.

Replacement cost minus physical depreciation

Fair market value

According to the broad evidence rule

The first definition—the cost to replace the property less a deduction for any physical depreciation—is the traditional insurance industry definition. There are many court cases applying and upholding it.

However, sometimes the courts have found the replacement-cost-less-depreciation definition of actual cash value to be too limiting. Some of these courts have adopted the fair market value definition. Fair market value is generally defined as the price a willing buyer would pay a willing seller if neither were under any special constraints.

Some courts that deem the replacement-cost-less-depreciation definition of actual cash value too limiting have reached the same conclusion about the fair market value definition, and instead have applied the broad evidence rule. The broad evidence rule calls for all relevant evidence of the value of the covered property to be considered in determining its ACV.

Exceptions to Actual Cash ValueThe policy’s automatic ACV valuation provision establishes a few exceptions.

Tenant’s improvements and betterments. The valuation of tenant’s improvements and betterments is dependent on how quickly repairs are made. If repairs are made “promptly,” valuation is at actual cash value. If repairs are not made promptly, improvements are valued at a percentage of their original cost; the applicable percentage is the ratio of the number of days between the loss date and the expiration of the lease to the number of days between the installation of the improvements and the expiration of the lease. The reason is that since the tenant is not permitted to remove the improvements, the value to the tenant of permanent improvements made to leased real property declines with the running of the lease period. With the expiration of the lease, the tenant’s interest in the improvements will be completely

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extinguished. Therefore, an adjusted loss settlement would be justified in the event of a lengthy delay in effecting repairs.

Glass. The valuation of glass is at the cost to replace with safety glazing material if required by law.

Stock that has been sold but not yet delivered. Stock that has been sold but has not yet been delivered is valued at its selling price.

Damage to covered building property costing $2,500 or less to repair. Damage to covered building property that costs $2,500 or less to repair is covered on a replacement cost basis, provided that the limit of insurance for the building satisfies the policy’s coinsurance provision. The coinsurance provision is discussed later.

Replacement Cost OptionIf the replacement cost valuation option in the building and personal property coverage form has been selected, as evidenced by an indication in the policy declarations, most covered property is valued at its “replacement cost (without deduction for depreciation).” Under the replacement cost coverage option, the insurer will pay the smallest of the following amounts.

The cost to replace lost or damaged property with other property used for the same purpose, of comparable material and quality

The amount that is actually spent to repair or replace the damaged property

The limit of insurance that applies to the damaged property

There is no requirement to rebuild on the same premises. However, the insured’s loss recovery is limited to what it would have cost to rebuild on the same premises.

The insured may elect to make a claim on an ACV basis initially, perhaps to hasten the receipt of some loss recovery funds, and still submit a claim for the difference between the ACV settlement amount and the replacement cost, provided that the insurer is notified of this intent within 180 days from the loss date.

Replacement cost coverage applies only when the damaged property is actually repaired or replaced within a reasonable length of time after the loss. If the property is not actually repaired or replaced, loss payment will be made on an ACV basis (i.e., including a deduction for depreciation).

Four categories of property are covered on an ACV basis even when the insured has selected the replacement cost coverage option.

Fine arts. Fine arts are often insured on a valued basis using an inland marine fine arts coverage form to avoid disputes about valuation. (With valued coverage, each item is valued at the amount shown for it on a schedule of covered items.)

Residential contents. Residential contents will seldom be the subject of insurance under a commercial property policy. If so, it might be possible to negotiate replacement cost coverage on residential contents using a manuscript endorsement.

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Stock (unless the “including stock” replacement cost option in the declarations is indicated). Although stock and personal property of others are exceptions to the replacement cost coverage option, these types of property can be covered on a replacement cost basis by making the appropriate notations on the declarations page.

Personal property of others (unless the “replacement cost—personal property of others” extension in the declarations is indicated). The replacement cost coverage option does not alter the valuation provisions spelled out for stock that has been sold but not delivered and glass that, by law, must be replaced with safety glazing material. However, it does alter the valuation of tenant’s improvements and betterments, which are covered at replacement cost if repaired promptly; if not, the loss recovery will be a portion of the original cost.

Real Life Scenario

Phil owns a court reporting company and the building that houses the company. His agent, Lex, obtains commercial property coverage for the building through an insurer, Van Gough. Six months after the coverage is obtained, Phil decides to decorate the waiting room of his company with three paintings by a local artist, Richard. The commercial property policy is renewed each year with no major changes. A fire ensues 4 years later. XYZ offers to pay $2,500 for the three paintings, the amount Phil paid for them. However, this is not satisfactory to Phil because Richard has become quite famous in the ensuing 4 years, and Phil had the paintings appraised at $30,000, 2 months before the fire. Van Gough refuses to pay more than the $2,500 because the commercial policy pays for fine art on an actual cash value basis. Phil makes a claim against Lex, who submits it to his E&O insurer.

Result: The E&O insurer investigates and determines that while Phil had a duty to advise Lex of the subsequent appraisal, Lex had failed to discuss or document any offer of additional coverage for the paintings. The claim was settled for $10,000.

Lex should have offered Phil an inland marine fine arts coverage form. This endorsement would have provided additional coverage for the paintings. Each painting would have been individually appraised, and the value would have been shown on the declarations page.

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Valuation EndorsementsSeveral endorsements can be used to modify the valuation provisions of the policy.

The manufacturer’s selling price finished “stock” only endorsement (CP 99 30) is available to insure finished stock manufactured by the insured at its selling price, less discounts and unincurred expenses. Otherwise, only stock that has been sold but not yet delivered is valued at its selling price. The importance of this endorsement is explained in Chapter 4.

The functional building valuation endorsement (CP 04 38) is designed to be used when the cost of a functionally equivalent building would be less than the cost to replace the existing building “with like kind and quality.” It provides for settlement at functional replacement cost in the event of a total loss and for repairs in the same architectural style, but of less costly materials, if that is feasible, in the event of a partial loss.

The functional personal property valuation other than stock endorsement (CP 04 39) can be used when functional replacement cost exceeds replacement cost or when the cost to replace in function would be less than replacement cost.

The market value—stock endorsement (CP 99 31) is available to cover stock that is bought and sold at a market exchange at the value set by the market as of the time and place of loss.

A storage or repairs limited liability endorsement (CP 99 42) can be used to value personal property of others held by an insured bailee at the lesser of ACV or the value shown on the receipt issued to the owner.

Manufacturers with stock that would decline in value or be rendered valueless by the destruction of other stock in process of manufacture can have the reduction in value of the undamaged stock covered using a manufacturers consequential loss assumption endorsement (CP 99 02). In the absence of this endorsement, there would be no recovery for any physically undamaged stock.

CoinsuranceThe coinsurance provision in the building and personal property coverage form requires the insured to purchase a limit of insurance that is equal to a specified percentage of the full value of the covered property. The applicable coinsurance percentage is shown on the policy declarations page; it is typically 80 or 90 percent. If, at the time of loss, the limit of insurance is less than the limit of insurance required by the coinsurance provision, the insured will not collect the full amount of the loss. Instead, the insured will have to bear a portion of the loss that would otherwise have been covered by the insurer—that is, the insured will become a coinsurer for that loss. The amount of the

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loss that is not payable to the insured as a result of failure to comply with the coinsurance provision is commonly referred to as a coinsurance penalty.

If the insured fails to comply with the coinsurance provision, the loss recovery will be limited to the same percentage of loss as the ratio of the amount of insurance carried to the amount of insurance required. The formula in Exhibit 3.1 shows the calculation of the amount payable after application of the coinsurance requirement.

Exhibit 3.1Coinsurance Formula

For example, suppose that a particular building has a replacement cost value of $1 million and is insured under a property policy with a 90-percent coinsurance clause. Suppose further that the limit of insurance on the building is $800,000 and that there is a $500 deductible. Subsequently, there is a $100,000 loss. The 90-percent coinsurance clause requires that the building be insured for at least 90 percent of its full replacement value, which, in this case, is $900,000 ($1 million x .90). The insured’s recovery for the $100,000 loss will be $88,389, calculated as follows.

( $100,000 x $800,000 ) – $500 = $88,389$900,000

In this case, noncompliance with the coinsurance clause will result in an $11,111 coinsurance penalty to the insured business.

The coinsurance clause reduces the amount of recovery only in partial loss situations. In the event of a total loss, the policy would pay the total limit of liability applicable to that property—in this case, $800,000. Note that, in that case, the business would suffer an uninsured loss of $200,000 (the difference between the replacement cost value of the building and the amount of insurance purchased). However, this uninsured loss is the result of underinsurance, rather than a coinsurance penalty. Adhering to the coinsurance requirements of the policy serves only to prevent a coinsurance penalty in the event of partial loss; it does not prevent underinsurance. Blindly insuring to only 80 or even 90 percent could result in substantial hardship due to underinsurance in the event of a total loss.

A coinsurance clause is the insurer’s means of protecting itself against underinsurance. Since most property losses are partial losses, rather than total losses, insureds could purchase limits of insurance equal to only a fraction of the total value of covered property and still be fully covered for most losses. If this were permitted, insurers would receive an inequitable premium in relation to the risk of loss they assumed. In addition, few insureds would then have adequate protection against the catastrophic loss exposures for which insurance is the best, and often the only, remedy.

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Real Life Scenario

Agreed Value Coverage OptionOne way to avoid a coinsurance penalty is to activate the agreed value coverage option in the building and personal property coverage form. The agreed value coverage option eliminates the possibility of a coinsurance provision by suspending the coinsurance provision. The concept underlying the agreed value coverage option is that the insurer accepts the agreed value as an adequate portion of the total insurable value of the property to which the provision applies. Since this issue has been resolved prior to loss, there is no need for the coinsurance clause protecting the insurer against underinsurance. Therefore, the insurer agrees to suspend the coinsurance condition for 12 months from the effective date of the agreed value coverage option.

Most insurers will consent to provide agreed value coverage on receipt of an acceptable statement of property values signed by the insured. Receipt of an updated statement of property values is usually required for renewal of the agreed value coverage option.

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Susan owns a commercial building. She meets with Bill, who inspects the building and procures a commercial property policy with ABC in the amount of $500,000 on the building with an 80 percent coinsurance provision and a $1,000 deductible. Eight months later, a partial fire occurs, inflicting $100,000 in damage. ABC investigates and determines the building is underinsured and that the value of the building is actually $1 million. ABC applies the coinsurance provision and pays Susan $49,000 ($100,000 x $500,000/$1,000,000 – 1,000). Susan makes an E&O claim against Bill, who submits the claim to his E&O insurer.

Result: The E&O insurer investigates and learns that Bill admittedly took a "wild guess" as to the value of the property when completing the application. The E&O insurer settles with Susan for $49,000.

This is a frequent area of E&O claims. The insurance agent should take great care in making sure the property is appropriately appraised. There are several ways to do this: ask the insurer to do it, ask the insured to do it, or use an appraisal tool. From an E&O perspective, the best method is to have the customer provide the appraisal. All of the appraisal efforts should be carefully documented, and the customer's agreement with the value and process should be thoroughly documented with the customer's final approval of any valuations.

As explained later in the chapter, this is a very desirable coverage option. While a coinsurance penalty can also be avoided by insuring to the stipulated percentage of the value of the covered property, property values can be difficult to determine accurately, despite the insured’s best efforts. With the agreed value coverage option, there is no possibility of the insured suffering a coinsurance penalty until and unless it is allowed to expire.

Limits of Insurance The limits of insurance provision in the building and personal property coverage form states that the most that will be paid for loss or damage from any one occurrence is the applicable limit of insurance shown on the declarations page of the policy. The most that will be paid for loss to outdoor signs is $2,500 per sign.

Despite the statement that the applicable limit of insurance shown on the declarations page is the most that will be paid for loss from any one occurrence, the policy provisions establish a number of limits that apply in addition to the limit of insurance shown in the declarations—that is, they provide additional insurance. All six of the form’s coverage extensions and five of the form’s six additional coverages provide additional amounts of insurance. The amounts that are payable in addition to the limit(s) in the declarations are summarized in Exhibit 3.2.

Exhibit 3.2Amounts Payable in Addition to the Limits in the Declarations

Additional Coverages $10,000 per location—Debris removal expenses (under certain circumstances)

$1,000 per occurrence—Fire department service charges

$10,000 per location—Pollutant cleanup and removal expenses

$10,000 per building—Increased cost of construction

$2,500 policy year aggregate—Electronic data

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Exhibit 3.2 (cont’d)Amounts Payable in Addition to the Limits in the Declarations

Coverage Extensions $250,000 per building—Newly acquired or constructed buildings

$100,000 per building—Newly acquired personal property or personal property in newly acquired or constructed buildings

$2,500 per location—Personal effects and property of others

$2,500 per location—Valuable papers and records (other than electronic data)

$10,000 per occurrence—Property off-premises

$1,000 per occurrence—Outdoor property (fences, antennas, and trees, shrubs, and plants)

$5,000 per occurrence—Nonowned detached trailers

Scheduled versus Blanket LimitsThe limits shown in the declarations may be scheduled limits (also called specific limits) or blanket limits.

A scheduled limit is a limit of insurance that applies to a particular type of property at a particular location. If the declarations indicate a separate limit of insurance for each building and for personal property at each building, the policy is said to have scheduled (or specific) limits.

A blanket limit is a single limit that applies to more than one category of property, more than one location, or both. If the declarations indicate a single limit covering all covered property at all locations, the policy is said to have a blanket limit. Alternatively, there may be one blanket limit covering all buildings at all locations and another blanket limit covering all personal property at all locations. Another possible blanket limit arrangement is one blanket limit covering both buildings and personal property at a particular location, and another blanket limit covering both buildings and personal property at a second location.

Using an example to illustrate the difference between scheduled and blanket limits, take the case of a business with two buildings located in different cities, each having a replacement cost value of $2 million, and each furnished with business personal property having a replacement cost value of $1 million. The scheduled limits would be as follows.

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Buildings Personal Property

Location 1 $2 million $1 million

Location 2 $2 million $1 million

If there were, instead, a single blanket limit covering both locations and both buildings and personal property in full, it would be $6 million. If there were two separate blanket limits for buildings and personal property, the building blanket limit would be $4 million and the personal property blanket limit would be $2 million. If there were separate blanket limits for each location, the limits would be $3 million at location 1 and $3 million at location 2.

