Property Insurance

Chapter 1 – Introduction
Review of commercial risk management process
Identify potential risk control solutions for a few loss exposures
Introduce the structure of commercial property insurance policies
Review some concepts from FIL 250

Four Types of Loss Exposures
All organizations are faced with loss exposures or possibilities of accidental loss
Loss exposure: identify assets- it may decline in value, actual cause of loss “peril”, financial consequences- value of the property; cost of rebuilding.
Property
Damages to property to which organization has a financial interest
Liability
Third party seeking legal remedy against organization. Financial consequences difficult to determine.
Personnel
Individual cannot be replaced depriving organization of their skills. Disabled, dies, injured.
Net income Indirect exposures: property is damaged so net income is down while they reconstruct the building. Airline; price of gas goes up, sales go down.

Risk Management Process
Businesses don’t ignore/accept risks, but instead actively manage the exposures in the most cost effective manner possible
1. Identify loss exposures
2. Analyze (measure) loss exposures
Begins process for determining appropriate response to risks.
Risk matrix: avoid upper right quadrant; don’t hire truck drivers severity
Who have DUI’s. upper left; insurance: tornado impact is huge.
3. Examine risk management alternatives
4. Select the appropriate technique frequency
5. Implement the risk management technique Shopping around for best: Fire extinguishers, sprinkler system, fire wall, buy insurance
6. Monitor outcomes and revise program

Risk Management Techniques
Risk Control
Minimize losses
Avoidance
Loss prevention- frequency: reduce number of times we experience a loss, safety training
Loss reduction- severity: minimize the effects “sprinkler system”
Separation- physically separating inventory in a couple buildings
Duplication- having a backup
Diversification- variety of services or products

Risk financing
Retention- pay losses when they occur
Risk transfer

Risk Control Techniques
Risk control measures are designed to attack:
The chain of events leading to loss
The convergence of events that lead to loss
Most effective when targeted to:
Specific perils (cause of loss)
Specific hazards (conditions that increase frequency/severity of loss)
Two types of risk control approaches, both which highlight the need of risk management to study perils
Engineering approach reviews design and potential hazards; technology
Human behavior approach modifies behavior; safety program

Example of Risk Control Techniques: Fire
Attack the three elements of fire (occurring in uninterrupted chain reaction)
Initial source of heat (e.g., electrical, chemical),
Oxygen, and
Fuel
Risk management options
1. Separate heat from fuel (fire wall)
2. Reduce fuel sources (building contents) or choose less combustible construction material
Wood frame, joisted masonry, noncombustible
3. Fire extinguishment methods (temporarily) cut off oxygen
Internal or external fire protection

Theft Risk Control Techniques
Three types of theft
Burglary is forced entry
Robbery is use of force (or threat) against another
Employee theft/embezzlement

EXAMPLE: Suppose you are a risk manager…..
Avoidance: close the shop, eliminate risk of employee being injured
Separation: only a few stores, not all stores being open.
Loss prevention: two people working, not just one. Security guard, camera
Loss reduction: having less money on the premises
Retention: accepting the risk, actively paying losses, being passive
Transfer: crime insurance

Risk increases as:
Value increases
Size/weight decrease
Liquidity increases

Risk Control Techniques: Other Perils
Updated technology requires current knowledge
Explosions are rapid combustion
Explosion suppression systems
Explosion of pressure vessels (steam boilers) are a risk for many companies
Windstorm, flood, and earthquakes
Cannot control the source
Building construction, design, and maintenance
Simulation of earthquake example

Common Insurance Policy Formats
*Lines of Insurance Property –BPP chapter 2:
- direct damage-BPP
- indirect damage; not covered by BPP chapter 7-BI
*Commercial crime
- theft not covered by BPP
*Equipment breakdown -BPP doesn’t cover when it’s your equipment that damages property (Boiler&Machinery) chapter10
*Transportation Insurance -to ship to store
Despite best efforts to prevent losses through risk management programs, losses still occur
Insurance can be used a method for risk financing
“Policy format” refers to the structure/type of coverage for insureds
A line of business or “line” is a type of coverage
Monoline policy provides coverage against one type of protection
Multiline (or package) polices include several coverages- most common, group many lines together.
Insurers may use standard or nonstandard forms
Insurance Services Office (ISO) standardizes insurance contract language (see ReggieNet by chapter for examples)
Insurers and brokers also develop their own
“Broker forms” or manuscript forms
*Brokers represent the business, help find insurance for customer* Insurance Policy Analysis
Sections of an insurance policy – for commercial insurance, these are often separate documents
DICE
o Declarations form (summary of insured & coverage) policy limits, coverage period, property covered, name of insured, premium o Insuring agreement (defined in a “coverage form”) promises that insurer makes, promises to pay if sued. “coverage form” separate document listing promises o Conditions (may be separate form or part of coverage form) only pay for certain conditions o Exclusions o Also, may have endorsements modifying any part of contract

