Covered Property

What constitutes a building and business personal property may appear obvious. The insurer, however, must be very precise in defining its intent because, as you know, insurance is a contract of adhesion. Ambiguities, therefore, are generally construed in favor of the insured. Figure 15.2 "Building as Defined in ISO Building and Personal Property Coverage Form (Sample)" lists the items defined as buildings. Figure 15.3 "Business Personal Property as Defined in ISO Building and Personal Property Coverage Form (Sample)" lists those items defined as business personal property.

Figure 15.2 Building as Defined in ISO Building and Personal Property Coverage Form (Sample)

Source: ISO Commercial Property Building and Personal Property Coverage Form CP 00 10 06 07. Includes copyrighted material of Insurance Services Office, Inc., with its permission.

Figure 15.3 Business Personal Property as Defined in ISO Building and Personal Property Coverage Form (Sample)

Source: ISO Commercial Property Building and Personal Property Coverage Form CP 00 10 06 07. Includes copyrighted material of Insurance Services Office, Inc., with its permission.

In addition to limiting coverage by defining building and business personal property, the BPP lists specific property that is excluded from protection. These items are listed in Figure 15.4 "Listed Property Not Covered as Defined in ISO Building and Personal Property Coverage Form (Sample)". Reasons for exclusions in insurance were discussed earlier. Note in Figure 15.4 "Listed Property Not Covered as Defined in ISO Building and Personal Property Coverage Form (Sample)" and in the corresponding section in the policy the exclusion of “electronic data, except as provided under additional coverages.” In part f (4) of Additional Coverages, discussed below and in Figure 15.5 "Additional Coverage and Coverage Extension as Listed in ISO Building and Personal Property Coverage Form", the electronic data that is covered is limited to a loss of up to $2,500 sustained in one year. The low limit on electronic equipment and data losses have propelled many businesses to buy the e-commerce endorsement discussed in Chapter 11 "Property Risk Management". This exclusion is not always noticed by businesses. To ensure adequate coverage, insurers began to offer education programs to risk managers about their cyber-risk exposures.

Figure 15.4 Listed Property Not Covered as Defined in ISO Building and Personal Property Coverage Form (Sample)

Source: ISO Commercial Property Building and Personal Property Coverage Form CP 00 10 06 07. Includes copyrighted material of Insurance Services Office, Inc., with its permission.

Figure 15.5 Additional Coverage and Coverage Extension as Listed in ISO Building and Personal Property Coverage Form

Additional Coverages and Coverage Extensions

In addition to paying for repair or replacement of the listed property when caused by a covered peril, the BPP pays for other related costs. The BPP also extends coverage under specified conditions. These coverage additions and extensions are listed in Figure 15.5 "Additional Coverage and Coverage Extension as Listed in ISO Building and Personal Property Coverage Form".

The value of these additional and extended coverages can be significant. Debris removal, for example, is a cost that is often overlooked by insureds, but can involve thousands of dollars. Recent tornadoes in the midwestern United States caused heavy property damage, and for many insureds, the most significant costs involved removal of tree limbs and other debris.

An interesting additional coverage is pollutant cleanup and removalA provision that specifies the conditions under which, and the extent to which, protection for cleanup costs are paid by the insurer., a provision that specifies the conditions under which, and the extent to which, protection for cleanup costs are paid by the insurer. Because of large potential liabilities, coverage is narrowly defined as those situations caused by a covered loss, and only for losses at the described premises. The amount of available protection is also limited.

The extended coverages primarily offer protection for properties not included in the definition of covered buildings and personal property. The intent is to provide specific and limited insurance for these properties, which is why they are separated from the general provision. Newly acquired property and property of others, for instance, involve exposures distinct from the general exposures, and they require special attention in the coverage extensions. Some of the coverage extensions offer protection against loss from a short list of causes to property otherwise excluded. Outdoor equipment is an example of property otherwise excluded.

Valuation

As has been discussed in prior chapters, property insurance payments may be made on either a replacement cost new (RCN) basis or an actual cash value (ACV) basis. If the insured chooses actual cash value, then the provision 7 valuation of section E, loss conditions, applies. The valuation provision involves a number of parts.A detailed description of this part of the policy is beyond the scope of this text. Parts (b) through (e) explain the insurer’s intent for valuation in situations involving RCN when ACV may be difficult to measure or inappropriate. Part (b), for instance, permits payment at RCN for relatively small losses: those valued at $2,500 or less.

If the insured chooses replacement cost new, this optional coverage must be designated in the declarations. Further, the insured ought to recognize the need for higher limits than if ACV is used. Typically, the insurer does not charge a higher rate for RCN coverage; however, more coverage is needed, which translates into a higher premium. For RCN to be paid, the insured must actually repair or replace the covered property. Otherwise, the insurer will pay on an ACV basis.