A blanket limit helps to avoid the possibility of underinsurance, particularly when used in combination with the agreed value coverage option. For example, suppose that in the foregoing example, a tornado totally destroys the building and its contents at location 1, and despite the business’s best efforts to develop accurate replacement cost value estimates, it will actually cost $2.25 million to replace the building and $1.5 million to replace the machinery and equipment. With specific limits as described, the business is underinsured by $750,000 ($250,000 for the building and $500,000 for the personal property). With either of the first two blanket limit arrangements described and the agreed value coverage option, the business is not underinsured at all. (However, with the third blanket limit arrangement described, the business is underinsured by $750,000, just as with specific limits. The $3.75 million loss exceeds the $3 million blanket limit applicable to buildings and contents at location 1 by $750,000.)

Even without the agreed value coverage option, a blanket limit does offer some protection against underinsurance in the event of a total loss. However, it does not necessarily prevent a coinsurance penalty because the coinsurance clause includes a blanket limit provision. This provision specifies that when a blanket limit applies to damaged property, the coinsurance clause applies to the total value of all of the property covered by the blanket limit. Using the previous example to illustrate, suppose that the business had underestimated the value of all of its property such that each building would cost $2.25 million to replace and the contents of each of the two buildings would cost $1.5 million to replace. The total value of the property covered by a $6 million blanket limit is $7.5 million; the blanket limit needed to comply with a 90-percent coinsurance clause would be $6.75 million. Recovery for the $3.75 million tornado loss at location 1 would be 88 percent ($6 million divided by $6.75) of $3.75 million, or $3.3 million. Had specific limits been in effect, the recovery would have been $3 million (the $2 million limit on buildings at location 1 plus the $1 million limit on personal property at location 1).

In the event of a partial loss, the effect of blanket insurance on loss recovery varies depending on whether the location involved in the loss was more or less significantly undervalued than the other loss locations. Exhibit 3.3 illustrates this point.

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Exhibit 3.3Effect of Blanket Insurance on Partial Loss Recovery in the Absence of the Agreed Value Coverage Option

Amounts Insured Actual Replacement Cost Values

Location 1 (specific) $1,000,000 $1,800,000Location 2 (specific) $1,500,000 $1,700,000Locations 1 & 2 (blanket) $2,500,000 $3,500,000

Exhibit 3.3 (cont’d)Effect of Blanket Insurance on Partial Loss Recovery in the Absence of the Agreed Value Coverage Option

Amount of Insurance Required at 80-Percent CoinsuranceLocation 1 $1,800,000 x .80 = $1,440,000Location 2 $1,700,000 x .80 = $1,360,000Locations 1 & 2 $3,500,000 x .80 = $2,800,000

Coinsurance Formula[Amount of Insurance Carried ÷ Amount of Insurance Required] x Loss =Loss Recovery (up to 100 percent)

Situation 1$500,000 Partial Loss at Location 1

Loss Recovery if $1,000,000 specific limit applies:     [1,000,000 ÷ 1,440,000] x 500,000 = .69 x 500,000 = $345,000Loss Recovery if $2,500,000 blanket limit applies:     [2,500,000 ÷ 2,800,000] x 500,000 = .89 x 500,000 = $445,000

Situation 2$500,000 Partial Loss at Location 2

Loss Recovery if $1,500,000 specific limit applies:     [1,500,000 ÷ 1,360,000] x 500,000 = 1.00 x 500,000 = $500,000Loss Recovery if $2,500,000 blanket limit applies:     [2,500,000 ÷ 2,800,000] x 500,000 = .89 x 500,000 = $445,000

Provided that the values used to arrive at the specific limits are very accurate and are adequate to contain normal fluctuation in contents values, there is no need to fear specific limits. However,

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blanket limits do offer a reassuring margin for error, particularly when combined with the agreed value coverage option.

Blanket limits are particularly helpful in situations where inventory is frequently moved between two or more locations, while the total value at risk remains relatively constant. The blanket limit eliminates the need to insure each location on the basis of the anticipated maximum value of the inventory.

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Real Life Scenario

Dealing with Fluctuation in Property ValuesIf the insured’s property values are stable, maintaining appropriate limits of insurance during the policy term is not a problem. In this situation, the policy’s limits of insurance can be reviewed annually and adjusted at each policy anniversary. If relatively small increases or fluctuations in property values are expected during the year, simply setting the applicable limits of insurance high

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Roger owns a duck hunting decoy business. He makes duck decoys and markets them on the Internet. He has a manufacturing plant, located north of Anywhere, U.S.A., as well as a warehouse and office, located south of Anywhere. His agent, Larry, obtains a commercial property policy for each location. Larry obtains a commercial property policy with insurer XYZ for the manufacturing plant with $1 million in building coverage and $500,000 in business contents. He gets the exact same policy for the warehouse. A fire breaks out in the warehouse, rendering it a total loss. The contents damages are evaluated at $780,000. XYZ pays Roger the contents limits of $500,000. Roger files a claim against Larry, stating that he thought the two policies could be added together so that he had $1 million in contents coverage. Larry submits the claim to his E&O insurer.

Result: The E&O insurer investigates and determines that there is no documentation regarding the discussions regarding the total limits of the policy and no documentation regarding other limit options. The insurer argued that Roger had a duty to read his policy but felt there was some exposure to Larry for failing to discuss various coverage options. Larry was aware that in the summer and early fall, Roger manufactured more decoys and that he had a significant amount of more decoys stored at the warehouse. The claim was ultimately settled with a payment to Larry for $125,000.

Larry should have either offered Roger higher limits on the warehouse or considered offering blanket commercial property coverage for the two locations, which could then be combined to provide higher total limits per loss.

enough to contemplate the highest expected values would eliminate the need for constant monitoring of property values, and any resulting overpayment of premium would be insignificant.

However, if the insured’s property values are expected to fluctuate significantly during the year, or if inflation is such that the cost to replace covered property will rise significantly during the policy term, maintaining appropriate limits is much more challenging. Fortunately, there are coverage options and endorsements designed to address these situations.

Inflation Guard OptionStandard commercial property policies contain an inflation guard option. The inflation guard increases the limit of insurance for the property to which it applies, automatically and continuously, by a stipulated percentage of the initial coverage limit.

The inflation guard option is activated by an entry on the declarations page of an annual percentage increase in limit of insurance and an indication of what the category of covered property to which it applies. Although it is most often applied to the building property limit, the inflation guard can also apply to business personal property.

Peak Season EndorsementSome types of businesses experience much higher sales volumes during certain times of the year, and their inventories increase accordingly. The classic example is the toy industry, which makes a disproportionate share of annual sales during the Christmas season. Using a traditional approach to setting policy limits, an insured that purchased adequate insurance limits during its peak season would be overinsured during the remainder of the year.

The peak season limit of insurance endorsement (CP 12 30) provides a means to avoid overinsurance during the insured’s slack season (or underinsurance during the peak season) by establishing a higher limit for the period of time specified in the endorsement for the remainder of the year. For example, a retailer might use the endorsement to arrange for much higher limits during the months of November and December to properly insure its increased inventories during the Christmas season.

Value Reporting EndorsementThe value reporting form endorsement (CP 13 10) provides a solution for businesses that experience significant fluctuation in inventory levels that is not seasonal. When this endorsement is attached to the policy, the insured selects a limit of insurance that is equal to or higher than the maximum anticipated value for each location that is subject to the endorsement. The insured pays an estimated premium charge at the beginning of the policy term, but the final premium is determined by averaging the periodic reports of actual values that the insured is required to submit to the insurer. In this way, the insured business avoids paying for more insurance than is needed while maintaining adequate insurance for peak inventory levels.

However, the value reporting endorsement has significant disadvantages. The first is the reporting requirement itself, which must be taken very seriously. As long as reports are submitted on time, the insured can recover the full amount of the loss, up to the applicable limit of insurance. However, if a

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report is overdue at the time of a loss, the most the insured can collect is the value that was last reported for that location. If the first report is overdue at the time of the loss, the loss recovery will be limited to 75 percent of the loss, subject to the reporting limit as a maximum.

A second disadvantage of reporting forms is the full-value reporting requirement, which functions as a 100-percent coinsurance clause. Full, 100-percent values, on whatever valuation basis has been agreed to and specified in the policy (ACV or replacement cost), must be reported in order to avoid a potentially severe penalty.

It is important to realize that reporting values in excess of the limit will not act to increase the limit and that premium is to be paid on total values reported, even if the values reported exceed the limit. If personal property values increase beyond the applicable limit, the limit must be increased by endorsement to provide full coverage.

DeductibleThe building and personal property coverage form contains a deductible provision. The deductible provision establishes that the insurer will pay only the portion of the loss that exceeds the deductible amount indicated in the declarations, after first subtracting any applicable coinsurance penalty. Once the deductible has been subtracted, the insurer will pay the entire amount of the loss, up to the limit of insurance. The deductible applies once per occurrence only.

Since the deductible is subtracted from the amount of the loss, not from the amount of insurance, the application of the deductible does not always reduce the insured’s loss recovery. If the loss amount exceeds the applicable limit plus the deductible, the insurer must pay the limit of insurance (assuming that there is no coinsurance penalty), and therefore, the application of the deductible has no effect on loss recovery.

For example, suppose that a building valued at $100,000 is insured for $90,000, subject to 90-percent coinsurance and a $5,000 deductible. If that building were destroyed, the insured would collect the limit of insurance ($90,000). The loss amount ($100,000) minus the deductible ($5,000) is a figure larger than the limit of insurance ($95,000), but the limit of insurance ($90,000) is the most the insured can collect.

Failure To Match Limits with the Valuation Basis

When inadequate limits of property insurance have been purchased and a loss occurs, the limits of insurance may be used up before the insured has been compensated for the entire loss. Thus, inadequate limits may cause the insured to incur an out-of-pocket loss. The insured, of course, is likely to blame the agent who sold the policy with inadequate limits.

The insurable value of property depends on the valuation basis used in the policy. The applicable valuation basis under a property policy is usually replacement cost or ACV. As mentioned earlier, actual cash value usually means replacement cost minus physical depreciation—that is, original cost of new property less accumulated depreciation.

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Insureds, and even insurance producers, sometimes look at accounting reports to determine the value of the insured firm’s covered property. This is a mistake. The “book” value shown in these reports is a number used for accounting purposes. It should not be used as the insurable value of property. The book value of an item of property reflects an accelerated rate of depreciation, instead of actual physical deprecation. The purpose of the accelerated depreciation reflected in book value is to spread the acquisition cost of property over the property’s useful life for accounting purposes.

For example, Cookies-R-Us is a commercial baker. The firm has just spent $30,000 for a new oven that is expected to last 15 years, after which, it will be worth nothing. If the same amount of depreciation is allocated to each of the 15 years (using straight-line depreciation), the value of the oven will decrease by $2,000 each year (30,000/15 = 2,000) at an annual rate of .06667 (2,000/30,000). The firm’s accountant thinks that Cookies-R-Us will get the most benefit from the oven in the early years after its purchase. Thus, he employs accelerated depreciation at double the straight-line rate (.13334) over 15 years. He deducts $4,000 the first year, $3,470 the second year, $3,000 the third year, and so on. By the third year, his oven has a book value of $19,530, rather than the $24,000 value it would have using the straight-line method. If Cookies-R-Us uses this book value as the insurable value, the oven will likely be underinsured even if coverage is written on an ACV basis (since book value reflects accelerated depreciation instead of actual physical depreciation). If coverage is written on a replacement cost basis, the oven that is insured to book value will be even more significantly underinsured.

Some agents and brokers (and insurers) use computer programs to calculate the ACV or replacement cost of property. These programs have limitations and should not be relied upon exclusively. Some programs use little information about the specific property, relying instead on averages or generalizations. Some programs may not take into account geographic variations, building codes, and other factors that can affect property value. A program that produces accurate values for property located in Topeka, Kansas, may produce inaccurate values for property in New York City. These types of risk-specific adjustments require an element of human expertise and judgment.

RISK CONTROL TIP

To prevent problems associated with the incorrect valuation basis.

Understand why book value should not be used in determining a property item’s insurable value.

Make sure property limits reflect the property’s true insurable value, not its book value. Likewise, property insured for replacement cost should not have limits based on the property’s actual cash value.

Don’t rely solely on computer programs when establishing insurable property values.

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Less than Optimal Valuation Provisions

The valuation provisions in property policies vary. Some policies contain multiple provisions, applying replacement cost to some property (e.g., buildings) and ACV to other property (e.g., personal property). (This approach is common with homeowners insurance.) Certain types of property, such as stock and valuable papers, may be valued differently than other property items. The manner in which property is valued is important because it is a major factor in determining limits of insurance to carry and the amount of recovery the insured will receive after a loss. Therefore, valuation provisions in policy forms must be scrutinized to ensure they are appropriate and will afford adequate compensation for any losses that occur.

As explained above, ACV is calculated by subtracting accumulated physical depreciation from replacement cost. Thus, the only difference between the two valuation methods is the amount calculated for depreciation. The cost to insure a piece of property on a replacement cost basis is usually more than the cost to insure the same item of property on an ACV basis, primarily because of the need to purchase a higher limit of insurance when property is insured on a replacement cost basis. Thus, some insureds may choose to buy insurance that applies on an ACV basis because it is cheaper than replacement cost coverage. While premiums are reduced, the primary disadvantage of ACV coverage is that loss payments are also reduced. The insured must pay the cost of depreciation out of pocket.

Some types of property are not insured on a replacement cost or ACV basis. Items that are unique, irreplaceable, and/or hard to value should be insured on a valued basis. Suppose that Cookies-R-Us owns a statue that is displayed in the entryway of the firm’s head office. The statue is one of a kind, and the sculptor who made it is deceased. Cookies-R-Us had the statue appraised by an art expert. The statue is covered under Cookies-R-Us’s property policy on an inland marine form. The applicable limit for the statue is the appraised value.

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RISK CONTROL TIP

To prevent problems associated with the incorrect valuation basis.

Understand why book value should not be used in determining a property item’s insurable value.

Recognize the distinction between replacement cost and actual cash value

Insure property for its replacement cost unless there is a good reason to use actual cash value

Recognize situations in which alternative valuation methods are more appropriate than actual cash value or replacement cost.

Use of Specific Limits Rather than Blanket Limits

Although specific limits are a somewhat more straightforward approach, there are advantages to the use of blanket limits. An insured whose loss is not covered in full may blame his or her agent for failure to point out the advantages of blanket coverage.

