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Chapter 5: conditions.

Commercial Property General Conditions

Common Policy Conditions form, IL 00 17, of the ISO commercial property program contains six conditions that must be incorporated into any policy written and that apply to all the policy's coverages. Most of these common policy conditions are restatements of provisions, modified in varying degree, that have been standard features of property provisions since the advent of the standard fire policy. The common policy conditions form has not been revised nearly as often as the building and personal property coverage form and the causes of loss forms. The two editions that have been released are the IL 00 17 11 85 and IL 00 17 11 98.

Cancellation

The cancellation provision gives the named insured the ability to cancel the policy at any time by notifying the insurer. The notification may be that the insured's copy of the policy is returned or a lost policy release is signed. Because the insured requests the cancellation, the return premium is calculated at rates less than pro rata.

The insurer may also cancel the policy at any time with appropriate written notice mailed to the insured. Cancellation for nonpayment requires a ten day notice; for any other reason, thirty days must be provided. When the insurer cancels, the return premium is figured on a pro-rata basis. Jurisdictions may have different statutory requirements regarding form and timing for insurance policy cancellations. These requirements are tracked in FC&S Cancellation and Nonrenewal, an annual compendium published by The National Underwriter Company.

The policy calls for cancellation notices to be to or from the first named insured (the person or entity whose name appears first on the policy).

Changes

This condition stipulates that any changes in the terms of the policy can be made only by endorsement issued by the insurer. Any change requests by the insured must be by the first named insured.

Examination of Your Books and Records

This condition gives the insurer the right to audit books and records of the insured relating to the policy. The examination or audit may be made during the policy period or any time within three years after the policy period ends. The condition does not allow the insurer to go randomly through the insured's records. Rather, the insurer may examine only the records that relate to the policy. Such related records may involve finances, safety, inventory, and so on.

Inspection and Surveys

The first part of this condition (D.1.a through c) gives the insurer the right to conduct inspections, surveys, and reports, and to make recommendations. These may be part of the underwriting process or may involve the insurance company's loss control or safety programs. They might relate to risk management, insurability, or conditions on the premises.

The second part of the condition (D.2.) makes clear that the insurer is not accepting liability related to these inspections, surveys, and reports. This acts as a disclaimer of liability so that liability for conditions existing in the insured's operations that may or may not be discovered or disclosed in an insurer's inspection cannot be passed on to the insurance company. Inspections, surveys, or reports the insurer performs do not act as a guarantee.

The forms states:
   We are not obligated to make any inspections, surveys, reports or
   recommendations and any such actions we do undertake relate only to
   insurability and the premiums to be charged. We do not make safety
   inspections. We do not undertake to perform the duty of any person
   or organization to provide for the health or safety of workers or
   the public. And we do not warrant that conditions:


a. Are safe or healthful; or

b. Comply with laws, regulations, codes or standards

This condition makes the point that an insurance inspection for underwriting or other purposes is not meant as a warranty from the insurer that the insured's operations are safe or healthful. Nor does it warrant that the insured is in compliance with legal requirements that may pertain to those operations.

Another part of the condition brings any rating, advisory, or similar organization-such as Insurance Services Office (ISO) or American Association of Insurance Services (AAIS)-who may make inspections or reports under the liability disclaimer.

The inspection and surveys condition was called into play in the 1977 litigation involving a fire at the Beverly Hills Supper Club in Kentucky that killed 165 people. The property insurer had recently inspected the building. Based on this inspection, some plaintiffs' attorneys attempted to hold the insurer and ISO liable for the deaths and injuries sustained in the fire. The courts, however, did not allow the suit to go forward. (The cause of the fire was eventually determined to be due to faulty aluminum wiring.)

Premiums

This condition specifies that the first named insured is responsible for paying the policy premium. It also calls for any return premiums to be sent to the first named insured.

Transfer of Rights and Duties under This Policy

The final common policy condition requires the insurer's written consent in order to transfer the insured's rights and duties under the policy to another person. The only time the written consent of the insurer is not needed is upon the death of a named insured. When a named insured dies his rights and duties are transferred to the named insured's legal representative. In such cases, the legal representative exercises the deceased insured's rights and duties while acting as legal representative. Until a legal representative is appointed, rights and duties of the deceased insured with respect to the deceased insured's property pass to anyone having proper temporary custody of that property. Such individuals might include a spouse, a partner, or a corporate officer.