Reasons for Exclusions
Some perils are not commercially insurable o Catastrophic losses, including war o Predictable loss (wear and tear)
Extraordinary hazards are present (e.g., taxi)
Coverage is better provided by other contracts o BPP does not cover autos
Moral hazard is present difficulty in measuring losses o BPP does not cover cash
Coverage is specialized and not needed by typical insureds o E.g., equipment breakdown

Three Common Commercial Policy Formats
Instead of buying individual monoline policies, most businesses get package policies
Commercial Package Policy (CPP) mid sized businesses, 500-1000 employees
Businessowners Policy (BOP) small business, mom and pop shop. Need simple insurance needs
Output policy

Commercial Package Policy (CPP)
Provides customized insurance
Multiline policy, usually including at least:
1. building and business personal property (BPP) and
2. commercial general liability (CGL) “product liability”
Other coverages may be added as needed “crime insurance” product breakdown
CPP combines coverage forms for individual lines plus: o Common declarations – identifies all coverages included in package and associated premiums *p 1.14 in the book* o Common conditions that apply to all lines

Businessowners Policy (BOP)
Small businesses, provide basic protection
Multiline policy covering major property and liability issues faced by most small businesses o Building and business personal property o Business income (and extra expense) o Commercial general liability o Other coverages can sometimes be added
Analogous to homeowners o Standardized coverages (unlike customization of CPP) o Quick, automated underwriting decisions
Some insurers specialize by type of business (office, barber/beautician)

Output Policy
For manufacturing companies, manufacturing and stores as inventory, transportation
Instead of separating coverages in CPP, an output policy combines coverages under the one form
Often includes property and inland marine, needed during transportation of goods
Useful for manufacturing companies, or others with multiple locations

Some Review Concepts From FIL 250
Other insurance provisions
Valuation, including actual cash value
Insurance to value requirements (coinsurance)

Other-insurance Provisions
Prevents policyowners from collecting twice from insurance, which violates the principle of indemnity Pro rata liability shares losses based on the proportion of insurance relative to the total Policy Limit A 100,000 B 400,000
Loss = 160,000
A Pays 100,000 400,000 X 160,000 = 40,000
B Pays 300 400 X 160,000 = 120,000 Primary and excess insurance provision o Certain policies are designated as primary until benefits are exhausted o Remaining losses are picked up by excess policy

Valuation Basis
Determines how much an insurer will pay for losses
Though each coverage form defines the valuation basis (usually a loss condition), several common approaches used in property insurance
Replacement cost – depreciation = Actual Cast Value $20,000 office furniture bought 2 years ago Depreciated by 20% Fire = complete loss, furniture completely gone Similar new furniture costs $24,000
ACV = 24,000 - .20(24,000) = $19,200

Example: $10,000 computer that’s 50% depreciation $8,000 new computer
ACV= 8,000 - .50(8,000) = $4,000

o ACV at time of loss – standard measure o Replacement cost (no deduction for depreciation) insurer pays you, repairs completely; mostly used for buildings: policy holder may cause damage for something new
Replacement cost for $8,000 computer is the $8,000
Common for real property o Selling price (for manufactured goods), less discounts and other expenses
Loss sharing provisions affect loss payments o Deductibles o Coinsurance

Deductibles
With deductibles, first part of loss accepted by policyowner
Purposes:
o Eliminate handling costs of small claims which reduces premiums o Also helps reduce moral “fraud” and morale hazard
Types of deductibles o Straight deductible (per occurrence) – Insured pays for EACH and every loss (most property coverages) most common; o Aggregate deductible – Accumulates losses over a policy period; common in health insurance o Elimination (waiting) period – A deductible stated in days used in business income insurance (and health coverage); days not dollars

Coinsurance Provision
Some preliminaries: Rates vs. Premiums o Property insurance rates are typically quoted per dollar of coverage

Example: Limit= $500,000
Premium= 500,000 X .25/100 =$1,250 (full insurance)
*Standard rate assumes 80% coinsurance
*If policy holder chooses 90% coinsurance, get 5% discount on the rate
*If 100% coinsurance, get 10% discount

