Web viewFire, tornado, wind, lightning, explosion. New Hampshire. 407:11. Buildings. Fire and lightning. North Dakota. 26.1-39-05. Real property. ... (0.875 x $50,000

Page

1

The Basics of Property Values and Coinsurance Conditions

I. Values Assignable to PropertyA. The Amount For Which It Can Be Sold

B. What An Expert Thinks It Is Worth

C. The Value The Individual Places On The Property

D. Depreciated Value

1. Obsolescent depreciation

2. Economic depreciation

3. Accounting depreciation

E. The Value For Tax Purposes

F. The Remaining “Use” Value

G. The Cost To Replace The Property With Something Just Like It

H. The Cost To Replace With Something Functionally Equivalent

http://www.independentagent.com/

Page

2


II. Key Insurance Valuation ConceptsA. Indemnification

1. Definition: “The contractual obligation of one party (the insurance carrier) to return another party (the insured) to essentially the same financial condition enjoyed before the loss without improvement or betterment.”

2. Indemnification is accomplished in the commercial property policy by paying “the lesser of…”:

a. The “value” of the lost or damaged property;

b. The cost of repairing or replacing the lost or damaged property;

c. The agreed or appraised value; Use of the “Appraisal” process; or

d. The cost to rebuild or repair with other property of like kind and quality (LKQ).

B. Broad Evidence Rule

1. This “rule” is used to help establish the “actual cash value” of property for settlement purposes.

2. All surrounding information (and evidence) is used in establishing the damaged properties value.

3. What information is considered:a. Age;

b. Condition;

c. The surroundings;

d. The usefulness (obsolescence); and

Page

3


e. Economic value.

C. Valued Policy Statutes

1. Purpose: Avoid any argument of over insurance by requiring the insurance carrier to pay the policy limits in the event of a total property loss. The covered causes of loss and property types vary by state.

2. Effect: a. May alter the application of the “indemnification” provisions in the CPP.

b. Requires the carrier to avoid over-insurance on real property. (Over insurance is also bad practice because of the effect on rates.)

3. Valued Policy States:State Statute Property Protected Causes of Loss

Arkansas 23-88-101 All Real PropertyFire and natural disasters (excluding flood and quake)

California2052, 53, 54, 55, 56, 58 and 75

BuildingsAll perils covered by the property policy

Florida 627.702

Any building (including mobile and manufactured homes)

All perils covered by the property policy

Georgia 33-32-51 or 2 family residential bldgs.

Fire

Kansas 40-905All improvements on real property

Fire, tornado, wind, lightning

Louisiana 22:1318Inanimate / immovable property

Fire

Minnesota 65A.08 All propertyAll perils covered by the policy

Page

4


State Statute Property Protected Causes of LossMississippi 83-13-5 Buildings FireMissouri 379.140; 145 All property Fire

Montana 33-24-102 and 103Improvements to Real Property


Nebraska 44-501.02 Real propertyFire, tornado, wind, lightning, explosion

New Hampshire 407:11 Buildings Fire and lightning

North Dakota 26.1-39-05 Real propertyAll perils covered by the property policy

Ohio 3929.25 Any building Fire and lightningSouth Carolina 38-75-20 All real property Fire

South Dakota 58-10-10 Real propertyFire, lightning, and tornado

Tennessee 56-7-801 to 803 Any building FireTexas 862.053 All real property Fire

West Virginia 33-17-9 Real propertyAll perils covered by the property policy

Wisconsin 632.05(2)Owner-occupied dwellings


4. Modified Valued Policy States – Premium Refund Laws: If, at the time of loss, the amount of coverage is greater than value of the building, the insurance carrier must return the excess premium. Three states:a. Massachusetts (Chapter 175 Section 96 – limited to fire loss);

b. North Carolina(58-43-10); and

c. Wyoming (26-23-103).