As mentioned earlier in this chapter, commercial property insurance limits are usually arranged on either a scheduled or a blanket basis. A scheduled limit is a limit of insurance that applies to a particular type of property at a particular location. If limits are arranged on a scheduled basis, separate limits of insurance will apply to buildings and to personal property at each location.

A blanket limit is a single limit that applies to more than one category of property, more than one location, or both. Blanket limits can be arranged in several different ways. For example, a single blanket limit may apply to all property at all locations; this is the ideal arrangement. Alternatively, one blanket limit may apply to all buildings at all locations, and another blanket limit may apply to all personal property at all locations. Another possible arrangement is for one blanket limit to cover both buildings and personal property at a particular location, and another blanket limit to cover both buildings and personal property at a second location.

Blanket limits are generally preferable to single limits since blanket limits offer greater flexibility and protection. For example, suppose that Cookies-R-Us owns three large buildings at three separate locations. One building is used for manufacturing. A second building, located 4 miles from the factory, is used as a warehouse. The third building is located 5 miles from the factory. It houses the firm’s administrative staff and serves as a garage for the company’s 30 delivery trucks. The firm’s property policy shows the following scheduled limits.

Factory: $20 million building and $10 million contents

Warehouse: $10 million building and $5 million contents

Office/garage: $10 million building and $5 million contents

A fire breaks out at the warehouse. The building and all of the contents are completely destroyed. Just before the fire broke out, the warehouse received an unusually large delivery from a supplier.

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Cookies-R-Us has agreed to provide cookies for a county fair scheduled for the following week. At the time of the fire, the contents of the warehouse were valued at $7 million (replacement cost). This exceeds the $5 million contents limit by $2 million. Cookies-R-Us will have to pay the remaining $2 million out of pocket. Had all of the buildings and contents been covered under a single blanket limit of $60 million, Cookies-R-Us would have had ample coverage for the $17 million loss.

Use of a Per Occurrence Limitation or Margin Clause

Per occurrence limitations and margin clauses can create problems by effectively eliminating the advantages of blanket insurance. Therefore, the prudent agent or broker should avoid them. Here’s why.

A per occurrence limitation of liability provision limits the amount that the insured can collect for loss at a particular location to the amount shown for it on the schedule of values. It is often used with a margin clause, which increases the amount the insured could otherwise collect under a per occurrence limitation of liability provision. A typical margin clause allows the insured to collect up to a stipulated percentage of the value shown on the statement of values, such as 110 to 125 percent.

For example, assume that the contents of three warehouses are covered under a blanket limit of $10 million. The applicable deductible is $1,000. The policy includes a per occurrence limitation of liability endorsement with a margin clause of 115 percent. The value last reported at warehouse #1 is $3 million. The maximum loss payable is $3 million x 1.15 = $3,450,000. A fire destroys the contents of warehouse #1. The value of the contents at warehouse #1 at the time of loss was $3.1 million. After the deductible is subtracted, the loss amount becomes $3,099,000. The actual value did not exceed the $3,450,000 maximum value, so the insurer pays $3,099,000.

Now suppose that the last value reported was $3.3 million. The maximum loss payable is $3,795,000. The loss at the warehouse is $3.9 million. Once the deductible is subtracted, the loss becomes $3,899,000. This exceeds the maximum loss payable, so the insurer pays only $3,795,000.

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RISK CONTROL TIP

To prevent problems resulting from the use of specific limits.

Use blanket limits whenever possible to cover more than one type of property and/or property at more than one location..

Per occurrence limitation of liability provisions and margin clauses are typically attached to policies with blanket limits so that they essentially convert blanket limits to specific, per location limits. These provisions should be avoided if possible.

No Agreed Value Clause

As mentioned earlier, an agreed value clause can be used to suspend the operation of the coinsurance clause, thereby eliminating the possibility of a coinsurance penalty. Here’s how that works to prevent problems for the producer and the insured.

Most property forms, including the ISO building and personal property coverage form, contain a coinsurance clause. These clauses are designed to force the insured to purchase adequate limits of insurance. Most property losses are partial, rather than total, losses. If left to their own devices, many insureds who recognize that fact would purchase low limits of insurance. If many policyholders purchased only a minimum amount of insurance, insurers would collect fewer premiums, and they might lack the funds to pay large losses. A coinsurance clause imposes a penalty for underinsurance. When coinsurance applies, a coinsurance percentage is shown in the property policy declarations.

For example, if the coinsurance percentage is 90, the insured must purchase a limit of insurance equal to at least 90 percent of the insurable value of the property at the time a loss occurs. If a loss occurs and the insured has purchased less coverage than required, the insured becomes a coinsurer (pays a portion of the loss).

An agreed value (also called agreed amount) provision suspends the coinsurance clause. For example, the agreed value clause in the ISO property form CP 00 10 states that the coinsurance condition does not apply. It is replaced with a provision stating that the most the insurer will pay for a loss is the proportion that the limit of insurance bears to the agreed value shown for it in the declarations. By showing in the declarations an agreed value that is equal to the limit of insurance, the insurer essentially agrees in advance that the limit of insurance purchased by the insured is adequate for purposes of coinsurance compliance. Therefore, the loss will be paid in full (up to the limit of insurance and minus the deductible).

An agreed value provision may be included in the policy or added by endorsement. Regardless of the approach used, most insurers require a signed statement of property values from the insured as a

RISK CONTROL TIP

To prevent problems resulting from limitation of liability provisions and margin clauses.

Resist the use of these clauses.

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condition of granting an agreed value provision. A recent property appraisal or an explanation of how the values were determined may also be required to verify that the agreed value is accurate.

Agreed amount provisions are valuable since they suspend those troublesome coinsurance clauses. Such clauses should not be overlooked when policies are renewed. It is important to check the renewal to ensure the agreed amount provision is included.

Not Understanding Reporting Form Coverage

Because it matches insurance premiums with the values actually exposed to loss, reporting form coverage seems like the ideal way to provide coverage for clients with fluctuating values. However, these advantages are accompanied by the potential for serious problems if the client fails to report values accurately and on time. After a brief recap of reporting form coverage, we will who why it is so important to ensure that clients do report their values accurately and on time.

Reporting form coverage solves a problem. When insured values fluctuate, there is a danger that the values on hand at any given time may exceed the limit of insurance. For example, suppose the insured operates a large retail store that sells large appliances like ovens and washing machines. The amount of inventory fluctuates from one month to the next depending on sales and deliveries from manufacturers or wholesalers. Thus, the insured has elected to insure his property on a reporting basis. Under the ISO value reporting form, the insured may elect daily, weekly, monthly, quarterly, or annual reporting.

The Value Reporting Form (CP 13 10) is used to convert personal property coverage for some or all locations under the building and personal property coverage form to a reporting basis. Reporting form coverage applies to any location for which a reporting symbol is shown in the declarations instead of a coinsurance percentage. The value reporting form also extends reporting form coverage to any of three special types of locations for which a limit of insurance is shown in the declarations or schedule of limits.

Reported locations are locations, other than those shown in the declarations, that have been reported to the insurer as of the inception of reporting form coverage.

Acquired locations are locations acquired after reporting form coverage becomes effective.

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RISK CONTROL TIP

To prevent problems resulting from coinsurance penalties.

Activate or add the agreed value (or agreed amount) provision.

Make sure the limit of insurance is consistent with the agreed amount and that the agreed amount reflects an adequate determination of the values at risk.

Incidental locations are defined as locations other than those listed in the declarations, and other than reported or acquired locations, with values of up to $25,000.

Failure to submit reports on time can have very serious consequences. As long as accurate reports are submitted on time, the insured can recover the total amount of the loss, irrespective of the amount shown for that location on the last report of values, subject to the applicable limit of liability and the deductible. But late reporting limits the loss recovery to no more than the value last reported for that location; locations not shown on the previous report of values are not covered at all. If the first report is overdue at the time of loss, locations not identified in the declarations are not covered at all, and recovery is limited to 75 percent of the amount the insurer would have paid otherwise. This means 75 percent of the loss, but no more than 75 percent of the applicable limit shown in the declarations. In other words, even if the loss amount equals or exceeds the applicable limit of insurance, the insurer will pay only 75 percent of the limit.

Underreporting of values is also penalized. The full reporting requirement of the value reporting form is essentially a 100-percent coinsurance clause. In the event of loss, if the insured is found to have underreported the values for the loss location on the last report, recovery is limited to the same portion of the loss as the ratio of the reported values to the actual values as of the report date. For example, if the value shown for the loss location in the last report of values was $80,000, whereas the actual value for that location as of the report date was $100,000, the insured would collect only 80 percent (80,000 ÷ 100,000) of the loss amount—subject, of course, to the applicable limit of insurance. In the event of loss to a location acquired since the last report, compliance with the full reporting clause is measured in terms of the adequacy of reported values for all locations (rather than just the loss location) on the last report.

Because of the penalties imposed to late reporting or underreporting, it is important to submit reports of values on time and to include actual values. Also, it is important to realize that, even when reports are submitted properly, the values shown on the reports of value do not affect the applicable limits of insurance. Reported values in excess of the limit will not act to increase the limit. Moreover, premium is to be paid on total values reported, even if the values reported exceed the limit. If personal property values increase beyond the applicable limit, the limit must be increased by endorsement to provide full coverage.

RISK CONTROL TIP

To prevent problems associated with fluctuating values and reporting form insurance.

Understand how reporting form insurance works.

Emphasize to clients with reporting form coverage the importance of submitting reports of values accurately and on time. These reports should include the value of all covered property. For example, if all personal property is covered under the reporting form, the insured should not report only inventory values.

Do not use reporting forms with clients who are not able and willing to submit timely and accurate reports.

Monitor clients with value reporting forms to ensure

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Not Considering Cost of Debris Removal

Because debris removal costs usually reduce the limit of insurance available to replace damaged property, it is important to consider these costs when establishing the property limit. The remaining property limit should be high enough to pay for repairing or replacing that property once the debris has been removed. Here is why that can be a problem.

Many commercial property forms provide coverage for debris removal expense as part of the stated limits of insurance, subject to a sublimit of 25 percent of the direct damage loss amount. An additional $10,000 of coverage typically applies if the direct damage loss and debris removal expenses together exhaust the limit of insurance, or if 25 percent of the sum of the direct damage loss payment and the deductible is insufficient to cover the debris removal expense. Some forms cover debris removal within the limit of insurance but do not specify a sublimit.

The ISO direct damage coverage forms (such as the building and personal property coverage form) cover the cost to remove debris of covered property after a covered loss, subject to a sublimit equal to 25 percent of the direct damage loss amount plus the deductible. An additional $25,000 of debris removal coverage is available if the direct damage loss amount plus the debris removal expenses exceed the limit of insurance, or if the debris removal expenses exceed the sublimit. The debris removal additional insurance endorsement (CP 04 15) can be used to increase the additional debris removal coverage granted in the coverage forms to the amount specified in the endorsement.

Debris removal costs can be substantial. These costs are affected by factors such as the dump site fee, transport costs (to the disposal site), and accessibility of the property. Debris removal costs may be higher if the damaged property is located in a remote area or if the terrain is difficult to navigate. Property containing hazardous material like asbestos or lead may require special disposal methods. Also, if debris of covered property must be removed from a body of water located near the property, this may be challenging and costly.

Some categories of property are covered under a separate limit that includes debris removal costs. An example is trees, shrubs, and plants, which are usually covered under an outdoor property coverage extension, for named perils only and subject to a sublimit. The allotted limit varies from $1,000 in the

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RISK CONTROL TIP

To prevent problems associated with fluctuating values and reporting form insurance.

Understand how reporting form insurance works.

Emphasize to clients with reporting form coverage the importance of submitting reports of values accurately and on time. These reports should include the value of all covered property. For example, if all personal property is covered under the reporting form, the insured should not report only inventory values.

Do not use reporting forms with clients who are not able and willing to submit timely and accurate reports.

Monitor clients with value reporting forms to ensure

ISO form to $25,000 in some insurer forms. The limit typically includes removal of tree or plant debris.

Real Life Scenario

RISK CONTROL TIP

To prevent problems associated with the high cost of debris removal expenses.

Understand how the debris removal coverage of the insured’s policy works and how amounts spent on debris removal may reduce the limits available to pay for repair or replacement of damaged property.

Recognize factors that can increase a client’s debris removal costs.

Consider increasing debris removal coverage using the debris removal additional insurance endorsement.

Parker owns a bar and grille. He has obtained commercial property coverage with his friend, agent Tony, for several years, on the bar. Tony obtains commercial property coverage on the building in the amount of $400,000 and contents coverage in the amount of $80,000 with insurer ABC. Parker's bar is the most popular spot in town. Especially on weekends, there is a line out the door. Tony is a frequent patron of the bar. Tony's agency has a website, advertising their services. The website contains testimonials from happy customers. In addition, the website includes the following language, "We are your insurance partner. We have over 30 years in protecting the insurance needs of our bar and restaurant clients. You can be assured we will tailor your insurance policy to fit your specific business needs. You can rely on us to fully protect your business." The bar and grille sustains a total fire loss. ABC investigates and determines the replacement cost of the building is over $750,000. ABC pays their limits of $400,000. Parker is upset and instructs his lawyer to file suit against Tony for the

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Result: The insurer investigates and determines that while it is clear on the policy the limits for the property, and there is an argument that Larry had a duty to read his policy, the language on Tony's website, declaring they were "experts in the field of insuring bars and restaurants" and further promising to "fully protect the business" imposed a higher standard of care on Tony to take additional steps to make sure Parker was appropriately and adequately insured. The claim is settled for $300,000.

Be careful of what is written on agency websites or other

agency advertising. Any promises or claims can be used as evidence in a subsequent E&O claim to argue that the agent took on a heightened duty of care to obtain adequate or additional coverage.

Chapter 3 Review Questions1. Courts have used all the following in determining actual cash value EXCEPT:

a. Broad evidence rule

This answer is incorrect. The courts have used the broad evidence rule in defining actual cash value.

b. Fair market value

This answer is incorrect. Some courts have used fair market value in determining property’s actual cash value.

c. Preferred value

That is correct! The term preferred value has no relevance in the context of establishing insurable values.

d. Replacement cost minus physical depreciation

This answer is incorrect. Replacement cost minus physical depreciation is the traditional insurance industry definition of actual cash value.

