CAIB 2 Ch 1.pdf

Chapter 1 Introduction to Commercial Property Insurance Chapter 1 - Outline Introduction to Commercial Property Insurance nw*'.?'.???' xxsnmMoaaiiMHaHB Section 1 - Commercial Property Defined Defining Property Insured...

Chapter 1 Introduction to Commercial Property Insurance Chapter 1 - Outline Introduction to Commercial Property Insurance nw*'.?'.???' xxsnmMoaaiiMHaHB Section 1 - Commercial Property Defined Defining Property Insured 1-2 Determining Insurance Values 1-6 Section 2 — Commercial Property Insurance Policies (General Information) Types of Policies Issued 1-11 Reinsurance/Subscription Policies 1-11 Minimum Premium/Minimum Retained Premium 1-12 Common Policy Clauses 1-12 Statutory Conditions or Commercial Property Policy Conditions 1-24 Additional Conditions 1-27 Note: Forms marked * are included at the back of the chapter. Introduction to Commercial Property Insurance Section 1 - Commercial Property Defined Chapter 1 Introduction to Commercial Property Insurance 'SGSt - -- - Section 1 - Commercial Property Defined T he use of buildings normally falls within Most communities have a number of one of the following categories: institutional risks which may include hospitals, nursing homes, municipal and Residential. other government buildings, and public and Non-mercantile. separate schools. Although most of these do some selling of goods or services, such Mercantile. activity is incidental to their primary Manufacturing/industrial. purpose. These risks are classified as non- mercantile exposures. Risks such as In insurance terms, buildings used for other accountants', doctors' and dentists' offices than residential purposes are referred to as also fall within the non-mercantile category. commercial risks. The focus of this course is on the commercial use of property. From an insurance point of view, the above risks do not contain the same exposure for Commercial risks are more likely to suffer a loss as is common to manufacturing and loss than similarly constructed buildings used other commercial risks. for residential purposes. Manufacturers, for example, use a variety of processes to make The physical assets of mercantile, their products. These processes may include manufacturing and industrial risks are the use of fire or heat, welding or spray insured under commercial property insurance painting. Businesses such as bakeries, policies. Non-mercantile properties are also restaurants and dry cleaners all use underwritten in the Commercial Property processes which increase the potential for Insurance department of most Insurers. loss by fire. For the purposes of this course, the physical There are a number of buildings in every assets of all of the above occupancies shall community that serve as centres which be included within the general term provide public services. These include commercial property. churches, public halls, town libraries, and skating and curling rinks. Private Service clubs such as the Lions Club, Canadian Legion and Kinsmen Club often own their own buildings. September 2010 IBAC CAIB 2 1-1 Section 1 - Commercial Property Defined introduction to Commercial Property Insurance Property Insured coverage is usually subject to a minimum 90% co-insurance requirement, the Insured The more traditional policy forms used by has little room for error in selecting the Insurers divide commercial property into amounts to be insured. three specific classes: Building. Defining Equipment. Property Insured Stock. Coverage can be provided on a scheduled or The definitions of building, equipment and all property (formerly Property of every stock may vary from one insurance policy to Description - POED) basis. another. In spite of this lack of standardization, any variances in definition When coverage is provided on a scheduled basis, only that property which is specifically tend to be minimal. Whenever possible, IBC Forms will be used as the standard for this identified or scheduled on the policy is insured. A commercial property policy issued course. It is the responsibility of brokers to be familiar with the definitions of insured on a scheduled basis might be formatted in the following way: property used in the forms sold by them. The following definitions are taken directly $1,500,000 on a building being of one from Commercial Property - Broad Form story, wood frame construction, asphalt (IBC 4037 (09.06), hereinafter referred to shingles, wood floor, no basement, as the Broad Form policy. forced air/gas heat occupied as a gro¬ cery store by the Insured/nil by others Building Defined and situated at 555 Duncan Road in the city of Vancouver, British Columbia. Building means the building (s) described on $400,000 on stock situated in the the Declarations Page, and Temporary building as described above. Locations and Newly Acquired Location, if covered by this form; and in or on vehicles $125,000 on equipment situated in the within 100 metres (328 feet) of such building as described above. locations: As the following example demonstrates, property can also be scheduled on an even i) "fixed structures pertaining to the more specific basis. building (s) and located on the "premises";" Example: Premises is defined as "the entire area Item 1 - $10,000 on 1997 Kushmann fork¬ within the property lines and areas lift, s/n 3351881. under adjoining sidewalks and Building, stock and equipment can also be driveways at the locations described on insured on an "All Property" basis. In such the Declarations Page and in or on cases, a single limit of insurance is stated on vehicles within 100 meters (328 feet) of the policy. such locations." When coverage is provided on an AH Fixed structures can include permanently Property basis, all property owned by the erected pole signs, yard lights, and perimeter Insured is covered by a single limit of fencing constructed on the premises. insurance. However, it should be noted that, A key limitation to coverage is that all such as with all insurance policies, there are structures must be situated on the premises certain classes of property such as and pertain to, or be used in the Insured's automobiles and aircraft which are usually business. Any fixed structure at a location excluded. other than that insured by this policy is excluded. In most such instances, coverage Coverage limits on AH Property policies can can be readily endorsed onto the existing be extended to include property at more policy. than one location. However, as blanket 1-2 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 1 - Commercial Property Defined ii) "additions and extensions for decorative purposes when the communicating and in contact with Insured is the owner of the the building(s);" "building"." The value of an addition or extension to any Businesses often contain growing plants or building is included in the amounts provided flowers throughout the building. In many under the policy for building. To qualify for instances, such greenery extends to include coverage, the addition or extension must shrubs and trees. communicate and be in contact with the Coverage is provided for these items under building, and not separate from it. the amount of insurance selected on The cost of adding a lean-to to a storage building, provided the insured can establish warehouse or to construct an enclosed that: walkway between buildings on the premises would fall within the coverage limits provided Such property was inside the for building. The value of a new warehouse building; and currently under construction at the rear of It was being used for decorative the premises constitutes neither an addition purposes; and nor extension and must be insured separately. The Insured was the owner of the building. iii) "permanent fittings and fixtures Growing plants, trees, shrubs or flowers attached to and forming part of the situated outside, or which are held for sale, building(s);" are not insured within the definition of The value of heating, plumbing and air building. conditioning systems, lighting fixtures, wall- The condition that the Insured be the owner to-wall carpeting, burglar and fire alarm of the building is a logical one. Coverage for systems and other permanently installed the above items is included under the fittings and fixtures is included in the amount insurance on the building, and the only of