Commercial Property Policy Conditions

In addition to the common policy conditions, the Commercial Property Policy Conditions form is attached to form a commercial property policy. The current edition of this form is the CP 00 90 07 88, meaning that these conditions have had no revisions since July 1988. The following conditions comprise this form:

1. Concealment, Misrepresentation, or Fraud

2. Control of Property

3. Insurance under Two or More Coverages

4. Legal Action Against Us (the insurer)

5. Liberalization

6. No Benefit to Bailee

7. Other Insurance

8. Policy Period, Coverage Territory

9. Transfer of Rights of Recovery Against Others to Us

Concealment, Misrepresentation, or Fraud

This condition voids coverage if, at any time pre- or post-loss, the named insured commits a fraudulent act relating to the policy. Misrepresenting the use or occupancy of the building-representing the property as a pharmacy when in reality it is an illegal methamphetamine lab, for example-or misrepresenting the value of destroyed equipment to boost insurance recovery is fraud. Such an act before or after loss voids coverage. Void does not mean that the policy is canceled or suspended, but that a contract between the insurer and insured never existed. In other words, a bargain was never struck due to the misrepresentation or fraud of the party.

The policy is also void if the named insured or any other insured intentionally conceals or misrepresents a material fact about the coverage, the covered property, a claim under the policy, or the named insured's interest in the property.

Fraud of any type by the named insured related to the policy voids coverage. Concealing or misrepresenting material facts by the named insured or any other insured also voids coverage.

The phrase any other insured does not void the policy only for the person committing the misrepresentation or concealment. It is possible that the act of any insured could void the policy as to all other insureds, including the named insured. A number of courts have interpreted the language the insured under the concealment, fraud, or neglect provisions of the standard fire policy as applying only to the individual insured guilty of the fraud, giving coverage to other innocent insureds. However other court decisions have interpreted language similar to the ISO any other insured phrase in certain fire policies as unambiguously precluding coverage to innocent, as well as guilty, insureds. In Employers Mutual Casualty Company v. Tavernaro, 4 F. Supp.2d 868 (E.D. Mo.1998), the Tavernaros owned a business covered on a businessowners policy (with the same wording as the commercial property policy). Mr. Tavernaro set the building on fire and Mrs. Tavernaro attempted to collect the insurance proceeds as an innocent coinsured. The court concluded that "the language clearly precludes recovery by either party in this case."

Control of Property

This condition protects the insured from the acts of others. It provides that acts or neglect by any person that are not under the direction or control of the named insured will not affect coverage. For example, if an employee of the named insured causes intentional damage the damage will be covered, despite the intentional acts exclusion (i.e., the intentional act is not imputed to the insured).

The language of the second part of the control of property condition states that a breach of any condition at one or more locations does not affect coverage at any location where the breach does not exist at the time of loss. For example, a breach of the vacancy condition at one insured location will not spill over to affect coverage at a second insured location.

Additionally, as there is no specific exemption regarding the fraud, misrepresentation, or concealment condition, it is reasonable to assume that the second part of the control of property condition applies equally to the fraud provision. If an employee of the insured commits fraud in connection with a claim, that will not bar the insured from recovering under the policy.

Insurance under Two or More Coverages

In the event that more than one of the commercial property policy's coverages applies to a loss, this condition prevents double payment. It limits the amount of payment to the actual amount of loss or damage. For example, a piece of business equipment might be covered under both the building and contents section of the commercial property policy. The insured cannot recover under both. However, if the amount of coverage left under one section is insufficient to pay the entire loss, it could be paid under either or both sections, up to the actual amount of loss or damage.

Legal Action against Us

If the insured wishes to bring suit against the insurer, she must first fully comply with all the policy terms. The insured must bring the suit within two years following the loss or damage (not two years after a formal denial of the claim). Earlier policies that incorporated the standard fire policy language gave the insured one year in which to bring suit.

Liberalization

The commercial property policy states that if the insurer liberalizes the policy (i.e., broadens or adds coverage) without any corresponding premium increase, the revisions automatically apply to the insured's unrevised policy. This provision applies to any liberalizations adopted by the insurer during the policy term or forty-five days prior to the inception date. For example, the current version of the commercial property policy provides $250,000 for a newly acquired or constructed building. If an insurer changes its policy to provide $300,000, without increasing the premium, all existing policyholders receive the $300,000 coverage.

No Benefit to Bailee

The commercial property policy is intended to protect the insured's property; there is no insurance under the policy for the benefit of others to whom insured property may be entrusted. If the insured owns a clothing store and sends some of the clothing out to be dry cleaned, the dry cleaner is responsible for the clothing while it is in his care. If the clothing is damaged while at the dry cleaner, the dry cleaner cannot look to the clothing owner's commercial property policy for coverage. While the commercial property policy insurer may eventually settle with its own insured, it would still retain the right to enter into subrogation proceedings against the dry cleaner to recover the insurer's payment and would make no payment to the insured or the bailee for the benefit of the bailee.

