Mastering Coverages. A Continuing Education course for Insurance Agents

Transcription

1 Mastering Coverages A Continuing Education course for Insurance Agents This course is based on six issues of Adjusting Today, a publication of Adjusters International. Agreed Value Clause Coinsurance: What Insured s Need to Know Concurrent Causation Debris Removal and Pollution Damage Functional Replacement Cost Ordinance or Law Coverage Discover how to turn these newsletters into CE credit by proceeding to the tab at the left titled CE Credit. Adjusters International is a disaster recovery consulting organization. Our focus is maximizing and expediting our clients financial recovery through their property and business interruption insurance claims and the FEMA Public Assistance program. We are industry leaders and pioneers of providing this unique combination of services to our clients, ensuring a consistent and cohesive team of skilled professionals to provide for a full financial recovery. Adjusting Today is one of our technical publications and has been published for more than 20 years. With more than 30 editions in circulation, Adjusting Today has become a must have reference library component for many of our readers. The featured topics deal with various property-damage and business income insurance claim issues. Adjusters International s expertise in disaster recovery is a result of our 25-year history handling damages stemming from all perils including the Midwest floods, California earthquakes and terrorist acts such as the Oklahoma City and World Trade Center bombings and 9/11, providing us with proficiency on the topics that we publish. All editions of Adjusting Today can be downloaded or read online at our website where we also welcome you to subscribe free of charge. Simply go to:

2 A CE Course for Insurance Agents Based on Adjusting Today newsletters published by Adjusters International This course if offered and administered by The Van Wyhe Group, a leader in insurance education for over 15 years. Please visit us at or contact us with any questions you may have. Turning these newsletters into CE is as easy as 1, 2, 3 1. Read the newsletters The newsletters that are covered in this course are easily assessable on the tabs at the left. You can print them out or download them to your desktop. 2. Find a monitor and take the exam The exam is a multiple-choice, closed-book, monitored quiz. You can download the exam and the affidavit at the left. On the affidavit, you will find information on monitor qualifications in your state and how the exam is to be administered. 3. with payment the affidavit and the answer key to angela@insurancece.com. The affidavit includes a place for a credit card payment of the filing fee of $45 ($30 in Washington). We will grade your exam; 70% is required for passing. We will contact you within 3 business days. Assuming you have passed, we will file the credits with the state and forward a certificate of completion to you. This course is approved for 3 credits (2 credits in Washington) of Continuing Education for Insurance Agents in select states. To find a complete list of approved states, as well as other CE courses based on Adjusting Today, please go to and click on the Adjusting Today button on the home page. Adjusters Recovery Consultingrvices The Van Wyhe Group P O Box 4130 Waukesha, WI angela@insurancece.com Voice: Fax:

3 A D J U S T I N G Adjusters International Providing Loss Consulting Services to the Insured EDITOR S NOTE For all policyholders, avoiding coinsurance penalties is of paramount importance. However, keeping up with current values, and adjusting your insurance routinely can overwhelm most property owners. The use of the Agreed Value Option is an excellent tool for insureds to avoid the possible penalty effects of the coinsurance clause in both property and business income insurance. While it provides the benefit of removing coinsurance, it can also create problems if not properly exercised. The following article by Adjusters International s insurance expert Paul O. Dudey details the origins, benefits and potential pitfalls of this alternative to coinsurance. Stephen J. Van Pelt, Editor Agreed Value Clause FRIEND? OR SOMETIMES FOE? Paul O. Dudey, CPCU O ne of the major disappointments a firm may discover following a severe disaster: While the limit of insurance is higher than the total amount of the loss, the insured did not have a high enough limit of insurance to satisfy the coinsurance clause of the policy, so that insurance recovery of the loss is dramatically reduced. Because most property losses are partial rather than total, it was commonplace for insureds to gamble and buy and pay for only enough insurance to cover what they believed would be the highest loss likely to be incurred, even though well below the total value at risk. In most loss scenarios, this gave the cost advantage to that insured as compared to the prudent insurance buyer who insured the property at risk for its full value. Only in the unlikely case of a loss that exceeded their expectations did the gamblers lose out. To combat this practice of deliberate underinsurance, property insurers devised the coinsurance clause, which requires the insured to carry at least a stated percent (80, 90, or 100% are common) of insurance to the value of the property insured, for which a substantial reduction in rate is offered. Failing to carry at least the required percent- age of insurance to value, the insured becomes a coinsurer, with recovery of any loss reduced in proportion to the deficiency. For example: Assume total insurable A major problem with coinsurance, of course, is that coinsurance applies to values at the time of loss, not at policy inception when the amount of insurance is usually established. value of $100,000 with an 80% coinsurance clause and the insured buys $40,000 of insurance. A loss of $30,000 occurs. Because the insured bought only half of what the coinsurance clause required $40,000, (continued on next page)

