RiskManagementandCommercialProperty—PartI

Chapter9?2005,Thomson/South-Western?2005SouthwesternChapterObjectivesExplainhowtheSimplifiedCommercialLinesPortfoliopolicymeetspropertylossexposuresIdentifypropertyandperilscoveredbyboilerandmachineryinsuranceDescribehowinsurancecontractscanbedesignedtoinsurepropertythatfluctuatesinvalueListthedifferenttypesofconsequentiallossexposuresandtypesofinsurancecoverageavailableforsuchlossexposures2TheCommercialPackagePolicy(CPP)InJanuary1986,anew,simplifiedapproachtocommercialinsurancecoveragewasintroducedbytheinsuranceindustryUndertheCommercialPackagePolicy(CPP)TheinsuredcanobtainalmostalltypesofinsurancecoverageBroadercontractprovisionsareincludedintheCPPTheCPPhassevenseparatesetsofcoverageCommercialproperty,liability,crime,boilerandmachinery,commercialauto,inlandmarine,andfarm3TheCommercialPackagePolicy(CPP)AninsuredcanpickandchoosecoveragesintheCPPTheCPPallowsmanyinsuredstouseonepolicytomeetmostoftheirinsuranceneedsWorkers’compensationandoceanmarineinsurancemustbepurchasedseparatelyTheCPPhasmanyoptionsavailable4BuildingandPersonalPropertyCoverageFormBasicprotectionforbuildingsandpersonalpropertyintheCPPPropertycoverageisdividedintothreemajorcategoriesBuildingsIncludesthebuildingsdescribedonthedeclarationspageAnyadditions,extensions,fixtures,machineryandequipmentconstitutingapermanentpartofthedescribedbuildingsServiceequipmentYourbusinesspersonalpropertyIncludesbusinesspersonalpropertyownedbytheinsuredandusualtotheoccupancyoftheinsuredPersonalpropertyofothersImprovementsandbettermentsAlterationsmadetoaleasedbuildingbytheinsuredthattheinsuredcannotlegallyremovewhentheleaseisterminatedPersonalpropertyofothersintheinsuredscontrolDevelopsinsituationswheretheinsuredrepairsthepropertyofothers5ExtensionsofCoverageBPPhasextensionsofcoveragethatexpandprotectiontoothercategoriesofpropertyNewlyacquiredorconstructedpropertyYourbusinesspersonalpropertyatnewlyacquiredpremisesPersonaleffectsandpropertyofothersValuablepapersandrecords–costofresearchPropertyoff-premisesOutdoorpropertyAlloftheseextensionsareanadditionalamountofinsuranceApplyonlyifthepolicyhasan80percentorhighercoinsuranceclause6SpecificversusBlanketCoverageUnderspecificcoverage,propertyatoneormorelocationsislistedandspecificallyinsuredUnderblanketcoverage,propertyatseverallocationsmaybeinsuredunderasingleitem7CommonClausesintheBPPCommonclausesincludeCoinsuranceSubrogationElectricalapparatusNolosstoelectricalitemswillbecoveredifcausedbyartificiallygeneratedelectricalcurrentsUnlessfireensues,andthenlossiscoveredonlyforthefiredamagePowerfailureSpoilageduetopowerfailurefromaninsuredperilisnotcoveredunlessthelossofpowerisfromanon-premisesinsuredperilOperationofbuildinglawsNolosswillbepaidthatresultsfromtheoperationofbuildingcodesAlterationsandrepairsAllowstheinsuredtomakethistypeofmodificationwithoutitsbeingconsideredanincreaseinhazardWhichwouldcausethecoveragetobesuspended8CommonClausesintheBPPTwoimportantexclusionswereaddedtopropertyclausesin2002MoldclaimsHaveskyrocketedinafewstatesintheearly2000sPriorto2002,moldwaslistedintheso-called“wearandtear”exclusionAftertheterroristattacksofSeptember11,insurersbeginexcludingterrorismfromtheirpoliciesTheTerrorismRiskInsuranceAct(TRIA)wasenactedinNovember2002Bythefederalgovernmenttoprovideabackupforinsurersthatcouldnotgetreinsurancecoverageforterrorism9InsuredPerilsThebasicformoftheBPPcoversFire,lightning,explosions,windstormandhail,smoke,riotorcivilcommotion,vandalism,sprinklerlinkage,sinkholecollapse,andvolcanicactionThebroadformincludesthebasicperilsplusFallingobjects,theweightofice,sleet,andsnow;andaccidentaldischargeofwaterorsteamfromasystemorappliancecontainingsteamorwaterotherthananautomaticsprinklersystemThespecialcauseoflossformcoversalldirectphysicallossesexceptthosethatareexcludedExamplesofexcludedperilsEarthmovement,flood,war,enforcementofbuildingordinance,smog,insectdamage,andwearandtearTheoldnameforthistypeofcoveragewas“allrisk”Thenewnameis“openperils”10DebrisRemovalTheBPPformincludescoveragefordebrisremovalHoweverifthelossis>orequaltothepolicyThereisadditionaldebriscoverageupto$10,000BPPprovidescoverageforcostsofpollutioncleanupandremovalfromlandorwateratthedescribedpremises11SubrogationPracticallyallcontractsofpropertyinsurancearesubjecttotherightofsubrogationBytheinsureragainstanyliablethirdpartyItmayturnout,forexample,thatwhiletheinsured’spropertyinsuranceprovidescoverageforlossSomeoneelsehasagreedtoassumethisliabilitybycontractorisheldliablebecauseofitsnegligenceincausingthedamagesIftheinsurerpaystheclaim,ithasarighttoanysuchclaimsthattheinsuredmayhavehadagainstothersSuchrecoveriesassignresponsibilitytothepartythatisresponsibleforthedamagesHoldingthatpartyaccountableforitsactions12EndorsementsusedwiththeBPPAninsuredcanaddearthquakeandradioactivecontaminationtothelistofinsuredperilsThelimitsofrecoveryonsuchpropertyasoutdoorsigns,trees,shrubs,plants,andradioandtelevisionantennasmaybeincreasedSpecialmarketvalueendorsementsareavailablefordistilledspiritsandwines13EndorsementsusedwiththeBPPTwoendorsementsthatmodifytheBPPincludeReplacementcostLikethatfoundinthehomeowner’spolicyandchangesthebasisofrecoveryfromactualcashvaluetoreplacementcostOrdinanceandlawendorsementUsedwhenolderbuildingsmustberepairedaccordingtoamorestringentbuildingcode14BoilerandMachineryInsurance(EquipmentBreakdownCoverage)Explosionscausedbysteamboilers,compressors,engines,electricalequipment,flywheels,airtanks,andfurnacesconstituteaserioussourceoflossthatthelaypersonoftendoesnotrecognizeHasdevelopedalongsomewhatdifferentlinesfromtheusualinsurancecontractRecognizingthatpreventionoflossesisevenmoreimportantthanindemnificationoflossInsurershavetakenontheserviceofinspectionandservicingofboileroperationsandtechnicalmachineryFailureofthevesseltopassaninspectionmaymeanimminentdangertocontinuedoperationsTheinsurerreservestherighttosuspendcoverageimmediatelyifrecommendedrepairsorreplacementsarenotmade15InsuringAgreementsLosstopropertyPerhapsthechiefreasonforthepurchaseofboilerandmachineryinsuranceiseithertoReplacedamagedpropertybelongingtotheinsuredintheeventofsuddenoraccidentallossOrtopreventtheoccurrenceofsuchaloss