Other Insurance

While this condition does not prohibit an insured from carrying more than one property policy-and, in fact, states that the insured may have other insurance subject to the same plan, terms, conditions, and provisions -it spells out how a loss is handled in such a situation. If the insured has more than one policy that covers the same plan, terms, conditions, and provisions, then any loss will be split pro rata by limits. For example, the XYZ Company headquarters is insured for $1 million with two policies covering the same plan, terms, conditions, and provisions. ABC Insurance has a policy for $750,000; DEF Indemnity has a policy for $250,000. If the XYZ building suffers a $400,000 fire loss, the payments would be split as follows: ABC-$300,000; DEF-$100,000. The insured would be responsible for two deductibles under this scenario. The second part of this condition makes the commercial property policy excess over any other policy that does not cover the same plan, terms, conditions, and provisions. The commercial property policy is excess even if the insured cannot collect from the other insurer.

Policy Period, Coverage Territory

The commercial property policy covers losses that commence during the policy period, which is shown on the declarations page of the policy. The loss must also commence within the coverage territory-the United States (including territories and possessions), Puerto Rico, or Canada.

Transfer of Rights of Recovery against Others to Us

This condition defines the insurer's subrogation rights when it makes a payment under the policy. To expedite the claim process, many times an insurer will, pay its insured for property that was damaged by someone else. This condition allows the insurer to pursue the responsible party to recover the amount it paid to the insured.

The subrogation condition also preserves the rights of the insurer when it comes to third parties such as a bailor or mortgagee. The insurer is first in line to get money back from the responsible party (at least for the amount it paid).

At any time prior to a loss an insured may waive, in writing, possible recovery rights against anyone. However, once a loss has occurred the insured may waive those rights against only another insured, a business that the insured owns or controls (or owns or controls the insured), or a tenant of the insured.

Other Relevant Provisions of the Commercial Property Policy

While not designated as conditions, there are several provisions in the Building and Personal Property Coverage form that operate as conditions.

Limits of Insurance

The policy states that the most it will pay for loss or damage in any one occurrence is the limit of liability shown on the declarations page. Unlike commercial general liability policies, the commercial property policy is not subject to annual aggregate limits (meaning that once the limit is exhausted during the policy period, it is gone); instead, the commercial property policy's limits are per occurrence. For example, if the insured's building is insured for $100,000 and suffers fire damage in the first month of the policy period of $75,000, full policy limits of $100,000 are available for windstorm that may occur in the eleventh month.

The limits section goes on to indicate that the amounts of insurance applicable to Fire Department Service Charge, Pollutant Clean-up And Removal, Increased Cost Of Construction, and Electronic Data are in addition to the declared policy limits.

The section also provides $2,500 coverage for outdoor signs attached to buildings.

The limits section concludes by putting the additional coverage of Preservation of Property within the policy limits. Debris Removal was included here, as well in previous editions, but the Debris Removal additional coverage now describes the maximum payable under that coverage (see Chapter 2).

Deductible

One deductible applies per loss occurrence, i.e., not per insured peril or each item of building or personal property damaged. A loss may involve both fire and windstorm damage-only one deductible applies; or, the loss may involve damage to (1) the insured's building; (2) a structure on the premises; and (3) items of personal property-again, one deductible applies.

By policy provision, the amount of loss is first reduced (if required) by the coinsurance condition or the agreed value option coverage. If this adjusted amount of loss is less than the deductible, the insurer pays nothing on the claim. If the adjusted amount of loss exceeds the deductible, the deductible is subtracted from the adjusted amount of loss and that is the amount the insured recovers, subject to the applicable policy limits.

The deductible condition explains the application of the deductible when the occurrence involves loss to more than one item of covered property and separate limits apply to those items. For example, a building on the property has a $60,000 limit and another has a value of $80,000. Both are damaged in the same occurrence, building #1 with damage totaling $60,110, and loss to building #2 is $90,000. The losses to each building are not combined in determining the application of the deductible, but the deductible is applied only once per occurrence (see the following example from the policy).
Deductible                    $250

Limit of--building # 1        $60,000

Limit of--building # 2        $80,000

Loss to building # 1          $60,100

Loss to building # 1          $90,000


The amount of loss to building #1 ($60,100) is less than the sum of the limit of insurance applicable to building #1, plus the deductible ($60,250). The deductible is subtracted from the amount of loss in calculating the loss payable for building #1 ($60,100 - $250) for a loss payable on building #1 of $59,850.

Because the deductible applies only once per occurrence, it is not subtracted in determining the loss payable for building #2. The loss payable for building #2 is its limit of insurance ($80,000). The insured still has an uninsured loss in the amount of $10,000 (because the loss was $90,000 and the limits are $80,000) and a deductible is not applied to building #2.