4 2 A D J U S T I N G TODAY instead of 80% of the $100,000 value at risk, or $80,000 recovery will be limited to half of the amount of loss or $15,000, even though the amount of insurance carried, $40,000, substantially exceeds the amount of loss, $30,000. A major problem with coinsurance, of course, is that coinsurance applies to values at the time of loss, not at policy inception when the amount of insurance is usually established based on the values at risk at that time. Or often, if values are not reviewed and the limit of insurance adjusted at policy renewal, they may already be inadequate to satisfy the coinsurance requirement, and can become even more out of line as time passes. In times of rapid price inflation, or at any time for a growing business, values at risk can quickly outgrow the insurance, leaving the insured subject to a coinsurance penalty at the time of loss, unless values are reviewed and adjusted frequently, which few insureds have the time or patience to do. To minimize this problem, insurers came up with a provision which they initially called the Agreed Amount clause, but now call the Agreed Value Optional Coverage. This option can be included with the property insurance, usually for a period of one year, by noting on the property coverage declaration page that it applies. It suspends the operation of the coinsurance clause until the expiration date of the Agreed Value Option or of the policy, whichever comes first. To obtain this Option, the insured must submit a statement of values to the underwriters showing the insurable value actual cash value (ACV) or, if replacement cost insurance is carried, the cost to replace new for old with no deduction for depreciation of all property to be insured. The underwriters can review this report, and perhaps even order an inspection of the premises and appraisal to determine the report s accuracy, and if satisfied with it, can authorize use of the Agreed Value Optional Coverage for a period of up to one year from the date of acceptance. This report does not become a part of the policy. Allowing the Agreed Value Option to lapse can be quite harmful for the insured. If values have increased substantially in the year since the limit of insurance was established and a loss occurs, applying the coinsurance provision to the increased values can, of course, produce a coinsurance penalty in the loss recovery. Prior to the expiration date of the Agreed Value Option, a new statement of values must be submitted to the underwriters and the Option extended for another year. Failing that, the Option will lapse and coinsurance will again apply. Note that most insurers apply a small additional charge (5% is common) for the use of the Option. Allowing the Agreed Value Option to lapse can be quite harmful for the insured. If values have increased substantially in the year since the limit of insurance was established and a loss occurs, applying the coinsurance provision to the increased values can, of course, produce a coinsurance penalty in the loss recovery. Notice also that if the expiration of the Agreed Value Option is beyond the policy expiration, the Agreed Value Option will end with the expiration of the policy, and unless the policy renewal or extension shows that the Agreed Value Option again applies, coinsurance will again apply, again with the possibility of a coinsurance penalty in the event of loss. Use with Fluctuating Values One possible use of the Agreed Value Option is to replace a reporting form, eliminating the need under the reporting form for monthly or quarterly reports of values. The average of the annual values can be shown on the annual

5 A D J U S T I N G TODAY 3 report. This eliminates coinsurance as well as the possibility of penalty for underreporting of values under a reporting form policy, and it is necessary to review values and extend the Agreed Value Option only once a year. This works quite well as long as the Agreed Value is high enough to cover the maximum possible loss, including the cost of debris removal. Use with Blanket Coverage For example, with blanket coverage over two or more separate locations far enough apart that they would not be totally involved in the same loss, the entire blanket amount is available for a single loss. A further advantage of the Agreed Value Option with blanket coverage is that, unlike with coinsurance, it is unnecessary after a loss to prove the values at all locations other than the loss at the involved location. Failure to Carry Enough Insurance A word of caution: The Agreed Value Option requires the amount of insurance carried to be not less than the agreed value stated in the Option. Failing this, the insurers will pay only that proportion of the loss that the amount of insurance carried bears to the amount that should have been carried, as stated in the Agreed Value Option. What occasionally happens is that the insured s values drop substantially for whatever reason, so that less insurance is required. A case in point might be an insured with substantial values in the World Trade Center insured blanket with property at other locations, as well. If the insured reduces the amount of insurance to reflect the World Trade Center destruction, if the Agreed Value is not also reduced to reflect this change, a reduction in recovery of any future loss can result. Change in Language When the Agreed Value Option was introduced by the Insurance Services Office (ISO) in 1986, replacing the Agreed Amount clause, changes were made in the language with (according to the Bulletin from ISO announcing the changes) no important change in the meaning of the provision. Note that for the purposes of this article, reference is to the ISO forms and endorsements, but insurers not following ISO also usually use the equivalent Agreed Value provisions to the same general effect. The Agreed Amount Endorsement CF 12 A word of caution: The Agreed Value Option requires the amount of insurance carried to be not less than the agreed value stated in the Option. 10 was replaced by Optional Coverage G.1. Agreed Value, which is activated by appropriate entry on the property coverage declarations of the limits of insurance to be carried and the expiration date of the Agreed Value Option. Added under the new provision is an expanded explanation of the expiration provision, which the ISO Bulletin states is for clarity. The Waiver of Inventory and Appraisement clause of the Agreed Amount Endorsement is eliminated on the Agreed Value Option because, as the ISO Bulletin states, all inventories are optional with the company in the simplified form. Use with Business Income Insurance The effects of coinsurance (or contribution clause as it is sometimes called with time element insurance) can be even more devastating with this coverage than with property insurance. Earnings, income, and expenses can fluctuate greatly over time, and limits of insurance established at a low period can become woefully inadequate at time of loss, even if only a short time later. ISO did make one improvement in this provision a few years ago. It made the coinsurance clause apply to the values for the 12 months immediately following the inception date of the policy term in which the property damage giving rise to the time element claim loss occurred. Previously, the clause applied to the values for the 12 month period immediately following the date of loss. In a time of rising insurable values, this change can make quite a difference in the effect of coinsurance. There may be some independent insurers still using the older clause. Insureds would be well advised to check their policies for this provision, and if the older provision is still in use, ask that it be changed. To combat coinsurance problems, underwriters offer the Business Income Agreed Value Coverage Option, which is included as an optional coverage under the ISO Business Income Forms CP and To obtain this option, the insured must submit an annual business income report/work sheet