Limits of Insurance

As just discussed, you need to be cautious when selecting an amount of insurance that will cover your potential losses. The insurer will not pay more than the limit of insurance, except for the coverage extensions and coverage additions (fire department charges, pollution cleanup, and electronic data). In addition to concern over having a sufficient amount of insurance to cover the value of any loss, some insureds need to worry about violation of the coinsurance provision, which is found under section F, additional conditions of the BPP. The policy provides examples of coinsurance. An example of underinsurance in the policy is provided in Table 15.1 "Example of Underinsurance in ISO Building and Personal Property Coverage Form (Sample)" below.

The BPP policy continues to include a coinsurance provision as a major condition of coverage. For most insureds, however, there is a choice to override the coinsurance clause with an agreed value option, found in section G of optional coverages. The agreed value optionRequires the policyholder to buy insurance equal to 100 percent of the value of the property, as determined at the start of the policy. requires the policyholder to buy insurance equal to 100 percent of the value of the property, as determined at the start of the policy. If the insured does so, then the coinsurance provision does not apply and all losses are paid in full, up to the limit of insurance. The wording in the policy is shown in Figure 15.6 "Agreed Value Option in ISO Building and Personal Property Coverage Form (Sample)".

Figure 15.6 Agreed Value Option in ISO Building and Personal Property Coverage Form (Sample)

Source: ISO Commercial Property Building and Personal Property Coverage Form CP 00 10 06 07. Includes copyrighted material of Insurance Services Office, Inc., with its permission.

The agreed value option, however, does not ensure that the policyholder will have sufficient limits of insurance to cover a total loss, especially in times of high inflation. To ward off unwanted retention of loss values above the limit of insurance, the insured can purchase the inflation guard option found in section G, optional coverages (which is discussed in Chapter 13 "Multirisk Management Contracts: Homeowners"). The inflation guard optionProvides for automatic periodic increases in insurance limits; the intent is to keep pace with inflation. provides for automatic periodic increases in insurance limits; the intent is to keep pace with inflation. The amount of the annual increase is shown as a percentage in the declarations.

Causes of Loss—Basic Form

The basic causes of loss formA named-perils option of the commercial property policy that covers eleven named perils. is a named-perils option of the commercial property policy that covers eleven named perils (see Figure 15.7 "Causes of Loss Forms, ISO Commercial Property Policy"). Some perils are defined and others are not. When exists, the common use of the term, supplemented by court opinions, will provide its meaning.

Fire, for example, is not defined because it has a generally accepted legal meaning. Insurance policies cover only certain fires. While excessive heat may be sufficient for the fire protection to apply, oxidation that results in a flame or glow is typically required. Further, the flame must be hostile, not within some intended container. For instance, if you throw something into a fireplace, intentionally or not, that fire is not hostile and the loss likely is not covered.

A review of the policy and Chapter 13 "Multirisk Management Contracts: Homeowners", where many of these same perils were discussed as they apply to homeowners coverage, may clarify which loss situations are payable on the basic causes of loss form. Review of the exclusions is just as important.

Figure 15.7 Causes of Loss Forms, ISO Commercial Property Policy

Exclusions found in the basic causes of loss form can be categorized as follows:

• Ordinance of law
• Earth movement
• Governmental action
• Nuclear hazards
• Power failure
• War and military action
• Water damage
• Fungus, wet rot, dry rot, and bacteria
• Other, involving primarily steam, electrical, and mechanical breakdown

Most of these exclusions involve events with catastrophic potential, such as floods (the water exclusion).

Causes of Loss—Broad Form

The broad causes of loss formA named-perils option of the commercial property policy that covers fifteen named perils. is a named-perils option of the commercial property policy that covers fifteen named perils. It differs from the basic form in adding some perils, as listed in Figure 15.7 "Causes of Loss Forms, ISO Commercial Property Policy". Geography may dictate, to some extent, preference for the broad form because of its ice and snow coverage. Also note that the water damage peril is for the “sudden and accidental leakage of water or steam that results from the breaking or cracking of part of an appliance or system containing water or steam (not a sprinkler system).” It does not cover floods or other similar types of catastrophic water damage.

In addition to adding these perils, the broad form includes a provision to cover collapse caused by the named perils or by hidden decay; hidden insect or vermin damage; weight of people or personal property; weight of rain that collects on a roof; or use of defective materials in construction, remodeling, or renovation. While this “collapse” additional coverage does not increase the amount of coverage available (as the other additional coverages do), it does expand the list of covered-loss situations.