insurance selected on building. Permanent person having an insurable interest in a clearly means such items are intended to building is its owner. remain as part of the insured structure. The additional requirement that they be attached to and form part of the building (s) insured Stock Defined serves to confirm their permanency. Stock means iv) "materials, equipment and supplies on the "premises" for maintenance i) "merchandise of every description of, and normal repairs and minor usual to the Insured's business;" alterations to the "building" or for The type of business in which the Insured is building services;" engaged will normally be indicated on the The definition of building includes the value policy. Goods held for sale will be insured of materials such as lumber, roofing shingles within the coverage provided for stock so and glass. It also extends to include long as they constitute goods usual to the equipment and supplies of all kinds. A claim Insured's business. If the Insured's business for payment of such items under the amount is described on the policy as a retail book insured as building will be made only where store, the Insurer will have grounds to deny the insured is able to establish that they any claim for loss of merchandise not usual were used for the purposes of maintenance to a book store and which is being sold by of the premises, normal repairs, alterations the I nsured out of the same premises. or for building services. The definition of The rate or premium charged is determined building excludes payment for materials, in large part by the nature of the Insured's equipment and supplies intended or being stock. The value and susceptibility to loss used for major renovations, new construction can be significantly different from one type or any other purpose. of stock to another. The Insurer who provides coverage on a retail book store, for v) "growing plants, trees, shrubs or example, should not be obligated to insure, flowers inside the "building" used September 2010 I BAG CAIB 2 1-3 Section 1 - Commercial Property Defined Introduction to Commercial Property Insurance for the same premium, other stock items The Insured must have had an having a greater potential for loss. obligation to keep the property insured. The description of the Insured's business provided on the Declarations Page is It is normal practise for manufacturers, extremely critical. It sets the parameters of wholesalers and other suppliers to coverage provided on stock to those items enter into written agreements with usual to the business of the Insured, At the business owners outlining the credit time the application is taken, the broker arrangements extended to them. Also, must ensure all business activities are usually included is a contractual properly described to ensure all stock items obligation upon the Insured to maintain are fully covered. The Insured must advise insurance on the property belonging to the broker of any new business activities the supplier, until such time as the entered into after the policy is issued. supplier has been paid; or ii) "packing, wrapping and advertising The Insured must have been legally materials; and" liable for it. Stock includes the value of all packing Even in the absence of a formal materials such as bubble plastic, Styrofoam agreement such as discussed above, and paper used to package items for the Insured's policy will respond to shipment. In more recent times, popped cover loss to property for which the popcorn has proved its value as a packing Insured is legally liable. material. When Insureds are acting in the All types of materials used as wrappings are capacity of a bailee for hire, the extent also insured under the values selected for of their legal liability for loss to the stock. This includes bags of all types, paper property of others will already have and any other outer wrappings as might be been established in law. Normally, used. Insureds are obligated to exercise ordinary care over the property of The value of advertising flyers, catalogues others left on their premises. They and in-store advertising materials is included become legally liable for loss to such in the values selected on stock. Advertising property when they have breached this hand-outs such as pens, key chains and standard of ordinary care because of coffee mugs also qualify as stock items. negligence, or when they have assumed additional responsibility for it iii) "similar property belonging to in contract. For example, a T.V. left for others which the Insured is under repair - if lightning causes the loss of obligation to keep insured or for the building and contents the Insured is which he is legally liable." not held responsible. However, if the The value of property belonging to others is T.V. is stolen from an unlocked area, insured within the values selected on stock the Insured could be liable. subject to the following conditions: Some Insureds may have property of others held on consignment. This The property lost or damaged must consignment stock does not belong to be similar to that insured by the the Insured but a consignment policy. agreement may require the Insured to Television, appliance, bicycle and a maintain insurance on this consignment variety of other stores commonly stock. provide on-premises service for the products they sell. Many businesses It is important that Insureds select an also sell goods of others on a amount of insurance sufficient to cover consignment basis. their contractual and legal requirements arising out of loss to The value of the property of others is similar property of others. It is always a included within the limits selected on good idea to discuss this consignment stock provided such items fall within property with the underwriter. the same general description as those insured by the policy. 1-4 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 1 - Commercial Property Defined Equipment Defined It is crucial that the broker review all lease agreements to ensure proper values and Equipment means: coverages are affected. Also at various times an increase in limits may be necessary. i) "generally all contents usual to the Insured's business, including iii) "tenant's improvements, which are furniture, furnishings, fittings, defined as building improvements, fixtures, machinery, tools, utensils alterations and betterments made and appliances other than at the expense of the Insured to a "building" or "stock"; "building" occupied by the Insured and which are not otherwise Note: Review assets with the Insured and insured, provided the Insured is inform the underwriter if in doubt. not the owner of such "building". If Examples of equipment items insured by the Insured purchased the use commercial policies include: interest in tenant's improvements made by a predecessor tenant, this Office furniture and furnishings. form applies as though such tenant's improvements had been Fittings and fixtures such as portable made at the expense of the shelving units and display cases. Insured." Machinery ranging from air compres¬ Not all businesses operate out of buildings sors to tractors and fork-lifts used on owned by Insureds. Renting business space the premises. in multiple occupancy buildings such as malls Utensils and appliances such as cutlery and commercial high rises is attractive to and dishes, microwave oven and porta¬ business owners for a variety of reasons. ble dishwasher, all if not for sale. Normally, the space rented to the tenant is unfinished and requires substantial ii) "similar property belonging to improvements and betterments prior to others which the Insured is under opening for business. Installing wall-to-wall obligation to keep insured or for carpet and adding lighting and wall panelling which he is legally liable;" are the kinds of improvements and betterments tenants will normally make to This clause is also contained in the definition the business premises they rent. Were the of stock and is identical in its intent. Insureds to own, rather than rent the Insureds often have in their possession premises, the value of these betterments equipment they do not own, but which is and improvements would be insured as used in their business operations. It may building Because the Insureds do not own or include computers, photocopiers, mailing have an