In policy example no. 2, the deductible and limits are the same as in example no. 1. In this example,
Loss to building #1                $70,000 (which exceeds the limit
                                   and deductible)
Loss to building #2                $90,000 (which exceeds the limit
                                   and deductible)
Loss payable on building #1        $60,000 (limit of insurance)
Loss payable on building #2        $80,000 (limit of insurance)
Total amount of loss payable       $140,000


Deductible-How to Apply

The insured property is a hotel located on the coast of North Carolina. The hotel is insured on a commercial property form CP 00 10 with Special Causes of Loss form, CP 10 30. The amount of building coverage is $6,905,000 with a deductible of $353,193. In order to get the insurance the hotel owners had to agree to a manuscripted change in the form. It excludes hail damage to some types of outdoor property, such as exterior paint, landscaping, and parking lots.

When Hurricane Floyd hit the Carolinas, this hotel suffered severe damage. The amount of the loss is $5 million; out of that $5 million, $1.3 million is uncovered damage to exterior property. Of the remaining $3.7 million only about $800,000 is damage to covered property.

The difficulty is the application of the deductible. The adjuster says that it applies to the amount of the covered loss. Thus, the deductible of $353,193 applies to the $800,000 that is payable, leaving an amount payable of $446,807.

The policy says the deductible applies "in any one occurrence of loss or damage (herein referred to as loss)." This is not otherwise qualified by "covered loss" or "the amount of loss covered by this policy." The deductible in a commercial property policy applies to the total amount of the loss as respects the insured -not to the limit of liability or special sublimits of liability.

The deductible is applied to the total amount of the loss, $5 million, leaving $4,646,807 as the amount of loss. However, that amount is further limited by the exclusion of damage to certain types of exterior property. Thus, the $1.3 million in uncovered hail damage is taken from that, leaving a final amount of $3,346,807.

Even if the insurer prevails at appraisal and is correct that only $800,000 is payable under the policy, the deductible still applies to the amount of the loss-$5 million. If the insurer prevails in appraisal and the amount payable is reduced to $800,000, the insurer will still owe the full $800,000: amount of loss ($5 million); less the deductible ($353,193) for an initial amount payable of $4,646,807; less the $1.3 million in uncovered hail damage (leaving $3,346,807); less $2,546,807 that the insurer claims is not covered (leaving a total amount payable of $800,000). No further deductions would be taken.

For example, a standard limitation in the CP 10 30 is $2,500 for the theft of patterns, dies, molds, and forms. A thief breaks into a machine shop covered by a CP 00 10 and CP 10 30. The deductible is $1,000.

The thief takes $4,000 worth of patterns, dies, molds and forms. The $1,000 deductible first applies to the loss, leaving $3,000 payable. However, that amount is further limited to $2,500 by the above provision. This insured is owed $2,500 by his insurer. If the deductible of $1,000 were applied to the sublimit of $2,500, the insured could collect only $1,500. If this were the case, the policy would never pay its full limits.

Loss Conditions In addition to the common policy conditions and the commercial property conditions, the commercial property policy contains a set of loss conditions that operate in case of a loss.

Abandonment and Appraisal

Abandonment. The first loss condition is abandonment. The insured may not simply abandon damaged property to the insurance company. The insurer has the right to the salvage value of property for which it makes total payment but cannot be compelled to take damaged or destroyed property.

Appraisal. The second loss condition, appraisal, provides a method to settle differences between insured and insurer regarding the valuation of damaged property or the amount of the loss. In this event each party selects its own appraiser. Then the two appraisers select an umpire. If the appraisers cannot agree on an umpire they may request that the umpire be chosen by a judge of a court having jurisdiction. The appraisers then separately value the property and set the value of the loss. If the appraisers are unable to agree the matter goes to the umpire. A decision to which any two agree (either both appraisers or an appraiser and the umpire) is binding on both parties. The condition states that each party must pay its own appraiser. The costs of the umpire and of the appraisal process are shared equally.

The condition ends with these words: "If there is an appraisal, we will still retain our right to deny the claim." The inclusion of this statement helps the insurer avoid the implication that by participating in the appraisal process there is an implied agreement to pay the claim. It also prevents the insured from claiming that entering the appraisal process keeps the insurer from denying the claim further on down the road. Appraisal applies to the value of property, not whether the loss is covered.

Appraisal of a Loss

A commercial property insured suffered a major fire loss. The insured first hired a public adjuster, submitted a proof of loss, and awaited the insurer's decision. When the insured and the insurer could not agree on the amount of the loss, the dispute was submitted to appraisal.

The appraisers reached a decision favorable to the insured. At that point the insurer decided that it wanted to readjust the claim, but that is contractually impermissible. Once a claim goes through the appraisal process and an amount is set, the insurer no longer has the options it had. The language clearly says that the decision of any two of the three (appraisers and umpire) is binding on all parties.