6 4 A D J U S T I N G TODAY (ISO Form 15 15) listing the gross sales (Gross sales value of production for manufacturing risks) less outgoing prepaid freight, returns and allowances, discounts, bad debts, and collection expenses, to arrive at net sales or sales value of production, add other earnings from the business, and deduct cost of goods sold, certain other allowable expense deductions, and, if ordinary payroll expense is either excluded or limited, the uninsured portion of ordinary payroll expense. Note that for business income cost of goods sold differs from the same term in conventional accounting parlance, in that for the insurance there is no deduction for any labor consumed in the process. Each of the items on the report/work sheet is carefully described so that even a lay person not well versed in accounting terminology can, with a little study, figure out how to complete the report/work sheet in a satisfactory manner. Note also that the availability of yearend figures for business earnings usually lag behind the end of each fiscal year, so it is a good idea to have the annual policy expiration or anniversary and the effective date of the Agreed Value Option to also lag perhaps three months behind the end of the fiscal year, to allow time for accurate preparation of the report/work sheet, showing exact fiscal year figures. Another change in the Business Income Agreed Value Option occurred under the ISO 1995 revision. Previously, the report/work sheet used to determine insurable values became a part of the policy. This provision was eliminated in the 1995 revision. ISO, in its Bulletin describing the many 1995 changes, makes no mention of this change or any reason behind it. Presumably ISO felt that whether the report/work sheet was or was not a part of the policy had little bearing on the adjustment of any Business Income loss. Unless it could be definitely established that the values shown were deliberately understated no penalty could be assessed, while if deliberately understated, the fraud clause of the policy could be invoked to void the coverage entirely, whether the report/work sheet was or was not considered a part of the policy. Included on Form 15 15, along with the last fiscal year figures, is an estimate of the figures for the 12 months, beginning not with the start of the current fiscal year, but with the date of the estimate. So with a growing business this difference should be recognized and the numbers adjusted accordingly. Summary The use of the Agreed Value Option is an excellent tool for insureds to avoid the possible penalty affects of the coinsurance clause in both property and business income insurance. Great care must be taken in its use, however, to be sure that 1) the values used to set the amount of insurance are reasonably accurate; 2) the new values for the future year are established and the Option extended before its expiration to avoid reapplication of coinsurance; and 3) the amount of insurance actually carried equals or exceeds the amount called for in the Option. A D J U S T I N G TODAY AT ADJUSTERS INTERNATIONAL. ALL RIGHTS RESERVED. ADJUSTERS INTERNATIONAL Corporate Office 126 Business Park Drive Utica, New York Outside U.S. (315) FAX: (315) editor@adjustingtoday.com PUBLISHER Ronald A. Cuccaro, SPPA EDITOR Stephen J. Van Pelt WEB SITE ADDRESSES ADJUSTING TODAY is published as a public service by Adjusters International, Inc. professional loss consultants. It is provided for general information and is not intended to replace professional insurance, legal and/ or financial advice for specific cases. PRINTED ON RECYCLED PAPER

7 TODAY A D J U S T I N G Providing Loss Consulting Services to the Insured Adjusters International Coinsurance What Insureds Need to Know Robert J. Lucurell, FPPA Adjusters International Seattle The story could have had a happier ending! Company XYZ, a major supplier to the aerospace industry, had been growing rapidly. Its ownership was hands-on and imaginative. For several years, the company had been purchasing used equipment along with new components for existing machinery. Most hookups and modifications were done by XYZ s own personnel. Company officials believed they had comprehensive insurance coverage and, in fact, their coverages were excellent. But when a substantial loss took place, they were able to recover only 31 percent on their property claim, and only 12 percent on their loss-of-income claim. The problem: horribly understated values, far too low to meet the policy s coinsurance requirements. The result: a disastrous financial loss that could have been avoided with better communications between the insured and the broker when the insurance program was established. Had the broker known it was the insured s practice to expense and not book all costs for items and equipment under $300, he would have had a far different picture of what those values should have been. But because the costs were not carried in the financial records, and because the insured didn t explain their procedures to the broker, the insurance was woefully inadequate. A similar problem affected the business interruption coverages. In designing the program, neither the broker nor the insured allowed for the planned expansion of the business, therefore the full potential of the business interruption exposure and its effect on the coinsurance provision were never determined. Coverage the insured presumed to be adequate fell short. Had the policyholder and broker discussed the company s plans for growth, the outcome no doubt would have been different. An unfortunate sequence of events! But a valuable lesson for insurance professionals who assume that clients understand the coinsurance principle as well as they do. It s essential that the broker make it a priority to extract all pertinent information when the client s insurance program is formulated. Thorough communication, initiated by the broker, is the key to devising and maintaining a program that will best serve the insured when it is called upon to deliver. THE FIRST CONTACT The broker is the policyholder s first and often only contact with an insurance professional, and he or she can never assume that the client understands the coinsurance concept. Just as important, it s essential that the broker be familiar with the net effect of undervaluation in a claim situation, so that condition can be explained to the client. Definitive communication is important in all coverage areas, but it is especially vital in three: 1. Replacement costs of personal property, including furniture, fixtures, equipment and inventory. 2. Replacement costs of buildings. 3. Business interruption values. PERSONAL PROPERTY Because insureds usually rely on historical costs to value inventory or business personal property, the figures they provide are often unsatisfactory for (continued on next page)

