Insurers to Curb Agency Compensation in 2010, Consultant Study Finds
January 7, 2010
Total property/casualty insurance agency compensation is expected to decrease slightly in 2010, largely due to contingent commission changes, according to a new compensation study.
Four out of 10 insurance companies plan to modify their agent compensation plans in 2010 by hiking premium volume requirements, increasing stop loss thresholds, adding growth requirements or eliminating contingent commission plans altogether, reports the insurance consulting firm Ward Group in its findings from a study of agency compensation and management practices for property/casualty insurance companies.
The study focused on commission practices, agent incentives and other agency management practices and includes aggregated results from 2008 and 2009 for 99 companies. Independent agency companies represented 80 percent of the participants.
Key findings include:
- 40% of companies plan to modify their contingent plan in 2010;
- 10% of companies plan to increase premium volume requirements compared to 4% that plan to decrease the volume requirement;
- 6% of companies plan to increase the stop loss thresholds compared to only 1% that plan to decrease the amount;
- 12% of companies plan to change their contingent formulas to pay less contingent commission compared to 4% that expect to pay more;
- 6% of companies plan to add growth requirements to their contingent formulas and 5% plan to add retention requirements; and
- 3% of companies are considering eliminating their contingent commission plans completely.
- Are more likely to modify base commission by line of business
- Are more likely to modify base commission by new and renewal business
- Are less likely to have separate plans for personal and commercial lines
- Have 20% fewer agents per manager than average
- Require their top tier agents to demonstrate exceptional characteristics and proven commitment to the company. This benchmark had 50% fewer agents in their top tier and had implemented more challenging criteria for their top agency selection (in terms of higher production and lower loss ratios requirements)
In addition to predicting that agency compensation will drop in 2010 largely due to contingent commission changes, Rieder said he expects agency trips and conferences to be smaller and less costly than in 2009 and prior years.
He also said that agency recruitment appears to be more aggressive as companies appoint more new agents to expand their sales forces. However, he believes most companies have not made effective changes to their contingent plans over the last three to five years to align with current market conditions.
2010년 1월 14일 목요일
Local Governments Increase Homeowners' Loss - Part III
Local Governments Increase Homeowners' Loss - Part III
Christopher J. Boggs, CPCU, ARM, ALCM
October 13, 2008
Our previous article ended with several examples of coverage limit gaps created by the application of local building codes. This post will discuss those examples further and end with a highlighted discussion of the HO 04 77 endorsement.
Loss/Gap and the Reality of Building Codes
In all the prior examples, the greatest ordinance or law expense is the cost associated with the undamaged portion of the house (the cost to tear down and rebuild to current code). However, consideration must be given to the fact that it is not likely a house could be 80 percent damaged and not be declared a total loss or at least a constructive total loss (unless it's a magic fire that just stops and causes no further damage). This massive cost and gap in coverage limit is most likely to be found in a house that suffers 50 to 60 percent damage.
Discounting the costs associated with the undamaged part of the house, the cost to bring the entire house up to current building code could, itself, use up and greatly exceed the ordinance or law coverage offered in the unendorsed homeowners' policy. In the first example, the cost to bring the entire house up to current code is $60,000 (3,000 square feet times $20 per square foot) leaving the homeowner out of pocket $30,000.
The difference between the cost to rebuild the structure as it stood and the cost to bring it to current building code is largely a function of the house's age and the rapidity and breadth of changes in the building codes adopted by the authority having jurisdiction. Agents should have a good handle on the major changes between the time the house was built and the current building code. With that recommendation made, it is impossible to know all applicable building codes, several volumes of manuals are necessary to hold them; but the agent can undertake to know the major changes involving major requirements such as are contained in the national electric code, the applicable flood plain management codes and other MAJOR changes (ADA guidelines and changes in building procedures and materials since the house was constructed).
As stated earlier, the building codes applicable to a specific house, while enforced by the local authority, can emanate from enumerable sources; but the good news is that ordinance or law coverage responds to ALL building codes, regardless of the genesis. The policy specifically states, "You may use up to 10% of the limit of liability that applies to Coverage A for the increased costs you incur due to the enforcement of any ordinance or law which requires or regulates…". "Any" has no limitation.
Homeowners' Endorsements NOT Altering the Ordinance or Law Exclusion/Limitation
Additional Limits of Liability for Coverages A, B, C and D (HO 04 11 or equivalent state-specific form). This form allows the insured to purchase an additional amount of dwelling coverage (Coverage "A") AFTER the loss occurs in the event that the estimated replacement cost purchased was less than the actual replacement cost (the old "guaranteed replacement cost" coverage). Once additional Coverage "A" limits are purchased, all other coverage parts increase in kind (based on the applicable percentages), including the 10 percent additional coverage for ordinance or law.
Endorsement provisions require the insured to: 1) carry 100 percent insurance to value; 2) allow the insurance carrier to adjust the limits based on replacement cost valuations completed; 3) allow the insurer to apply an inflation factor; and 4) notify the insurance carrier if any improvements are made that increase the value of the structure more than 5 percent.
However, this endorsement does NOT alter the ordinance or law exclusion in the loss settlement provisions. ISO's HO-3 form specifically states, "In this Condition C., the terms 'cost to repair or replace' and 'replacement cost' do not include the increased costs incurred to comply with the enforcement of any ordinance or law, except to the extent that coverage for these increased costs is provided in E.11. Ordinance Or Law under Section I - Property Coverages." The E.11. additional coverage is the 10% of Coverage A as discussed previously.
Specified Additional Amount Of Insurance For Coverage A - Dwelling (HO 04 20 or equivalent state-specific form). This is a modified version of the HO 04 11 containing all the same provisions and limitations. The major difference is that only Coverage Part A (Dwelling) can be increased. None of the other limits, including the ordinance or law limit, are increased. A second difference of this endorsement is that the amount of additional coverage available for purchase is limited to either 25 percent or 50 percent of the pre-loss Coverage A (whichever the underwriting carrier will allow).
The HO 04 20 uses the same definition of "replacement cost" as the HO 04 11; meaning that none of the additional costs required by the application of an ordinance or law are covered by the attachment of this endorsement.
Confusion over both forms is generated by a misunderstanding of the meaning of "replacement cost" used in the homeowners' form and the subject endorsements. Replacement cost means to replace with "like kind and quality." Basically this translates "to put back exactly what was there, like it was, using new material; but excluding the cost of any upgrades requested by the insured or mandated by any governmental authority."
The definition of replacement cost does not include the cost to do such things as:
• Raise the house three feet to get it above base flood elevation (BFE) to comply with the current flood plain management code;
• Add more electrical outlets to meet national electric code (NEC) requirements;
• Move the house back 10 feet to meet set-back requirements; or
• Widen doorways and raise counters to meet ADA requirements.
All of these costs result from governmental ordinances or laws and are examples of expenses not included in the definition of "replacement cost." So, even buying more Coverage "A" will not cover these expenses. The cost to meet any or all of these and other jurisdictional requirements will have to be covered under the ordinance or law extension, the endorsement increasing coverage (HO 04 77) or out of the insured's pocket (if there is not enough additional coverage from either of the other options).
In short, neither endorsement rescues the insured from the additional costs necessitated by a local jurisdiction's enforcement of the local building codes requiring a house to be brought, in its entirety, up to current building code.
Ordinance or Law Increased Amount of Coverage (HO 04 77)
Two ordinance or law endorsements exist for use with homeowners' policies: 1) the Ordinance or Law Increased Amount of Coverage (HO 04 77); and 2) the Ordinance or Law Coverage (HO 05 62). The HO 05 62 is attached when there is no automatic ordinance or law coverage provided by the homeowners' form. Coverage provided by this endorsement is the same as has been discussed previously except that the insured chooses the coverage limit desired.
However, since most ISO homeowners' policies include ordinance or law as an additional coverage (10 percent of "A" as reported), this article focuses on the use of the HO 04 77 to increase the amount of ordinance or law coverage.
Coverage breadth is not changed by the HO 04 77, only the amount of coverage. The insured can choose to increase the limits to 25 percent, 50 percent 75 percent or even 100 percent of Coverage "A." The premiums for each level is a percentage of the homeowners' base premium ranging from 13 percent (to increase to 25 percent of "A") up to 67 percent (raising the limit to 100 percent of Coverage "A").