An insured must submit a proof of loss so that the insurer may investigate the claim. That was already done in this case. The policy says that the insurer will pay a loss within thirty days after receiving the proof of loss and an appraisal award has been made. In this case, the appraisal award was made. The insurer cannot now decide to settle the claim in a different manner.

Appraisal Clause and Disinterested Appraisers

The insurer and insured disputed resolution of a fire loss claim. There is no dispute as to the cause of the fire loss and the insured pre pared a building estimate. The dispute was over the extent and valuation of the loss.

The insured instituted the appraisal process under the policy and submitted the name of a disinterested builder and asked the insurer to do likewise. The insurer selected the original builder with whom the insured could not agree about the amount of damages.

The appraisal clause states that "each party will choose a competent appraiser." If these two cannot reach an agreement, they select an umpire. Having one of the original parties to the dispute chosen as an appraiser seems to build a barrier in the appraisal process, but the policy requires only that the appraiser must be competent; it does not require that each party select a disinterested appraiser.

The hope is that because the appraisers are competent professionals who are one step removed from the dispute, they will reach an agreement despite a certain natural bias in favor of their employer. If they cannot, the policy offers a mechanism for them to choose an umpire who decides which of the appraisers is right. If they cannot agree on an umpire, the policy provides for a court to select the umpire. These contingencies for involving an umpire are based in part on the recognition that the appraisers chosen by the parties might not be completely unbiased.

The Insured's Duties in the Event of Loss

The policy lists eight things an insured must do in the event of loss or damage under the policy. It also specifies the right of the insurer to examine the insured under oath without any other insured being present. The policy specifies that the insured must:

1. Notify the police if a law was broken.

2. Send the insurance company a notice of loss that includes a description of the property. The provision does not specify that the description must be in writing but it must be given promptly. The condition begins with the word give not send, so presumably notice to the insured's agent of loss by telephone is sufficient to fulfill this condition.

3. Provide a description of how, when, and where the loss or damage took place. This must be done as soon as possible.

4. Protect the covered property from any further damage and keep track of costs for emergency and temporary repairs to do so. This includes separating damaged from undamaged property if feasible. The insured must document expenses incurred in preserving the property from further loss. Such documentation is necessary for consideration in the settlement of the claim. These expenses are subject to the limit of insurance. "For consideration in the settlement of a claim" does not mean that the insurance company can consider whether to reimburse the insured for expense to protect covered property from further damage; consideration here can be taken in the contract context of consideration, meaning "due consideration" in a pecuniary sense.

The insured must protect the covered property from any further damage, not just damage from a covered peril. However, the insurer is not liable for subsequent loss or damage resulting from any uncovered cause of loss.

5. Compile an inventory of damaged and undamaged property if the insurer so requests.

6. Allow the insurer to inspect the property, including the insured's books and records. The insurer may also take samples of damaged and undamaged property. Comparing these types of property helps in the investigation of a loss.

7. Submit a signed, sworn proof of loss, if requested.

8. Generally cooperate with the insurance company. Cooperation includes submitting to questions under oath. It also includes allowing the insurer to examine the insured's books and records. Any insured answering such questions in writing must sign his answers.

The form states that the insurer may examine the insured under oath (a term that courts have held encompasses both oral and written examination). The insurer may examine insureds separately and out of the presence of other insureds. In USF&G v. Hill, 722 S.W.2d 609 (Mo. App. 1986), the court found the insurer's right to examine insureds separately had to be made explicit in the policy or the insurer had no such right this language was added to the form.

Loss Payment

After a covered loss, the insurer has four settlement options; the policy specifically gives the insurer the selection of which option to employ. Settlement will be effected using one of these options:

1. Pay the value of the property. Prior editions of the commercial property policy did not define the word value, but the CP 00 10 10 00 edition added a paragraph in the provision stating that the insurer will determine the value of the damaged property or the cost to repair or replace in accordance with the valuation condition.

2. The cost to repair or replace the damaged property. The policy reiterates the ordinance or law exclusion by specifically eliminating insurance recovery for any extra costs due to the operation of building or zoning laws.

3. The insurer may take the property at an agreed or an appraised value.

4. The insurer may actually repair, rebuild, or replace the property with that of "like kind and quality." This option also excludes any extra costs due to the operation of building laws.

Within thirty days of receipt of the sworn proof of loss, the insurer must advise the insured which option it chooses. Whichever option is chosen, the insurer will not pay the insured more than the insured's financial interest in the property.

Property of others is also subject to the same four options. The insurer deals directly with the owner of the property in the insured's stead. Again, the insurer owes the owner of the property no more than his financial interest in it.