8 Coinsurance (continued from previous page) insurance purposes. Replacement cost and actual cash value can mean one thing to the insurance buyer, and something else to the broker or adjuster. Insureds who normally purchase used equipment, for example, might assume that they can replace a lost piece with another used item. In fact, replacing the piece could mean not only incurring the cost of a new unit, but paying to have it delivered and installed. Sometimes installation costs can be as high as the price of the machine itself, yet they are often left out when determining insurance values! So, it s essential that all of these factors and interpretations be thought through. Many insureds rely solely on historical or accounting records, and value inventories differently for different purposes. For instance, inventory value may reflect the figure arrived at for tax purposes and the insured might submit this same inventory or a depreciation schedule for setting insurance values. Unless the risk is a new business, some pieces of equipment might not be listed. That equipment could be very valuable to the business, but for tax reasons it is no longer listed on the schedules supplied to the insurance carrier. If a loss occurs, the insured is likely to suffer a coinsurance penalty because the inventory at risk is of greater value than that insured. As we saw in the case of company XYZ, this can dramatically undervalue an inventory in which parts and supplies have been expensed rather than capitalized, because much of its equipment will not appear on the asset list. Tools, for example, if expensed to a specific project, must be replaced in the event of a loss, yet their value would not have been included in the insured values. These valuation problems are all too common. But even more surprising is the fact that in many instances, the insured has absolutely no idea that the A D J U S T I N G TODAY submitted valuations are incorrect. With better communication and education, most of these valuation errors can be avoided! BUILDINGS Insureds frequently make a mistake here when answering the question, How much would it cost to replace your building? They don t realize that what replacement means to them can be very different from what it means to claims personnel settling a loss. When valuing a building for its replacement cost, pay close attention to the details of the structure and the materials used in its construction. If the original values were determined through a simple square footage calculation, or a cursory examination of construction materials, significant discrepancies can result when the insurance company s representatives establish values after a loss. Such discrepancies can translate into a coinsurance penalty. BUSINESS INTERRUPTION VALUES A very important element in establishing proper valuation for business interruption coverage is the company s growth factor in terms of sales or sales value of production. Most insureds tend to think of only projected profit and not of the full impact of additional sales, production, or the accompanying payroll, cost of raw materials, etc. The completion of the business interruption worksheet provides the perfect opportunity for the broker and client to review not only the company s past performance, but also its future potential. What if scenarios can be developed to provide valuation data that can forecast potential recoveries in the event of a loss. Terminologies used in the policy carry different meanings than used by the accounting profession. It is necessary, therefore, to unravel these differences prior to making a determination of sums to be insured. Further, it is important to determine the time period that will be used for establishing value at the time of loss. Historically, valuation was based on the 12-month period following the date of loss; however, more recent policy forms require the valuation to be based on the 12-month period following the policy s inception date or most recent anniversary date. COINSURANCE FROM A CLAIMS PERSPECTIVE When values are determined, coinsurance and its requirements should be viewed from a claims perspective to support better communication. Ask questions like: What would happen in the event of a loss? If the insured lost a plant or a section of a plant, how would the company adjusters approach valuation of the property to determine recovery? What would the actual replacement cost of the structure, and equipment and all of the inventory be? What would the actual cash value of that same property be, and how would that compare with the stated values? Has this information been reported correctly? And have we estimated what the true business interruption value would be, considering growth, and what it would be in the eyes of an adjuster? The time to eliminate a potential coinsurance penalty is before the loss occurs. That means both the broker and client must communicate effectively up front, and understand the language that s being spoken. There s no better way to ensure that reported values will be in line with the values used at the time of any subsequent adjustments. When a broker has cultivated that understanding, he or she has acted in the very best interests of the client.

9 A D J U S T I N G TODAY 3 The Extended Period of Indemnity Endorsement A GOOD INVESTMENT IN COMPLETE RECOVERY William G. Rake, SPPA Adjusters International Los Angeles Loss consultants from Adjusters International are sometimes asked to review, from a claims perspective, the property and business interruption coverages of companies concerned that their policy might not be adequate to cover a serious loss. In the course of such a review, the immediate priorities are usually to determine the values at risk; to ensure that the limits of liability are adequate; and to make sure that any existing coinsurance requirements are met. However, it s just as essential to remember less obvious but equally important areas of coverage whose existence, or lack thereof, can make significant differences in the insured s ultimate claim recovery. One of the most important and helpful endorsements to a business interruption policy is the Extended Period of Indemnity Endorsement. If the business interruption coverage is being written under more recently issued forms, an automatic 30-day extended period of indemnity is built into the coverage. But absent one of these forms, this endorsement must be added to the policy to extend the indemnity period. As its name suggests, the benefit of this coverage is that it extends the covered loss period beyond the time required to restore the property. In both mercantile and manufacturing businesses, the level of sales or production during the time following the restoration period is often not as high as the level would have been had no loss taken place. Additional time may be needed to restore revenues to preloss levels. Making the situation more critical is the fact that because the business is up and running, the full costs of operation are being absorbed without corresponding income. The effect of the revenue shortfall, therefore, goes right to the bottom line. With the proper coverage, however, the insured can be indemnified for the shortfall that occurs during the extended period. This endorsement also opens up another avenue of indemnification for the insured for expenses that otherwise would not be covered by the basic business interruption policy. The Extended Period of Indemnity Endorsement can enable the policyholder to recoup significant preopening expenses, incurred during the extended period, to restore revenues to their preloss levels. They might include extraordinary advertising and public relations activities, or be related to locating and hiring new personnel. These expenses are not ordinarily reimbursed under basic BI coverage because they do not qualify as normal operating expenses, nor would they be considered expediting expenses because they do not reduce the loss within the traditional loss period. On the other hand, these expenses do reduce the carrier s liability when the post-restoration period is covered by the Extended Period of Indemnity Endorsement. Consider the following illustration: The REM corporation manufactures widgets to order. A fire causes extensive damage to the manufacturing facility, resulting in a shutdown and period of restoration of six months. When REM reopens, company officials find that their level of business is only 50 percent of what it would have been had the loss not occurred. The second month after reopening, the firm is realizing only 75 percent of anticipated volume. Ultimately, it takes four months after reopening to return to preloss levels. One month before reopening, and for a considerable period thereafter, the company incurs significant additional expense contacting the trade to advise that it will be back in business shortly. Advertisements are placed in trade journals and representatives are sent around the world to assure customers that the company will be able to fill their orders. Without the Extended Period of Indemnification Endorsement, the REM corporation would have been indemni- (continued on next page)