The very first example presented in the first post developed an ordinance or law-induced claim expense of $165,000; that equates to about 55 percent of Coverage "A." Increasing the ordinance or law limit to 50 percent of Coverage "A" would increase the base premium by approximately 35 percent. A $1,000 premium would become a $1,350 premium; but that $350 is preferable to the out-of-packet expense of $135,000 presented in the example.
But, as previously stated, such a loss and extreme application of an ordinance or law claim is probably rare. However, it is still highly recommended and even professionally necessary to offer additional amounts of ordinance or law coverage, at least the 25 percent option. In some states, Florida being one, the agent is required to offer the 25 percent and 50 percent alternatives; and the insured has the option to purchase or reject the offer of coverage (by signature).
Conclusion
Ordinance or law coverage is more commonly discussed and highlighted in commercial property conversations, but rarely is such a discussion carried on with personal lines clients. As was presented in this three-part series, the lack of this coverage has the potential to be very expensive to the insured (and potentially the agency if an errors and omissions suit results).
Without being overly dramatic, ordinance or law is a very real homeowners' exposure often overlooked during the personal lines risk management and insurance planning process. Agents should offer the protection and explain the exposure as clearly and quickly as possible; especially to clients in a home 10 years old and older. A great marketing opportunity may be to write a letter to clients owning older homes to explain their new exposure and present a solution. Regardless, do not ignore this potential out-of-pocket expense faced by your homeowner clients.
The next post will provide agents a sample letter that can be sent to clients to explain this gap in coverage. Hopefully the letter will serve two purposes: 1) as a marketing tool to let your homeowner clients know that you are looking out for their best interest; and 2) as an errors and omissions protection. If one of your clients suffers major damage leading to an ordinance or law problem that is not paid by insurance; being able to prove in court that you notified the insured of this potential gap will go a long way towards helping you win the case.
Christopher J. Boggs, CPCU, ARM, ALCM
October 13, 2008
Our previous article ended with several examples of coverage limit gaps created by the application of local building codes. This post will discuss those examples further and end with a highlighted discussion of the HO 04 77 endorsement.
Loss/Gap and the Reality of Building Codes
In all the prior examples, the greatest ordinance or law expense is the cost associated with the undamaged portion of the house (the cost to tear down and rebuild to current code). However, consideration must be given to the fact that it is not likely a house could be 80 percent damaged and not be declared a total loss or at least a constructive total loss (unless it's a magic fire that just stops and causes no further damage). This massive cost and gap in coverage limit is most likely to be found in a house that suffers 50 to 60 percent damage.
Discounting the costs associated with the undamaged part of the house, the cost to bring the entire house up to current building code could, itself, use up and greatly exceed the ordinance or law coverage offered in the unendorsed homeowners' policy. In the first example, the cost to bring the entire house up to current code is $60,000 (3,000 square feet times $20 per square foot) leaving the homeowner out of pocket $30,000.
The difference between the cost to rebuild the structure as it stood and the cost to bring it to current building code is largely a function of the house's age and the rapidity and breadth of changes in the building codes adopted by the authority having jurisdiction. Agents should have a good handle on the major changes between the time the house was built and the current building code. With that recommendation made, it is impossible to know all applicable building codes, several volumes of manuals are necessary to hold them; but the agent can undertake to know the major changes involving major requirements such as are contained in the national electric code, the applicable flood plain management codes and other MAJOR changes (ADA guidelines and changes in building procedures and materials since the house was constructed).
As stated earlier, the building codes applicable to a specific house, while enforced by the local authority, can emanate from enumerable sources; but the good news is that ordinance or law coverage responds to ALL building codes, regardless of the genesis. The policy specifically states, "You may use up to 10% of the limit of liability that applies to Coverage A for the increased costs you incur due to the enforcement of any ordinance or law which requires or regulates…". "Any" has no limitation.
Homeowners' Endorsements NOT Altering the Ordinance or Law Exclusion/Limitation
Additional Limits of Liability for Coverages A, B, C and D (HO 04 11 or equivalent state-specific form). This form allows the insured to purchase an additional amount of dwelling coverage (Coverage "A") AFTER the loss occurs in the event that the estimated replacement cost purchased was less than the actual replacement cost (the old "guaranteed replacement cost" coverage). Once additional Coverage "A" limits are purchased, all other coverage parts increase in kind (based on the applicable percentages), including the 10 percent additional coverage for ordinance or law.
Endorsement provisions require the insured to: 1) carry 100 percent insurance to value; 2) allow the insurance carrier to adjust the limits based on replacement cost valuations completed; 3) allow the insurer to apply an inflation factor; and 4) notify the insurance carrier if any improvements are made that increase the value of the structure more than 5 percent.
However, this endorsement does NOT alter the ordinance or law exclusion in the loss settlement provisions. ISO's HO-3 form specifically states, "In this Condition C., the terms 'cost to repair or replace' and 'replacement cost' do not include the increased costs incurred to comply with the enforcement of any ordinance or law, except to the extent that coverage for these increased costs is provided in E.11. Ordinance Or Law under Section I - Property Coverages." The E.11. additional coverage is the 10% of Coverage A as discussed previously.
Specified Additional Amount Of Insurance For Coverage A - Dwelling (HO 04 20 or equivalent state-specific form). This is a modified version of the HO 04 11 containing all the same provisions and limitations. The major difference is that only Coverage Part A (Dwelling) can be increased. None of the other limits, including the ordinance or law limit, are increased. A second difference of this endorsement is that the amount of additional coverage available for purchase is limited to either 25 percent or 50 percent of the pre-loss Coverage A (whichever the underwriting carrier will allow).
The HO 04 20 uses the same definition of "replacement cost" as the HO 04 11; meaning that none of the additional costs required by the application of an ordinance or law are covered by the attachment of this endorsement.
Confusion over both forms is generated by a misunderstanding of the meaning of "replacement cost" used in the homeowners' form and the subject endorsements. Replacement cost means to replace with "like kind and quality." Basically this translates "to put back exactly what was there, like it was, using new material; but excluding the cost of any upgrades requested by the insured or mandated by any governmental authority."
The definition of replacement cost does not include the cost to do such things as:
• Raise the house three feet to get it above base flood elevation (BFE) to comply with the current flood plain management code;
• Add more electrical outlets to meet national electric code (NEC) requirements;
• Move the house back 10 feet to meet set-back requirements; or
• Widen doorways and raise counters to meet ADA requirements.
All of these costs result from governmental ordinances or laws and are examples of expenses not included in the definition of "replacement cost." So, even buying more Coverage "A" will not cover these expenses. The cost to meet any or all of these and other jurisdictional requirements will have to be covered under the ordinance or law extension, the endorsement increasing coverage (HO 04 77) or out of the insured's pocket (if there is not enough additional coverage from either of the other options).
In short, neither endorsement rescues the insured from the additional costs necessitated by a local jurisdiction's enforcement of the local building codes requiring a house to be brought, in its entirety, up to current building code.
Ordinance or Law Increased Amount of Coverage (HO 04 77)
Two ordinance or law endorsements exist for use with homeowners' policies: 1) the Ordinance or Law Increased Amount of Coverage (HO 04 77); and 2) the Ordinance or Law Coverage (HO 05 62). The HO 05 62 is attached when there is no automatic ordinance or law coverage provided by the homeowners' form. Coverage provided by this endorsement is the same as has been discussed previously except that the insured chooses the coverage limit desired.
However, since most ISO homeowners' policies include ordinance or law as an additional coverage (10 percent of "A" as reported), this article focuses on the use of the HO 04 77 to increase the amount of ordinance or law coverage.
Coverage breadth is not changed by the HO 04 77, only the amount of coverage. The insured can choose to increase the limits to 25 percent, 50 percent 75 percent or even 100 percent of Coverage "A." The premiums for each level is a percentage of the homeowners' base premium ranging from 13 percent (to increase to 25 percent of "A") up to 67 percent (raising the limit to 100 percent of Coverage "A").
The very first example presented in the first post developed an ordinance or law-induced claim expense of $165,000; that equates to about 55 percent of Coverage "A." Increasing the ordinance or law limit to 50 percent of Coverage "A" would increase the base premium by approximately 35 percent. A $1,000 premium would become a $1,350 premium; but that $350 is preferable to the out-of-packet expense of $135,000 presented in the example.