Page

5


III. Defining “Values” Applicable to Insurance A. Market Value

1. Definition: The value agreed to by a willing buyer and a willing seller.

2. Rarely an “insurance” value, unless the government gets involved.

3. Could be considered the value assigned by the commercial property policy to “stock” that has been sold but not delivered.

In E.7.c. “stock” sold but not yet delivered is valued at its selling price.

B. Actual Cash Value

1. Definition: Replacement cost new on the date of the loss LESS physical depreciation.

2. The customary/historical valuation method in commercial property insurance coverage.

C. Replacement Cost Value

IV. Replacement CostA. Defining “Replacement Cost”

1. An optional coverage (G.3.)

2. The cost to replace damaged/destroyed property with new property of like kind and quality. The valuation is at the time of the loss.

Page

6


B. Replacement Cost and the Principle of Indemnification

1. Does replacement cost violate the Principle of Indemnification because it places the insured in a better condition that prior to the loss (new stuff for old stuff)?

2. No! Replacement cost is actually the truest form of indemnification available.

3. The insured needs the building or the machinery more than they need the money.

4. To qualify for replacement cost, the insured has to value the property covered at the cost new and pay a premium based on that value. They pay for the additional coverage amount; and if incorrect, they are subject to a “penalty.”

C. Barriers to Replacement Cost

1. Actual repair or replacement (G.3.d.)a. G.3.d. We will not pay on a replacement cost basis for any loss or

damage: (1) Until the lost or damaged property is actually repaired or replaced;

and (2) Unless the repair or replacement is made as soon as reasonably

possible after the loss or damage.”

b. If the property is not repaired/replaced, the insurance carrier must only pay the ACV.

2. Ineligible property (G.3.b.)a. Personal property of others (can request replacement cost be applied to

this property);

b. Contents of a residence;

Page

7


c. Works of art, antiques or rare articles, including etchings, pictures, statuary, marbles, bronzes, porcelains and bric-a-brac (an Inland Marine policy should be used for these types of property); and

d. Stock (can have stock covered for replacement cost if indicated in declarations page).

3. Coinsurance (this is discussed in Section II)

4. Governmental Problems (Ordinance or Law)

V. Ordinance or Law (Building Codes)A. Effect on “Replacement Cost”

1. Insureds think “replacement cost” means they will get a new building for the old one (because that’s what the insurance industry has told them).

2. Two gaps in the unendorsed commercial property policy that makes this incorrect:

a. The unendorsed CPP only pays to repair the property actually damaged by a covered cause of loss – not the value of the unusable though undamaged portion of the building; and

b. Exclusion “B.1.a.” specifically excludes any loss caused by the enforcement of any ordinance or law (the cost to bring the building up to current building code). There is a small amount ($10,000) given back as additional coverage, but this only applies to the portion damaged.

3. If an insured building suffers “major damage,” the unendorsed CPP will pay the replacement cost on the damaged portion, but it will not cover the results of the enforcement of any building codes.

Page

8


B. What is “Major Damage”

1. Defined as: “The amount of damage necessary to cause the local jurisdiction to require the entire building be brought into compliance with the current building codes.” Or, “The point at which ‘grandfathered’ status is removed.”

2. The “Percentage Rule”: Buildings damaged beyond a certain percentage of their value or square footage must be fully brought into compliance with current building codes.

a. The application of “value” varies by jurisdiction.

b. Percentage of square footage is the easiest to apply.

3. The “Jurisdictional Authority Rule”: The authority having jurisdiction decides if the damaged building must be brought into full compliance with the current building code.

a. Very subjective. Subject to the authority of the man with the clipboard.

b. In these states, the methods used to establish the point at which damaged buildings must be brought into compliance with current building codes can vary from county to county.

c. Jurisdictions could use a percentage method or a “public safety” method, etc.