10 4 Indemnity Endorsement (continued from previous page) fied only for the first six-month period, through the period of repair. With the endorsement, the firm would also be paid for the covered loss occurring during the four-month period following reopening. What s more, the endorsement would provide coverage for the costs incurred to publicize the reopening to customers. Just how long the period of indemnity should be extended depends on the nature of the individual risk. A period of 90 to 120 days is the recommended minimum, but the characteristics of each individual risk must be weighed carefully. For example, a bowling alley that suffers a fire in July and doesn t reopen until October is likely to lose all of its league business, and therefore substantial revenues, through the next season. Another attractive feature of the endorsement is that its cost is usually minimal because it doesn t necessarily increase the business interruption limits. This makes the coverage an even better value. Simply put, the Extended Period of Indemnification Endorsement provides an insured with an otherwise uncollectible reimbursement; that cannot only help a business return to prosperity, but could be decisive to the company s very survival. LEARNING THE LANGUAGE Adjusting worldwide requires an understanding of worldwide terminology. Here are a few common terms used in policy interpretation. United States Actual Cash Value Replacement Cost Business Interruption Lost Sales General and Admin. Expenses Expenses to Reduce Loss Freight Coinsurance Expediting Expense United Kingdom Indemnity Reinstatement Consequential Loss Shortfall in Turnover Standing Charges Increased Cost of Working Carriage Average Clause Expense to Reduce Loss A D J U S T I N G TODAY Adjusting Today Meeting a Need! Ronald A. Cuccaro, SPPA President and Chief Executive Officer, Adjusters International ADJUSTERS INTERNATIONAL Corporate Office 126 Business Park Drive Utica, New York Outside U.S. (315) FAX: (315) @adjustersinternational.com PUBLISHER Ronald A. Cuccaro, SPPA EDITOR Stephen J. Van Pelt TODAY A D J U S T I N G When Adjusters International introduced Adjusting Today in the fall of 1989, we promised that it would be a tool designed to help you stay current in a rapidly changing profession. Your enthusiastic reactions continue to indicate that the newsletter is fulfilling that pledge. I m pleased to welcome you to this issue of Adjusting Today, which features two more timely and thought-provoking articles. The first, by Bob Lucurell, FPPA, addresses the crucial subject of coinsurance. Examples of the unfortunate consequences that can result when insureds misunderstand the coinsurance principle are all too numerous. Bob explains how they can be avoided through better communication, and offers some specific recommendations on steps the broker can take in leading that process. Our second article targets the Extended Period of Indemnity Endorsement, extremely valuable but often overlooked coverage that can mean the very survival of a company following a major loss. Bill Rake, SPPA, points out that the time it takes a business to fully recover from a loss can extend significantly beyond the period required to restore the property itself, and provides insight as to why this endorsement deserves attention in formulating a sound business interruption insurance program. And since the language of the adjusting field differs around the world, we have again included a table of corresponding terms used in the United States and United Kingdom. We hope you will enjoy and be stimulated by these discussions and this information. As always, we welcome your questions, comments and suggestions as to how Adjusting Today can help all of us better serve our industry. WEB SITE ADDRESSES ADJUSTING TODAY is published as a public service by Adjusters International, Inc. professional loss consultants. It is provided for general information and is not intended to replace professional insurance, legal and/or financial advice for specific cases. PRINTED ON RECYCLED PAPER AT90-1R 1990, 1996, 1998, 2002 ADJUSTERS INTERNATIONAL. ALL RIGHTS RESERVED. 3002R

11 A D J U S T I N G TODAY Providing Loss Consulting Services to the Insured Adjusters International EDITOR S NOTE Concurrent causation is a term referring to two or more events acting at the same time or in sequence to cause a loss. The concept of concurrent causation exclusions in insurance policies began after a series of California court rulings found that even though an event, such as earthquake or flood, was clearly excluded from coverage, if another event, i.e. faulty design or maintenance, not excluded, could be found, coverage could be applied. In order to restrict coverage to the intended perils, insurers included concurrent causation exclusions in their policies. However, while solving one problem, interpretation of the new language in some cases went so far as to deny coverage formerly offered under all risks policies. While several courts have rescinded the concurrent causation doctrine, insurers have not, leaving the adjustment of certain losses up to the interpretation of those involved. This article, by Adjusters International insurance expert, Paul O. Dudey, CPCU, reviews the history, application and future of the concurrent causation exclusions in most policies. We hope you will find this interesting and useful information in the adjustment of property losses. Stephen J. Van Pelt, Editor Concurrent Causation HISTORY OF THE CONCURRENT CAUSATION THEORY Paul O. Dudey, CPCU I n the early 20 th century, property insurance was offered on an individual peril basis. There was fire insurance, to which was then added lightning because of the close relationship of the two perils. Separately, an insurance buyer could also obtain wind and hail insurance, explosion (but separate boiler explosion coverage from separate underwriters), riot and civil commotion, damage by vehicles, damage by aircraft, vandalism and malicious damage insurance, and various other individual coverages. But selling these coverages separately led to adverse selection, as insurance buyers tend to be better underwriters of their own exposures than insurance company underwriters could ever be, and would only buy those coverages for which they perceived a high potential exposure in relation to the cost. Later, when underwriters began to offer the extended coverage endorsement to the fire and lightning policy, which provided most of the above perils (but not boiler explosion or vandalism and malicious mischief insurance) they found surprisingly that, because the element of adverse selection was minimized, they could price the extended coverage endorsement substantially lower than the cost (continued on next page)

12 2 A D J U S T I N G TODAY of insuring all of the various perils separately. Next came a broad perils endorsement, which added vandalism and various other perils. Then, finally, following the lead of Marine underwriters, insurers began to offer all risks insurance, which, instead of covering only perils named in the policy, covered any physical loss or damage to property not specifically excluded. Along with such items as wear and tear, rust, corrosion, fungus, decay, deterioration, and other naturally occurring and generally considered uninsurable damage, two of the major perils commonly excluded were earth movement (including earthquake) and flood (which usually also included various other kinds of water damage), which were clearly spelled out in the exclusionary language of these policies. This was a satisfactory arrangement for both insurers and insurance buyers. Earthquake and flood insurance could be purchased separately, the latter usually through the Federal Flood Insurance Program or, to a limited extent, through the surplus lines market. Concurrent Causation Coverage In 1982 and 1983 two court cases in California, which involved a concept known as concurrent causation, produced a drastic change in underwriters thinking about all risks coverage. The first case, Safeco Insurance Co. v. Guyton, 692 F.2d 551 (1982), found the insurer liable for flood damage under an all risks homeowners policy, notwithstanding its flood exclusion, because of the failure of a third party resulting in the flood which damaged the insured s property. The theory was that negligent maintenance of the flood control structures was not an excluded peril so, using the concept of concurrent causation, the covered (not excluded) peril took precedence over the excluded peril, to allow coverage. Similarly, in Premier Insurance Co. v. Welch, 140 Cal. App. 3d 720 (1983), a homeowner s all risks policy was found to cover landslide damage to the insured s home, notwithstanding the earth movement exclusion, because faulty installation of a drain by a third party, not excluded, was held to be a concurrent cause of the loss. Concurrent Causation Exclusions In response to these two claims, the Insurance Services Office (ISO) quickly drafted revised exclusions for their all risks policies and also, believing that the term all risks