insurable interest in the building, machines, postage metres, facsimile they are not entitled to place insurance on it. machines, telephones and coffee makers. Instead, all improvements and betterments they make must be insured as equipment. In many cases, Insureds have leased equipment required to operate their A new tenant assumes the improvements business. Almost without exception, they will and betterments and must insure them as be required to sign an agreement assuming such. full responsibility for any damage to it. The lease agreement may also require that insurance coverages be purchased. In some instances, equipment may be borrowed or loaned to the Insured. When the Insured is under a contractual obligation to keep the property insured, or is legally liable for loss or damage to it, the coverage provided on equipment will extend to include that property September 2010 IBAC CAIB 2 1-5 Section 1 - Commercial Property Defined Introduction to Commercial Property Insurance a) Formula/Cost Approach Method Determining Insurance Values This is the traditional approach most commonly used in determining the value of lost or damaged property. The onus is upon the Insured, and not the The first step in using this approach is to broker, to establish the amount of insurance determine the replacement cost of the required and to prove the amount of any property. Once that value has been loss. The broker's role is to provide the established, the rate of depreciation is advice, guidance and direction Insureds need determined by using either of: to meet those obligations. A major part of the broker's role is to ensure that the Straight line depreciation. Insureds know the level of property values required for insurance purposes, and to Assuming a building loss, this method of calculating depreciation is based on guide them towards insuring to those levels. the number of years the building could While brokers are not property appraisers, have reasonably been expected to be they can assist the Insured in completing functional. If a building was 30 years standard industry forms when prescribed by old at the time of loss and it could an Insurer. Brokers can also make reasonably have been used for still recommendations as to established appraisal another 30 years, the rationale is that firms who, for a fee, will help the Insured it was 50% depreciated at the time of arrive at a proper valuation. loss. A problem with this approach is that it assumes that all property When Insureds are unwilling to pay the costs depreciates the same amount each of hiring an appraisal firm to establish year. insurance values, they often turn to local building contractors as reliable alternatives. Plateau accelerated depreciation. The broker should recognize that, while contractors can arrive at an estimate to This approach to depreciation is rebuild a building, they do not stand behind commonly used on property where it's that estimate in the same way that most useful productively during its professional appraisal firms are required in early years. It proceeds on the basis law to do. that the greatest depreciation will occur in the first few years of use and that It is important for the broker to recognize once a certain age has been reached, that property may be valued in different the depreciation rate tends to plateau. ways. Items usually subject to this method of calculating depreciation include office 1) Actual Cash Value and restaurant equipment, and production machinery. The meaning of actual cash value is not provided in property insurance policies. Its b) Market Value/Direct Sales meaning has come to be defined through Approach usage and decisions rendered by the courts. A licensed real estate appraiser will generally In its most traditional meaning, actual cash be consulted to provide an expert opinion as value is understood as being the cost to to the fair market value of: repair or replace lost or damaged property, less the application of any The property before the loss. depreciation. While this basic definition is workable on the more straightforward types The property after the loss. of losses it is open to considerable The land. interpretation when losses are more complicated. The opinion of the appraiser will be influenced by the condition and location of Following is a discussion of five methods the Insured’s building when compared to used to determine the actual cash value of similar properties that have recently sold in lost or damaged property. the area. The sale of similar lots will be 1-6 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 1 - Commercial Property Defined researched in order to gain an appreciation d) True Value to the Owner of land values. This approach can be used when Insureds A shortcoming to this approach is that it is claim the previous three methods have failed not always easy to arrive at a fair market to consider their special circumstances. value when the property is not actually being sold. Too, for buildings such as churches, there is no real market value as that which Example: exists for houses, stores or factories. Even for these types of buildings, it does not The Insureds maintain an old warehouse necessarily follow that the market value on their property which they use to store represents the actual loss to the Insured. It lumber products. After a total fire loss, may be too high or too low depending on the the Insurer advises the Insureds that due circumstances. In the final analysis, it is to the age of the building, a depreciation often the opinion of the appraiser which factor of 60% is being applied to the estimates value and not the actual workings settlement. of the market itself. It shouldn't play a role in the insurance industry. The Insureds' position is that the building must be replaced and that its value to c) Income Approach them is significantly different than This method of evaluating a loss is determined by the Insurer. The courts commonly used with income producing have shown support for this argument. properties. It is especially useful when income is produced from dilapidated or run¬ down buildings. The net annual rental e) Broad Evidence Rule income is determined and a capitalization The Broad Evidence Rule ties together all factor applied to it to produce an actual cash four of the above approaches used to value amount. establish actual cash value. When the courts are asked to rule on the determination of actual cash value, they must take into Example: account many different factors, not the least Net annual rent = $30,000 of which are: Capitalization Rate* = 75% Actual Cash Value = $200,000 Replacement value less depreciation. ♦Arriving at this calculation usually Market value. requires the services of a qualified Rental value. accountant. It represents the percentage of years left in the useful life of a Use of building. property. To determine this rate, a Location. number of factors will be considered including number of years property could Obsolescence. continue to produce income, variability, Assessed valuation. prevailing interest rates, and rate of return on similar properties. In this Resale success. example, the annual rent represents the capitalization rate of 15%, therefore 2) Replacement Value 30,000/15% is 200,000 of the value left in the life of the property. Replacement value represents the costs to repair, replace or rebuild the lost or damaged property without deduction for depreciation. Insurance policies normally use the term replacement cost when referring to this value. An appraisal will normally be required when buildings are insured on this basis. September 2010 IBAC CAIB 2 1-7 Section 1 - Commercial Property Defined Introduction to Commercial Property Insurance 3) Book Value The benefits to a business in reducing the book value of tangible property are primarily Book value is the price which was expended financial. Revenue Canada allows a business at the time of purchase and which has been to use depreciation and other agreed reduced by depreciation or other write-offs. deductions in the calculation of income tax. The intervening effects of inflation are not The more deductions or write-off, the less included in the calculation of book value. tax required to be paid by the business. Book value is not an appropriate means of The calculation of book value