2. Patty Cake Company has a standard commercial property policy with a 90-percent coinsurance provision. If the insurable value of the building is $1 million, what is the smallest limit of insurance for that building that Patty can buy and still be in compliance with the coinsurance provision?

a. $800,000

This answer is incorrect. Patty should purchase insurance with a limit that equals at least 90 percent of her building’s insurable value.

b. $900,000

That’s correct! Because $900,000 is 90 percent of $1 million, insurance with a $900,000 limit will meet the minimum coinsurance requirement. If Patty purchases insurance with a $900,000 limit, she should be sure to increase the limit if the value of her property changes.

c. $1 million

This answer is incorrect. Full insurance to value, combined with replacement cost coverage, will pay the cost of replacing the building if it is completely destroyed, and these limits substantially exceed the minimum limit that will meet coinsurance “requirements.”

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d. The limit of insurance is not relevant to coinsurance compliance.

This answer is incorrect. To determine whether the insured meets coinsurance requirements, it is necessary to compare the limit with the insurable value of the covered property.

3. Kristopher’s Klothing Store operates out of its own building, which has an insurable value of $200,000. The limit of insurance on the building is $160,000. Kristopher’s commercial property policy has an 80-percent coinsurance clause and a $10,000 deductible. If a fire destroys the entire building, how much will the insurer pay Kristopher for the loss?

a. $150,000

This answer is incorrect. $150,000 is the limit of insurance less the deductible, but the deductible is not subtracted from the limit.

b. $160,000

That’s correct! Since the amount of the loss ($200,000) less the deductible ($10,000) exceeds the limit of insurance, the insurer will pay out the limit of insurance.

c. $190,000

This answer is incorrect. $190,000 is the amount of loss minus the deductible, but the insurer will not pay more than the applicable limit.

d. $200,000

This answer is incorrect. The amount of insurance available is less than the property’s insurable value.

4. From the insured’s standpoint, per occurrence limitation of liability clauses or margin clauses that are attached to a blanket property insurance policy

a. are desirable because they convert blanket limits to specific, per location limits.

This answer is incorrect. They are not desirable.

b. have the undesirable effect of converting blanket limits to specific, per location limits.

That’s correct! Per occurrence limitation of liability provisions and margin clauses essentially convert blanket limits to specific per location limits, and they should be avoided if possible.

c. provide considerable flexibility in determining what insurance limits to carry.

This answer is incorrect. These clauses reduce the flexibility otherwise available by using blanket limits.

d. remove the limitation that would otherwise limit the maximum recovery for loss at a particular location to the amount shown in a schedule.

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This answer is incorrect. These clauses limit the maximum recovery for loss at a particular location.

5. Hugo agreed to renew his property coverage on a reporting form basis because he understood that this approach would cover the full value of his property without requiring him to overinsure at times when his insurable property values are low. However, Hugo's first report was submitted after the due date, and the reported values were higher than his policy limit. What would have happened if Hugo had had a loss to one of the locations shown in the declarations between the date the first report was due and the date it was actually submitted?

a. Hugo's limits would automatically have been adjusted to reflect the values shown in the report.

This answer is incorrect. The limits on a reporting form policy do not automatically adjust, even when reported values exceed the policy limit(s).

b. Hugo's loss recovery would have been limited to the amount shown in his application.

This answer is incorrect. Even if it is the same as the limit in the policy, the amount shown in the application is not the amount the insured will recover when the first report is overdue at the time of the loss.

c. Hugo's recovery would have been limited to 75 percent of the amount otherwise payable.

That's correct! If the first report is overdue at the time of loss, recovery is limited to 75 percent of the amount the insurer would have paid otherwise.

d. Hugo would have faced a 75-percent coinsurance penalty.

This answer is incorrect. The penalty calculation includes 75 percent, but not in the form of coinsurance.

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Chapter 4Time Element E&O Issues

The commercial property policies discussed in Chapters 2 and 3 provide coverage for direct damage losses—that is, they pay for the repair or replacement of the damaged property. An organization also may suffer a loss of income or an increase in operating expenses as a result of not being able to use the damaged property while it is being repaired or replaced. These indirect losses are called time element losses because the amount of the income loss or expense increase depends on how much time it takes to repair or replace the damaged property.

For many organizations, the time element loss exposure associated with their buildings, contents, and equipment is as serious as the direct property damage loss exposure. For some, it can even be more serious. The destruction of the property might bring operations to a halt or cause the organization to incur substantial unbudgeted expenditures to continue operations despite the damage. In either case, the continued existence of the organization may be threatened if the exposure is not properly identified and insured.

Coverage for time element loss exposures is generally available, provided that the correct coverage forms and endorsements are provided. Thus, it is crucial to correctly identify the organization’s time element loss exposures and to select and include in the policy the appropriate coverage forms.

This chapter addresses various problems the insurance producer may encounter, leading to errors and omissions (E&O) claims against the agent or broker if time element insurance is not handled correctly.

Chapter ObjectivesOn completion of this chapter, you should be able to

prevent problems associated with uninsured business income and extra expenses losses by understanding these exposures and choosing the most appropriate time element coverages.

prevent problems resulting from uninsured rental value losses by ensuring that clients who rent premises have rental value coverage.

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prevent problems resulting from uninsured leasehold interest losses by understanding the leasehold interest exposure and providing appropriate coverage to clients who currently have a favorable lease.

prevent problems resulting from business interruptions due to a loss of utility services, recognize the exposure, and provide coverage with an appropriate endorsement.

prevent problems associated with contingent business interruption exposures by recognizing the exposure and including contingent business income and/or extra expense coverage for firms exposed to contingent time element losses.

understand why many organizations need coverage for an extended indemnity period, and provide coverage where needed using an appropriate coverage option.

prevent problems when meeting the requirements of an ordinance or law involves an extended period of interruption by including time element ordinance or law coverage whenever providing ordinance or law coverage against direct losses.

prevent problems associated with inadequate business income limits by realistically evaluating the possible duration of a business interruption, using a worksheet, and using appropriate limits and coinsurance levels.

prevent manufacturing clients’ loss of profit due to damage or destruction of finished stock by using the manufacturer’s selling price finished “stock” only endorsement.

Failure To Cover Time Element ExposuresBusiness firms and their insurance advisors tend to focus attention on the firm’s liability exposures and its exposures to direct property loss or damage. E&O problems can develop when a producer fails to also recognize and insure against the firm’s business income and/or extra expense exposures. In some cases, these time element exposures can be even more critical or significant than the exposures to direct property loss.

There are two principal types of time element loss exposures associated with damage to an organization’s own facilities. Many organizations have a combination of both exposures.

Loss of income (including loss of rents)

Extra expense

Two additional key time element loss exposures are associated with damage to another organization’s facilities.

Dependent properties loss of income or extra expense

Utility service interruption

These exposures are discussed later in the chapter. For now, let us consider the issues associated with business income and extra expense exposures arising out of damage at the organization’s own premises.

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Loss of Income (Including Rents) Loss ExposuresOrganizations whose operations depend on particular buildings and specialized equipment typically have a loss of income loss exposure. In the event of severe damage to their facilities, these organizations would probably have to shut down until the buildings were repaired and the contents replaced, and the shutdown would cause a loss of income. Manufacturers are the classic example of businesses in this category because of their dependence on specialized production equipment.

Retailers also typically have a business income exposure for several reasons. First of all, the destruction of the retailer’s inventory alone would probably necessitate a shutdown, since there would be nothing to sell until new inventory arrives. Second, because usually both the location and the attractiveness of a retail store influence its success, makeshift operations will not, as a general rule, completely prevent an income loss. Even if new inventory is readily available, and even if it is possible to keep the store open for business while repairs are in progress, sales will probably suffer. Likewise, operating the store out of a temporary location while the damaged building is being repaired might be better than shutting down altogether, but some income loss is still likely, since the store’s usual clientele might be unaware of the new location or might find it less convenient or less appealing.

Organizations that own a building and lease space in it to others have a loss of rental income exposure. In most cases, the premises lease would not require the tenant(s) to continue to pay rent if the premises are not habitable as a result of a fire or other calamity. Thus, severe damage to the leased space would probably cause a loss of rental income.

The insurance coverage that addresses the loss of income loss exposure is called business income coverage (also referred to as business interruption coverage). Business income coverage is designed to replace the income that would otherwise have been earned by the business during the time when repairs are being made.

Extra Expense Loss ExposuresOrganizations that provide services, and whose property is not a key source of their income, are generally able to function out of temporary quarters in the event of damage to their own with little or no resulting loss of income. However, the expenses associated with arranging, equipping, and operating out of the temporary quarters are likely to be far in excess of normal operating expenses. For these organizations, the principal time element loss exposure is extra expense. Contractors, insurance agencies, and law firms are just a few examples of organizations whose principal time element loss exposure is extra expenses rather than business income.

Some organizations would go to great lengths to continue operations regardless of the cost—even if the additional costs of doing so would exceed the amount that the business would have earned during the period of interruption. The most frequently cited examples of businesses in this category are newspapers and dairies, whose customers would perhaps be permanently lost to competitors if continuous service were not provided. However, any organization for whom market share or customer service considerations are paramount could also fall into this category, if that organization would have some means of continuing operations despite the destruction of its own facilities (perhaps

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by prearranged reciprocal agreements with competitors to use the other’s facilities in the event of loss). These types of organizations also have an extra expense loss exposure.

The insurance coverage that addresses this time element loss exposure is called extra expense coverage. Extra expense coverage is designed to pay for increases in operating expenses that result from continuing operations on a makeshift basis while permanent repairs are being made.

Combination Loss ExposuresMany organizations whose principal time element exposure is loss of business income also need extra expense coverage for their nonincome-producing locations. Corporate office buildings and warehouses are examples of nonincome-producing locations often used by businesses whose principal time element exposure is loss of business income, like manufacturers and retailers. The destruction of these facilities would probably not disrupt normal manufacturing or retail operations, so a policy that covers loss of income but not extra expenses would not cover the extra expenses associated with arranging temporary replacement quarters. These organizations need a combination of business income and extra expense coverage.

Similarly, there are some organizations whose principal time element exposure is extra expense that could suffer an income loss as well if their property were severely damaged. For example, a hospital would probably go to great lengths to secure and equip temporary quarters and continue to serve the public, regardless of cost. Nevertheless, it would probably lose some income as a result of patients and physicians electing to have services performed elsewhere. Since extra expense coverage forms do not cover loss of income, these organizations need business income coverage as well as extra expense coverage.

In some cases, it is difficult to know in advance whether it will be necessary or even possible to resume operations while recovery is in process. An organization that plans to resume operations at any cost could find itself unable to do so at the particular time when loss occurs, perhaps as a result of a shortage of property for lease. In such a situation, a business that had purchased extra expense coverage, but no business income coverage, would suffer an uninsured income loss. Likewise, a business that had purchased business income coverage, but no extra expense coverage, could find itself underinsured if it elected to continue operations on a makeshift basis at costs exceeding projected income to meet contractual obligations, maintain market share, or keep customers happy.

The solution to these problems is the purchase of both business income and extra expense coverage. This can be accomplished with two separate coverage forms or a combination form.

RISK CONTROL TIP

Focusing attention on an organization’s business income exposures while ignoring its extra expense exposures, and vice versa, can cause problems. To prevent these problems.

Do not overlook a client’s time element exposures when insuring against direct property loss.

Understand the distinction between business income and extra expense exposures.

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Real Life Scenario

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Rex owns a dry cleaning business. He has obtained insurance for this business for several years through agent Alex. Alex obtained a commercial property policy with XYZ. A fire occurs at the dry cleaning business, and Rex is unable to operate for 5 months. While the building is being rebuilt, Rex moves to a rented facility and opens back up. He incurs $45,000 in additional expenses to move and to rent the new building. He also loses $40,000 in lost profits, as many of his customers are unaware of the new location. Unfortunately, Alex did not obtain business income or extra expense coverage on the policy. Rex makes a claim against Alex for $85,000. Alex reports the claim to his E&O insurer.

Business income and extra expense coverage is a very important coverage for nearly any business owner. Many E&O claims arise over the failure to offer the coverage, failure to obtain the coverage when asked to do so, or failure to procure adequate coverage limits to protect the business from economic hardship in the event of a loss. This coverage should virtually always be offered, and special attention should be directed to the needs of the client. The offers and acceptance/rejection should be well-documented by the agent.

Result: The E&O insurer investigates and determines that business income or extra expense coverage was not offered or discussed. While they were able to argue that Rex's damages were slightly exaggerated, Alex had to admit he had failed to offer business income or extra expense coverage, and the claim was settled for $72,000.

Failure To Choose the Most Appropriate Time Element Insurance Coverage(s) Business income coverage is added to a standard commercial package policy by including either of two business income coverage forms.

Business Income (and Extra Expense) Coverage Form (CP 00 30)

Business Income (without Extra Expense) Coverage Form (CP 00 32)

These two forms provide the same business income coverage. The difference between them is that one includes extra expense coverage, and the other does not. Instead of the extra expense coverage grant found in the business income and extra expense coverage form, the business income coverage form without extra expense contains an “expenses to reduce loss” additional coverage. Aside from this substitution and the deletion of all references to extra expense coverage, the business income coverage form without extra expense is virtually identical to the business income and extra expense coverage form.

Business Income CoverageBoth business income coverage forms provide coverage for loss of business income resulting from the necessary suspension of the insured’s business operations. There are two key requirements.

The suspension must be caused by property damage from a covered cause of loss.

The location suffering direct property damage that causes suspension of the insured’s operations must be a “described premises” for which a business income limit is shown.

Suspension is defined to mean the slowdown or cessation of operations. A complete cessation of operations is not required.

Definition of Business IncomeThe term business income is defined in the business income insuring agreement as follows.

The net profit or loss before income taxes that the insured would have earned or incurred, and

Continuing normal operating expenses, including payroll, that the insured incurs

Business Income and Extra Expense Coverage (CP 00 30)The Business Income (and Extra Expense) Coverage Form (CP 00 30) has two insuring agreements—a business income insuring agreement (just discussed) and an extra expense insuring agreement. The extra expense insuring agreement has three components.

The first component grants coverage for extra expense to continue operations despite the damage at the described premises, replacement premises, or temporary locations. This

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includes relocation expenses and the cost to equip and operate the replacement or temporary location.

The second component grants coverage for extra expenses to minimize the suspension of operations, if operations cannot be continued.

The third component grants coverage for extra expense to repair or replace property, to the extent that this expenditure reduces the amount of loss that would otherwise have been payable.