But, as previously stated, such a loss and extreme application of an ordinance or law claim is probably rare. However, it is still highly recommended and even professionally necessary to offer additional amounts of ordinance or law coverage, at least the 25 percent option. In some states, Florida being one, the agent is required to offer the 25 percent and 50 percent alternatives; and the insured has the option to purchase or reject the offer of coverage (by signature).
Conclusion
Ordinance or law coverage is more commonly discussed and highlighted in commercial property conversations, but rarely is such a discussion carried on with personal lines clients. As was presented in this three-part series, the lack of this coverage has the potential to be very expensive to the insured (and potentially the agency if an errors and omissions suit results).
Without being overly dramatic, ordinance or law is a very real homeowners' exposure often overlooked during the personal lines risk management and insurance planning process. Agents should offer the protection and explain the exposure as clearly and quickly as possible; especially to clients in a home 10 years old and older. A great marketing opportunity may be to write a letter to clients owning older homes to explain their new exposure and present a solution. Regardless, do not ignore this potential out-of-pocket expense faced by your homeowner clients.
The next post will provide agents a sample letter that can be sent to clients to explain this gap in coverage. Hopefully the letter will serve two purposes: 1) as a marketing tool to let your homeowner clients know that you are looking out for their best interest; and 2) as an errors and omissions protection. If one of your clients suffers major damage leading to an ordinance or law problem that is not paid by insurance; being able to prove in court that you notified the insured of this potential gap will go a long way towards helping you win the case.
Local Governments Increase Homeowners' Losses - Part II
Local Governments Increase Homeowners' Losses - Part II
Christopher J. Boggs, CPCU, ARM, ALCM
October 10, 2008
Insurance Services Office's (ISO's) unendorsed homeowners' policy provides a limited amount of coverage to pay the costs associated with the enforcement of any ordinance or law following a major loss. The next several paragraphs will highlight the coverage and limit provided by the unendorsed homeowners' policy, list the types of government-induced losses this limited amount is required to cover and provide claims examples.
Coverage Included in the Homeowners' Policy
Unendorsed, ISO's homeowners' policy(ies) provide only 10 percent of Coverage "A" (Dwelling), in addition to the Coverage A limit, to pay the cost of a loss or increase in loss resulting from the enforcement of any ordinance or law to which the house is subject. For example, a policy with a $300,000 Coverage A limit would provide up to $30,000 of additional protection to cover the add-on expenses arising from a building code-induced loss. Such limit would be called upon to cover three "additional costs" as detailed in the policy's "Additional Coverage - Ordinance or Law" provision:
1) The increased cost necessary to bring the damaged part of the house up to current code;
2) The cost to tear down and remove the debris of the undamaged part of the structure; and
3) The cost to rebuild or repair the undamaged part of the structure in compliance with current building code.
That's a lot to expect from such a minimal amount. Remember apart from this extension or any attached ordinance of law endorsement (if any), the homeowners' policy pays only the cost to tear down, remove the debris of and rebuild/repair the damaged part of the house. NO coverage apart from this additional coverage applies to the undamaged part of the house. An example using the same $300,000 house will help spotlight the potential limit gap. Following are some pertinent facts necessary for this example:
• Value of house: $300,000
• Square footage: 3,000
• Ordinance or Law Additional Coverage (included in the policy): $30,000
• Ordinance or Law Rule applied by the jurisdiction: Percentage Rule (60 percent of "value")
• Amount of Damage: $200,000 (66.7 percent)
• Square Footage Damaged: 2,000 square feet
Based on the above information, the jurisdiction will likely require the house to be torn down and rebuilt to meet current building code. The homeowners' coverage part will only pay the $200,000 plus the cost to remove the debris of the damaged property. Any additional cost resulting directly from the application of one or several ordinances or laws is specifically excluded (except for the small amount granted in the additional coverages section). So, how will the coverage break down; what claims costs will the ordinance or law extension be required to cover and how much will the insured have to pay from his own pocket?
The 10 percent ($30,000) ordinance or law coverage will be called upon to pay the additional per square foot cost to bring the damaged part of the structure up to current building code once rebuilt; the cost to tear down the remaining (undamaged) part of the structure and the cost to rebuild the undamaged part of the structure to comply with the current building code. What might all of this cost and is $30,000 enough? Assumptions needed to complete this example are:
• Cost to rebuild to current building code: $120 per square foot
• Cost to rebuild to prior code: $100 per square foot
• Demolition and Debris Removal cost: $5.00per square foot
Using this information and the costs and limits presented above, the homeowners coupled with the ordinance or law additional coverage will respond and pay as follows:
Homeowners' Policy (without the additional coverage)
• Cost to remove the debris of the damaged portion of the house: $10,000 (2,000 sq. ft. x $5 per sq. ft.)
• Cost to rebuild the damaged portion of the house to old code: $200,000 (2,000 sq. ft. x $100 per sq. ft.)
Total amount paid by the homeowners' coverage (without the additional ordinance or law coverage): $210,000
Ordinance or Law Additional Coverage
• Additional cost to bring the damaged portion of the house up to current building code: $40,000 (2,000 sq. ft. x $20 per sq. ft. (the difference between old building code and current building code));
• Cost to tear down and remove undamaged portion of the house: $5,000 (1,000 sq. ft. x $5 per sq. ft.); plus
• Cost to rebuild the undamaged part of the house to current building code: $120,000 (1,000 sq. ft. x $120 per sq. ft.)
Total amount that would be directly related to the enforcement of the ordinance or law: $165,000.
The amount of coverage available in the unendorsed policy is only $30,000 so the insured in this example would be out of pocket $135,000.
Even if the above example were altered to 80 percent of the house being damaged, the cost to comply with local building code as per the above break down would still be around $123,000 ($93,000 out of the insured's pocket).
Going one step further, if the difference between the old building code and the new is only $10 per square foot, and if the house is 80 percent damaged the amount provided by the ordinance or law extension is still short by $63,000 ($93,000 total cost minus the $30,000 available).
(*Contents coverage and loss of use is not considered in the above example.)
Total Loss
Essentially, the application of an ordinance or law requiring the house to be torn down and rebuilt to current code creates a TOTAL LOSS for the insured even if the house was not totally destroyed by the covered cause of loss. And the additional cost created by the enforcement of the building code is SPECIFICALLY excluded by the policy and coverage is limited to the amount given back in the Additional Coverage - Ordinance or Law (unless increased by endorsement).
Following
The next post will discuss some of the "real-world" fallacies with the above examples; but it will also briefly explore the some of the "real-world" pitfalls of not addressing this exposure. Plus, endorsements that some feel correct this problem will be discussed and a brief discussion of the endorsement that increases the limit of ordinance or law coverage available to the insured.
Christopher J. Boggs, CPCU, ARM, ALCM
October 10, 2008
Insurance Services Office's (ISO's) unendorsed homeowners' policy provides a limited amount of coverage to pay the costs associated with the enforcement of any ordinance or law following a major loss. The next several paragraphs will highlight the coverage and limit provided by the unendorsed homeowners' policy, list the types of government-induced losses this limited amount is required to cover and provide claims examples.
Coverage Included in the Homeowners' Policy
Unendorsed, ISO's homeowners' policy(ies) provide only 10 percent of Coverage "A" (Dwelling), in addition to the Coverage A limit, to pay the cost of a loss or increase in loss resulting from the enforcement of any ordinance or law to which the house is subject. For example, a policy with a $300,000 Coverage A limit would provide up to $30,000 of additional protection to cover the add-on expenses arising from a building code-induced loss. Such limit would be called upon to cover three "additional costs" as detailed in the policy's "Additional Coverage - Ordinance or Law" provision:
1) The increased cost necessary to bring the damaged part of the house up to current code;
2) The cost to tear down and remove the debris of the undamaged part of the structure; and
3) The cost to rebuild or repair the undamaged part of the structure in compliance with current building code.