The mold exclusion was discussed in prior chapters. The exact wording of the exclusion is excerpted from the ISO Causes of Loss—Broad Form in Figure 15.8 "Mold Exclusion as Listed in the ISO Causes of Loss—Broad Form (Sample)".

Figure 15.8 Mold Exclusion as Listed in the ISO Causes of Loss—Broad Form (Sample)

Source: ISO Commercial Property Causes of Loss—Broad Form CP 10 20 06 07. Includes copyrighted material of Insurance Services Office, Inc., with its permission.

The additional coverage in the policy permits a coverage limit for mold for up to only $15,000, as noted in Additional Coverage—Limited Coverage For “Fungus,” Wet Rot, Dry Rot And Bacteria.

Business income coverage will be discussed in the next section. For now, it is important to note that, under the mold exclusion and extension of coverage, business interruption income is provided for only thirty days. The days do not need to be consecutive.

Returning to the topic of cause of loss, it is very important to have a clear definition of what is considered a cause of loss for the limits of coverage. Whether or not the peril caused one loss or two separate losses is imperative in understanding the policy. A case in point is that of the complex decisions regarding whether the loss of the two World Trade Center buildings was one loss or two separate losses from two separate causes of loss. The stakes were very high, at $3.5 billion of limit. To understand the issue more clearly, see the box “Liability Limits: One Event or Two?”

Causes of Loss—Special Form

The special causes of loss formAn open perils or all risk coverage option for the commercial property policy. is an open perils or all risk coverage option for the commercial property policy. That is, instead of listing those perils that are covered, the special form provides protection for all causes of loss not specifically excluded. In this form, then, the exclusions define the coverage. Remember that all those exclusions listed in the basic form, except for the “other” category and some aspects of the water damage exclusion, apply to the special form.

Most of the additional exclusions found in the special form relate either to catastrophic potentials or to nonfortuitous events. Among the catastrophe exclusions are boiler or machinery explosions. Nonfortuitous exclusions relate to items such as wear and tear, smoke from agricultural smudging, and damage to a building interior caused by weather conditions, unless the building exterior is damaged first.

Some experts believe that the greatest benefit of the special form over the broad form is coverage against theft. You may recall that theft is not a listed peril in the broad or the basic form. Coverage of theft from any cause, however, is too costly for most policyholders. The special form, therefore, includes some limitations on this protection. For instance, employee dishonesty and loss of property that appears to have been stolen but for which there is no physical evidence of theft (“mysterious disappearance”) are not covered. In addition, certain types of property such as patterns, dyes, furs, jewelry, and tickets are covered against theft only up to specified amounts. The special form also provides coverage for property in transit.

Business Interruption

When operations shut down (are interrupted) because of loss to physical property, a business likely loses income. The definition of business income in the BIC is provided in Figure 15.9 "Business Income as Defined in the ISO Business Income (and Extra Expense) Coverage Form (Sample)".

Figure 15.9 Business Income as Defined in the ISO Business Income (and Extra Expense) Coverage Form (Sample)

Source: ISO Commercial Property Business Income (and Extra Expense) Coverage Form CP 00 30 06 07. Includes copyrighted material of Insurance Services Office, Inc., with its permission.

Normal operating expenses are those costs associated with the activity of the business, not the materials that may be consumed by the business. Included among operating expenses are payroll, heat and lighting, advertising, and interest expenses.

The intent of the BIC is to maintain the insured’s same financial position with or without a loss. Payment, therefore, does not cover all lost revenues because those revenues generally cover expenses, some of which will not continue. Yet because some expenses continue, coverage of net income alone is insufficient. An example of a BIC loss is given in “Business Income Coverage (BIC) Hypothetical Loss.”

It is important to note the wording in the policy. The coverage applies only to business interruption for damages to the property in the declaration. More specifically, the policy states,

Under this policy, businesses that sustained losses because of the economic backlash and fear after September 11, 2001, would not be covered for their loss of income. For discussion of this issue, read the box “Business Interruption with and without Direct Physical Loss” in Chapter 11 "Property Risk Management".

As noted above in the discussion of the BPP policy, this part of the commercial package also limits coverage for interruption to computer operations under Section 4, as presented in Figure 15.10 "Interruption of Computer Operations Coverage Limitation in the ISO Business Income (and Extra Expense) Coverage Form (Sample)".

Figure 15.10 Interruption of Computer Operations Coverage Limitation in the ISO Business Income (and Extra Expense) Coverage Form (Sample)

Source: ISO Commercial Property Business Income (and Extra Expense) Coverage Form CP 00 30 06 07. Includes copyrighted material of Insurance Services Office, Inc., with its permission.