The third component of the extra expense insuring agreement might be termed “expediting expense coverage.” It covers the cost to rush the repair or replacement of damaged property, the cost of temporary repairs, and the cost of property purchased for temporary use while the insured is awaiting permanent repairs or replacement. Examples of extra expenses falling into this category include express shipping charges to rush delivery of new equipment and overtime charges paid to contractors or architects to speed reconstruction. Note that the coverage for this third category of extra expense is subject to a limitation. Extra expenses to repair or replace property are payable only to the extent that they reduce the loss that would otherwise be payable. This limitation applies only to the third category of extra expense coverage. The other two categories of extra expense are fully covered regardless of whether they reduce the loss that the insurer would otherwise have to pay.

Business Income without Extra Expense Coverage (CP 00 32)The Business Income (without Extra Expense) Coverage Form (CP 00 32) does not provide “true” extra expense coverage. In place of the extra expense insuring agreement found in the business income and extra expense coverage form, the business income coverage form without extra expense contains an “expenses to reduce loss” additional coverage.

The expenses to reduce loss additional coverage grants coverage for extra expenses that the insured incurs to avoid further loss of income. However, the most that the insurer will pay for business income loss and expenses to reduce loss is the business income loss that would have been payable even if the insured had not incurred any extra expenses in an attempt to reduce the loss. In other words, the expenses to reduce loss additional coverage grants coverage for extra expenses only to the extent that the insured’s income loss is actually reduced by those expenditures.

To illustrate the difference between extra expense coverage and expenses to reduce loss coverage, suppose that a hospital’s buildings are damaged by a tornado. Suppose that it will take 6 months to repair the damage, and the hospital would suffer a $1-million loss of income during that time. However, the hospital feels strongly that it must continue to serve the public. It decides to equip and use temporary facilities while repairs are in progress, at a total cost of $100,000. It also decides to spend $200,000 to expedite the repairs by paying overtime costs to the architects and contractors. Because of this $300,000 expenditure ($100,000 for temporary facilities and $200,000 in expediting costs), the repairs are completed in only 5 months’ time, and the business income loss is reduced to $800,000 instead of $1 million. If the hospital’s commercial property policy has an adequate limit of insurance and includes CP 00 32, the expenses to reduce loss provision grants coverage for $200,000 of the $300,000 that the insured spent to reduce the business income loss because that is the amount

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of business income loss that was avoided as a result of these expenditures. There is no coverage for the other $100,000 of extra expense. The hospital will recover $1 million—the $800,000 business income loss, plus $200,000 for expenses to reduce loss. Under CP 00 30, assuming an adequate limit of insurance, the hospital would have recovered $1.1 million—the $800,000 business income loss, plus the full $300,000 extra expense loss.

Real Life Scenario

RISK CONTROL TIP

To prevent problems resulting from inadequate business income coverage or inadequate extra expense coverage.

Because loss circumstances are unpredictable, recognize the difficulty of predicting the best way for a client to address a business interruption (e.g., whether or not to incur extra expenses to remain in operation).

Offer both business income and extra expense coverage to clients, probably by using a combination form that includes both business income and extra expense coverage..

Abby owns a strip shopping mall she insures through agent Lauren. Bernard rents a store space at Abby's mall for his bookstore. The lease is for 12 months and requires Bernard to pay Abby $5,000 per month in rent. Abby has insured her mall with Lauren for several years through insurer ABC but decides to move her insurance to Cynthia with insurer XYZ. No business income coverage is obtained by Cynthia. A customer negligently drops a lighted cigarette in Bernard's bookstore. A fire ensues 1 month after Bernard signs the lease. The fire damage is significant, and Bernard goes out of

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Failure To Cover Rental Income Exposures

In addition to income from their primary business activities, many firms also own property that generates significant rental income. Providing business income insurance while failing to recognize and insure this sometimes subtle loss exposure can create E&O problems.

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business as a direct result of the fire. Abby is unable to rent the space for 11 months. Abby makes a fire loss claim to XYZ, and she also makes a claim for lost income in the amount of $55,000. XYZ denies that claim, as there is no coverage for lost income on the policy. Abby then makes an E&O claim against Cynthia for $55,000.

Result: Cynthia's E&O insurer investigates and denies liability. Abby's previous policy with a different agency and insurer also did not have business income/extra expense coverage. Abby had simply asked Cynthia to replace the coverage obtained by Lauren. Cynthia had notes and correspondence in her file that she had discussed whether Abby wanted her to look into other coverages, and Abby stated she just wanted the same coverages that were provided by Lauren.

Extra expense/business coverage should always be offered

to this type of customer. Also, the agent should focus on the type of coverage needed. In this case, there is some significant rental income loss exposure. In this case, however, the E&O insurer was able to establish that Abby never had the coverage and made the argument that she did not want the coverage. However, the defense of this case would have been stronger had Cynthia offered the coverage and documented her client's rejection of the coverage. However, the defense of this case would have been stronger had Cynthia offered the coverage and documented her client's rejection of the coverage.

The Insurance Services Office, Inc. (ISO), business income forms offer the following three options.

Business income including rental value

Business income other than rental value

Rental value

Whichever option is designated in the declarations, along with a limit of insurance, applies. Rental value, which is also called rental income or simply rents, means net income (profit or loss before income taxes) the insured would have earned or incurred as rental income from tenants occupying the premises described in the declarations. Rental value also includes the fair rental value of any portion of the premises the insured occupies and continuing normal operating expenses; these expenses include payroll and any charges that are the legal obligation of the tenant but would otherwise be the insured’s obligations. Some insurers cover rental value via a separate form or policy rather than including it in a business income coverage form.

Rental value coverage is most often written subject to a monthly limitation rather than a coinsurance provision. The monthly limitation provision found in most rents coverage forms restricts loss recovery to a specified fraction (such as one-third, one-quarter, or one-sixth) of the rental value coverage limit during each 30-day period following the loss. When rental value coverage is provided using a standard business income coverage form, election of the monthly limit of indemnity coverage option replaces the coinsurance provision that would otherwise apply with the type of monthly limitation just described.

Failure To Provide Leasehold Interest CoverageThe leasehold interest exposure is easily overlooked, but overlooking the exposure can create an uninsured loss for clients who benefit from the terms of a favorable lease that is canceled when the premises are damaged.

RISK CONTROL TIP

To prevent problems resulting from failure to include rental value coverage.

Understand the rental income loss exposure.

Determine whether clients derive income from rental property, and if they do, make sure the business income policies include rental value coverage with adequate limits.

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Leasehold interest insurance covers the loss suffered by an insured tenant when a premises lease with very favorable terms is canceled as a result of damage to the premises from a covered cause of loss when that happens, and the insured must therefore lease replacement premises at significantly greater expense. Leasehold interest coverage can be used not only when the insured occupies the leased premises, but also when the insured subleases the premises.

The key element of coverage is the insured’s net leasehold interest, which is the present value of the difference between the total rent payable over the unexpired portion of the lease and the total estimated rental value of the leased premises for the same time period. The present value is figured at the rate of interest shown in the leasehold interest coverage schedule. The standard leasehold interest coverage form is ISO form CP 00 60. Leasehold interest factor tables for interest rates from 5 to 15 percent are available as ISO endorsements CP 60 05 through CP 60 15. If indicated in the leasehold interest coverage schedule, coverage is also provided for the unamortized portion of prepaid rent, bonus payments, and improvements and betterments.

Failure To Provide Business Income Coverage for Utility Interruption

Failure to cover business interruption arising from utility interruption that originates away from the insured’s premises, including overhead transmission lines, can lead to E&O claims. It is important to recognize and address that exposure.

Virtually all organizations depend on utility companies that supply power, water, and telephone services. If a fire at a utility company facility or storm damage to its transmission lines were to prevent the utility company from supplying its services for an extended period of time, many organizations would suffer a loss of income or incur extra expenses as a result.

For example, many manufacturers are heavy users of electricity. Their machinery, lighting, computer systems, and office equipment will come to a standstill if a fire or other peril that occurs at the utility

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RISK CONTROL TIP

To prevent problems resulting from failure to provide leasehold interest coverage.

Understand the leasehold interest exposure.

Determine whether clients currently benefit from a favorable lease that would be canceled if the premises are damaged or destroyed. If they do, make sure to offer leasehold interest coverage with adequate limits.

causes a power outage. Even if the outage lasts for only a few days, it can cause a manufacturer to incur a significant loss of income.

Virtually all commercial property policies contain a utility services exclusion, which eliminates coverage for business income and extra expense loss that results from utility service failure that originates away from the insured’s premises (e.g., at a utility company substation) or from transmission lines, regardless of location. The current ISO causes of loss forms exclude failure of power, communication, water, or other utility service supplied to the described premises if the failure originates away from the described premises, or if the failure originates at the described premises and such failure involves equipment used to supply the utility service to the described premises from a source away from the described premises.

Utility services (or simply “services”) interruption time element coverage is needed to address this loss exposure. It may be included as an option in some insurer forms, but often must be added by endorsement.

EndorsementThe standard endorsement is the utility services— time element endorsement (CP 15 45). It extends whichever time element coverage form is included in the policy to apply to loss as a consequence of damage to the property of a utility company. For coverage to apply, the utility service interruption must be caused by damage from a covered cause of loss to the types of utility service property identified in the endorsement schedule. Loss resulting from damage to overhead transmission lines is not covered unless the appropriate “including overhead transmissions” options in the endorsement schedule are indicated as applicable.

The ISO utility services interruption time element endorsement extends business income and/or extra expense coverage to apply to a suspension of operations at the described premises caused by an interruption in utility service to that premises. The interruption in utility service must result from direct physical loss or damage by a covered cause of loss to the property described in the endorsement that is indicated by an “X” in the schedule. Options are available for water supply property (pumping stations and water mains), communications supply property, and power supply property. Coverage for communications supply and power supply property is available either including or excluding overhead transmission lines. Communications supply property includes property supplying telephone, radio, microwave, or television services, including transmission lines. Power supply property includes property supplying electricity, steam, or gas to the described premises (e.g., utility generating plants; switching stations; substations; transformers; and transmission lines). No coverage is afforded for utility service that causes loss or damage to electronic data, including destruction or corruption of electronic data.

The standard utility services time element coverage endorsement does not impose a proximity requirement. However, many insurers restrict utility services time element coverage to apply only when the damaged property causing the utility service interruption is within a specified distance of the insured’s facility—typically 1 mile or 5 miles.

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It is important to remember that commercial property policy utility service time element coverage options and endorsements do not cover income or expense loss that results from the breakdown of the utility company’s equipment, since equipment breakdown is not a covered cause of loss under a commercial property policy. However, coverage for this loss exposure is available under an equipment breakdown policy.

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Real Life Scenario

RISK CONTROL TIP

To prevent problems resulting from failure to provide utility services time element coverage.

Recognize that most businesses will suffer a business income loss if one or more utility services is interrupted. For some, this is a bigger concern than others.

King & Queen Foods own a grocery store and has been insured through agent Bob for many years. Bob has obtained a commercial property policy with ABC. The policy contains coverage for the building, contents, as well as business income/extra expense coverage. During a severe thunderstorm, which occurred at 11 p.m., lightning strikes an electric utility station 1 mile away from King & Queen's store. Power is disrupted for 3 days. King & Queen moves all of their frozen and refrigerated goods to a rented facility, but they are unable to sell those goods until power is restored to their original location. King & Queen alleges that they incurred extra expense damages in the amount of $48,000 and business income loss of $125,000. ABC disclaims coverage because their commercial property policy contained a utility services exclusion. This exclusion eliminated coverage for business income and extra expense loss that occurred due to a utility service failure away from the insured's premises. King & Queen files suit against Bob and ABC, claiming damages in excess of $200,000.

Result: Bob's E&O insurer investigates and is unable to locate any documentation regarding whether the utility coverage exclusion was discussed or if any coverage for this was offered. Bob is unable to recall if the coverage was offered but thinks he discussed it with them. The case goes to trial, and the jury awards King & Queen $160,000. The jury assigns 20 percent liability on King & Queen for failing to read their policy, 0 percent liability on ABC, and 80 percent liability on Bob for failing to procure the coverage.

This is a common area of E&O claims, especially involving restaurants and grocery stores. The insurance professional should pay close attention to policies obtained for these businesses and make sure they cover all realistic exposures including the exposure due to loss of power. An endorsement should be offered to lessen or avoid this type of loss exposure.

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No Coverage for Contingent Business Interruption Exposures

Not arranging coverage for contingent business interruption exposures arising from damage to property of the insured’s key suppliers, customers, or businesses that attract the insured’s customers can create problems.

Organizations that depend on a single source supplier could be susceptible to an income or expense loss as a result of a fire or other catastrophe at the supplier’s facility. The same is true for organizations with one or two major customers: a serious fire at the customer’s facility could prevent the customer from purchasing the organization’s goods as expected. A similar exposure confronts retailers and service businesses, such as shoe repair shops and dry cleaners, whenever customers are attracted to the insured’s premises at least in part because of its proximity to another business, such as a grocery store or a hotel. In such situations, if a fire were to shut down the “leader location,” the insured’s business income might well suffer as a result. These types of loss exposures are called dependent property time element loss exposures.

Not all dependent property time element exposures are serious enough to warrant insurance. For example, a manufacturer that depends heavily on a single supplier could find that the supplier has more than one facility that could produce the item in question, so there would be little or no interruption in supply. Sometimes, there are risk management alternatives to insurance, such as cultivating an alternate source of supply as a backup or routinely using two suppliers as a safeguard. However, if insurance is needed, the time element coverage that applies to the insured’s own facilities can be extended to apply to loss resulting from damage to a dependent property location.

For example, Elite Electronics, a computer manufacturer, relies on Champion Chips, a chip maker, for computer chips. A tornado hits Champion Chips’s manufacturing facility and tears off part of a wall. Champion Chips is unable to make chips for several weeks while its facility is undergoing repairs. It takes Elite Electronics 3 days to find an alternate chip supplier. During that time, it is unable to manufacture any computers. Elite Electronics suffers an income loss due to the damage to Champion Chips’s facility.

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RISK CONTROL TIP

To prevent problems resulting from failure to provide utility services time element coverage.

Recognize that most businesses will suffer a business income loss if one or more utility services is interrupted. For some, this is a bigger concern than others.

Champion Chips may also have a dependent property exposure, particularly if Elite Electronics is the only company to which it distributes its products. Suppose that Elite Electronics’s manufacturing facility suffers damage from a tornado and is forced to shut down for a week. Champion Chips is likely to incur a loss of income during Elite Electronics’s shutdown because no one is buying its chips. To protect themselves against dependent income losses, both companies may purchase contingent (or dependent) business income coverage.