Example: Full coverage 100%
.25/100 X 500,000 X (1-.10) =$1,125

Example: 1,000,000 building Rate= .50 per $100 80% coinsurance, but buy full insurance/coverage Standard rate .50 when coinsurance is 80% Premium= 1,000,000 X .50/100 = $5,000
What if value of building changes to 1,200,000? Required amount of insurance= 80% X 1,200,000= 960,000 still meet coinsurance requirement.
*Advantage of lower coinsurance, if property value goes up, still fully covered atleast up to policy limit. No coinsurance penalty Example: same but 90% coinsurance which 5% discount Premium= 1,000,000 X .50/100 (1-.05) = 4,750
If property goes up to 1,200,000 required amount of insurance is;
90% X 1,200,000 = 1,080,000 not fully reimbursed
*Disadvantage can get coinsurance penalty if it’s over the policy

o Premiums are the dollars actually paid for insurance coverage
Rate x Coverage
As complete losses are “rare”, insured may have incentive to buy less insurance and save premium dollars
Coinsurance condition requires a minimum insurance-to-value requirement o Stated as a percentage of potential losses (ACV or replacement value) o 80% coinsurance is common, but higher coinsurance requirements get rate discount
If coinsurance requirement is not met, insured shares in the loss

Example: $500,000 building, insured limit = $200,000 80% coinsurance requirement $1,000 deductible $100,000 Loss
.80 X 500,000 = 400,000 of coverage but you only had 200,000
Loss payment from insurance company is amount of insurance you; (only if you don’t make coinsurance requirement)
DID carry
Should have carried X Loss – Deductible
200,000
400,000 X 100,000 -- 1,000 = $49,000

Suppose Limit = $500,000 and required insurance is still $400,000
They are fully reimbursed if they meet the coinsurance requirement

Meet coinsurance: Yes, fully covered. No, DID/SHOULD X Loss – Deductible

Common Policy Conditions
Common Policy Conditions are attached to every CPP and apply to all coverage parts to avoid repetition Six specific conditions qualify insurer’s promises
First named insured has a few more rights/responsibilities
Cancellation
o Insurer can cancel by notifying first named insured
10 day notification for nonpayment of premium
30 day notification for other reasons
State law may require more time or list allowable reasons for cancelling
Changes condition o (First) Insured can request changes through written endorsement o Though not stated, verbal changes are generally binding
Examination of books and records up to 3 years after policy period o Commercial insurance premiums are often based on self-reported sales, payroll, inventory , etc. o Estimating loss may require documentation of property or income
Insurer has right to inspect the premises during policy period o Determines insurability, rates, and risk control recommendations o Insurer inspection does not constitute any legal/regulatory or safety inspection
First named insured is responsible for paying premiums and will receive any refunds
Insurance cannot be assigned to others, except upon death of first named insured

Commercial Property Conditions Form
In addition to common conditions for the overall CPP, each coverage part may have its own conditions Conditions may limit/expand coverage, explain the determination of loss payments, or place requirements on parties
Any CPP with property insurance (building and business personal property) will include property conditions 1. Fraud or misrepresentation/concealment by insured will void coverage part
2. If insured had no control over property, insurance is not affected
3. Cannot collect double if two coverage parts apply to loss
4. If policyholder has complied with policy terms, they have two years to legally challenge an insurer (from date of loss)
5. Liberalization o No benefit to bailee
6. Insurer may subrogate if bailee causes loss
7. Other insurance – Examples presented in class o Pro rata: Proportional to total insurance if other policies have same provisions and conditions o Excess otherwise – other insurance pays first
8. Policy period begins at 12:01am and the coverage territory is US, Canada, and Puerto Rico o Property elsewhere is not covered
9. Policyholder will not hinder subrogation rights of insurer
Other Typical Conditions in Property Insurance
Other conditions are often included in coverage forms o In BPP, see Sections E (Loss Conditions) and F (Additional Conditions)
Insured’s duties in the event of a loss o Notify insurer promptly and perhaps proof of loss statement and examination under oath o Notify police if laws are broken (e.g., theft) o Must protect against further damage
Appraisal clause is available if a dispute on loss payment
Reduced loss payments if buildings are vacant for 60 days o Vacancy defined as at least 70% of space is not rented o No coverage for broken glass, theft, vandalism, sprinkler leakage, water damage o 15% reduction in payment for other perils
Mortgageholders (listed in the declarations page) may still receive payment even if insurer denies insured’s claim

Summary – Chapter 1
Review of the risk management process
Discuss some risk management methods such as risk control and risk financing
Describe the formats of commercial insurance policies o Mono/multiline o Standard/non-standard o Examples: BOP, CPP, output policy
Describe other insurance, valuation, and coinsurance provisions
List the common policy conditions and commercial property conditions attached to CPPs