C. Who Makes the Rules

1. Federal Government

2. Local Jurisdictions

3. Historical Societies

Page

9


4. All ordinances and laws (building codes) are enforced by the local jurisdictional authorities

D. Limitations of Coverage to Consider

1. The building codes to which the Ordinance or Law coverage applies

2. What must occur before Ordinance or Law coverage responds

3. The coverage limitations

E. Two Key Ordinance or Law Coverage Forms

1. Ordinance or Law Coverage – CP 04 05

2. Ordinance or Law – Increased Period of Restoration – CP 15 31

F. Three Coverage Parts of CP 04 05

1. Coverage A – Coverage for Loss to Undamaged Portion of the Buildinga. Purpose: Pay the difference between the damage to the building (paid by

the CPP) and the value of the undamaged portion.

b. How coverage can be provided: Cannot be written on a blanket basis, scheduled only.

c. Choosing limits: No limit chosen.

d. Cost: Approximately 15% of the net building premium (excluding earthquake)

Page

10


2. Coverage B – Demolition Cost Coveragea. Purpose: Cover the cost of tearing down and removing the debris of the

undamaged part of the building.

b. How coverage is provided:1) On a scheduled, per building basis (Coverage B only)

2) Combined B & C on a scheduled basis (requires CP 16 15)

3) Single blanket limit all locations – Coverage B only

4) Combined B & C blanket limits

c. Choosing limits:1) Determine the “worst case” scenario – how much of the building

could be undamaged and still have to be torn down;

2) Convert this scenario to square footage;

3) Determine the cost per square foot for demolition and removal

4) Multiply step 2 by step 3 to develop a limit

d. Cost: (Limit/100) * Net Building Rate = Coverage B Premium

3. Coverage C – Increased Cost of Constructiona. Purpose: Pay the difference between what the CPP pays combined with

Coverages A and B and the total replacement cost.

b. How coverage is provided: Same options as Coverage B

Page

11


c. Problems with choosing limits:1) Coverage C pays the difference between the insurance meaning of

replacement cost and the “true” (insured’s belief about) replacement cost.

2) Cost estimators develop the cost to rebuild a structure to current building code.

3) Contractor estimations are also based on current code

4) Unendorsed CPP won’t pay to bring the building up to current code.

5) One possible solution involves a lot of assumption.

d. Cost: (Limit/100) * Net Building Rate = Coverage C Premium

e. Special provision: Building must be rebuilt within two years (E.4.a.(2)) for coverage to apply.

VI. Property Value OptionsA. Functional Replacement Cost (CP 04 38)

1. Pays the cost to replace damaged property with something functionally equivalent. Not the same, but just as functional:

a. The insured does not “need” an all concrete building;

b. Sub-floor and carpet is functionally equivalent to hard wood.

2. A specific limit is assigned to the building.

3. Coinsurance does not apply.

Page

12


4. “Market Value” is used as a gage of payment in this endorsement (if the insured does not replace the building).

5. Ordinance or Law coverage is included in the coverage (all three parts).

B. Agreed Value (Optional Coverage G.1.)

1. Essentially, the insurance carrier and the insured “agree” on the value of the property being insured.

2. Standard coinsurance limits apply even though the coinsurance clause does not apply; however, there is a “penalty” clause (calculated like coinsurance).

3. The CP 16 15 (Statement of Values) must be completed.

4. Coverage can be provided on either an ACV or RCV basis.

C. Stated Amount

1. This is an inland marine term that is often confused with Agreed Value. There is no benefit to using “Stated Amount”

2. This is a “lesser of” provision paying the lesser of:a. The stated amount; or

b. The ACV

D. Inflation Guard (Optional Coverage G.2.)

1. The amount of coverage automatically increases during the year (but it does not make the renewal coverage higher).

2. The increase is prorated throughout the year.

Page

13


VII. How to Develop Property ValuesA. Insurance Valuation Software

B. Use Builder Software

C. Use Tax Records

D. A professional appraisal

E. The Underwriter’s Responsibility

VIII.Why Coinsurance ExistsA. To assure that the insurance carrier receives adequate premium for the risks

insured.