Dependent property time element coverage insures against income loss or expense increase suffered by the organization as a result of damage to the property of another organization on which the insured depends. These types of losses are not covered under most business income or extra expense coverage forms because they do not result from damage at an insured premises.

EndorsementsISO offers three endorsements that cover dependent properties.

Business income from dependent properties—broad form (CP 15 08)

Business income from dependent properties—limited form (CP 15 09)

Extra expense from dependent properties (CP 15 34)

CP 15 08 extends the same limit(s) that applies to loss from damage to the insured’s own facilities to loss resulting from damage to the dependent property locations described in the dependent properties endorsement schedule. The limited form business income from dependent properties endorsement and the extra expense from dependent properties endorsement establish a separate limit for each scheduled dependent property listed in the endorsement schedule, rather than extending the insured’s “regular” business income coverage limits. The term dependent property includes the following.

Contributing locations: A business that delivers materials or services to the insured or to others for the insured’s account (e.g., the chip maker described above).

Recipient locations: A business that accepts the insured’s products or services (e.g., the computer manufacturer from the perspective of the chip maker).

Manufacturing locations: A business that manufactures products for delivery to the insured’s customers under contract of sale. For example, Fancy Foods, a food products manufacturer, contracts with Foods Inc., another manufacturer, to make some of Fancy’s products to sell as grocery store brands. Foods Inc. makes the products and delivers them to the grocery stores.

Leader locations: Businesses that attract customers to the insured’s locations.

Both the broad and limited business income from dependent property forms cover the actual loss sustained in business income loss due to the necessary suspension of the insured’s operations during the period of restoration when the suspension is caused by loss or damage from a covered cause of loss to a dependent property shown in the endorsement schedule. The period of restoration includes a 3-day waiting period after the physical loss occurs. Coverage ends on the date when the property at

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the premises of the dependent property should be repaired, rebuilt, or replaced with reasonable speed and similar quality.

The extra expense from dependent property endorsement is used with the extra expense coverage form. It covers the necessary extra expense the insured incurs due to loss or damage from a covered cause of loss to a dependent property shown in the endorsement schedule. There is no waiting period. Coverage begins with the date of direct physical loss and ends on the date when the property at the premises of the dependent property should be repaired, rebuilt, or replaced with reasonable speed and similar quality.

No Extended Period of Indemnity Coverage

Failing to procure extended period of indemnity coverage when arranging business interruption coverage for an organization that will experience a slow resumption of sales following a shutdown creates a major coverage gap likely to lead to E&O problems.

Under most business income forms, the period of indemnity ends when the lost or damaged property is repaired, rebuilt, or replaced. However, the insured’s business may not have returned to its pre-loss level when the insured’s business income coverage ends. Even though the insured’s damaged property has been repaired or replaced, the insured’s business operations may not return to normal levels for some time. Customers may have left and established business relationships with other companies. An extended period of indemnity, as its name suggests, extends the period of indemnity for a specified number of days (30, 60, 90, or more), beginning with the date the damaged property has been repaired, rebuilt, or replaced and operations are resumed. The extension allows the insured to recover for business income loss suffered after resumption of operations, subject to the limit of insurance. Here is how that works.

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RISK CONTROL TIP

To prevent problems resulting from failure to provide contingent (dependent properties) business income coverage.

Understand the contingent business income exposure.

Identify clients with contributing locations, recipient locations, manufacturing locations, and/or leader locations.

Include contingent business income and/or extra expense coverage for firms exposed to contingent time element losses.

Indemnity PeriodIn a business income policy, the indemnity period is the period of time during which the insured’s income or extra expense loss must occur for the insured to recover for the loss under the policy. There are several provisions that determine the indemnity period in the business income coverage forms.

Period of restoration definition

No restriction on length of period of restoration

Extended period of indemnity coverage option

Period of Restoration DefinitionFirst and foremost, coverage applies to income or expense loss suffered by the insured during the period of restoration. This term is defined in the definitions section of the forms.

For business income coverage, the period of restoration begins 72 hours after the time of the direct physical loss.

For extra expense coverage, provided only in the Business Income (and Extra Expense) Coverage Form (CP 00 30), the period of restoration begins immediately after the direct physical loss.

For both business income and extra expense coverage, the period of restoration ends when the property is (or should have been) repaired or replaced with reasonable speed and similar quality, or when the insured has resumed operations at a new permanent location.

No Restriction on Length of Period of RestorationThe expiration of the policy has no effect on the period of restoration. Also, the period of restoration is not restricted to a certain number of days or months. The period of restoration extends until the property is, or should have been, repaired or replaced with reasonable speed and similar quality, regardless of how long that is.

For example, suppose that the insured’s manufacturing facility is destroyed by fire 1 month before policy expiration, and it takes 18 months for the facility to be rebuilt and reequipped with the necessary machinery. The period of restoration for business income begins 72 hours after the fire and ends not on policy expiration, but 18 months after the date of the fire. Coverage applies to income loss incurred suffered during the entire 18-month period of restoration.

Extended Business Income Additional CoverageIn many cases, the insured’s business income will not return to pre-loss levels for some time after the premises have been restored and operations have been resumed. Former customers may be unaware that the insured is back in business. Some may have made alternate contractual arrangements that must run their course.

The extended business income additional coverage, found in both business income coverage forms, addresses this problem. It provides coverage for loss of income suffered by the business during the

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first 60 days after the property has been repaired or replaced. In other words, it extends the indemnity period for up to 60 days after the period of restoration ends. (Keep in mind that this does not increase the limit of insurance. It only extends the period of recovery.)

Indemnity Period OptionsThe business income coverage forms include three optional coverages that, if elected, alter the indemnity period of the policy.

Extended period of indemnity

Maximum period of indemnity

Monthly period of indemnity

These options apply only to the particular locations that are indicated in the declarations. Since the declarations must specify whether coverage includes rental value, excludes rental value, or applies only to rental value, it is possible to elect a different covered income and different indemnity period option for each location. For example, location 1 might be covered for rental value only under the monthly period of indemnity option, and location 2 under the same policy for business income excluding rental income under the maximum period of indemnity option.

Extended Period of Indemnity If the extended period of indemnity option is elected, it replaces the 60-day extension granted by the extended business income additional coverage with the number of days specified in the declarations. Coverage ends with the expiration of the stated number of days or when the income is restored to the level that would have existed had there been no loss, whichever is sooner.

Maximum Period of Indemnity If the maximum period of indemnity option is elected, the insured’s recovery for business income and extra expense is limited to the loss incurred during the first 120 days after the period of restoration begins. (Recall that, for business income coverage, the period of restoration begins 72 hours after the direct damage loss. For extra expense coverage, the period of restoration begins at the time of the direct damage loss.) This option voids the business income coinsurance provision for any location to which it applies. (Business income coinsurance is discussed in Chapter 10.)

This option might be appropriate for businesses that would suffer only a relatively brief suspension of operations even in the event of a total loss. Insureds who are reluctant to reveal financial information about their businesses may also be interested in this option, since underwriters are typically willing to provide business income coverage on this basis without a business income worksheet. Finally, since use of this option voids coinsurance, those who are uncomfortable with the concept of coinsurance may consider it an attractive alternative.

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Monthly Period of Indemnity If the monthly limit of indemnity coverage option is elected, it voids the business income coinsurance provision for any location to which it applies. Instead, the insured’s loss recovery for business income loss for that location is limited to a specified fraction (e.g., one-third, one-quarter, one-sixth, etc.) of the business income coverage limit during each 30-day period following the expiration of the 72-hour waiting period. Extra expense recovery is not limited under this coverage option; only business income loss recovery is affected.

The monthly limit in this coverage option imposes a maximum on the amount that is recoverable for business income loss incurred during any one month. For example, suppose a business owner purchases a $100,000 business income coverage limit for its facility and selects the monthly limit of indemnity coverage option with a one-quarter monthly limit. The one-quarter monthly limit establishes that $25,000 (1/4 of the $100,000 limit) is the most that the insured can collect for loss incurred in any one 30-day period. If the insured incurs a business income loss of $40,000 during the first 30-day period following the direct damage loss, the insurer will pay only $25,000. If the insured incurs a business income loss of $10,000 during the second 30-day period following the direct damage loss, the insurer will pay the full $10,000 loss for that month. Note, however, that the $15,000 unpaid loss suffered that first month is not recoverable during the second month. For this reason, it is important for the insured to select a fraction that yields a monthly limit high enough to cover the maximum monthly loss the insured is likely to sustain.

This option does not restrict the number of months for which the insured may receive payment for covered loss. If a business with a one-quarter monthly limit suffers a business income loss for 8 months following the direct damage loss, it can collect for loss suffered in each of those 8 months, subject to the monthly maximum, until the limit of insurance is exhausted.

The monthly limit of indemnity coverage option may be appropriate for businesses whose income does not vary significantly from month to month. For example, a business whose income consists primarily of rents might safely elect this option. Like the maximum limit of indemnity option, it may also appeal to insureds who are uncomfortable with the concept of coinsurance or reluctant to reveal financial information about their businesses.

Many insurers’ business income forms include an extended period of indemnity. These forms may provide considerably more than the 30 days provided by the ISO form for extended business income. Some insurers’ forms provide an extension of 90, 120, or even 180 days.

RISK CONTROL TIP

To prevent problems resulting from failure to provide extended period of indemnity coverage.

Understand the reason why many organizations need an extended period of indemnity.

Identify clients who can benefit from extended period of indemnity coverage.

Recommend and offer extended period of indemnity coverage to clients who could benefit from this coverage.

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No Time Element Ordinance or Law Coverage

Coverage gaps may occur when building ordinances or laws extend the time period needed to repair or rebuild a damaged building, and the insured has not purchased the time element version of ordinance or law coverage. Building codes may add additional steps to the building process. Delays may occur if plans must be redrawn, supplies must be obtained, or experts must be consulted. All of this may lengthen the time it would otherwise have taken to repair or rebuild the insured’s facility.

EndorsementsThe ISO business income form does not cover the income lost or extra expense incurred during the additional time needed to comply with these laws. Coverage for this exposure is available via endorsement CP 15 31.

If property at a described premises is damaged by a covered cause of loss, coverage is extended to include the actual loss sustained during the increased period of suspension of operations resulting from the enforcement of a building ordinance or law. For coverage to apply, the law must have been in force at the time of the loss and either regulate construction or repair of property, or require the demolition of undamaged parts of property.

The period of restoration begins 72 hours after the physical loss for business income coverage and immediately after the loss for extra expense coverage. It ends on the date when the property at the described premises should be repaired, rebuilt, or replaced with reasonable speed or the date when business is resumed at a new permanent location, whichever comes first. The “period of restoration” definition in the endorsement includes any increased period required to repair or reconstruct the property to comply with the minimum standards of any ordinance or law, in force at the time of loss, that regulates the construction or repair, or requires the tearing down of any property. Note that the endorsement excludes the enforcement of laws related to the remediation or cleanup of pollutants or fungus.

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RISK CONTROL TIP

To prevent problems resulting from failure to insure the time element exposures associated with the operation of ordinances or laws.

Understand how the operation of ordinances or laws can extend the period of a business interruption.

Include time element ordinance or law coverage for every client with ordinance or law coverage against direct losses. If there is a direct damage exposure, there is also a time element exposure.

Inadequate Business Income Coverage Limits When determining the limit to purchase for business income coverage, it is important to be realistic in estimating the time required to restore the premises to operating conditions after a total loss. Business owners or managers are often overly optimistic when estimating recovery time. For some businesses, the length of time necessary to replace machinery and rebuild the building in the event of a total loss may exceed 1 year. If coverage is based on annual revenues or an assumption that all of the work will be completed in 1 year or less, the business income limit of insurance on the insured’s property policy may be used up before the repairs are completed. This will result in a coverage gap.

In order to estimate recovery time accurately, the agent or broker must consider factors that may lengthen that time and, thus, increase the limit of business income coverage that is needed. Some of these factors are listed below.

Time for the direct-loss adjustment process

Federal, state, or local government involvement, including building laws or ordinances

Time for plans to be drawn and approved

Time necessary to choose the contractor

Scheduling and completion of demolition and site work

Building permits that must be applied for and issued

Outside factors, such as weather, strikes, and the availability of materials, that may lengthen the time needed to rebuild

Time necessary to find and obtain replacement machinery or stock—specialized equipment may take several months to obtain

The first step in determining the business income limit needed is to complete a business income worksheet, such as the ISO Business Income Report/Work Sheet (CP 15 15). The worksheet is a tool for estimating the company’s future revenues and expenses. Once the insured has calculated business income for the upcoming 12-month period, the next step is to estimate how long it would take to restore the premises to operating condition in the event of a total loss. Assuming that the firm’s operations are not seasonal, the number of months of the anticipated worst-case recovery time determines the portion(s) of the projected business income to insure.

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For example, if it would take a particular business 6 months to resume operations, the portion of the upcoming year’s business income at risk is 50 percent (6 months divided by 12 months). Accordingly, the insured should select a business income coverage limit equal to 50 percent of the projected business income, provided this limit would comply with any applicable coinsurance provision. If the length of time necessary to replace machinery and rebuild the building in the event of a total loss would exceed 1 year, then the amount to insure is the actual multiple of 12 months’ gross earnings that is anticipated. For example, if the insured anticipates a 15-month shutdown, then the limit needed is 125 percent (15 months divided by 12 months = 125 percent) of the 12 months’ gross earnings. Likewise, if the insured expected an 18-month shutdown, then the insured would need a limit equal to 150 percent of the 12 months’ gross earnings (18 months divided by 12 months is 150 percent).

Finally, when estimating the loss of income from a worst-case scenario, the insured should consider the extra time that might be required to reestablish business income to its pre-loss level. The insured may need extra time after the physical property has been repaired, rebuilt, or restored to regain previous customers and attract new ones. The ISO business income forms include a coverage called extended business income, which provides an extra 30 days of business income coverage after the damaged or destroyed property has been repaired or replaced. This coverage is included in the business income limit of insurance. This 30-day extension should be considered when one is determining the business income limit.

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Real Life Scenario

RISK CONTROL TIP

To prevent problems resulting from inadequate business income limits.

Be realistic when estimating the possible duration of a business interruption.