Sometimes the owners of damaged property may bring suit against the insured. The insurer promises to defend such suits at its own expense.

Once the insurer receives the signed, sworn proof of loss and reaches an agreement with the insured regarding the value of the property, the loss will be paid within thirty days. Reaching an agreement on the value includes the award of an appraisal.

ISO added a loss payment condition to address exposures related to party walls in the CP 00 10 06 07 edition. A party wall is generally defined as a wall that divides two adjoining properties and in which each of the owners shares the rights. Ownership of a party wall may or may not be shared; there are numerous legal variations including tenancy in common and unilateral ownership with easement rights. A coverage issue may arise when one owner of a party wall refuses or is unable to repair his side of a party wall following loss or damage.

The policy was revised to identify the exposure and convey loss adjusting procedures for it. In this provision, loss payment relating to a party wall reflects the insured's partial interest in that wall. However, if the owner of the adjoining building elects not to repair or replace that building (and the building insured under this insurance is being repaired or replaced), this insurance will pay the full value of the party wall, subject to all other policy provisions.

Actual Cash Value Defined

Actual cash value (ACV) has three meanings in actual usage:

1. Fair market value, which is usually described as the price a willing buyer would pay to buy property from a willing seller in a free market.

2. Replacement cost less depreciation, which is generally accepted to mean the cost to replace property at the time of the loss minus its physical depreciation.

3. The broad evidence rule, which involves a judicious application of either one or two to the unique circumstance of the claim, whichever is more favorable to the insured.

State laws vary considerably on the definition. In California, an appeals court decided that ACV means fair market value in Cheeks v. California Fair Plan, 61 Cal. App. 4th 423 (1998). The court admonished insurers: "If it [the insurer] wants to determine actual cash value on the basis of replacement cost less depreciation, all it has to do is say so in the policy." Courts in Pennsylvania have taken the opposite view that ACV means replacement cost, such as in Judge v. Celina Mut. Ins. Co. 449 A.2d 658 (Pa. Super. 1982).

Fair market value, replacement cost, and depreciation are all fairly common and have commonly accepted meanings. They have been used over and over in establishing the value of damaged property.

The broad evidence rule, on the other hand, tries to bring other factors into consideration. McAnarney v. Newark Fire Ins. Co., 247 N.Y. 176 (1928) is a leading case on this question. The case involved the fire destruction of an old brewery that could not be used because of the National Prohibition Act. The building apparently had no other economic use, and the owner advertised it for sale, unsuccessfully, for a fraction of the amount of insurance carried. In striking a compromise between the insured and the insurer, the court said: "Where insured buildings have been destroyed, the trier of fact may, and should, call to its aid in order to effectuate complete indemnity, every fact and circumstance which would logically tend to the formation of a correct estimate of the loss. It may consider original cost and cost of reproduction; the opinions upon value given by qualified witnesses; declarations against interest which may have been made by the insured; the gainful uses to which the buildings may have been put; as well as any other reasonable factor tending to throw light on the subject." In so reasoning, the court decided on a value between replacement cost less depreciation and the market value of the building.

The most important point regarding the broad evidence rule was quoted in McAnarney. The court said that "every fact and circumstance which would logically tend to the formation of a correct estimate of the loss," including the economic value of the property, should be considered in determining the actual cash value.

Valuing Business Personal Property

Valuing business personal property may be less difficult because the value of the contents is not tied to the value of the land as with a building. The problem with using replacement cost less depreciation is that business personal property is often diverse, is acquired over a period of time, and depreciates at various rates. Often receipts are unavailable. Market value is also not a reliable guide. Few businesses would want their fairly new office furniture replaced with similar furniture that had been rented to others.

Another problem for businesses is the value of stocks of merchandise and raw materials. These items usually do not suffer depreciation. In such a case the proper measure of recovery is the cost of replacing them at the current market value, less any salvage value. Merchandise that has become shopworn and has deteriorated in value should be subject to depreciation. The measure of recovery might be more or less than the original cost; however, the standard of recovery is the cost to the insured not the price at which it is expected to sell. Rules in most states permit use of a market value or selling price clause that converts, for some insureds such as manufacturers and retailers, finished stock from actual cash value to selling price less discounts and unincurred expenses. Form CP 99 30 provides for valuation based on selling price, less any applicable discounts and expenses, for all completed stock (not just finished stock that is sold but not delivered, as in the building and personal property coverage form).

Recovered Property

This condition provides a method for loss readjustment in case stolen property is recovered. If either party recovers any property after loss settlement prompt notice must be given to the other party. The insured has the option to return the amount of claim payment in return for the original item. The insurer cannot require the insured to return payment and take back recovered property. Recovery expenses and necessary repairs to the property are borne by the insurance company up to the applicable limit.