B. To avoid chronic underinsurance and artificially high property insurance rates.

C. To avoid shuttered businesses.

Page

14


IX. The Results of No Coinsurance

X. Property “Maximums”A. Maximum Possible Loss (MPL)

1. It is possible that the entire structure could be destroyed.

2. The MPL is 100% of the TIV

B. Probable Maximum Loss (PML)

1. A partial loss is statistically more likely; thus the PML is some percentage less than the MPL.

Page

15


2. The PML is generally directly related to the first three factors of COPE:a. Construction

b. Occupancy

c. Protection

C. Why These Differences Matter

1. Insured’s with the perceived greatest differences between the MPL and the PML may purchase lower limits of coverage IF there was no coinsurance provision.

2. If insureds are chronically underinsured: 1) rates spiral up; 2) insureds purchase lower limits; and 3) the property insurance mechanism falters.

D. MPL/PML Comparison Example

Building 1 – 1234 Main StreetConstruction (C):

Masonry/Non-Combustible (CC 4) 30,000 square feet 2 stories

Occupancy (O): Office

Protection (P): PPC 3 Fully Sprinklered Fire stops with self-closing fire doors Central alarm

Building 2 – 6789 Broad StreetConstruction (C):

Joisted Masonry (CC 2) 8,000 square feet 1 story

Occupancy (O): Paint and body shop 100 gallons of paint stored in

approved cabinet (H of O)

Protection (P): PPC 9 Non-Sprinklered Fully open Local alarm

Page

16


Which building is more likely to suffer the greatest amount of damage?

XI. The Insured’s Opinion A. The insured does not care about any of this! They just want to avoid any

sort of penalty following a partial loss.

B. Most insureds confuse property coinsurance with health insurance coinsurance.

C. Coinsurance is a way to cheat them out of more money.

XII. The Coinsurance CalculationA. The “Simplified” Coinsurance Calculation

((Did / Should) x Loss) – Deductible = Payment Did = Amount of Insurance Carried (IC) Should = Amount of Insurance Required (IR)

B. Developing “Should”1. This is a two-part process.

2. Step 1 – You must know the Total Insurable Value (TIV) at the time of the loss.

3. Step 2 – Multiply the TIV by the specified coinsurance percentage

100% TIV x Coinsurance % = Should (IR)

Page

17


C. The “Actual” Coinsurance Calculation

((Did / (TIV x Coinsurance %)) x Loss) – Deductible = Payment

1. Did / IC is the amount of insurance carried – Easy (from policy)

2. TIV is based on the valuation method (ACV or RCV) and is the hard part (from Section I)

3. Coinsurance % - found in the policy

4. Should / IR is easy, once the 100% TIV is known

D. Coinsurance Example

Insured Property InformationTotal Insurable Value (TIV): $500,000Coinsurance Required: 80%Deductible: $1,000Amount of Loss: $50,000

Inadequate Limits of CoverageAmount of Insurance Carried - “Did” $350,000Amount of Insurance Required (TIV x Coinsurance) – “Should”

($500,000 x 80%)$400,000

Coinsurance Penalty Calculation Factors:1. Did / Should ($350,000 / $400,000)2. Loss Amount3. Deductible

1. 0.8752. $50,0003. 1,000

Coinsurance Penalty Calculation: (1. x 2.) – 3.

(0.875 x $50,000) - $1,000

Amount of Payment (From Coinsurance Penalty Calculation Above)

$42,750

Amount of Coinsurance Penalty (Ignoring

Page

18


Deductibles)(Loss Amount – Payment Amount (before deductible))$50,000 - $43,750

$6,250 ($7,250 with Ded.)

1. The insured in the above example is a 12.5% “co-insurer” in all partial losses

2. To be fully insured for all partial losses, this insured would need to carry $400,000 of coverage.

3. Even if the insured carries $400,000 as required by the coinsurance provisions, it would still be underinsured for any loss greater than $400,000.