is a straight valuing property for insurance purposes. The line reduction in value from the original fact that an item's book value can be purchase or acquisition cost. However, in reduced to zero while it continues to serve a calculating actual cash value you use the useful purpose demonstrates that point. replacement cost at the time of loss - less depreciation. Similarly if the policy is written to include replacement cost it is the replacement cost at the time of loss. 1-8 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 2 - Commercial Property Insurance Policies (General Information) Section 2 - Commercial Property Insurance Policies (General Information) Types of Policies Insured The following rules or guidelines apply when reinsurance is used to provide insurance coverages: T here are a wide variety of insurance All Insurers share in both the coverage options available to owners of premiums collected and the losses commercial property. Available coverages incurred. range from basic protection provided under the Fire Policy to all risks coverages insured Many of the Reinsurers used by by Broad Form policies. In between are Canadian Insurers are based overseas. It is through these exchanges of risks policies insuring against Fire and Extended that insurance has truly become a Coverage and Named Perils. universal and international commodity. Composite or package policies are common The contract is between the in today's commercial insurance marketplace. These policies combine, under primary Insurer and the Reinsurer. one form, a variety of coverages needed by The Insured is most likely not even the majority of offices and small mercantile aware that such a contractual operations which make up the main street relationship exists. business district in most communities. The policy is controlled by the Manuscript policies are designed for risks primary Insurer and all claims are having a specialized exposure and for which paid by it. no standard coverage form exists. They are generally developed by larger brokerage Only when the claim has been paid is firms where sizeable national accounts and the Reinsurer asked to contribute its other risks having specialized insurance share of the loss. needs would not be well served using standard industry forms. 2) * Subscription Policies Reinsurance/ Under a subscription policy, a group of Insurers have agreed to share in providing Subscription Policies insurance coverages. There are times when a subscription policy may be the only alternative available. While Insurers may choose to underwrite Subscription policies can be issued when: 100% of smaller risks, they often seek to limit the amount of their exposure on large The line of business is so risks. This reduction in exposure is achieved specialized as not to be covered by through the use of reinsurance and the Insurer's treaty with its subscription policies. Reinsurers. The type of risk is one which the 1) Reinsurance Insurer does not want to expose to its reinsurance treaties. Many Insurers of commercial property reinsure the risks they write. Reinsurance The limits do not exceed the involves an Insurer passing off or ceding part Insurer's net retention limits but of the risk it has assumed to one or more are beyond what it is prepared to "other Insurers". These other Insurers are pay in a single claim. called Reinsurers. The broker wants to spread a good large line of business among markets. September 2010 (BAC CAIB 2 1-17 Section 2 - Commercial Property Insurance Policies (General Information) Introduction to Commercial Property Insurance In such instances, the ability to provide the Insured with appropriate coverages over¬ Minimum rides all other concerns, Premiums/Minimum Subscription policies share the following Retained Premium characteristics: Most Insurers of commercial property have Participating Insurers share both established a minimum premium to be the premiums and the losses. charged all policyholders. This amount varies between Insurers and minimum premiums Each agreement is usually required within the range of $500- $1000 are not to be negotiated separately. unusual in today’s marketplace. Coverages are provided on a form which is The minimum retained premium refers to the acceptable to all subscribers. The company amount of premium kept by the Insurer which assumes the greater portion of the when the policy is terminated prior to its liability for loss is called the lead company. When the participating Insurers agree to expiry date. This amount varies from a low of $25 to amounts into the thousands of share the risk equally, the Insurer which was dollars. The purpose of a minimum retained initially approached by the broker often becomes the lead company. premium is to ensure the costs of underwriting the policy can be recouped, at When subscription policies are used, the lead least in part. company normally issues the policy and provides all policyholder services, including the handling of claims. The broker collects Common Policy Clauses and distributes the premium to all participating Insurers. The subscribing companies are identified and the There are a number of clauses, conditions participation percentage of each is indicated and limitations contained in policies of on the policy documents. In effect, each commercial property insurance. They are the Insurer contracts with the Insured for a very core of the insurance policy. They are specific limit of liability in a manner as the statements that govern how the policy though each had issued its own policy. works. They are the result, in certain cases, Claims are paid on a proportion equal to the of an evolutionary process which goes back percentage of participation of each Insurer. to the beginnings of property insurance. Separate cheques are provided from all Brokers who have a solid understanding of subscribing companies to the claimant. The the purpose and workings of these important fact that the lead or any other subscriber chooses to pay or deny a claim does not areas will be of invaluable assistance to their clients. mean the others must follow suit. Whether Insurers choose to share risks with See appendices in Chapter 3 for examples of each other under formalized reinsurance policy forms. contracts, or on a more informal subscription basis, the end result is the same. Both Indemnity Agreement arrangements limit the participant's liability in the event of loss. The way each method of "In the event that any of the insured risk sharing works, however, is significantly property is lost or damaged during the different. policy period by an insured peril, the From a broker's point of view, it is far Insurer will indemnify the Insured simpler to deal with an Insurer protected by against the direct loss or damage so reinsurance contracts than to negotiate the caused to an amount not exceeding insuring of individual risks on a subscription whichever is the least of: basis. (a) the value of the lost or damaged From the Insured's perspective a property as determined in Clause subscription is transparent, while the use of 15; reinsurance is usually not known to the (b) the interest of the Insured in the Insured. property; 1-12 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 2 - Commercial Property Insurance Policies (General Information) (c) the amount of insurance specified causing an intentional loss unless the on the "Declarations Page" for the deductible was inordinately high. lost or damaged property. Currently, a minimum deductible of $500 The inclusion of more than one person appears to be the standard for smaller retail or interest shall not increase the and office risks. Insureds receive a rate Insurer's liability." credit for selecting increased deductible amounts and all quotations presented by the The payment of a claim will be made only broker should provide deductible options. after the adjuster has established a value for Small retail stores and offices, for example, each of the three criteria stated above. The might be provided with a choice of principle of indemnity is deemed to have deductibles of $500 or $1000. Larger been upheld where the amount of the department stores and manufacturers may payment to the Insured is the least of the find higher deductibles more attractive for amounts so calculated. their operations. This clause also