That's a lot to expect from such a minimal amount. Remember apart from this extension or any attached ordinance of law endorsement (if any), the homeowners' policy pays only the cost to tear down, remove the debris of and rebuild/repair the damaged part of the house. NO coverage apart from this additional coverage applies to the undamaged part of the house. An example using the same $300,000 house will help spotlight the potential limit gap. Following are some pertinent facts necessary for this example:
• Value of house: $300,000
• Square footage: 3,000
• Ordinance or Law Additional Coverage (included in the policy): $30,000
• Ordinance or Law Rule applied by the jurisdiction: Percentage Rule (60 percent of "value")
• Amount of Damage: $200,000 (66.7 percent)
• Square Footage Damaged: 2,000 square feet
Based on the above information, the jurisdiction will likely require the house to be torn down and rebuilt to meet current building code. The homeowners' coverage part will only pay the $200,000 plus the cost to remove the debris of the damaged property. Any additional cost resulting directly from the application of one or several ordinances or laws is specifically excluded (except for the small amount granted in the additional coverages section). So, how will the coverage break down; what claims costs will the ordinance or law extension be required to cover and how much will the insured have to pay from his own pocket?
The 10 percent ($30,000) ordinance or law coverage will be called upon to pay the additional per square foot cost to bring the damaged part of the structure up to current building code once rebuilt; the cost to tear down the remaining (undamaged) part of the structure and the cost to rebuild the undamaged part of the structure to comply with the current building code. What might all of this cost and is $30,000 enough? Assumptions needed to complete this example are:
• Cost to rebuild to current building code: $120 per square foot
• Cost to rebuild to prior code: $100 per square foot
• Demolition and Debris Removal cost: $5.00per square foot
Using this information and the costs and limits presented above, the homeowners coupled with the ordinance or law additional coverage will respond and pay as follows:
Homeowners' Policy (without the additional coverage)
• Cost to remove the debris of the damaged portion of the house: $10,000 (2,000 sq. ft. x $5 per sq. ft.)
• Cost to rebuild the damaged portion of the house to old code: $200,000 (2,000 sq. ft. x $100 per sq. ft.)
Total amount paid by the homeowners' coverage (without the additional ordinance or law coverage): $210,000
Ordinance or Law Additional Coverage
• Additional cost to bring the damaged portion of the house up to current building code: $40,000 (2,000 sq. ft. x $20 per sq. ft. (the difference between old building code and current building code));
• Cost to tear down and remove undamaged portion of the house: $5,000 (1,000 sq. ft. x $5 per sq. ft.); plus
• Cost to rebuild the undamaged part of the house to current building code: $120,000 (1,000 sq. ft. x $120 per sq. ft.)
Total amount that would be directly related to the enforcement of the ordinance or law: $165,000.
The amount of coverage available in the unendorsed policy is only $30,000 so the insured in this example would be out of pocket $135,000.
Even if the above example were altered to 80 percent of the house being damaged, the cost to comply with local building code as per the above break down would still be around $123,000 ($93,000 out of the insured's pocket).
Going one step further, if the difference between the old building code and the new is only $10 per square foot, and if the house is 80 percent damaged the amount provided by the ordinance or law extension is still short by $63,000 ($93,000 total cost minus the $30,000 available).
(*Contents coverage and loss of use is not considered in the above example.)
Total Loss
Essentially, the application of an ordinance or law requiring the house to be torn down and rebuilt to current code creates a TOTAL LOSS for the insured even if the house was not totally destroyed by the covered cause of loss. And the additional cost created by the enforcement of the building code is SPECIFICALLY excluded by the policy and coverage is limited to the amount given back in the Additional Coverage - Ordinance or Law (unless increased by endorsement).
Following
The next post will discuss some of the "real-world" fallacies with the above examples; but it will also briefly explore the some of the "real-world" pitfalls of not addressing this exposure. Plus, endorsements that some feel correct this problem will be discussed and a brief discussion of the endorsement that increases the limit of ordinance or law coverage available to the insured.
Local Governments Increase Homeowners' Loss - Personal Lines Ordinance or Law
Local Governments Increase Homeowners' Loss - Personal Lines Ordinance or Law
Christopher J. Boggs, CPCU, ARM, ALCM
October 8, 2008
Exponential technological advances, improvements in building materials and methods, changes in external and environmental conditions and the rewriting and re-codification of building codes all occur during the life of a house. The results, within 10 years of completion (maybe even as little as five years past) the house may violate some part of the most current jurisdictional building codes.
Any house not in compliance with current building codes subjects the owners to a coverage limit gap following a "major" loss (as defined below) because: 1) specific jurisdictional requirements stipulate the point at which a particular house has suffered "major" damage and must be brought into building code compliance; and 2) Insurance Services Office's (ISO's) unendorsed homeowners' policy provides only a minimal amount of coverage to pay for the increased expenses resulting from the enforcement of current building codes. Combined, the limitations on coverage and the building code's specifications can lead to a potentially large out-of-pocket expense for the insured.
Major loss or damage is uniquely defined by individual jurisdictions with each applying its own connotative twist. However, two broad categories of major damage have evolved into which most state and local building codes fall:
• The Jurisdictional Authority Rule: States applying this as the measure of major damage allow the authority having jurisdiction (the local government) to judge when a damaged building must be brought in its entirety into compliance with the current building code; and
• The Percentage Rule: Simply, when a building is damaged beyond a certain percentage of its "value," the entire structure must be brought into compliance with local building code. There is no subjective interpretation involved.
Each rule presents its own set of problems regarding ordinance or law coverage and the minimal limits automatically provided in most homeowners' policies. For example:
• The jurisdictional authority rule is subjective in its application. Each jurisdiction develops and applies its own standard to define major damage and determine a structure's fitness for continued use. Decisions can be based on the amount of damage, the age of the building coupled with pre-loss compliance shortfalls or simple safety concerns. There is no one criteria upon which homeowners and their agents can depend, making risk management and insurance planning very difficult in states applying this rule. The jurisdictional authority rule has been likened to being "at the mercy of the man with the clipboard."
• The percentage rule's definition of "value" differs among the states applying this as their codified statute. "Value" in these states could mean anything from actual cash value to appraised value or even market value*. Such breadth of interpretation can create problems for agents that operate in more than one state. (*Market value is negotiated between and agreed to by a willing buyer and a willing seller. It can fluctuate up and down based on the economy, condition, use or need and has little relation to the true cost to rebuild a particular structure.)
Ordinance or Law Sources
Building ordinances and laws enforced by local jurisdictions are promulgated by a wide assortment of contributors. States use these model codes to create a statutory infrastructure but endow to local jurisdictions the authority to adopt and customize building codes to meet local preferences and needs as necessary. Building codes and ordinances are developed and published by:
The Federal Government. Three major advisory codes flow from the Federal government, flood plain management requirements, building requirements contained in the Americans with Disabilities Act (ADA) and the National Earthquake Hazards Reduction Program (NEHRP) model code. All of these are model codes, most specifically the flood plain management requirements (communities desiring to be part of the NFIP must develop their own code utilizing the model code from FEMA). Each state and even the local jurisdiction mold these codes to fit their particular need and exposure. These are not the only codes developed by the Federal government, but they are the best known.
Advisory Organizations. Most codes and standards are developed, monitored and updated by independent advisory organizations. A 1996 National Institute of Standards and Technology (NIST) study revealed that 700 distinct advisory organizations account for more than 93,000 separate standards and codes (not all are building codes, these includes codes for materials, boilers, fire protection systems, etc.).
State and Local Codes. Each state and local jurisdiction has the authority, subject to certain minimum requirements, to massage codes and ordinances as necessary to meet that jurisdiction's needs.
Historical Societies. Although these societies are not branches of local, state or national governments, they are granted pseudo-governmental authority regarding the rebuilding of particular structures. Historical societies' desire to save the historical integrity of a structure for future generations; such efforts, while admirable, can significantly increase the cost of rebuilding a house under the society's control. Any house in an historical district merits special attention and potentially special endorsements outside the intended scope of this article.
Agents planning their homeowner client's insurance and risk management program with these authorities and exposures in mind:
• Need to have a basic understanding of the building codes applicable to and affecting their homeowners' clients;
• Must know which rule of "major damage" is applied; and
• Are required to be versed in how the individual jurisdiction applies the specified rule.
Coming Up!