13 A D J U S T I N G TODAY 3 created the impression in the minds of policyholders that the policy gave more coverage than was intended, dropped the term all risks from the forms, replacing it with risk of direct physical loss unless excluded or limited. The same or comparable exclusionary language was also adopted on most independently filed forms. The concurrent causation exclusions found in Section B.3. of ISO Causes of Loss Special Form CP , covering risks of loss not otherwise excluded or limited, reads as follows: We [the insurer] will not pay for loss or damage caused by or resulting from any of the following, 3.a. through 3.c. But if an excluded cause of loss that is listed in 3.a. through 3.c. results in a covered cause of loss, we will pay for the loss or damage caused by that covered cause of loss. a. Weather conditions. But this exclusion only applies if weather conditions contribute in any way with a cause or event excluded in paragraph 1. above [the opening paragraph of the exclusions] to produce the loss or damage. b. Acts or decisions, including the failure to act or decide, of any person, group, organization or governmental body. c. Faulty, inadequate or defective: (1) Planning, zoning, development, surveying, siting; Summary of the Concurrent Causation Exclusions Loss caused by weather conditions that contribute to an otherwise excluded loss. Loss caused by acts or decisions of any person, group or government body. Loss caused by faulty, inadequate or defective activities such as planning, design, maintenance, or faulty materials. (2) Design, specifications, workmanship, repair, construction, renovation, remodeling, grading, compaction; (3) Materials used in repair, construction, renovation or remodeling; or (4) Maintenance; of part or all of any property on or off the described premises. Note that these exclusions do not apply to loss or damage from a covered cause of loss caused by any of these exclusions. However, in the minds of some insurers adjusters, especially since the tragedy of September 11 th, these exclusions are treated as much broader than the exclusions authors intended. The result is that legitimate claims, also involving a concurrent causation exclusion, are sometimes denied even when the resulting loss is by a cause not excluded in the form. Typically, insurers adjusters may seize on any of the b. or c. exclusions and endeavor to apply them to fire, explosion, collapse, or other covered losses, despite the fact that these causes of loss are not excluded. Under the special form (formerly all risks form) covered causes of loss are not specifically listed (as they are under the basic and broad forms), so coverage for specific perils may not be obvious to policyholders. In the absence of an alert broker, attorney, or public adjuster, an insured, unfamiliar with the basis for the concurrent causation exclusions, may blindly accept the adjuster s position and not get paid for a loss that is legitimately (continued on next page)

14 4 A D J U S T I N G TODAY covered under the policy. In 1989, the California supreme court, in Garvey v. State Farm Fire & Casualty Co., 770 P.2d 704, held that the California appellate courts had misinterpreted the cases discussed above that used the concurrent causation doctrine to allow coverage in the face of a clearly excluded peril. The supreme court stated that when a loss can be attributed to two causes, one covered and one excluded, coverage exists only if the covered peril is the efficient proximate cause of the loss. Had this decision been adhered to in Guyton and Welsh, perhaps insurers would not have felt a need to add these exclusions. But having added them, ISO and most independent insurers have, up to this point, left them in, with potential harm to insureds who suffer a loss where the efficient proximate cause is a covered (not excluded) cause of loss but one of the excluded causes is also involved. A case in point, in another California case, State Farm Fire and Casualty Co. v. Von Der Lieth, 218 Cal. App. 3d 964 (1990), an appeals court overruled a lower court which had held that third party negligence rather than earth movement was the efficient proximate cause of the loss. In this case, the appeals court found that even though the third party was indeed negligent, this was not the efficient proximate cause of the loss; the earth movement was. In a Utah case Alf v. State Farm Fire and Casualty Ins. Co., 650 P.2d (1993), while the efficient proximate cause doctrine was upheld, it was not applied when the parties have agreed freely to contract out of it, which the court found to be the case here. Insureds sometimes will encounter the ordinance or law exclusion and the insurer s reliance on this exclusion to deny recovery for the cost of demolition and debris removal of a structure severely damaged by a covered cause of loss, when authorities condemn the property as a threat to public safety and order it demolished. But in at least two cases, courts have held that the condition of the building after a loss required its demolition, apart from the authorities demolition order, setting aside the exclusion. These two cases are Norfolk & Dedham Mutual Fire Ins. Co. v. DeMarta, 799 F.Supp.33 (1993) and Digravina v. Merchants Mutual Ins. Co. A number of additional states have also begun to grapple with the problem of concurrent causation. A research project by the Central Arizona Chapter, Society of CPCU, published in May 1988, listed 18 states with cases involving concurrent causation at that time. They were Colorado, Connecticut, Louisiana, Illinois, Iowa, Maryland, Michigan, Minnesota, Mississippi, Missouri, Ohio, New York, Tennessee, Texas, Washington, and Wisconsin. Probably more states could be added to this list since that time. In general, although not entirely, these cases follow the Garvey interpretation that the insured peril must be the efficient proximate cause of the loss. Future Expectations There are no signs at this point that ISO is likely to delete the concurrent causation exclusion any time soon. However, as the industry recovers from the September 11 th disaster, some independent insurers, especially in the surplus lines markets, may begin to offer property coverage with all or some of these exclusions deleted. If so, and if other features of their coverage and price are satisfactory, they will be an attractive alternative to policies with these exclusions intact. A D J U S T I N G TODAY AT ADJUSTERS INTERNATIONAL. ALL RIGHTS RESERVED. ADJUSTERS INTERNATIONAL Corporate Office 126 Business Park Drive Utica, New York Outside U.S. (315) FAX: (315) editor@adjustingtoday.com PUBLISHER Ronald A. Cuccaro, SPPA EDITOR Stephen J. Van Pelt WEB SITE ADDRESSES ADJUSTING TODAY is published as a public service by Adjusters International, Inc. professional loss consultants. It is provided for general information and is not intended to replace professional insurance, legal and/ or financial advice for specific cases. PRINTED ON RECYCLED PAPER