addresses the matter of The broker may find that the amount of multiple Insureds. When there is Joss to credit provided by Insurers does not justify property which is owned by more than one Insured, the Insurer is obligated to pay only saddling the Insured with a high deductible. Given that the minimum expense for a claim that amount stated on the Declarations Page file assigned to an adjuster is approximately in total, and not that amount for each person $250, some brokers find it surprising that named on the policy. the amount of the deductible credit is not substantially more than is currently provided Deductible by the majority of Insurers. "The Insurer is liable for the amount by Co-insurance which the loss or damage caused by an insured peril exceeds the amount of the "This clause applies separately to each deductible specified on the item for which a co-insurance "Declarations Page" in any one percentage is specified on the occurrence. Should any occurrence give "Declarations Page" and only where the rise to the application of more than one amount of loss or damage exceeds the deductible amount for any one lesser of 2% of the applicable amount of "premises", only the highest deductible insurance or $5000. will be applied." The Insured shall maintain insurance Black's Law Dictionary defines a concurrent with this form on the insured deductible as "the portion of an insured loss property to the extent of at least the to be borne by the Insured before he is amount produced by multiplying the entitled to recovery from the Insurer." value of the property as determined in Clause 15 by the co-insurance The broker should be aware there is no one percentage specified on the single deductible clause which has been "Declarations Page". If the Insured fails adopted exclusively for use by the insurance to do so, the Insured shall be entitled to industry. Nevertheless, the majority of recover that portion of any loss that the policies provide for an occurrence basis amount of insurance in force at the time deductible. This means the Insurer agrees to of loss bears to the amount of insurance apply only one deductible to the total required to be maintained by this amount claimed for losses arising out of a clause." single event or occurrence. The application of co-insurance requirements The deductible clause is used by Insurers to to fire insurance policies was not generally eliminate minor maintenance types of claims. practised until the 20th century. This concept It can be argued it also serves to reduce is not new, however. The principle of moral hazard by making Insureds participate averaging the loss between the Insurer and in their losses. However, it is unlikely those the Insured in cases of under-insurance has Insureds who represent the extreme in terms been used in marine insurance since its of moral hazard would be deterred from earliest beginnings. September 2010 IBAC CAIB 2 1-13 Section 2 - Commercial Property Insurance Policies Introduction to Commercial Property Insurance (General Information) The basics of co-insurance have been discussed in great detail in CAIB 1 In this Did course, only the introductory statement Should X Loss = Settlement requires further explanation. It states that the Insurer agrees to waive or give up its $72,000 right to apply the provisions of the co¬ $96,000 X $1,200 = Settlement insurance clause in certain loss situations, even though it is obvious that the claimant is 3 X $1,200 = $900 under-insured and, in most other instances, 4 would be subject to penalty. This Waiver of Co-insurance recognizes many Note: insured losses are small ones. Where the The amounts used in the above formula to total loss is a few hundred dollars, or even a determine whether the Insured has complied few thousand dollars, the cost for the with the provisions of the co-insurance Insured to conduct a full inventory of clause are determined as follows: remaining values to prove compliance with the co-insurance clause could well exceed Did = Amount of insurance the amount of the claim. So, for smaller purchased valued losses, it makes sense for the Insurer to remove this obligation from the Insured. Should = Minimum co-insurance By the terms of this clause, the Insurer percentage required to be agrees that when the total loss to property is insured times actual cash less than either of 2% of the amount of value of property being insurance or $5,000, the provisions of the insured co-insurance clause will not be applied. The co-insurance clause will not be applied if Pete Moss is able to establish that the loss is: A Claims Example !s less than $5,000; or Is less than 2% of the amount of Pete Moss owns and operates a lawn and insurance ($72,000 x 2% = garden retail business. In May he suffered a $1,440). $1,200 fire loss to stock. His insurance policy provided coverage for $72,000 subject to an Pete Moss is able to qualify on both counts 80% co-insurance requirement. Just two and amount of the claim is paid in full, weeks before the loss, Pete received $40,000 subject to the deductible provided by the in bedding plants and, at his own estimate, policy. In this example, it is easy to see how the value of stock on the premises at the the costs of compiling a complete inventory time of the loss was $120,000. on an item-by-item basis could well exceed the amount of the loss itself. The amount of the waiver is not sufficient to If the provisions of the co-insurance clause encourage Insureds to deliberately under¬ were strictly applied, Pete would have to insure. In this instance, the amount of the provide evidence showing the amount of payment is only $300 more than would have stock insurance he purchased represented at been received had the provisions of the co¬ least 80% of the value of stock on hand at insurance clause been strictly applied. the time of the loss. If he failed to purchase enough insurance to satisfy this requirement, Although the example used to waive the Pete would be required to share in the loss. coinsurance clause is based on a maximum The co-insurance clause provides for the of dollar amount of $5,000 and a percentage following calculation: of 2%, many Insurers may offer different maximum amounts and percentages to their policies. These will vary between a percentage maximum of 2% to 10% and a maximum dollar amount ranging from $2,500 to $10,000. 1-14 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 2 - Commercial Property Insurance Policies (General Information) Co-insurance Clause Not Acceptable to insurance provided the insured complies with All Insureds the following coverage requirements: Insureds who have substantial real estate Files a Statement of Values with and property holdings may find themselves the Insurer representing 100% of uncomfortable with the co-insurance clause the value of all property insured, as in its standard form. This is particularly true verified by appraisal or other when inflation rates show marked increases means acceptable to the insurer; over relatively short periods. At those times, and even the Insured who meets or exceeds the Insurer's co-insurance requirements at the Maintains those values throughout time insurance is purchased may end up the term of the policy. sharing in a future loss. To prevent against that happening, the co-insurance clause can Should the Insured NOT maintain insurance be replaced with the Stated Amount Co¬ to 100% of the Stated Amount during the insurance Clause. entire policy period the policy will revert to a 100% Co-insurance basis. The following Stated Amount Co-insurance Clause is reproduced from a current comm¬ ercial property insurance form. Exclusions "(Applicable only when specified on the There is no single property policy which Declarations). covers all property owned by an Insured (a) In consideration of a statement of against all losses. All property policies have values filed and attested by the two types of exclusions relating to: Insured, the following clause (paragraph b) is substituted for the Property excluded. Co-insurance Clause cited in this Perils excluded. form, and shall be effective until 12;01 a.m. Standard Time on the Why Exclusions Exist expiry date of this policy. Exclusions are designed for one or more of (b) it is part of the consideration of the following reasons: this form and the basis upon which the