Recognize the extra time following a business interruption that might be required to reestablish

Paul owns a clothing store. He approaches insurance agent Ron and asks Ron to procure commercial property, contents, business income, and extra expense coverage. Ron asks Paul for an estimate of his yearly net income. Paul advises Ron that he has averaged $500,000 per year for the past 4 years. Paul obtains business income/extra expense coverage in the amount of $500,000 with XYZ insurer. The policy limits remain the same for the next 4 years. A fire occurs, and it takes Paul 12 months to rebuild. He submits a business income claim for $825,000 and backs it up with income tax records. Paul's business had grown substantially since he first approached Ron. The insurer pays Paul $500,000 for business income. Paul makes a claim against Ron for the balance, $325,000.

Result: Ron submits the claim to his E&O insurer. The insurer argues that Paul should have read his policy and was in the best position to determine how much coverage he needed. However, during litigation discovery, Ron testified at his deposition that he normally met with his clients each year and went over the client's insurance needs and asked them if they needed additional coverage. Ron failed to follow that procedure with Paul and could not explain why. The claim was settled with a payment of $100,000.

The insurance professional needs to be consistent in their practices and procedures with all of their clients. Failure to use the same care with some clients could result in an E&O claim. Also, the agent needs to make sure clear communication is maintained and make sure that the client is updating him regularly on their business so that he can make sure they have adequate limits for business .income/extra expense

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Not Insuring Finished Stock on a Selling Price Basis

Manufacturers usually expect to earn a profit when their finished goods are sold. Unless insurance is properly arranged, they will not experience this expected profit when finished goods are damaged or destroyed before they have been sold.

A manufacturer’s manufacturing operations are, by definition, complete with respect to finished stock; the destruction of finished stock will not suspend operations. However, destruction of finished stock involves a loss of the anticipated profit on the sale of that stock.

All three commercial property causes of loss forms (basic, broad, and special) contain an exclusion that specifies that there is no coverage for business income loss resulting from loss of or damage to finished stock or the time needed to replace finished stock. In other words, the stock itself is covered by the insured’s personal property coverage, but not the income the manufacturer expected to derive from selling it. It will take time to remanufacture the missing stock; the manufacturer is also not entitled to any compensation for this time.

The aforementioned exclusion applies only to insured manufacturers. “Finished stock” is defined in the business income coverage form to mean only stock that the insured has manufactured. Thus, retailers and other mercantile businesses do have business income coverage for loss in connection with their inventories. Also, the definition of “finished stock” establishes that manufacturers that sell their own merchandise at a retail outlet that is covered under the policy have business income coverage for loss in connection with that merchandise, even though it was manufactured by the insured.

EndorsementManufacturers whose finished stock has been damaged or destroyed would like to recover the price for which the stock could have been sold, a figure that includes the manufacturer’s expected profit.

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RISK CONTROL TIP

To prevent problems resulting from inadequate business income limits.

Be realistic when estimating the possible duration of a business interruption.

Recognize the extra time following a business interruption that might be required to reestablish

Although this anticipated profit is not covered under the business income coverage form, coverage is available by endorsement to the building and personal property coverage form, using the manufacturer’s selling price finished “stock” only endorsement (CP 99 30). This endorsement adds a clause to the valuation condition in the building and personal property coverage form. The clause provides that if the insured’s finished stock is lost or damaged, the value of finished stock the insured manufactures will be valued based on the selling price, as if no loss or damage occurred, minus any discounts and expenses the insured otherwise would have had.

RISK CONTROL TIP

To prevent problems resulting from damage to or destruction of a manufacturer’s finished stock.

When insuring a manufacturer, make sure the manufacturer’s building and personal property coverage form is modified by attachment of the manufacturer’s selling price finished “Stock” only endorsement (CP 99 30).

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Chapter 4 Review Questions

1. Which one of the following is an example of a time element loss?

a. Cost of demolition and reconstruction in accordance with current building codes

This answer is incorrect. The cost of compliance with building codes is part of the direct damage loss. However, the extra work involved in demolition and new construction might increase the amount of time during which business is interrupted.

b. Cost of repairs to a damaged building

This answer is incorrect. That is a direct damage loss.

c. Loss of income incurred while damaged property is being repaired or replaced

That’s correct! A firm’s income loss varies with the length of time it takes to repair or replace the damaged property.

d. Loss of inventory that must be restocked

This answer is incorrect. Although it might take time to restock damaged inventory, the loss of inventory itself is a direct damage loss.

2. Sylvester owns and occupies an office building that he could otherwise rent out for $1,500 a month. As used in Sylvester's Insurance Services Office, Inc. (ISO), business income forms, the term "rental value" includes

a. revenues derived from renting equipment and other personal property to others.

This answer is incorrect. The term refers to the rental of real property, not personal property.

b. the fair rental value of the premises Sylvester occupies.

That's correct! "Rental value" includes the fair rental value of any portion of the premises the insured occupies.

c. the value of real property that is rented to one or more tenants.

This answer is incorrect. It's not the value of the property, but the value derived from its use.

d. use and occupancy.

This answer is incorrect. "Use and occupancy" is an obsolete term that was used for business interruption insurance in boiler and machinery forms.

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3. Major Manufacturing produces lawn mowers. Major's first plant manufactures the engines used in the lawn mowers, which are then shipped to Major's second plant. The second plant manufactures the housing, handles, and all the other component parts and assembles the lawn mowers. These two plants are said to be

a. codependent locations.

This answer is incorrect. The term codependent is not used.

b. dependent locations.

That is correct! Dependent locations are facilities of the insured that rely on products or services from another of the insured's facilities to function normally. A lawn mower could not function normally without an engine or housing.

c. independent locations.

This answer is incorrect. One plant would be useless without the other, so they are by no means independent.

d. reliant locations.

This answer is incorrect. One location relies on the other, but the term “reliant locations” is not used.

4. A fire badly damages Slow Food Restaurant. Slow reopens 6 months later, but it takes 4 weeks for most of their regular customers to return. As a result, Slow Food’s business income is much lower than normal during the first 4 weeks after it reopens. If Slow Food has a commercial property policy with the business income and extra expense coverage form but none of the available coverage options, does it have coverage for the reduction in income suffered during the first 4 weeks after reopening?

a. No, coverage ends when the property is (or should have been, given the exercise of due diligence) repaired or replaced.

This answer is incorrect. The policy includes a limited amount of extended business income coverage.

b. This loss is covered only if Slow Food’s policy includes a restaurant operations resumption endorsement.

This answer is incorrect. There is no such endorsement.

c. Yes, the business income and extra expense coverage form automatically provides coverage for as long as it takes for the insured's business income to be the same as it was prior to the damage.

This answer is incorrect. There is a time limit on extended business income.

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d. Yes, the extended business income additional coverage covers business income loss suffered during the first 60 days after the damaged property has been repaired or replaced.

That’s correct! The extended business income additional coverage covers business income loss suffered during the first 60 days after the damaged property has been repaired or replaced.

5. Current building codes could have a substantial impact on the amount of time that Crane Corporation will not be operating if an explosion destroys more than 50 percent of its factory. Before Crane can begin reconstruction of the damaged portion of its building, the undamaged portion will have to be demolished, and the replacement structure will have to be redesigned to comply with current building codes. To cover Crane's business income lost during the extended period of reconstruction attributable to building code compliance, Crane should

a. add ordinance or law coverage to its building and personal property policy coverage form.

This answer is incorrect. Given the exposure, Crane should have this coverage for other reasons, but the building and personal property coverage form does not address Crane's loss of business income.

b. add ordinance or law coverage to its business income and extra expense policy.

That's correct! The ISO business income form does not cover the income lost or extra expense incurred during the additional time needed to comply with these laws. Coverage for this exposure is available via endorsement CP 15 31.

c. purchase business income and extra expense insurance on an agreed value basis.

This answer is incorrect. Valuation is not the issue here.

d. purchase higher limits of business income and extra expense insurance.

This answer is incorrect. Crane should have adequate limits to cover the amount of time necessary to replace the damage plus the additional time to comply with the building code, but merely increasing the limits does not expand the scope of coverage.

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Chapter 5Inland Marine E&O Issues

Chapter 5 concerns errors and omissions (E&O) problems that occur in connection with commercial inland marine policies. Inland marine coverage is a type of property insurance primarily designed to cover property in transit over land. Most inland marine insurance policies cover property that cannot be conveniently or reasonably confined to a fixed location. Many of these inland marine coverage forms use the word “floater” in the title to reflect the fact that the property being insured typically does not remain in one place. Some inland marine policies also cover fixed-location structures, such as bridges, tunnels, and antenna towers that are associated in some manner with transportation or communication.

Most commercial inland marine policies are nonstandard forms, with terms that vary from one insurer to the next. This means that the producer must pay special attention to the terms of each specific policy, but it also means that underwriters often have flexibility in modifying the forms to meet a client’s specific needs.

Chapter Objectives

On completion of this chapter, you should be able to

recognize why inland marine builders risk forms are generally superior to commercial property insurance written on a builders risk form.

prevent coverage gaps associated with property in the custody of a common carrier and property temporarily in a warehouse during the course of transit.

recognize potential problems associated with coverage on rental equipment, and take appropriate steps to remedy them.

Inadequately Insuring Property under Construction

Unless a project is very small, it is usually not desirable to rely on the project owner’s commercial property insurance program to cover a construction project. Moreover, commercial property builders risk forms tend to provide more restrictive coverage than inland marine forms that are also available. Here is why this is an issue.

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Commercial property insurance forms provide limited coverage for property under construction. One reason is the lack of adequate coverage under property forms for property located off premises and while in transit. An all risks commercial property policy written on current standard forms (using the Building and Personal Property Coverage Form (CP 00 10) and the Causes of Loss—Special Form (CP 10 30)) provides $250,000 in coverage for new buildings under construction, but only if they are built on the described premises. These forms provide only $10,000 of coverage on property away from the insured’s premises and only $5,000 on property in transit. The transit coverage applies only to loss from a few specified perils. Also problematic is the fact that commercial property policies typically have more exclusions than builders risk policies written on inland marine forms.

Another issue relates to contractors, if the owner’s permanent property insurance is used to cover property under construction, contractors do not have insured status under the policy. Lack of insured status denies contractors some significant rights and protections under the policy. In addition, many of the coverage extensions afforded under the property policy are available only to the named insured. Finally, any adverse loss experience on the construction project will impact the project owner’s entire property insurance program. Consequently, the project owner may have a disincentive to file claims for certain covered losses, especially for damage to a contractor’s property. If the project owner fails to file claims for damage to contractors’ property, this can destroy the relationship between the project owner and the contractors covered by the policy and interfere with the successful completion of the project.

Builders risk forms in the commercial property series of forms are specifically designed to cover construction, renovation, or expansion projects. While Insurance Services Office, Inc. (ISO), and the American Association of Insurance Services (AAIS) have both published standard builders risk forms, these forms are rarely used. Both contain some serious coverage limitations, such as little or no coverage for property in transit and at off-site storage locations, which make them undesirable compared with inland marine-type builders risk forms.

In many states, insurers are not required to file their inland marine builders risk forms or rates for regulatory approval. Thus, forms vary widely in scope of coverage, terms, and provisions. Either the project owner or the general contractor can purchase a builders risk policy. No matter who buys the policy, it should cover the project owner, general contractor, and all subcontractors as insureds.

The term covered property normally includes all fixtures, materials, supplies, machinery, and equipment that will be used in the construction. Most builders risk forms provide coverage for property of others for which the insured may be liable on the same basis that they cover property of the insured. Nearly all builders risk policies are written on an all risks basis. Exclusions include faulty workmanship and design error (except for resulting damage), fungus, asbestos, flood, earthquake, and mechanical breakdown.

Construction contracts routinely include a provision that the parties covered by the builders risk policy waive their rights of recovery against one another to the extent the loss is covered by the builders risk policy. Most builders risk policies allow pre-loss waivers of subrogation, either

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affirmatively or impliedly. By long-standing industry consensus, both of these types of subrogation provisions are interpreted as allowing the insured to waive recovery rights against others prior to loss.

Builders risk insurance can be written on either a completed value form or reporting form. With either approach, the anticipated completed value of the project is used as the limit of insurance. The completed value form is by far the most popular.

A significant exposure with regard to construction projects is loss resulting from a delay in the completion of the project. A delay in the project may cause the owners to suffer the loss of the anticipated revenue stream that could have been earned if the building were put into use on schedule. Owners may also incur additional costs, such as additional financing and insurance costs, as well as additional real estate taxes. Delayed completion coverage reimburses the insured for covered loss resulting from a delay in the project’s completion when the delay is a direct consequence of damage to the project by an insured peril. Coverage includes loss of income coverage and soft costs coverage. Soft costs, meaning costs other than costs for labor and materials, include additional interest expense on funds borrowed to finance the project and for additional advertising and promotional expenses, additional real estate taxes, design fees, insurance premiums, and general overhead costs.

Real Life Scenario

Bailey purchases an inland marine builders risk policy through agent Stuart, who obtains the policy with XYZ insurer. One of Bailey's roofers fails to secure part of the roof. A rainstorm causes damage to the interior. Bailey is sued by the building owner and submits a claim to XYZ. The insurer denies coverage due to the policy exclusion for faulty workmanship. The damages are $25,000. Bailey makes a claim against Stuart, who submits the claim to his E&O insurer.

Result: The insurer investigates and denies liability to Bailey. The basis for the liability denial is that this coverage had a standard fault workmanship exclusion. Stuart documented that he had discussed this exposure with Bailey.

Inland Marine policies are often more complicated than other commercial policies, especially as to what they do or do not cover. Special attention should be given to understanding their terms and conditions.

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Not Insuring Property Shipped by Common Carrier

Businesses that hire common carriers to transport property require special attention. Assuming that the common carrier will pay for any losses to property in transit can create problems for both the insured and the producer who arranged the insurance.

Before property is shipped, it is important to establish the obligations of both parties (shipper and carrier) for loss of, or damage to, the property. Also important is which party is responsible for insuring the property from the time the carrier receives it until it is delivered to the business entity. By law, common carriers are not responsible for all damage to their cargo. For example, they are not accountable for “acts of God” (e.g., flood or tornado) or for damage resulting from the fault of the shipper, such as improper packing of cartons. Moreover, collecting from the carrier can be a difficult, time-consuming task, even if the carrier is clearly responsible for the loss. These are among the reasons why many businesses elect to purchase their own transportation insurance to ensure a means of prompt loss recovery, leaving to the insurer the task of subrogating against the liable carrier.

Another reason to purchase transportation insurance is the widespread use of released bills of lading. A released bill of lading limits the liability of the carrier to some specified dollar value per shipment or per pound of goods shipped. A tariff on the back of the bill of lading spells out the limitations that the carrier has established on its liability. The carrier may offer an option to insure the goods for their full value, but this option may be more costly than simply insuring the exposure directly in the shipper’s insurance program.