Vacancy

The vacancy provision contains two parts. The first defines building for both an owner-occupant and a tenant as meant in the vacancy provision. The second describes the manner in which losses to vacant buildings are handled.

The form defines building for a tenant as that portion rented or leased to the insured. The tenant's portion is vacant when it does not contain enough business personal property to conduct customary operations, which would mean its normal business.

When the policy is issued to the owner or general lessee rather than a tenant, the policy says that a building is vacant if the insured does not rent at least 31 percent of the floor space to others or if the insured does not use at least 31 percent of the floor space for his own operations.

Under prior editions a building with the furniture and fixtures of a business-but from which the stock had been removed-would be considered vacant since customary operations are not possible without stock. In post-2000 editions, a building containing fixtures, fittings, and business personal property would still be considered vacant if it were being underutilized. The vacancy provision could be an issue for insureds where a storefront operation is the only going concern in a multiple story building. Despite the going concern on the first floor, if less than 31 percent of the building is unrented or not used for customary operations, the building is considered vacant and the provisions related to vacant property are applicable.

Prior to 1995, only buildings under construction were exempt from the vacancy provision. The 1995 version added buildings under renovation. The times when the building and personal property coverage form applies-by coverage extension-to a building under construction are rare and are limited by the provisions of the form (thirty days). An existing structure, on the other hand, can be subject to renovation at any time with no requirement of notice to the insurance company since it will not be considered vacant. However, the insured must be careful of a coinsurance problem if much value is added prior to notifying the insurer.

The second part of the vacancy condition describes how losses are handled when the building has been vacant for more than sixty consecutive days, or longer, if so endorsed. There is no coverage for damage from vandalism, building glass breakage, water damage, theft or attempted theft, or sprinkler leakage, unless steps have been taken to protect the system against freezing. The policy covers loss from a covered peril in a vacant building at a reduction of 15 percent in what it otherwise would pay.

Valuation

The commercial property policy covers loss to covered property at actual cash value unless some other valuation method (such as replacement cost) has been arranged. The policy does, however, provide four exceptions. Valuable papers and records were at one time a fifth exception, but the CP 00 10 04 02 edition's treatment of electronic data and valuable papers and records necessitated its removal from this section. The exceptions are as follows:

1. If the insured meets the coinsurance requirement, the policy covers any loss under $2,500 at replacement cost. However, the following building items are still subject to ACV adjustment: awnings, floor coverings, appliances, outdoor equipment, and furniture. Replacement cost does not include any extra cost due to the operation of building laws.

2. Stock sold but not delivered is valued at selling price less any applicable discounts and normally incurred expenses. For example, if the insured sells widgets at $100 each and offers a discount of 2 percent if paid within ten days, entire amount due within thirty days, with $10 in shipping expense, the recovery on the $100 item might be $88 ($100 selling price less 2 percent discount minus shipping fee of $10). Trade and business practice, along with examination of books and records, determines actual valuation.

3. The policy provides for replacement of damaged glass with safety

glass if required by law.

4. Tenants improvements and betterments are adjusted at ACV if repairs are made promptly. If the insured does not make repairs promptly to improvements and betterments the insurer offers a proportional settlement via the following formula. The original cost of the improvement times the number of days from the loss to the lease's expiration or the expiration of the renewal option period, if applicable. The amount computed is then divided by the number of days from the installation of the improvement to the expiration of the lease or the expiration of the renewal option period. The inclusion of renewal option periods addresses the long standing question of whether such periods should be considered during loss settlement calculations to provide a better restitution for an insured's use interest in a damaged improvement.

Assume a tenant holds a one-year lease for a commercial building that expires on July 31. The lease contains a one-year renewal option. On March 3, the tenant installs paneling costing $1,500. A fire occurs on June 2 that causes damage so extensive that the insured closes the business permanently. Had no loss occurred, the tenant would have stayed in business and exercised the renewal option.

Without taking the renewal option period into consideration, the insured stands to receive a $600 payment for the improvement ($1,500 x 60/150 = $600; where 60 equals the days from loss to lease expiration and 150 equals the days from improvement installation to lease expiration). When the renewal option period (365 days) is included in the calculation, the result of the proportional loss settlement is $1,238-[$1,500 x (60 + 365/150 + 365)] = $1,238-a significant difference.
   These formulas come into play only if the insured does not make the
   repairs promptly, thus disqualifying him from actual cash value
   recovery. The insured receives nothing from the insurer if someone
   other than the tenant (the landlord, for instance) repairs damaged
   improvements.


Valuation and Selling Price

A load of nonalcoholic beer was damaged when the load shifted during transit. The insured's customer made a claim against the insured for replacement of the shipment and a dispute over the value of the beer ensued.