rate of premium is fixed that a) To exclude losses which are the Insured shall maintain generally considered by Insurers to insurance by - or concurrent in be commercially uninsurable. form, range and wording with - this The following are examples of uninsurable form on the property hereby types of risk and are standard exclusions for insured, so that the total amount of losses caused by: insurance on the said property shall be not less than the amount Deliberate acts of violence (war. indicated in the Statement of rebellion, revolution etc.). values on file with the Insurer Nuclear energy hazard. (including the amount of insurance effected by this policy) and that, b) To exclude losses which have failing so to do, the Insured shall within them the potential to be be a co-insurer to the extent of an amount sufficient to make the total catastrophic, including; insurance on the said property Earthquake, snowslide, landslide and equal to the amount indicated and, flood. in that capacity, shall bear their proportion of any loss that may c) To exclude losses for which more occur." specialized policy forms have been developed. When indicated on the Declarations Page, the Stated Amount Co-insurance Clause replaces Common to this category are exclusions the Co-insurance Clause normally contained relating to losses caused to: in the policy. It provides for the removal of the standard co-insurance penalty for under¬ Automobiles and aircraft. September 2010 IBAC CAIB 2 1-15 Section 2 - Commercial Property Insurance Policies Introduction to Commercial Property Insurance (General Information) Business records. * Money and securities Note to Students: Overseas shipments of Insured's products. Exclusion clauses vary from one Insurer to another, therefore it is important to check Property owned, operated or controlled the policy wordings of each insurance by the Insured by explosions of boilers Over the past company you represent. and certain pressure vessels. several years Insurers have introduced new exclusions applicable to Terrorism, Data and d) To exclude losses that are wholly Data Problem, Mould, Asbestos, Drug or partially in the control of the Cultivations, and Abuse. For a complete Insured, or which can be expected, description of these exclusions, please refer such as those resulting from: to Appendix “A" at the back of the text for further details. Application of heat or other process. Marring, scratching or crushing. Normal wear and tear. Permission e) To exclude losses which are not "Permission is granted: common to a large number of Insureds, but which represent an (a) for other insurance concurrent with increased potential for loss which this form; is deserving of an additional (b) to make additions, alterations or premium charge. repairs; Losses to the following property represent (c) to do such work and to keep and such additional exposure to the Insurer use such articles, materials, and Outside communication towers, anten¬ supplies in such quantities as are nae (including satellite receivers) and usual or necessary to the Insured's attached equipment. business." Property in the custody of a sales Permission is extended by the Insurer as representative. follows: Buildings in the course of construction. "(a) For other insurance concurrent Where these exclusions appear in the policy with this form;" depends on the type of policy purchased. A policy which insures only certain named Problems can arise when there are two or perils will normally state the exclusions more policies covering the same risk, each immediately below a description of each insuring against different perils. When the coverage provided by it. On the other hand, cause of the loss is insured on one policy and policies providing the broadest coverages will not the other, no one is well served. When identify applicable exclusions under clearly coverages are the same or concurrent, these identified subsections or headings entitled problems do not exist and the Insurers Property Excluded and Perils Excluded. contribute towards payment of the loss on a pro-rata basis. The insurance purchased by f) To exclude losses whole or in part the Insured must be more than concurrent where there the activity is illegal. as to the types and number of perils insured against. It must be concurrent in all Loss of illegal substances. respects. This includes selecting the same deductibles and co-insurance percentages. It is a good practice to encourage Insureds to purchase all of their coverages from one brokerage. This enables the broker to establish a complete insurance portfolio for Insureds and better anticipate and serve their overall insurance needs, 1-16 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 2 - Commercial Property Insurance Policies (General Information) "(b) "to make additions, alterations or Pete Moss's insurance policy contains a repairs;" condition which requires him to advise the Insurer "forthwith.... of any interruption The Insured is entitled to make additions, to, or flaw or defect, coming to the alterations or repairs to existing structures knowledge of the Insured, in any without having to first seek the permission of sprinkler or other fire extinguishing the Insurer. When such activities are planned system..." Pete recently disconnected the or are underway. Insureds should be advised to report any significant increase in values to sprinkler system in his store when it their insurance broker. developed a major leak. He failed to advise the Insurer of this interruption to the Clearly, there is no permission provided for system. From the moment the sprinkler the construction of new structures. A system was disconnected, Pete was in breach separate Course of Construction or Builders' of a policy condition. The sprinkler system Risk policy is required to provide necessary was still not operational when thieves broke protection to the insured. into Pete's store two weeks later. They were able to steal Pete's entire inventory of "(c) To do such work and to keep and begonias and tulip bulbs. The theft of stock use such articles, materials, and from Pete's store would not be excluded supplies in such quantities as are under a policy of theft insurance because of usual or necessary to the Insured's his failure to advise the Insurer of an business." interruption of the water supply to the sprinkler system. Certainly, the Insurer The items or materials used and stored by a would have a difficult time convincing the business and the work or processes courts that the failure of the Insured to conducted by it are permitted, without the comply with the terms of that condition requirement for notice to the Insurer, so long directly caused or contributed to the loss. as they are "usual or necessary” to the business. b) The breach of condition occurred in a portion of the premises over Breach of Conditions which the Insured has no control. Bea Wreel is the owner of a local shopping "If the Insured does not comply with a mall which contains 30 businesses. The condition of this insurance, any claim for insurance policy provided on the mall by Ms. subsequent loss or damage is not Wreel's broker contains a number of policy recoverable. The Insured will not deny a conditions, one of which states "No Welding claim for this reason if the Insured or Spray Painting Permitted." proves that the non-compliance neither caused nor worsened the loss or Jimmy Nash, one of the tenants in the mall, damage. Coverage will not be affected if is a noted collector of classic automobiles. He the Insured fails to comply with a recently acquired a 1957 Chevrolet car, and condition in part of the "premises" over he spent most nights and weekends working which the Insured has no control." on it. Just last week, he completed all of the required body work. A friend who worked in Insurance policies contain a variety of types a local auto body shop agreed to help paint of conditions ranging from statutory the car and a space was made ready at the conditions which are imposed by law, to rear of Jimmy's business premises in the policy, other and additional conditions mall. While spray-painting the Chevy, an imposed by Insurers. A condition imposed explosion occurred. No one had told Jimmy upon an Insured under the policy requires that paint fumes and a lighted cigarette were them to do, or not to