Most property policies provide little, if any, transit coverage. ISO’s Building and Personal Property Coverage Form (CP 00 10) excludes personal property while airborne or waterborne. Moreover, it covers personal property only while it is within 100 feet of the premises. ISO’s Causes of Loss—Special Form (CP 10 30) (all risks) provides a $5,000 named perils only coverage extension for personal property in transit by motor vehicles owned, leased, or operated by the insured. For many

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RISK CONTROL TIP

To prevent problems associated with coverage limitations on insurance on buildings under construction.

Use inland marine builders risk forms tailored to the needs of a specific client.

Chapter 5—Inland Marine E&O Issues

businesses, however, a $5,000 limit is grossly inadequate. Also, the extension does not apply to property transported by someone other than the insured, and it applies only to loss by specified perils. Some independently filed commercial property policies are more generous than the ISO form with regard to transit coverage, providing a limit of $50,000 or more.

Inland marine transportation insurance (often referred to simply as transit insurance) covers property while in transit from one place to another, principally over land and, to a lesser extent, by inland waterways. (Ocean marine insurance, which covers property in transit across the world’s oceans, is completely separate from transit insurance.)

Commercial output policies (COPs) also provide transit coverage. A COP combines commercial property with commercial inland marine coverages. The AAIS offers a COP form, as does ISO (called the capital assets form), and some insurers have devised their own proprietary forms. COPs provide transit coverage as a coverage extension subject to a limit of $50,000 or more.

If a business entity does not have adequate transit coverage under a property policy or COP, separate transit coverage should be purchased. Trip-transit policies cover a one-time-only shipment, while an annual transportation policy (also known as annual transit, or simply transportation policy) is generally designed to cover an owner’s shipments by carrier for hire or on the owner’s vehicles. An owner’s goods being transported on its own trucks may also be insured under an owners cargo policy. Transit policies cover direct damage only; they do not include time element coverages.

No Warehouse Coverage for Property in Transit

When a client ships property over land or over water, it is important for the agent or broker to establish who is responsible for the property while it is temporarily stored in a warehouse. Otherwise, coverage gaps may occur, and coverage gaps often lead to E&O claims against the producer that failed to address them.

Common carriers transporting cargo by truck often stow the property in a warehouse temporarily so it can be sorted. Items that are to be delivered to a certain geographic area are consolidated and then loaded onto into the same truck. Warehousing enables common carriers to use their trucks more efficiently.

RISK CONTROL TIP

Do the following to prevent problems resulting from losses to property in transit.

Recognize the limitations on property in transit of the insured’s commercial property or COP policies, and make sure clients understand these limitations.

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Inland marine transit policies typically cover property during the time it is in temporary storage at a warehouse as long as it is still in the course of transportation. Transit insurance wording affords coverage from the time property passes to the carrier, throughout transit, until delivered to its destination, including risks incidental to transit on or in docks, depots, wharves, terminals, yards, platforms, garages, receiving, and/or forwarding offices.

An inland marine transit policy can be written on either an all risks or named perils basis and generally includes coverage for incidental water transportation. Waterborne coverage is offered on a full perils of the sea basis or the more limited perils basis, which covers sinking, burning, stranding, or collision of the transporting vessel. Certain waterways for certain times of the year may be excluded. Payment is subject to a maximum limit for any single “loss, disaster or casualty” occurrence. Claims are adjusted on the basis of invoice cost (market value if there is no invoice) plus freight charges and any other legitimate costs the insured has sustained after shipment.

Ocean marine insurance includes coverage for any goods onboard ocean-going vessels, in temporary storage, and in transit to port for shipment coverage. Coverage may be named perils or all risks. Marine cargo insurance indemnifies the shipper of goods in the event that the latter are damaged or lost while being transported over water. Shippers can choose between a trip or voyage coverage and open cargo coverage. Open cargo policies automatically cover the hauled goods any time a shipment is made. In this case, the only thing a shipper is required to do is notify the insurer of the shipments made.

The warehouse-to-warehouse provision of a marine cargo insurance policy is very favorable since it combines ocean with inland marine insurance. The warehouse-to-warehouse clause provides coverage of the transported goods while being transported inland, such as from the dock to the warehouse, along with the protection of the goods while being hauled over sea. Warehouse-to-warehouse insurance protection is provided on a primary or contingent basis, based upon insurance interest at the time of loss.

Many companies that frequently ship products buy annual policies that cover their shipments on an annual basis for total goods shipped, whereas companies that ship goods infrequently or one time can insure a single shipment. It is important to note that ocean marine cargo insurance ceases to cover the insured’s goods once they have made landfall unless the policy contains coverage for inland transit, also called inland marine insurance. These insurance products cover both the insured’s loss of goods or products in transit and the policyholder’s liability arising from loss or damage to the property of another that is in its care, custody, or control (CCC). Exclusions can be found for countries banned from doing business with companies in the United States, including Iran and some African countries.

Real Life Scenario

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Luke obtains a commercial property policy with XYZ insurer for Kerry, who owns a pottery making company. Kerry sells the pottery online. The pottery is transported by All Safe Trucking, who picks up the pottery and stores it in their warehouse until they are ready to ship it to the final destination. A forklift driver at the warehouse crashes into several cases of the pottery, shattering the pottery, with resulting damages of $35,000. All Safe has no insurance on the warehouse. Kerry makes a claim on their policy with XYZ, and it is denied. Kerry makes a claim against Luke alleging that he should have provided coverage for this type of loss. Luke reports the matter to his E&O

Chapter 5—Inland Marine E&O Issues

RISK CONTROL TIP

Do the following to prevent problems resulting from losses to the insured’s property in a warehouse.

Recognize the possibility that the insured’s property may be stored in a warehouse at some point while it is in transit.

Understand the limitations on warehouse coverage.

Arrange warehouse-to-warehouse coverage or other appropriate coverage for property in a warehouse.

Unless adequate coverage otherwise exists, recommend the purchase of an appropriate inland marine transportation policy.

Luke obtains a commercial property policy with XYZ insurer for Kerry, who owns a pottery making company. Kerry sells the pottery online. The pottery is transported by All Safe Trucking, who picks up the pottery and stores it in their warehouse until they are ready to ship it to the final destination. A forklift driver at the warehouse crashes into several cases of the pottery, shattering the pottery, with resulting damages of $35,000. All Safe has no insurance on the warehouse. Kerry makes a claim on their policy with XYZ, and it is denied. Kerry makes a claim against Luke alleging that he should have provided coverage for this type of loss. Luke reports the matter to his E&O

An inland marine transit policy would have covered this loss. It is important for the insurance professional to carefully analyze the exposures that the client faces and also to follow up and obtain the coverages promised.

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No Coverage for Rented/Borrowed Equipment

A client’s loss exposures often include not only owned equipment, but also equipment that the client rents or borrows from others. An agent or broker’s failure to recognize and address this exposure can lead to a loss that could have been covered, but wasn’t.

Equipment that a business entity rents or borrows may be insured under the entity’s property insurance policy or an inland marine policy. Which policy is appropriate depends on the type of property being rented or borrowed, where the equipment will be used (on the insured’s premises or away from those premises), and which policy affords coverage.

Property insurance policies typically cover personal property the policyholder has leased, rented, or borrowed from someone else. The ISO building and personal property coverage form covers, as business personal property, leased personal property that the insured is contractually obligated to insure. Coverage is provided subject to the limit of insurance for the insured’s own business personal property, so the value of leased personal property that the insured is obligated to insure must be considered in establishing the business personal property limit in order to avoid both coinsurance and underinsurance problems. Personal property borrowed from others by the insured is covered under the personal property of others category of covered property, provided that a limit of insurance is shown for it in the declarations.

Personal property of others, whether rented, leased, or borrowed, is insured for the actual cash value (ACV) of the property. If the insured is obligated to insure the leased property on a replacement cost basis, the insured may purchase “Extension of Replacement Cost to Personal Property of Others,” which is available under the ISO form as an optional coverage extension. Valuation of that item will be based on the amount for which the insured is liable under the contract, but not to exceed the lesser of the replacement cost of the property or the applicable limit of insurance.

Equipment that the insured has borrowed rather than rented is covered under the ISO form as personal property of others. To be covered, borrowed equipment must be in the insured’s care, custody, and control.

Whether rented by the insured or borrowed from someone else, all property of others is covered only while it is located in or on the building described in the declarations, or in the open (or in a vehicle) within 100 feet of the described premises.

COPs also cover leased personal property of others that the insured is contractually obligated to insure and personal property of others in the insured’s care, custody, and control. Yet, most COPs do not limit coverage to described locations; thus, rented or borrowed equipment may be covered while

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used away from the insured’s premises. Unlike most property forms, COPs generally value property of others on a replacement cost basis.

Contractors equipment policies are inland marine policies designed to address the mobile nature of this property and the unique hazards to which it is exposed. The covered property is insured regardless of its location if it is within the policy territory. The most common policy territory in a contractors equipment policy is the United States and Canada. Both ISO and the AAIS publish guides to unfiled inland marine coverages that include contractors equipment forms. Their insurance company customers are free to adopt these forms or to model their own forms after them. Even so, there is no standard contractors equipment policy. Thus, it is important to review the provisions of each coverage form being considered. 

Leasing and borrowing equipment is very common in the construction industry. For this reason, coverage for property of others is an important feature in contractors equipment policies. It is important to review the definition of contractors equipment in the policy to ensure it does not exclude the type of property the insured has rented or borrowed. The definition is typically broad, including virtually any type of mobile machinery, equipment, and tools that are used in the insured’s operations or projects. However, the definition often excludes tools, road maintenance, street cleaning, and snow removal equipment, as well as cherry pickers mounted on self-propelled vehicles, air compressors, pumps, and generators.

Contractors equipment policies can be written on a scheduled basis, a blanket basis, or some combination of the two. Some blanket contractors equipment policies specify that coverage applies to all equipment owned by the insured. These forms may include leased and borrowed equipment coverage options that can be triggered by appropriate entries on the declarations page. Otherwise, they must be endorsed to provide coverage for property of others. Other blanket contractors equipment policies specify that coverage applies to equipment owned by the insured and equipment owned by others that is in the insured’s CCC. These policies provide coverage on equipment that has been loaned or leased to the insured.

Most contractors equipment policies are all risks forms rather than named perils. Contractors equipment policies are typically written on an ACV basis, rather than on a replacement cost basis. Because of the nature of construction work, the wear and tear on contractors’ equipment is substantial, and the physical depreciation may be rapid. As a result, the difference between ACV and replacement cost is often much greater for contractors’ equipment than for other types of property. Although insurers are often unwilling to cover old equipment on a replacement cost basis, replacement cost coverage may be available on specified, newer equipment, with all other equipment covered on an ACV basis.

RISK CONTROL TIP

Do the following to prevent problems resulting from losses to equipment rented to or borrowed by the insured.

Determine whether a client occasionally or frequently rents or borrows equipment.

Ensure that adequate coverage on rented or borrowed equipment is in place under a commercial property form, a COP form, or an inland marine form.

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Chapter 5 Review Questions1. The Worst Eastern Motel, currently under construction, is insured under a typical inland marine builders risk policy. Which of the following losses that occurred during the course of construction is most likely to be covered by this policy?

a. A power scaffold used in construction was stolen from the construction site.

That’s correct! All risks coverage, which includes theft, applies to machinery used in the construction.

b. A power scaffold used in construction broke down, and substitute equipment had to be rented.

This answer is incorrect. Mechanical breakdown is excluded. (The substitute equipment might or might not be automatically covered as a temporary substitute for covered property.)

c. A brick wall that sustained earthquake damage had to be replaced.

This answer is incorrect. Earthquake is an excluded peril.

d. A brick wall that collapsed due to faulty workmanship had to be rebuilt.

This answer is incorrect. Faulty workmanship is excluded.

2. Property that is temporarily in a warehouse as it is being shipped from one point to another can be covered by

a. a business auto policy (BAP) naming the trucker as an insured.

This answer is incorrect. The BAP does not cover property in or on a covered auto.

b. blanket coverage commonly referred to as a TARP.

This answer is incorrect. A tarp, or tarpaulin, is a large sheet of water-resistant or waterproof material. Blankets are not generally waterproof.

c. commercial general liability (CGL) insurance written on the warehouse.

This answer is incorrect. A CGL policy does not provide first-party property insurance on property in transit or any other property.

d. inland marine transit policies.

That's correct! Inland marine transit policies typically cover property during the time it is in temporary storage at a warehouse as long as it is still in the course of transportation.

3. Busy Boy Chair Company frequently ships merchandise by common carrier to retail stores in other states who often purchase chairs by the truckload. What is the best advice Busy Boy’s insurance agent might give concerning insurance on these chairs that are shipped?

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a. Busy Boy should purchase an annual transit policy.

That’s correct! Companies that frequently ship products buy annual policies that cover their shipments on an annual basis.

b. Busy Boy should purchase commercial property coverage with the all risks (special) causes of loss form that includes coverage for property in transit.

This answer is incorrect. The suggested policy provides relatively limited coverage for property in transit.

c. Busy Boy should rely on the truckers’ insurance, as common carriers are liable for any damage to property in transit.

This answer is incorrect. Busy Boy would be better protected by its own all risks transit insurance.

d. Busy Boy should purchase trip-transit policies for each sizable shipment.

This answer is incorrect. It is probably not cost-effective to insure each shipment individually.

4. Cortez leases a forklift truck that replaces an owned forklift that recently wore out after years of service. Which one of the following factors is least relevant in determining whether to insure the forklift on a commercial property policy or an inland marine policy?

a. The forklift has a 4,000-lb. lift capacity.

This answer is incorrect. The type of property being rented is relevant to the decision.

b. The forklift is fueled by propane.

This answer is incorrect. A propane-powered forklift might be considered more hazardous than one that is powered by electricity.

c. The forklift is yellow and easy to see with a flashing amber light.

That’s correct! These physical characteristics may contribute to safety, but they have no direct bearing on how to insure the forklift.

d. The forklift will be used exclusively indoors and on the loading dock of Cortez’s warehouse.

This answer is incorrect. Where the forklift will be used is relevant to the decision. A forklift used in a warehouse might well be considered personal property used to service the premises under a commercial property policy, whereas a forklift used at various job sites might better benefit from inland marine coverage due to its mobility.

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