In Additional Coverage, the amount available for interruption of computer operation is $2,500. No wonder many businesses today purchase the e-commerce endorsement or buy the new policies from the companies described in Chapter 11 "Property Risk Management" and Chapter 12 "The Liability Risk Management".

Extra Expense

In addition to losing sales, a business may need to incur various expenses following property damage in order to minimize further loss of sales. These extra expenses are also covered by the BIC. A bank, for example, could not simply shut down operations if a fire destroyed its building because the bank’s customers rely on having ready access to financial services. As a result, the bank is likely to set up operations at a temporary location (thus reducing the extent of lost revenues) while the damaged property is being repaired. The rent at the temporary location plus any increase in other expenses would be considered covered extra expenses.

Causes of Loss

The same three perils options available for the BPP are also available for the BIC. Because the BIC requires that the covered income loss results from direct physical loss or damage to property described in the declarations, most insureds choose the same causes of loss form for both the BPP and the BIC. Now, we show a more detailed example of a hypothetical loss that occurred during the Chicago flood in 1992.

Coinsurance

The coinsurance provision of the BIC is one of the more confusing parts of any insurance policy. Its purpose is the same as that discussed earlier, which is to maintain equity in pricing. Its application is also similar. The difficulty comes in defining the underlying value of the full exposure, which is needed to apply any coinsurance provision. Following in Table 15.2 "Example of Underinsurance in ISO Business Income (and Extra Expense) Coverage Form (Sample)" is an underinsurance example from a BIC policy. More examples are provided in the policy sample.

Remember that a BIC loss equals net income plus continuing operating expenses. Coinsurance, however, applies to net income plus all operating expenses, a larger value. The amount of insurance required to meet the coinsurance provision is some percentage of this value, with the percentage determined by what the insured expects to be the maximum period of interruption. If a maximum interruption of six months is expected, for example, the proper coinsurance percentage is 50 percent (6/12). If it is nine months, a coinsurance percentage of 75 percent (9/12) is appropriate.

Because of the complexity of the coinsurance provision, however, many insureds choose an agreed value option. This option works under the same principles as those discussed with regard to the BPP. Using the example illustrated in “Business Income Coverage (BIC) Hypothetical Loss,” we can demonstrate the application of the coinsurance provision. Coinsurance requirements apply to net income plus operating expenses ($95,000 plus $405,000 per month on average, or $6,000,000 for the year). If a 50 percent coinsurance provision is used because the expected maximum period of interruption is six months, then the amount of insurance required is $3,000,000 (0.50 × $6,000,000). If the April figures are representative (which is really not the case with a tax accounting office), then a six-month interruption would result in a much lower loss.

Other Options

The BIC includes a number of options designed to modify coverage for the insured’s specific needs. Three options that affect the coinsurance provision are the monthly limit of indemnity, maximum period of indemnity, and payroll endorsements. For better understanding, the student is invited to read the policy in addition to reading the following explanations.

The monthly limit of indemnityNegates the coinsurance provision of business income coverage; instead, a total limit is listed, as is the percentage of that limit available each month. negates the coinsurance provision of business income coverage; instead, a total limit is listed, as is the percentage of that limit available each month. The policy uses the example of a $120,000 limit and ¼ monthly amount. For this example, only $30,000 (¼ × $120,000) is available each month. An organization with stable earnings and expectations of a short period of restoration would likely find this option worthwhile.

The maximum period of indemnityOption also negates the coinsurance provision of the BIC; instead, this option limits the duration of coverage to 120 days (or until the limit is reached, whichever comes first). option also negates the coinsurance provision of the BIC; instead, this option limits the duration of coverage to 120 days (or until the limit is reached, whichever comes first). Both the maximum period of indemnity and the monthly limit of indemnity address the fact that the standard policy cannot be used with a coinsurance provision of less than 50 percent (six months).

Instead of negating the coinsurance provision, as do the two options just discussed, the payroll endorsementAllows the insured to deduct some or all payroll expenses from the value of operating expenses before calculating the coinsurance requirement. allows the insured to deduct some or all payroll expenses from the value of operating expenses before calculating the coinsurance requirement. Doing so allows the insured to purchase less insurance (and usually pay lower premiums) and still meet the coinsurance provision. It also excludes payroll from covered expenses, however, so the insured must feel confident that payroll would not be maintained during a shutdown. A common payroll endorsement includes ninety days of payroll expense in the coinsurance calculation (and BIC coverage), assuming that a short shutdown might allow the insured to continue to pay employees. For a longer shutdown, termination of employment might be more cost effective.