Even though the buyer of the beer was to pay $4,300 for it replacement cost for the damaged goods to the insured was $10,260. It is standard practice in that industry to reduce the price on one product and increase prices on other products in order to maintain (or increase) profit margins.

The insurer took the position that it would pay the smaller of the replacement cost or actual cash value at the time of the loss. At the time of the loss, the value was the selling price, $4,300.

However, because the insured sold the beer for less than it cost does not reduce the value to that amount. What needs to be established is the ACV of the beer. The insured needs to demonstrate that this practice of selling certain items for less than their cost is a standard business practice in this industry.

Additional Conditions

The commercial property policy contains two additional conditions: coinsurance and mortgageholders.

Coinsurance

The principle of coinsurance says that in exchange for a reduced rate the insured must agree to maintain a specified relationship between property values and amount of insurance (e.g., 80 percent). For example, a building with a value of $1,000,000 must be insured for at least $800,000. If the insured agrees to carry this amount of coverage, the rate charged may be fifty cents per thousand dollars of coverage; however, if the insured chooses to carry only $500,000, that rate might increase to seventy-five cents or a dollar.

The form explains the mechanics of coinsurance with a step-by-step description. It also examines the ramifications of a coinsurance penalty. Examples show the effects of coinsurance computations in three different situations: where limits are inadequate, where limits are adequate, and where a blanket limit exists.

Since 1986, every version of the coinsurance provision found in the CP 00 10 applies the deductible after the calculation of the coinsurance penalty. The wording in the 2000 policy was rearranged to emphasize this point. Prior to 1986, the forms applied the deductible prior to the calculation of the coinsurance penalty, a manner more advantageous to the insured.

The following is an example of the interaction between the deductible and the coinsurance clause: Two insureds each have a $50,000 loss under policies with a $250 deductible. Insured A is in compliance with the coinsurance requirement and recovers $49,750 ($50,000 minus $250). Insured B is underinsured and must accept 25 percent of the loss as a coinsurer. Insured B will collect $37,500 (75 percent of $50,000) less the $250 deductible for a net recovery of $37,250. Had insured B been covered under a pre-1986 commercial property form, he would have collected $37,316 (75 percent of $49,750). Subtracting the deductible before calculating the coinsurance penalty makes a difference of $66 for the insured.

Mortgageholders This condition spells out the rights and duties of any mortgagees or trustees (here referred to as mortgageholders) that are named on the declarations. In the event of a claim, any listed mortgageholder receives payment for losses as interests may appear. However, the insured must be in compliance with all coverage terms. Even if foreclosure proceedings or similar actions have begun on a building that suffers a loss, a mortgageholder may collect a loss payment.

Further, even if the insurer denies a claim to the insured due to the insured's actions or lack of compliance with the terms for coverage, the mortgageholder may still collect. The mortgageholder must pay any premium due and submit the appropriate proof of loss. Additionally, a mortgageholder must notify the insurance company of any known change in ownership, occupancy, or increase of hazard. When these conditions are satisfied, all terms of the building and personal property coverage form become applicable to the mortgageholder.

If partial claim payment is made to a mortgageholder and not to an insured, the insurance company inherits a proportion of the mortgageholder's rights under the mortgage based on the extent of claim payment, and the mortgageholder retains subrogation rights and may attempt to recover the full amount of the claim.

The insurance company may, at its option, pay the mortgageholder the full amount of the principal and interest on the mortgage in exchange for transfer of the mortgage to the insurance company. In this case, the insured continues mortgage payments, but to the insurance company instead of the original mortgageholder.

If the insurer cancels the policy, it must send written notice to the mortgageholder thirty days before the effective date of cancellation. If the cancellation is due to nonpayment of premium by the insured, then notice to the mortgageholder is only ten days. In the event of nonrenewal, the insurer must also send a ten-day notice to the mortgageholder.

Loss during Foreclosure

A large warehouse was insured for over $1 million. The mortgageholder foreclosed on the property. Shortly after the foreclosure a fire caused nearly $700,000 in damage to the warehouse. The agent wondered about the insurer's obligation to the mortgageholder.

The amount of the loss does not determine the insurer's obligation to the mortgageholder; the amount of debt still owed on the property does. That amount is the mortgageholder's insurable interest.

The insurer's obligation to the named insured owner is the value of the loss limited to the former owner's insurable interest. If the owner of the building has complied with all the policy conditions, the insurer owes the loss to the named insured and the mortgageholder as their interests may appear. The amount of each of their interests is a legal.
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Author:Hillman, Bruce J.
Publication:Commercial Property Coverage Guide, 4th ed.
Date:Jan 1, 2009
Words:8153
Previous Article:Chapter 4: special causes of loss form (cp 10 30).
Next Article:Chapter 6: builders risk.
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