E. Percentage Deductible

1. Coinsurance is calculated the same way.

2. The percentage deductible is based on the “Did” not the “Should”

3. If the prior loss example had a 2% deductible, the total paid would be:(($350,000/$400,000) x $50,000) – ($350,000 x .02) = Payment

(0.875 x $50,000) - $7,000 = $36,750

XIII.Blanket Limits and Coinsurance

Page

19


A. Same formula is used for Blanket Limits

B. Rules require the limit of coverage be 90% of total insurable value

C. The coinsurance calculation is based on the total of all blanketed property

D. How the “Margin Clause” alters Blanket Coverage

1. The Limitation of Loss Settlement – Blanket Insurance (Margin Clause) - CP 12 32 - limits the amount of building coverage available when coverage is provided on a blanket basis. Available options are:a. 105% of the scheduled limit (0.93 rating factor)

b. 110% of the scheduled limit (0.94 rating factor)

c. 120% of the scheduled limit (0.95 rating factor)

d. 130% of the scheduled limit (0.96 rating factor)

2. The insured receives the lesser of:a. Maximum available based on the scheduled limit (from the CP 16 15

Statement of Values) multiplied by the margin percentage; or

b. The result of the coinsurance penalty.

3. Example:Blanket Values at the time of the Loss (4 buildings) $5,000,000

Page

20


Coinsurance Requirement 90%Insurance Carried $3,825,000Margin Clause Percentage (CP 12 32) 120%Deductible $5,000

Building 1 suffers a total lossThe building is scheduled on the Statement of Values (CP 16 15) at $1,000,000Value at the time of the loss: $1,300,000

How much is the insured due from the carrier?

Maximum available: $1,200,000 (Calculated by multiplying the scheduled value ($1,000,000) by 1.20 from the Margin Clause)

Coinsurance Calculation based on the blanket limits: ((Did / (TIV x Coinsurance)) x Loss) – Deductible = Payment (($3,825,000 / ($5,000,000 x .90) x $1,300,000) - $5,000 = Payment (0.85 x $1,300,000) - $5,000 = Payment $1,105,000 - $5,000 = $1,100,000

Insured gets the LESSER of:1. Maximum available limit (scheduled value x Margin Clause Percentage):

$1,200,000; or2. Coinsurance calculation result: $1,100,000

In this example, the insured gets paid $1,100,000. The remaining $200,000 must be paid out of pocket.

XIV. Differences Among the Various Coinsurance Provisions

Page

21


Commercial Property

BOP Homeowners’

Basis of Total Insurable Value (TIV)

Actual Cash Value or Replacement Cost

Replacement Cost Replacement Cost

Property Subject to Coinsurance

Real and Business Personal Property

Real and Business Personal Property

Real Property

Coinsurance Options

80%, 90%, 100% 80%80% (can be endorsed down)

Application of Coinsurance

PenaltyLesser of: Limit of Insurance or Coinsurance Calculation Result

Preserves IndemnificationGreater of: ACV or Coinsurance Calculation Result

Preserves IndemnificationGreater of: ACV or Coinsurance Calculation Result

XV. Coinsurance Conditions and IdeasA. Coinsurance “encourages” insureds to carry relatively high limits of

coverage compared to the statistical risk of a total loss while keeping the relative property rates low.

B. Coinsurance applies to partial losses only. Insureds never get more than the limits purchased.

C. Coinsurance is calculated based on the values at the time of the loss.

D. As the coinsurance percentage is increased, the rate goes down.

Page

22


E. It’s best to insure at 100% of TIV but NEVER use 100% coinsurance

1. Avoids a coinsurance penalty; and

2. Assures that enough coverage is available if a total loss does occur.

Documents

Web viewFire, tornado, wind, lightning, explosion. New Hampshire. 407:11. Buildings. Fire and lightning. North Dakota. 26.1-39-05. Real property. ... (0.875 x $50,000