15 A D J U S T I N G T O D A Y Adjusters International Disaster Recovery Consulting Debris Removal and Pollution Damage How These Additional Costs Impact the Property Claim EDITOR S NOTE Today, maintaining an insurance program that adequately protects a business means being aware of an unprecedented number and variety of complex exposures. Since its inception, Adjusting Today has offered important information on such exposures particularly as they relate to the property claims adjustment process to leading agents, brokers and business professionals. That effort continues in this latest edition as we focus on the timely issue of how debris removal and pollution damage costs affect property claims. Our feature article prepared initially by Paul O. Dudey and updated by Donald S. Malecki takes a close look at what is and what is not covered under basic policy provisions, including some steps that can be taken to arrange more adequate protection. Complementing this article is a piece by veteran public adjuster Patrick W. Bickford, SPPA, who provides examples of actual debris removal and pollution losses he has witnessed during his years in the field. Mr. Bickford is a member of the Board of Directors of Adjusters International and operates AI s Colorado office. Sheila E. Salvatore, Editor By Paul O. Dudey, CPCU; Donald S. Malecki, CPCU A tornado tears through a small Midwestern community, ripping the roof off the main plant of a large paint manufacturer. Parts, materials and equipment are blown everywhere, and the plant is shut down for an indefinite period. At first, the insured is relieved to think that their standard property and business income insurance policies will cover all of the losses and have them back up and running soon. Then, it s discovered that the winds have strewn debris across the company s own nine-acre complex, as well as onto the property of neighboring firms. And that debris from those operations has blown onto the paint manufacturer s premises. Further complicating matters is the fact that dyes and other chemicals used in making the paints have leaked outside the plant, contaminating the ground ADJUSTERSINTERNATIONAL.COM 1

16 A D J U S T I N G T O D A Y and water supply. Suddenly, the magnitude and nature of the loss are much different than originally believed. The insured, their broker and the adjuster are now facing a much more difficult task in determining what s covered, what s not and what better protection might have been available when the coverage was arranged. When calculating the many costs involved in repairing or restoring property following its destruction or damage, keep in mind that the costs of removal of the debris from the damaged property and the cleanup of possible pollution resulting from the property damage are in addition to rather than a part of the value of the damaged property. As such, their possible impact on the total amount of the loss, and the coverage limitations on these costs in most standard property insurance policies are frequently overlooked in arranging the coverage initially. Often the result in such cases is disappointment with the recovery made under the policy after a loss occurs. History of Debris Removal Coverage In examining the coverage available for these costs, a brief look at the history and development of debris removal coverage may be helpful. Under the 1943 New York Standard Fire Policy and its predecessors, no mention was made of debris removal costs as either covered or excluded. This gave rise to controversy, with some insurers routinely including these costs as a part of the claim settlement and others rejecting or resisting payment, contending that this cost was a consequential, rather than a direct, result of the loss, and as such, was not covered. To clarify the intent of the coverage as including these costs, a debris removal clause was added to the forms attached to the Standard Fire Policy. It simply stated that the coverage extended to include the cost of removal of the debris resulting from the property loss. The debris removal coverage was within, and did not increase, the limit of liability. Debris removal costs were not considered in determining compliance with the coinsurance clause of the policy; however, if a coinsurance penalty was found to apply, reducing the recovery of the property loss, customary adjustment practice was to apply the same limitation to the payment for debris removal. The coverage was thus limited by the amount of insurance carried, so that in a substantial loss, the property loss plus the cost of debris removal might well exceed the amount of insurance carried, unless debris removal costs had 2 ADJUSTINGTODAY.COM

17 A D J U S T I N G T O D A Y An insured, with the 180-day deadline approaching and unable to complete the debris removal within that time, is well advised besides giving notice to the insurer also to seek an extension rather than argue the point while the adjustment is in progress. Most insurers will grant such an extension, given a good reason for the delay. been anticipated and enough insurance was carried to provide for the full loss of property plus the cost of debris removal. One of the compelling arguments for blanket insurance over two or more locations was that coverage would be available at each location for the full property value plus debris removal costs whenever the amount of insurance over all locations was high enough to cover the loss (including debris removal) at any one location, and to meet the coinsurance requirement. In recent years, as the cost of cleaning up and disposing of debris increased substantially and environmental laws imposed progressively stricter and more costly rules on disposal particularly of hazardous materials insurers have been forced to build restrictions into the basic policy forms regarding both debris removal and pollutants. Unfortunately, these restrictions as included in most policy forms are complex and difficult to interpret, giving rise to frequent questions and misunderstandings. A typical case leading to the more restrictive coverage was a 1977 Georgia court of appeals case, Lexington Insurance Co. v. Ryder Systems, Inc., 234 S.E.2d 839, which found that the cost of removing and replacing oil-soaked ground around an oil storage tank that had developed a below-ground leak was covered as a cost of debris removal. The policy involved was an all risks policy that did not exclude accidental leakage. The oil was covered property and its escape and contamination constituted debris of covered property. The discussion that follows is based on Insurance Services Office (ISO) commercial buildings and personal property form CP Most commercial property forms have somewhat similar debris removal and pollution provisions. Homeowners policies also have a debris removal clause, with some significant differences from the commercial form, but these are outside the scope of this discussion. Current Debris Removal Limitations For commercial property insurance under form CP , debris removal coverage is offered as an additional coverage rather than a part of the basic property coverage. In this section of the form the coverage is limited to 25 percent of the insurer s liability for the direct property loss by a covered cause of loss, plus any applicable deductible (unless an additional debris removal limit is shown in the declarations). An additional $10,000 per occurrence of debris removal coverage is made available whenever: a) the sum of direct physical loss plus debris removal exceeds the limit of insurance, or b) the debris removal expense exceeds the 25 percent limitation in the debris removal, additional coverage. When there is concern that the 25 percent of loss limitation plus $10,000 or the total limit of ADJUSTERSINTERNATIONAL.COM 3