do, something. When a dangerous combination. The resulting fire a condition has been breached, the destroyed the entire mall. Insurer may have grounds to deny coverage. However, the Insurer agrees Even though the work conducted by Jimmy not to refuse payment where the and his friend constituted an activity which insured is able to establish that: breached a condition under B. Wreel's policy, her Insurer is obligated to pay for the loss to a) The loss was not caused or the property because the breach of condition contributed by the breach. occurred in a portion of the premises over which the Insured had no control. September 2010 IBAC CAIB 2 1-17 Section 2 - Commercial Property Insurance Policies Introduction to Commercial Property Insurance (General Information) Reinstatement that they request termination of the contract. The Insurer is required to provide a return of "Loss under any item of this form shall premium in accordance with the provisions of not reduce the applicable amount of Statutory Condition 5, Termination, even insurance." though it has fully satisfied the conditions for which coverage was purchased. Most The Indemnity Agreement limits the Insurers are prepared to accept this inequity Insurer’s liability under the policy to the because, even with such payments, there is amounts indicated on the Declarations Page. still an over-all savings in administration When those amounts have been spent to pay costs. claims, the reasonable conclusion is that the Insurer has satisfied its obligations under the Some Insurers, however, are not willing to contract and that coverage ceases. accept that Insureds should be entitled to a refund of premium when they have collected In years past, when an Insurer paid a claim, for a loss under the policy. So, while the amount of insurance indicated on the agreeing to the automatic reinstatement of Declarations Page was reduced by the all loss amounts, they have modified the amount of the payment. The balance Reinstatement Clause to reflect a more represented the remaining obligation of the stringent policy respecting return of insurer under the contract. premiums when a loss has been paid under Example: the policy. Building Insurance Purchased - $125,000 Loss - $50,000 Subrogation New Policy Amount After Payment Of Loss - $75,000 "The Insurer, upon making any payment or assuming liability therefore under In total loss situations, the Insured had no this form, shall be subrogated to all remaining insurance and was required to rights of recovery of the Insured against purchase a new policy. In partial loss others and may bring action to enforce situations, it was up to the insured to such rights. All rights of subrogation are request the policy limits be increased once waived against any corporation, firm, the lost or damaged property was reinstated. individual, or other interest with respect As the costs of doing business increased, to which insurance is provided by this Insurers found this method of dealing with policy. insurance policies after a loss could not be Where the net amount recovered, after cost justified. By the time the request for deducting the costs of recovery, is not increased coverage had been processed, sufficient to provide a complete billed and collected, there was little, if any, indemnity for the loss or damage profit realized from the transaction. It made suffered, that amount shall be divided sense for Insurers to look for an alternative between the Insurer and the Insured in way to handle the whole process of the proportion in which the loss or reinstatement of insured values. The damage has been borne by them automatic reinstatement of insured values, respectively. as existed immediately prior to the loss, was the accepted solution. In other words, the Any release from liability entered into Reinstatement Clause provides that Insureds by the Insured prior to loss shall not shall have as much insurance after a loss, as affect the right of the Insured to they did before it. recover." Automatic reinstatement of insured values is When loss to an Insured's property is caused a definite benefit for Insureds. Insurers have by others, the Insured is entitled to: benefited as well, but for one significant exception The Statutory Conditions allow for Initiate legal proceedings to recover the the termination of the contract by the amount of the damages caused; or Insured at any time upon request. In total Claim the amount of the loss under his loss situations, Insureds have lost all their or her insurance policy, assuming, of possessions and are quick to realize that course, that the loss is covered by the automatic reinstatement of insurance limits policy. holds no advantage for them. The result is 1-18 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 2 - Commercial Property Insurance Policies (General Information) Because of the delay, expense and corporation, firm, individual, or other interest uncertainty in dealing with the courts, most with respect to which insurance is provided insureds seek payment of their losses by this policy." Included in the list of those directly from their insurer. whom the Insurer agrees not to subrogate against are payees under the policy such as When applied to insurance contracts, individuals, banks, trust companies and subrogation refers to the right of the Insurer credit unions, business partners and to "step into the shoes" of the party whom it subsidiary firms and, generally, any entity has compensated and sue any party whom providing evidence of insurable interest. the compensated party could have sued. In initiating such suit, the Insurer effectively Property Protection trades places with the Insured. In Common Systems Law, the Insurer must bring the suit in the Insured's name. All expenses in bringing an "It is a condition of this insurance, for action are borne by the Insurer and the the purpose of Clause 9, that the Insured is required to cooperate with it. Insured shall immediately notify the The Insurer, in the subrogation process, is Insurer of any interruption to, or flaw or entitled to seek recovery of all amounts for defect, coming to the knowledge of the which the at-fault party might be liable, Insured, in any: including those not covered by the policy. If the amount recovered is in excess of that (a) sprinkler or other fire extinguishing paid by the Insurer under the policy but, at system; or the same time, is still inadequate to (b) fire detection system; or compensate the Insured fully for the loss, the amount recovered is shared between the (c) intrusion detection system; Insurer and the Insured "in the proportion in which the loss or damage has been borne by and shall also immediately notify the them respectively." There are instances Insurer of the cancellation or non¬ where the Insured may do things which renewal of any contract which provides would impair the ability of the Insurer to monitoring or maintenance services to successfully subrogate against a responsible any of these systems or of the notification of the suspension of police third party. For example, to entice tenants into his building, a landlord might enter into service in response to any of these a contract which holds them harmless for all systems." damages caused to the building. When such Insureds are encouraged to participate in loss does occur, the subrogation rights of the any measures which help prevent or reduce Insurer are restricted to those possessed by loss. Insurers commonly offer rate credits to the Insured at the time of the loss In this Insureds who install loss control devices such example, the Insurer's hands are tied. as fire alarms, smoke detectors, automatic Because of the landlord's agreements with sprinklers and burglar detection systems on the tenants, they landlord has effectively their premises. given up any legal right to sue them for damages caused to the building. The Insurer This clause outlines three obligations placed acknowledges that such agreements may upon Insureds who have installed any of the exist and agrees not to use its impaired above property protection systems on their ability to subrogate as a reason to deny premises. coverage to the Insured. i) The Insured shall notify the Insurer Certain Parties Protected "forthwith" of "any interruption to, or flaw or defect, coming to the There are certain