This is the first of a four-part series on ordinance or law coverage for homeowner clients. The problem and the sources of codes were introduced above. Following posts will highlight the coverage provided by the unendorsed homeowners' policy, claims examples spotlighting the effects of the gap, endorsements that many think correct the problem and the endorsements that do, in fact, mitigate the gap. The last post will be a sample letter agents can copy and paste to their letterhead and send to their clients.
Christopher J. Boggs, CPCU, ARM, ALCM
October 8, 2008
Exponential technological advances, improvements in building materials and methods, changes in external and environmental conditions and the rewriting and re-codification of building codes all occur during the life of a house. The results, within 10 years of completion (maybe even as little as five years past) the house may violate some part of the most current jurisdictional building codes.
Any house not in compliance with current building codes subjects the owners to a coverage limit gap following a "major" loss (as defined below) because: 1) specific jurisdictional requirements stipulate the point at which a particular house has suffered "major" damage and must be brought into building code compliance; and 2) Insurance Services Office's (ISO's) unendorsed homeowners' policy provides only a minimal amount of coverage to pay for the increased expenses resulting from the enforcement of current building codes. Combined, the limitations on coverage and the building code's specifications can lead to a potentially large out-of-pocket expense for the insured.
Major loss or damage is uniquely defined by individual jurisdictions with each applying its own connotative twist. However, two broad categories of major damage have evolved into which most state and local building codes fall:
• The Jurisdictional Authority Rule: States applying this as the measure of major damage allow the authority having jurisdiction (the local government) to judge when a damaged building must be brought in its entirety into compliance with the current building code; and
• The Percentage Rule: Simply, when a building is damaged beyond a certain percentage of its "value," the entire structure must be brought into compliance with local building code. There is no subjective interpretation involved.
Each rule presents its own set of problems regarding ordinance or law coverage and the minimal limits automatically provided in most homeowners' policies. For example:
• The jurisdictional authority rule is subjective in its application. Each jurisdiction develops and applies its own standard to define major damage and determine a structure's fitness for continued use. Decisions can be based on the amount of damage, the age of the building coupled with pre-loss compliance shortfalls or simple safety concerns. There is no one criteria upon which homeowners and their agents can depend, making risk management and insurance planning very difficult in states applying this rule. The jurisdictional authority rule has been likened to being "at the mercy of the man with the clipboard."
• The percentage rule's definition of "value" differs among the states applying this as their codified statute. "Value" in these states could mean anything from actual cash value to appraised value or even market value*. Such breadth of interpretation can create problems for agents that operate in more than one state. (*Market value is negotiated between and agreed to by a willing buyer and a willing seller. It can fluctuate up and down based on the economy, condition, use or need and has little relation to the true cost to rebuild a particular structure.)
Ordinance or Law Sources
Building ordinances and laws enforced by local jurisdictions are promulgated by a wide assortment of contributors. States use these model codes to create a statutory infrastructure but endow to local jurisdictions the authority to adopt and customize building codes to meet local preferences and needs as necessary. Building codes and ordinances are developed and published by:
The Federal Government. Three major advisory codes flow from the Federal government, flood plain management requirements, building requirements contained in the Americans with Disabilities Act (ADA) and the National Earthquake Hazards Reduction Program (NEHRP) model code. All of these are model codes, most specifically the flood plain management requirements (communities desiring to be part of the NFIP must develop their own code utilizing the model code from FEMA). Each state and even the local jurisdiction mold these codes to fit their particular need and exposure. These are not the only codes developed by the Federal government, but they are the best known.
Advisory Organizations. Most codes and standards are developed, monitored and updated by independent advisory organizations. A 1996 National Institute of Standards and Technology (NIST) study revealed that 700 distinct advisory organizations account for more than 93,000 separate standards and codes (not all are building codes, these includes codes for materials, boilers, fire protection systems, etc.).
State and Local Codes. Each state and local jurisdiction has the authority, subject to certain minimum requirements, to massage codes and ordinances as necessary to meet that jurisdiction's needs.
Historical Societies. Although these societies are not branches of local, state or national governments, they are granted pseudo-governmental authority regarding the rebuilding of particular structures. Historical societies' desire to save the historical integrity of a structure for future generations; such efforts, while admirable, can significantly increase the cost of rebuilding a house under the society's control. Any house in an historical district merits special attention and potentially special endorsements outside the intended scope of this article.
Agents planning their homeowner client's insurance and risk management program with these authorities and exposures in mind:
• Need to have a basic understanding of the building codes applicable to and affecting their homeowners' clients;
• Must know which rule of "major damage" is applied; and
• Are required to be versed in how the individual jurisdiction applies the specified rule.
Coming Up!
This is the first of a four-part series on ordinance or law coverage for homeowner clients. The problem and the sources of codes were introduced above. Following posts will highlight the coverage provided by the unendorsed homeowners' policy, claims examples spotlighting the effects of the gap, endorsements that many think correct the problem and the endorsements that do, in fact, mitigate the gap. The last post will be a sample letter agents can copy and paste to their letterhead and send to their clients.
A Letter to Your Homeowner Clients - Ordinance or Law Exposure
A Letter to Your Homeowner Clients - Ordinance or Law Exposure
Christopher J. Boggs, CPCU, ARM, ALCM
October 15, 2008
Following this introduction is a sample letter agents can send their homeowner clients to warn or, if you prefer, notify the insured about the potential coverage limit gap caused by the enforcement of any ordinances or laws. Agents should feel free to copy and paste this letter to their letterhead; making any necessary modifications.
Several parts of the letter are in parenthesis, underlined and italicized; these areas are to be filled in with specific information about the client; such as the Coverage "A" limit or the amount extended for Ordinance or Law coverage (usually 10 percent of Coverage "A"). This information will personalize the letter to the specific insured.
This letter is to convey several points and accomplish specific goals: 1) notifying the insured that there is a potential gap in available coverage; 2) notify the insured what, externally, creates this gap; 3) notify the insured that there is a fix; 4) get you in front of the insured giving you the opportunity to cement the relationship and protect the insured; and 5) give an errors and omissions defense.
Following is the letter.
******************************************
Dear (Homeowner),
Building codes are constantly changed and updated. Houses in total compliance just a few years ago may no longer meet our community's current building code requirements. In fact, homes built more than 10 years ago (maybe even as new as five or six years) may not comply with today's laws and ordinances.
Any lack of compliance, although unintentional, could be personally costly following a major loss to your home. Standard, unendorsed homeowners' policies provide only a limited amount of coverage to pay for any additional cost caused by the building inspector's insistence that your entire home be brought into full compliance with local building codes following a loss.
Your homeowners' policy provides (replace with the amount of coverage) coverage on your home; an additional (actual amount) is available to cover the add-on expense necessary to comply with local building code. That (Ordinance or Law amount) is all that is available to pay:
• The cost to tear down the undamaged portion of the house (so the entire house can be rebuilt to code); and
• The cost to rebuild the entire house to current building code (the damaged AND undamaged parts).
By itself, (Ordinance or Law amount) may not give you enough coverage to accomplish these requirements. Any amount above (Ord & Law amount) will have to be paid by YOU.
You do have the option to increase your protection and save yourself from this out-of-pocket expense. The Ordinance or Law Increased Amount of Coverage endorsement (HO 04 77 (or whatever state specific endorsement is used)) can be attached to fill this gaping hole. Several levels of protection are available to meet your needs.
We feel you need to be aware of your policy's current limits and coverage limitations. You also need to know that there is a way to fill the gap and protect yourself from a potentially devastating out-of-pocket expense. Please call us to explore your options.
Sincerely,
Agent's Name
*******************************************
This letter is solely intended to assist the agent in introducing this exposure to clients and in no way guarantees that the agent will be protected from any charges related to the conduct of his/her business or operation as an agent or agency. The duty to identify and manage a client's, prospect's or any other party's risk lies fully with the agent. Neither Insurance Journal, MyNewMarkets.com or Wells Publishing assume any liability associated with the use or non-use of this letter.
Christopher J. Boggs, CPCU, ARM, ALCM
October 15, 2008
Following this introduction is a sample letter agents can send their homeowner clients to warn or, if you prefer, notify the insured about the potential coverage limit gap caused by the enforcement of any ordinances or laws. Agents should feel free to copy and paste this letter to their letterhead; making any necessary modifications.