ExpeditingexpensesThereasonableextracostofexpeditingrepairofthemachineryIncludingovertimecostsandtheextracostofexpressorotherrapidmeansoftransportation16OptionalEndorsementsBusinessincomeinsuranceOneoftheimportanttypesoflossstemmingfromthefailureofthesteamboilerorothervitalmachineryIstheshutdownofanentireplantUseandoccupancyinsuranceiscommonlyaddedbyendorsementtotheboilerandmachinerycontractExtraexpenseCouldarisefromthefailureofaheatingplantboilerForcingabusinesstoinstalltemporaryalternativemethodsofheatingatconsiderableexpenseConsequentialdamageProvidesprotectionwhenaninterruptionofpowerisduetofailureofaninsuredobjectontheinsured’sownpremises17BusinessOwnersPolicyDesignedforcertainsmall-tomedium-sizedbusinessesSmall-tomedium-sizedisdefinedtomeanApartmentsandofficebuildingsoflessthansixstoriesandwithatotalareaoflessthan100,000squarefeetAstandalonepolicyandcannotbeaddedtotheCPP18BusinessOwnersPolicyPropertyformsusedStandardandspecialMandatorycoverageexistsforbothdirectandindirectlosstoproperty,liability,andmedicalpaymentsOptionsincludeoutdoorsigns,moneyandsecurities,employeedishonesty,andmechanicalbreakdownRecoverybasisPriorto1996,thebusinessownersprogramassumedtheinsuredwouldinsure100percenttovalueHoweverpracticalexperiencehasshowntheneedforaninsurance-to-valuerequirementBecausemanyinsuredsunderreporttheirpropertyvaluesForfullreplacementcostcoveragetoapplyTheamountofInsuranceatthetimeofthelossmustbeatleast80percentofthefullreplacementcost19OtherCommercialPropertyFormsDifferenceinconditionsinsurance(DIC)WrittenwiththeinsuredsbasiccontractbecauseDICexcludesthebasiccauseoflossperilsGenerallyonlylargefirmspurchasethiscoveragebutitisbecomingmorepopularBuilders’riskUsedtoinsurebuildingsunderconstructionUsualapproachrequirestheinsuredtopurchaseanamountofinsuranceequaltothefinishedvalueofthebuildingHowevertheratechargeisusually55%ofthestandardrateTheinsuredhasfullcoverageduringtheconstructionperiod20ReportingFormsDesignedtoadjustinsurablecoverageoncontentstochangingpropertyvaluesatonelocationorindifferentlocationsHaveseveraladvantagesTheamountofinsuranceprotectionisautomaticallyadjustedtochangesinvaluesofpropertyatdifferentlocationsNewlocationsareautomaticallycoveredTheinsureddoesnothavetopaypremiumsonlimitsofliabilityinthepolicyRatherpayspremiumsaccordingtotheactualvaluesatriskThepossibilityofhavinggapsincoverageorduplicationofinsuranceisvirtuallyeliminatedInsuredavoidsbeingshort-ratedwhencoverageisreduced21ReportingFormsImportantpurposeofreportingformsToadjustinsuranceprotectionforbusinessfirmsthathavemanyplantslocatedindifferentgeographicalareasOrwishprotectiontobeadjustedautomaticallytoconstantlychangingvaluesattheseplantsTheinsuredpurchasesaninsurancepolicywithastatedmaximumasitslimitThisfigureisthemosttheinsurerwilleverpayHowevertheinsuredisonlychargedfortheexposurethatexistsMayreceivearefundattheendofthepolicyperiodEachperiodtheinsuredisrequiredtoreporttothecompanywhattheactualvalueswereateachlocationonaspecificdate22ConsequentialLossCoverageSupposeasmallmanufacturersuffersaseriousfirethatshutsdownitsplantsfortwomonthswhilerepairsarebeingmadeThemanufacturerisfullyinsuredagainstdirectlossbyfireButcarriesnoconsequentiallosscoverageThefirepolicypaysforthecostoflostrawmaterials,goods-in-process,andfinishedgoodsAswellasrepairstomachineryandbuildingsHowever,themanufacturerfindsitisnecessarytokeepcertainkeyemployeesonthepayrolltohelpwiththereorganizationandtorenderservicetocustomers23ConsequentialLossCoverageAdditionally,expensesareincurredSuchastaxes,insurancepremiums,interest,heat,light,power,anddepreciationRegardlessofthevolumeofoperationThemanufacturerhasbeenunabletoearnanyprofitontheunsoldfinishedgoodsOronthevolumeofgoodsthatnormallywouldhavebeenproducedduringthisperiodThesumoftheselossesmaybesoseverethatthemanufacturerisunabletocontinueinbusinessConsequentialdamagecontractsaredevisedtoindemnifyforthistypeofloss24Time-ElementContractsBusinessesfaceindirectlossesofamuchgreatermagnitudethanindividualsbecauseBusinesseshandlelargeramountsofmoneyRestorationcantakelongerItmaytakeonetotwoyearstorebuildafactoryWhereasmosthousescanberebuiltwithinthreetosixmonthsTime-elementcontractsmeasuretheindirectlossintermsofxdollarsperunitoftimethatpassesuntilthesubjectmattercanberestored25BusinessIncomeInsuranceUndertakestoreimbursetheinsuredforprofitsandfixedexpenseslostasaresultofdamagetopropertyfromaninsuredperilThepropertywillindemnifytheinsuredsubjectgiventhefollowingconditionsPhysicaldamagetopropertybyfireorotherinsuredperilmustbepresentAreductioninbusinessmustoccurMustresultfromthephysicaldamagecausedbythenamedperilDuringtheperiodofrestoration,itmustbeestablishedthatthebusinesswouldhavecontinuedtooperateThelossmustoccurduringthepolicytermatthedescribedlocationIftheinsured’slosshadnotoccurred,thebusinesswouldhaveearnedaprofitoraportionoffixedcosts26BusinessIncomeInsuranceIfthebusinesshasonlybeenbreakingevenatthetimeoftheoccurrenceoftheinsuredlossAquestionwouldberaisedastowhetheranyprofitswouldhavebeenearnedIfitwerefoundthatnoprofitswouldhavebeenmadeevenifthebusinesshadnotbeenshutdownNoreallossfromthesourcewouldhaveoccurredNoindemnityforlostprofitswouldbepaidIfthebusinesshasbeenearningenoughmoneytocoveritsfixedexpensesThesecostswouldbereimbursed27BusinessIncomeLossThecentralideaistoexaminetheincomestatementofthefirmDerivefromthisstatementthevariousitemsofincomeandexpensethataretobeinsuredProcessofisolatingtheinsurablevalueDeductfromtotalgrossvaluetheexpensesandcoststhatarevariableThosethatmaybediscontinuedifafireorotherperilweretocauseashutdownofthebusinessTheamountobtainedistheinsurablevalueandformsthebasisofthelosssettlement28CoinsuranceMostbusinessincomeformscontainacoinsuranceclauseRequirementsvaryfrom50%upwardDependingontheamountofcoveragedesiredIfthebusinessconcernelectstotakethe50%formItisrequiredtocarryatleast50%ofitsprofitsplusoperatingexpensesFailingtocarrythisamount,itbecomesacoinsurer29HowMuchInsurancetoCarry?TheanswerdependsonwhatthefirmbelievesthemaximumlossmightbeCoinsuranceformsareavailablethatallowtheinsuredtocarryaslittleas?ofitsannualinsurablevalueHowever,ifthefirmhasreasontobelieveitmighttakeasmuchasayeartorestorethebusinesstoregularoperationsItshouldcarryinsuranceequaltoitsfullinsurablevalueSomefirmsoperateonaseasonalbasisAfewmonthsoperationsmightaccountforanentireyear’sprofits30HowMuchInsurancetoCarry?ThelossmaybeonlypartialIfthebusinessisonlypartiallyshutdownIndemnitycanbecollectedforthepartiallossExtended-period-of-indemnityendorsementUnderthetermsofthisendorsementthatperiodoflossisdefinedtomeanthatperiodnecessarytoreturntonormalbusinessoperationsNotjustthatperiodnecessarytoreopenthebusinessphysicallyAfirmmakeneedseveralmonthstoobtainnewcustomersandtoachievethesamelevelofoperationitenjoyedpriortoclosure31Insurance-to-ValueRequirementsByendorsementaninsuredcanchooseoneofthreealternativestocoinsuranceIncludingamaximumofindemnityAmonthlyamountofindemnityAnagreedamountUnderthestandardapproach,theinsurance-to-valuerequirementisbasedontheestimatedbusinessincomethatisexpectedduringthetwelvemonthsfollowingthedateofpurchaseoftheinsurancepolicyThisapproachreducessomeoftheuncertaintyassociatedwithestimatingtherequiredamountofinsuranceAstheinsuredknowsexactlywhichtwelvemonthswillbeusedinmakingthecalculationUsuallya50percentminimumcoinsuranceclauseispresentinthebusinessincomeformHoweverthisimplicitlyassumesasix-monthrestorationperiod32Insurance-to-ValueRequirementsThosefirmswithamaximumrestorationperiodoflessthansixmonthsmayhavetopurchasemoreinsurancethantheycancollectTheBPPhastwooptionalcoveragesfromwhichtochooseMaximumperiodofindemnityReplacestheinsurance-to-valuerequirementwiththemaximumrestorationperiodof120daysMonthlylimitofindemnityDesignedforsmallbusinessesanddoesnothaveacoinsuranceclauseToassurefullrecoveryforanylossTheinsuredmustcarrysufficientlimitssothattheselectedlimitwillcoverthetotalearningsforanyonemonth33Insurance-to-ValueRequirementsAgreedamountclauseSubstitutesanagreedamountofcoverageforthecoinsuranceclauseTheinsuredmustcompleteandsignabusinessincomeworksheetwhentheendorsementispurchasedIfthatstatementunderestimatesincomeApenaltywillbeappliedifalossoccursContingentbusinessincomeSometimesafirmisforcedtoshutdownbecauseaninsuredperilforcedtheshutdownofaplantbelongingtoasupplierortoanimportantcustomeronwhomthefirmdependsContingentbusinessincomeinsurancehasbeendevisedtodealwiththesesituationsTheregularbusinessincomepolicywillnotcoversuchlossesBecausetheinsuredperildidnotcauseanydamageatthefirm’sownpropertyThecoverageformiscalledthebusinessincomefromdependentproperties34ExtraExpenseIncomeCertaintypesofbusinessfirmsdonotfinditpossibleorexpedienttoclosedownfollowingthedestructionoftheirphysicalplantsFirmssuchaslaundries,newspapers,dairies,publicutilities,banks,andoildealerswilloftencontinuetheirbusinessesusingalternativefacilitiesClosingofthesefirmswoulddeprivethepublicofavitalserviceorwouldinvolveacompletelossofgoodwillorofbusinesstocompetitors35ExtraExpenseIncomeBecausethesefirmswillcontinuetooperateiflossoccursBusinessincomeinsuranceisnotattractiveThesefirmsneedextraexpenseinsurancethatcoversexpensesbeyondthenormalcostofconductingbusinessExamplesofextraexpensesRentalofquarters,purchaseofextratransportationfacilities,leasingofsubstituteequipment,overtimepaymentstoemployees,thecostofmovingtotemporaryfacilities,andthecostofadditionaladvertisingtoinformthepublicthefirmisstilloperational36LeaseholdInterestInsuranceLeaseholdAninterestinrealpropertythatiscreatedbyanagreement(alease)thatgivesthelessee(thetenant)therightofenjoymentanduseofthepropertyforaperiodoftimeMaybecomeveryvaluabletothelesseebecausechangingbusinessconditions,improvementsintheproperty,andgoodmanagementmayincreasetherentalvalueofrealestateconsiderablyabovetherentalundertheleaseThisincreaseinvaluecreateswhatisknownasleaseholdinterest,orleaseholdvalue37ContractsWithoutaTimeElementUsetoinsurelossesthatresultfromfireButwherethelosscannotbemeasuredeitherbydirectdamagebyfireorintermsofelapsedtime38ManufacturersSellingPriceBPPcoversgoodsandfinishedstockthataresoldbutnotdeliveredatsellingpriceThisendorsementappliesthisapproachtofinishedstockregardlessofwhetherithasbeendeliveredItdiffersfrombusinessincomeinsuranceThelattercoversprofitsthatwouldhavebeenearnedinthefuturehadthefireorotherinsuredperilnotdamagedthefirm’splantEndorsementcoversthelossoftheprofitelementi