parties against whom the Insurer agrees not to exercise its right of knowledge of the Insured" in any such system. subrogation. When losses are caused by the Insured or their partner. Insurers would be Forthwith conveys the same meaning in law under a great deal of negative public as immediately or without delay. Also implicit pressure if they were to pay the claim to one within the terms of this condition is the and subrogate against the other. To this end, requirement that the Insured must have had Insurers have agreed not to exercise the knowledge of the "interruption to, or flaw or right of subrogation "against any September 2010 IBAC CAIB 2 1-19 Section 2 - Commercial Property Insurance Policies Introduction to Commercial Property Insurance (General Information) defect" of the equipment. This prevents the This notification process is intended to Insurer from claiming breach of condition, impress upon the Insured the need for and subsequent denial of coverage, in correction. Police service is usually instances where the Insured did not know of discontinued only after it is apparent the the impaired capability of the equipment. equipment cannot be made to function The onus to prove the existence of prior properly or the Insured has given no knowledge rests with the Insurer. indication he is serious about remedying the problem. ii) The Insured shall advise the Insurer forthwith when any contract providing monitoring or Premium Adjustment maintenance services to such systems has been cancelled or not "This clause is applicable if a specific renewed. amount of insurance is shown on the "Declarations Page" for "Stock". It is common for Insurers to refuse to provide insurance for certain coverages and If, within six months after the expiry or types of occupancies unless the Insured anniversary date of each policy period, agrees to install and maintain certain loss the Insured shall file with the Insurer a control systems. Restaurants will normally be Premium Adjustment Application Form required to install an automatic fire showing, for the policy period, the value extinguishing system over the kitchen range. of the "stock" on the last day of each As a further condition of coverage, the month at each "premises" as restaurateur must provide evidence to the commented upon by the Insured's Insurer that a maintenance contract for the Accountant, the actual premium for the system has been entered into. Maintenance policy period shall then be calculated at services cost money, and it is not unusual for the rate applying to each "premises" for Insureds to reduce business overhead by the average amount of the total values cancelling the existing contract or declining declared. If the premium paid by the renewal of it. Jewellery stores will be Insured for such "stock" exceeds the required to be equipped with burglar alarms actual premium thus calculated, the and other intrusion detection devices. They Insurer shall refund to the Insured any may also be required to enter into a contract excess paid, subject to a maximum that provides monitoring services to the refund of 50% of the premium paid. In premises when they are closed for business. the event of any monthly declared Again, the costs to support the monitoring values being in excess of the amount of service may lead the Insured to cancel the insurance, the amount of the excess existing contract or decline its renewal. shall not be included in the premium When Insureds choose to cancel any existing adjustment calculations." agreement providing maintenance or Stock values have a tendency to fluctuate monitoring services, or declines its renewal, with changing economic conditions or buying they are obligated to inform the Insurer patterns. It is factors such as these that immediately. The Insurer will often cancel make it difficult to accurately project what the policy when the operation of these the values will be at any one time during the systems is compromised. term of the policy Insureds are properly encouraged to insure what they anticipate to iii) The Insured shall advise the be the maximum limits on hand at any one Insurer forthwith when provided time during the policy period. If they fall with notification of the suspension short, they stand to be under-insured in the of police service in response to any event of a loss. In certain instances, the of the above systems. Insured's estimate will be too high. When Where numerous malfunctionings of any of that happens, Insurers agree it would be the systems referred to in this clause cause unfair to penalize the insured by keeping all local police to suspend response service, the of the excess premium. When the Insured Insurer wants to know about it immediately. purchases too much insurance on stock, the In such circumstances, the Insured generally Insurer agrees to return a portion of the receives notification from local police premium paid, subject to the following advising of their intent to withdraw service guidelines or requirements: until such time as the system(s) is corrected. 1-20 IBAC CAIB 2 September 2010 Introduction to Commercial Property Insurance Section 2 - Commercial Property Insurance Policies (General Information) Claims for return of premium must for a reasonable time. A request to the be submitted no later than 6 Insured to open the store to the Insurer at months after the policy expiry date. midnight or on a Sunday or statutory holiday would not be reasonable. Claims must be presented on a Premium Adjustment Form, The right of inspection extends for up to a showing actual cash value of stock year after the policy is terminated or expires. on the last day of each month and At first glance this might seem excessive. verified by the Insured's However, Insureds have up to one year after accountant. a loss to make a claim under their policy. This explains the rationale for extending the When Insureds have provided such evidence period for access by the Insurer. Also, to the Insurer, they shall be entitled to a refund of the excess premium, subject to a establishing values after a loss can take a long time and can involve many meetings. maximum of 50% of the total premium paid. Extending the right to establish values This limitation serves to avoid deliberate over-insurance, the presence of which may beyond the life of the policy does have practical merit. encourage or point to the existence of moral hazard. Essentially, this clause does many things: When the Premium Adjustment Form shows Allows the Insurer the right to the values for any month(s) to be in excess confirm the values Insured under of those purchased, those amounts shall not the policy are reasonable and enter into the calculation of the return actually exist. This can usually be premium. The reason for excluding those established during an on-site inspection values is that, in the event of a loss, the of the premises and its books. When amount of payment to the Insured would be the values are unrealistically inflated limited to the amount of insurance for the purposes of insurance, the purchased. Insurer may be concerned about a potential moral hazard and will take all Verification of Values necessary steps to reduce or eliminate that exposure. "The Insurer or its duly appointed representative shall be permitted at all Permits the Insurer the opportunity reasonable times during the policy to determine values on hand at the period, or within a year after time of a previous loss. From this, termination or expiration, to inspect the the Insurer can determine if the insured property and to examine the Insured is in compliance with the co¬ Insured’s books, records and such insurance requirements contained in policies as relate to any insured the policy. property. Such inspection or Enables the Insurer to determine examination shall not waive nor in any the existence of any other policies manner affect any of the terms or of insurance which might be called conditions of this form." upon to share in the payment of a This clause requires the Insured to permit loss. the Insurer or its appointed representatives access to the premises at all reasonable Basis of Valuations times. Representatives of the Insurer might include its own employees or those of an "The value of the insured property shall independent appraisal company, accountants be determined as follows