Several parts of the letter are in parenthesis, underlined and italicized; these areas are to be filled in with specific information about the client; such as the Coverage "A" limit or the amount extended for Ordinance or Law coverage (usually 10 percent of Coverage "A"). This information will personalize the letter to the specific insured.
This letter is to convey several points and accomplish specific goals: 1) notifying the insured that there is a potential gap in available coverage; 2) notify the insured what, externally, creates this gap; 3) notify the insured that there is a fix; 4) get you in front of the insured giving you the opportunity to cement the relationship and protect the insured; and 5) give an errors and omissions defense.
Following is the letter.
******************************************
Dear (Homeowner),
Building codes are constantly changed and updated. Houses in total compliance just a few years ago may no longer meet our community's current building code requirements. In fact, homes built more than 10 years ago (maybe even as new as five or six years) may not comply with today's laws and ordinances.
Any lack of compliance, although unintentional, could be personally costly following a major loss to your home. Standard, unendorsed homeowners' policies provide only a limited amount of coverage to pay for any additional cost caused by the building inspector's insistence that your entire home be brought into full compliance with local building codes following a loss.
Your homeowners' policy provides (replace with the amount of coverage) coverage on your home; an additional (actual amount) is available to cover the add-on expense necessary to comply with local building code. That (Ordinance or Law amount) is all that is available to pay:
• The cost to tear down the undamaged portion of the house (so the entire house can be rebuilt to code); and
• The cost to rebuild the entire house to current building code (the damaged AND undamaged parts).
By itself, (Ordinance or Law amount) may not give you enough coverage to accomplish these requirements. Any amount above (Ord & Law amount) will have to be paid by YOU.
You do have the option to increase your protection and save yourself from this out-of-pocket expense. The Ordinance or Law Increased Amount of Coverage endorsement (HO 04 77 (or whatever state specific endorsement is used)) can be attached to fill this gaping hole. Several levels of protection are available to meet your needs.
We feel you need to be aware of your policy's current limits and coverage limitations. You also need to know that there is a way to fill the gap and protect yourself from a potentially devastating out-of-pocket expense. Please call us to explore your options.
Sincerely,
Agent's Name
*******************************************
This letter is solely intended to assist the agent in introducing this exposure to clients and in no way guarantees that the agent will be protected from any charges related to the conduct of his/her business or operation as an agent or agency. The duty to identify and manage a client's, prospect's or any other party's risk lies fully with the agent. Neither Insurance Journal, MyNewMarkets.com or Wells Publishing assume any liability associated with the use or non-use of this letter.
Property Value Options
Property Value Options
Christopher J. Boggs, CPCU, ARM, ALCM
June 11, 2008
Property insurance valuation options are not limited to replacement cost, actual cash value or even market value (although market value is not a customary insurance value). Insureds can choose among several specialized options to meet specific needs: functional replacement cost, agreed amount and stated value. Each valuation method has a specific use and meets a unique need as highlighted in the next several paragraphs.
Functional Replacement Cost
Building codes may not allow or the realistic needs of the insured may not require that a building be rebuilt to the same square footage or utilizing the same materials existing prior to a major loss. Likewise, the insured may not need furniture, fixtures or equipment with a myriad of additional features. ISO offers two endorsements which allow insureds to value real and personal property at less than replacement cost, but in amounts adequate to rebuild or replace with property that is operationally equivalent:
• CP 04 38 - Functional Building Valuation; and
• CP 04 39 - Functional Personal Property Valuation - Other Than Stock.
Functional replacement cost endorsements value property at the cost necessary to replace damaged or destroyed property with new property of unlike kind and quality which perform the same general function allowing the insured to accomplish their business objectives. Property replaced using functionally equivalent materials and products are less expensive and often require a shorter replacement schedule. Buildings may be smaller or built using less expensive building materials; and business personal property will perform the essential functions, but may not have the amenities of the furniture or equipment it replaces. This valuation option may be appropriate:
• When the insured cannot rebuild the same square footage, usually due to the application of building codes, and a smaller building will be built in its place;
• When the insured does not want to rebuild the same square footage;
• When lower cost building materials can or should be used (i.e. masonry/non-combustible vs. fire resistive); or
• If the insured does not need all the functions available on a particular piece of machinery or equipment (they found a great bargain on a top-of-the-line model, but don't need or use all the functions available and the insured does not want to pay the premium to insure it for cost new).
Both functional replacement cost endorsements allow the insured to purchase a lower amount of coverage (enjoying some premium savings) while retaining a form of replacement cost coverage for partial losses (subject to "lesser of" policy provisions). Other advantages within these forms include: 1) Coinsurance is waived; and 2) Ordinance or Law coverage is included in the form (no need for a separate endorsement).
Agreed Value
As the name suggests, this is the amount the insured and the insurer agree the property is worth. Since it is a "pre-negotiated" limit, the coinsurance condition does not apply provided the insured carries the amount of coverage agreed upon by both parties. The face amount is paid in the event of a total loss and partial losses are paid on a repair or replacement basis without the customary "lesser of" conditions common to other valuation methods.
Commercial property policies contain agreed value language. To trigger coverage the insured must 1) request the agreed value option in the application; and 2) complete and sign a statement of values for the insurance company to prove the values. The statement of values must be completed every 12 months in order to maintain agreed value coverage. If the statement of values is not completed, the coinsurance condition is reinstated.
Agreed value is appropriate anytime the insured wants to avoid potential coinsurance penalties. Such problems may arise when property is difficult to value due to its unique nature, availability or unstable values (which may trigger value and coinsurance issues as the cost at the time of loss may not be predictable). Retail or manufacturing operations which experience broad swings in stock value should avoid agreed value coverage on stock as limits may not be adequate to cover the amount on hand at the time of the loss.
Stated Amount
Stated amount is oft times confused with agreed value when discussing and planning coverage with the insured; these terms are not synonymous. In fact, stated amount valuation is detrimental to the insured as it is wholly subject to the "lesser of" limitation with no available option to increase payment.
Most often applied in inland marine policies and auto physical damage coverage, stated amount will only pay the lesser of:
• The stated amount on the policy;
• The actual cash value; or
• The cost to repair the item.
There is rarely a situation where this valuation method is advantageous to the insured. Stated amount endorsements should be avoided, and every attempt should be made to negotiate a different settlement option in policies using this as the primary valuation method (mostly inland marine coverage). If the only way an underwriter will agree to write the coverage is use of the stated value method and there are no other viable options, then the provisions must be clearly explained to the insured.
Coinsurance and Inflation Guard
Coinsurance provisions, requirements and penalties were addressed in a previous article. Not discussed were the available coinsurance options along with the benefits and pitfalls of each. Remember, coinsurance was introduced to penalize the insured for failure to purchase a required minimum amount of property coverage.
Standard commercial property policy coinsurance is 80 percent. That is, the insured must insure to at least 80 percent of the property's "value" to receive full payment for partial losses. "Value" can be either actual cash value or replacement cost value based on the insured's indicated desire in the application. Ninety percent and 100 percent are the other commonly used coinsurance percentages in property policies.
Rate credits are granted when the insured increases the coinsurance percentage. However, increasing the coinsurance percentage requires the insured to confirm that the limits of coverage correspond to the new "minimum" limit of protection created. The potential to suffer the coinsurance penalty increases as the insured increases the coinsurance percentage. If the insured opts to use 100 percent coinsurance, they must be absolutely sure that the limit of coverage equals 100 percent of the "value" (however defined in the particular policy) to avoid a coinsurance penalty. Opinions differ, but the rate credit is not worth the potential penalty for miscalculation.
Insure the property at 100 percent insurance to value (again, whichever definition of value is applied), but use 90 percent coinsurance as the basis. This accomplishes two goals: 1) guarantees that the insured is fully insured for all partial losses (subject to the deductible); and 2) assures the insured will be fully covered for total losses since the policy will never pay more than the limit purchased.
Agents and insureds that insist on using 100 percent coinsurance do have an optional coverage to allow the property limit to increase throughout the year. The optional inflation guard coverage increases the limit of coverage over the course of the policy year. Coverage is increased by the percentage selected by the insured. Annual inflation factors generally range between 2 percent and 8 percent and are prorated throughout the year (i.e. after six months, property values have been increased by one-half of the factor applied). Using 8 percent, property valued at $100,000 at the beginning of the policy period will be valued at $104,000 after six months and $108,000 at the end of the 12-month policy period.
The inflation guard optional coverage is essentially required when the insured insists on 100 percent coinsurance or in volatile economic times.
Conclusion
Property has many different values; some relate to insurance and many do not. Accurately valuing property for insurance, and even market, purposes is as much an art as a science. Insureds depend on their agents to protect them against devastating financial consequences following a loss. If the correct amount or the right type of coverage is not there, insured's can be bankrupted by the costs.
Insureds must understand the definition of "value," how to calculate the correct "value" and how policy provisions truly apply. Coverage gaps and solutions to close those holes must also be explained to insureds.
Christopher J. Boggs, CPCU, ARM, ALCM
June 11, 2008
Property insurance valuation options are not limited to replacement cost, actual cash value or even market value (although market value is not a customary insurance value). Insureds can choose among several specialized options to meet specific needs: functional replacement cost, agreed amount and stated value. Each valuation method has a specific use and meets a unique need as highlighted in the next several paragraphs.
Functional Replacement Cost
Building codes may not allow or the realistic needs of the insured may not require that a building be rebuilt to the same square footage or utilizing the same materials existing prior to a major loss. Likewise, the insured may not need furniture, fixtures or equipment with a myriad of additional features. ISO offers two endorsements which allow insureds to value real and personal property at less than replacement cost, but in amounts adequate to rebuild or replace with property that is operationally equivalent:
• CP 04 38 - Functional Building Valuation; and
• CP 04 39 - Functional Personal Property Valuation - Other Than Stock.
Functional replacement cost endorsements value property at the cost necessary to replace damaged or destroyed property with new property of unlike kind and quality which perform the same general function allowing the insured to accomplish their business objectives. Property replaced using functionally equivalent materials and products are less expensive and often require a shorter replacement schedule. Buildings may be smaller or built using less expensive building materials; and business personal property will perform the essential functions, but may not have the amenities of the furniture or equipment it replaces. This valuation option may be appropriate:
• When the insured cannot rebuild the same square footage, usually due to the application of building codes, and a smaller building will be built in its place;
• When the insured does not want to rebuild the same square footage;
• When lower cost building materials can or should be used (i.e. masonry/non-combustible vs. fire resistive); or
• If the insured does not need all the functions available on a particular piece of machinery or equipment (they found a great bargain on a top-of-the-line model, but don't need or use all the functions available and the insured does not want to pay the premium to insure it for cost new).
Both functional replacement cost endorsements allow the insured to purchase a lower amount of coverage (enjoying some premium savings) while retaining a form of replacement cost coverage for partial losses (subject to "lesser of" policy provisions). Other advantages within these forms include: 1) Coinsurance is waived; and 2) Ordinance or Law coverage is included in the form (no need for a separate endorsement).
Agreed Value
As the name suggests, this is the amount the insured and the insurer agree the property is worth. Since it is a "pre-negotiated" limit, the coinsurance condition does not apply provided the insured carries the amount of coverage agreed upon by both parties. The face amount is paid in the event of a total loss and partial losses are paid on a repair or replacement basis without the customary "lesser of" conditions common to other valuation methods.
Commercial property policies contain agreed value language. To trigger coverage the insured must 1) request the agreed value option in the application; and 2) complete and sign a statement of values for the insurance company to prove the values. The statement of values must be completed every 12 months in order to maintain agreed value coverage. If the statement of values is not completed, the coinsurance condition is reinstated.
Agreed value is appropriate anytime the insured wants to avoid potential coinsurance penalties. Such problems may arise when property is difficult to value due to its unique nature, availability or unstable values (which may trigger value and coinsurance issues as the cost at the time of loss may not be predictable). Retail or manufacturing operations which experience broad swings in stock value should avoid agreed value coverage on stock as limits may not be adequate to cover the amount on hand at the time of the loss.
Stated Amount
Stated amount is oft times confused with agreed value when discussing and planning coverage with the insured; these terms are not synonymous. In fact, stated amount valuation is detrimental to the insured as it is wholly subject to the "lesser of" limitation with no available option to increase payment.
Most often applied in inland marine policies and auto physical damage coverage, stated amount will only pay the lesser of:
• The stated amount on the policy;
• The actual cash value; or
• The cost to repair the item.
There is rarely a situation where this valuation method is advantageous to the insured. Stated amount endorsements should be avoided, and every attempt should be made to negotiate a different settlement option in policies using this as the primary valuation method (mostly inland marine coverage). If the only way an underwriter will agree to write the coverage is use of the stated value method and there are no other viable options, then the provisions must be clearly explained to the insured.
Coinsurance and Inflation Guard
Coinsurance provisions, requirements and penalties were addressed in a previous article. Not discussed were the available coinsurance options along with the benefits and pitfalls of each. Remember, coinsurance was introduced to penalize the insured for failure to purchase a required minimum amount of property coverage.
Standard commercial property policy coinsurance is 80 percent. That is, the insured must insure to at least 80 percent of the property's "value" to receive full payment for partial losses. "Value" can be either actual cash value or replacement cost value based on the insured's indicated desire in the application. Ninety percent and 100 percent are the other commonly used coinsurance percentages in property policies.
Rate credits are granted when the insured increases the coinsurance percentage. However, increasing the coinsurance percentage requires the insured to confirm that the limits of coverage correspond to the new "minimum" limit of protection created. The potential to suffer the coinsurance penalty increases as the insured increases the coinsurance percentage. If the insured opts to use 100 percent coinsurance, they must be absolutely sure that the limit of coverage equals 100 percent of the "value" (however defined in the particular policy) to avoid a coinsurance penalty. Opinions differ, but the rate credit is not worth the potential penalty for miscalculation.
Insure the property at 100 percent insurance to value (again, whichever definition of value is applied), but use 90 percent coinsurance as the basis. This accomplishes two goals: 1) guarantees that the insured is fully insured for all partial losses (subject to the deductible); and 2) assures the insured will be fully covered for total losses since the policy will never pay more than the limit purchased.
Agents and insureds that insist on using 100 percent coinsurance do have an optional coverage to allow the property limit to increase throughout the year. The optional inflation guard coverage increases the limit of coverage over the course of the policy year. Coverage is increased by the percentage selected by the insured. Annual inflation factors generally range between 2 percent and 8 percent and are prorated throughout the year (i.e. after six months, property values have been increased by one-half of the factor applied). Using 8 percent, property valued at $100,000 at the beginning of the policy period will be valued at $104,000 after six months and $108,000 at the end of the 12-month policy period.
The inflation guard optional coverage is essentially required when the insured insists on 100 percent coinsurance or in volatile economic times.
Conclusion
Property has many different values; some relate to insurance and many do not. Accurately valuing property for insurance, and even market, purposes is as much an art as a science. Insureds depend on their agents to protect them against devastating financial consequences following a loss. If the correct amount or the right type of coverage is not there, insured's can be bankrupted by the costs.
Insureds must understand the definition of "value," how to calculate the correct "value" and how policy provisions truly apply. Coverage gaps and solutions to close those holes must also be explained to insureds.
When Government Strikes - Ordinance or Law
When Government Strikes - Ordinance or Law
Christopher J. Boggs, CPCU, ARM, ALCM
June 9, 2008
Ordinance or law endorsements fill a major gap between the insured's belief about replacement cost and the commercial property policy's actual application of this valuation method. Disparity between the insured's concept and the true operation of replacement cost often arises from the development, codification and enforcement of building codes.
Building ordinances and laws are enforced by local jurisdictions but the codes are promulgated by an assortment of contributors including: state government, federal codes and regulations and advisory organizations such as the National Fire Protection Association (NFPA). States use these sources to create the statutory infrastructure but endow local jurisdictions with the authority to adopt and customize building codes to meet local preferences as necessary.
Specific legal requirements stipulate the point at which a structure must be brought into compliance with local building codes. Correction of life safety issues presenting an imminent danger is generally required immediately regardless of surrounding circumstances; otherwise existing structures are usually granted "grandfather" status and are not required to comply with all applicable building codes unless certain statutorily specified events occur. "Major damage" to the building is one of those qualifying events.
Major damage does not have a universal definition; each jurisdiction establishes and applies its own meaning. There are, however, two broad categories of major damage into which most state and local building codes fall:
• The Jurisdictional Authority Rule: States using this as the measure of major damage allow the authority having jurisdiction (the local government) to judge when a damaged building must be brought into compliance with the current building code; and
• The Percentage Rule: When a building is damaged beyond a certain percentage of its "value," the entire structure must be brought into compliance with local building code.
When government has the opportunity or feels the need to inject itself into issues related to property values - problems erupt as evidenced by these rules. Both rules present unique problems regarding insurance coverage and common policy provisions.
The jurisdictional authority rule is subjective in its application. Each jurisdiction applies its own standard to define major damage and determine a structure's fitness for continued use. Decisions can be based on the amount of damage, the age of the building coupled with pre-loss compliance shortfalls or simple safety concerns. There is no one criteria upon which building owners and agents can depend, making risk management and insurance planning very difficult in these states.
Even the percentage rule's definition of "value" differs among the states that apply this rule. "Value" could mean actual cash value, appraised value or market value. (Market value is negotiated between and agreed to by a willing buyer and a willing seller. It can fluctuate up and down based on the economy, condition, use or need and has little relation to the true cost to rebuild a particular structure. However, if market value is the rule applied, the agent must be prepared for and be able to explain this concept.)
Agents must know which rule of "major damage" is applied and how the individual jurisdictions apply the rule. Knowing this, the agent can explain the exposure and how replacement cost in the unendorsed property policy will and will not respond to losses triggering jurisdictional ordinance or law requirements.
Three Coverages
Replacement cost alone falls far short of paying much of the additional costs necessitated by a major loss (as defined above and by the applicable law). Damage crossing the threshold of "major" effectively creates a constructive total loss of the structure; however, the unendorsed commercial property policy only pays to repair or replace the damaged property back to the condition that existed prior to the loss.
No coverage exists in the unendorsed policy to pay the loss in value of the undamaged portion of the building no longer useable (the insured loses the use and value of the undamaged part). The cost to tear down and remove the undamaged portion of the building from the site is also borne by the insured. Finally, the additional cost necessary to bring the building into compliance with the current building code is wholly paid from the insured's financial resources.
Ordinance or Law endorsed to the commercial property policy assures the insured is indemnified (put back into the same condition enjoyed before the loss) for these expenses which would otherwise out-of-pocket. The endorsement's three coverage parts close the commercial property policy coverage gaps highlighted above:
• Coverage A - Loss to the Undamaged Portion of the Building: The remaining portion of the building cannot be used due to application of the local building code; the insured is out the use value of this section making the building a functional total loss. This coverage part pays that loss of value;
• Coverage B - Demolition Cost: Once the undamaged portion of the building has been torn down it must be removed from the site. The commercial property policy only pays to remove damaged property, Coverage B pays the cost to tear down and remove the undamaged part of the building; and
• Coverage C - Increased Cost of Construction: All buildings must be built in compliance with applicable building codes. Buildings that suffer major damage are no exception. Replacement cost coverage only pays to put back what was there; this coverage part pays the additional cost necessary to bring the building into full compliance with current building codes.
Ordinance or Law coverage also fills the gap between the insured's belief about replacement cost is and its customary application. Insureds must be informed of the exposures faced and the solutions available.
Building codes change and are updated frequently; the insured's building can become non-compliant very quickly. Most commercial properties over five years old fail to meet current building codes. Major damage triggering the application of the jurisdiction's laws or ordinances has the potential to cost the insured a large amount of out of pocket expense if the correct coverage is not provided; and the older the building is, the more expensive this gap in coverage.
Christopher J. Boggs, CPCU, ARM, ALCM
June 9, 2008
Ordinance or law endorsements fill a major gap between the insured's belief about replacement cost and the commercial property policy's actual application of this valuation method. Disparity between the insured's concept and the true operation of replacement cost often arises from the development, codification and enforcement of building codes.
Building ordinances and laws are enforced by local jurisdictions but the codes are promulgated by an assortment of contributors including: state government, federal codes and regulations and advisory organizations such as the National Fire Protection Association (NFPA). States use these sources to create the statutory infrastructure but endow local jurisdictions with the authority to adopt and customize building codes to meet local preferences as necessary.
Specific legal requirements stipulate the point at which a structure must be brought into compliance with local building codes. Correction of life safety issues presenting an imminent danger is generally required immediately regardless of surrounding circumstances; otherwise existing structures are usually granted "grandfather" status and are not required to comply with all applicable building codes unless certain statutorily specified events occur. "Major damage" to the building is one of those qualifying events.
Major damage does not have a universal definition; each jurisdiction establishes and applies its own meaning. There are, however, two broad categories of major damage into which most state and local building codes fall:
• The Jurisdictional Authority Rule: States using this as the measure of major damage allow the authority having jurisdiction (the local government) to judge when a damaged building must be brought into compliance with the current building code; and
• The Percentage Rule: When a building is damaged beyond a certain percentage of its "value," the entire structure must be brought into compliance with local building code.
When government has the opportunity or feels the need to inject itself into issues related to property values - problems erupt as evidenced by these rules. Both rules present unique problems regarding insurance coverage and common policy provisions.
The jurisdictional authority rule is subjective in its application. Each jurisdiction applies its own standard to define major damage and determine a structure's fitness for continued use. Decisions can be based on the amount of damage, the age of the building coupled with pre-loss compliance shortfalls or simple safety concerns. There is no one criteria upon which building owners and agents can depend, making risk management and insurance planning very difficult in these states.
Even the percentage rule's definition of "value" differs among the states that apply this rule. "Value" could mean actual cash value, appraised value or market value. (Market value is negotiated between and agreed to by a willing buyer and a willing seller. It can fluctuate up and down based on the economy, condition, use or need and has little relation to the true cost to rebuild a particular structure. However, if market value is the rule applied, the agent must be prepared for and be able to explain this concept.)
Agents must know which rule of "major damage" is applied and how the individual jurisdictions apply the rule. Knowing this, the agent can explain the exposure and how replacement cost in the unendorsed property policy will and will not respond to losses triggering jurisdictional ordinance or law requirements.
Three Coverages
Replacement cost alone falls far short of paying much of the additional costs necessitated by a major loss (as defined above and by the applicable law). Damage crossing the threshold of "major" effectively creates a constructive total loss of the structure; however, the unendorsed commercial property policy only pays to repair or replace the damaged property back to the condition that existed prior to the loss.
No coverage exists in the unendorsed policy to pay the loss in value of the undamaged portion of the building no longer useable (the insured loses the use and value of the undamaged part). The cost to tear down and remove the undamaged portion of the building from the site is also borne by the insured. Finally, the additional cost necessary to bring the building into compliance with the current building code is wholly paid from the insured's financial resources.
Ordinance or Law endorsed to the commercial property policy assures the insured is indemnified (put back into the same condition enjoyed before the loss) for these expenses which would otherwise out-of-pocket. The endorsement's three coverage parts close the commercial property policy coverage gaps highlighted above:
• Coverage A - Loss to the Undamaged Portion of the Building: The remaining portion of the building cannot be used due to application of the local building code; the insured is out the use value of this section making the building a functional total loss. This coverage part pays that loss of value;
• Coverage B - Demolition Cost: Once the undamaged portion of the building has been torn down it must be removed from the site. The commercial property policy only pays to remove damaged property, Coverage B pays the cost to tear down and remove the undamaged part of the building; and
• Coverage C - Increased Cost of Construction: All buildings must be built in compliance with applicable building codes. Buildings that suffer major damage are no exception. Replacement cost coverage only pays to put back what was there; this coverage part pays the additional cost necessary to bring the building into full compliance with current building codes.
Ordinance or Law coverage also fills the gap between the insured's belief about replacement cost is and its customary application. Insureds must be informed of the exposures faced and the solutions available.
Building codes change and are updated frequently; the insured's building can become non-compliant very quickly. Most commercial properties over five years old fail to meet current building codes. Major damage triggering the application of the jurisdiction's laws or ordinances has the potential to cost the insured a large amount of out of pocket expense if the correct coverage is not provided; and the older the building is, the more expensive this gap in coverage.
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