18 A D J U S T I N G T O D A Y insurance plus $10,000 might be inadequate to cover a property loss plus debris removal cost fully, the additional $10,000 debris removal limit can be increased by any amount desired, for additional premium, using ISO form CP (or its equivalent), which is entitled Debris Removal Additional Insurance. The limit shown on the endorsement is the amount to which the coverage is increased, with the $10,000 of basic coverage included. It can be applied in addition to the smaller of: a) 25 percent of the amount of the claim paid plus the deductible; or b) the limit of insurance when it is exceeded by the sum of the property loss and the cost of the debris removal. To illustrate, assume a $100,000 limit of insurance (sufficient to comply with the coinsurance requirement) with an additional debris removal limit of $10,000. With a property loss of $50,000, debris removal coverage of $12,500 (25 percent) plus $10,000, or $22,500 is available, for a total possible payment for property damage and debris removal of $72,500. But with a $90,000 property loss, $22,500 (25 percent) plus $10,000, or $32,500 becomes $122,500, when added to the $90,000 property loss. This is greater than the insurance limit plus $10,000 ($110,000). Payment is limited to $110,000 for property loss plus debris removal costs. Claims for debris removal expenses are payable only if they are reported to the insurer within 180 days after the date of loss. Note that the expenses must be reported, but not necessarily incurred, within that time. A contractor s estimate given to the insurer for work not yet completed will satisfy this requirement. However, we have seen cases where an insurer has taken exception to this, insisting that the work must have been completed within this time for coverage to apply. So an insured, with the 180-day deadline approaching and unable to complete the debris removal within that time, is well advised besides giving notice to the insurer also to seek an extension rather than argue the point while the adjustment is in progress. Many insurers will grant such an extension, given a good reason for the delay. While debris removal coverage will pay for pollution cleanup and decontamination of covered buildings and personal property, it does not apply to the cost to extract pollutants from land or water, or remove, restore or replace polluted land or water. Pollutant cleanup and removal is a separate additional coverage, discussed later in this article. Do Individual Limits Apply? The following question frequently is raised: In a severe loss involving two or more items of property coverage, how does the debris removal coverage apply separately, to each item of coverage, or collectively over all items involved in the loss? In cases where the limit of insurance for one item of coverage is exhausted but coverage is available under a second item, adjusters will sometimes attempt to apply the debris removal limits separately to each item. For example, assume $100,000 of building insurance and $50,000 of personal property insurance with no deductible. A fire totally destroys the personal property and causes $30,000 damage to the building. Cost of debris removal is estimated to be $26,000 for the contents (which includes toxic 4 ADJUSTINGTODAY.COM

19 A D J U S T I N G T O D A Y While debris removal coverage will pay for pollution cleanup and decontamination of covered buildings and personal property, it does not apply to the cost to extract pollutants from land or water, or remove, restore or replace polluted land or water. Pollutant cleanup and removal is a separate additional coverage. materials that require special handling) and $4,000 for the building. Applying the limits separately, the 25 percent limit of debris removal on the contents is $22,500 ($50,000 x 25% plus $10,000) $3,500 less than the cost of debris removal. Meanwhile, the cost of debris removal for the building loss ($4,000) is well below the available limit of $12,500 ($30,000 x 25% plus $10,000). The insured recovers $3,500 less than the total amount of the loss. However, there is no basis in the wording of the debris removal additional coverage for treating the various items of coverage separately. The language speaks only of debris of covered property at each location resulting from a covered cause of loss and, in applying the debris removal limitation, does not differentiate between debris of buildings or of personal property. So in the example given above, the insured has an $80,000 property loss, and $25,000 of debris removal expense. The policy will pay debris removal expense of 25 percent of the $80,000 loss ($20,000) plus $10,000, or $30,000, or more than the entire cost of debris removal. The $10,000 debris removal coverage above the $150,000 combined limits of insurance will not be a factor in this loss. But this interpretation works against the insured when property loss plus debris removal exceeds the limit of insurance for two or more items at a single location, because the $10,000 additional limit applies only once to the entire loss at the location instead of to each item separately. The answer is to project a worstcase scenario of the possible property loss plus debris removal expense, and set the limits of insurance accordingly including, when needed, the purchase of additional debris removal coverage. ADJUSTERSINTERNATIONAL.COM 5

20 A D J U S T I N G T O D A Y the premises habitable again can be prolonged. Older electric transformers may contain polychlorinated biphenyl (PCBs), and a small electrical fire involving PCBs can contaminate an entire building. Toxic or radioactive contamination can involve severe and expensive debris cleanup and disposal problems. Some Special Debris Removal Problems The debris removal provision of most property forms is restricted to the cost of removal of debris of covered property. So the cost of removing debris deposited on the premises, as by a windstorm or explosion, without damage to insured property is not covered. But when such debris causes damage to covered property, common adjustment practice will pay for its removal along with any debris of covered property. An exception to this language limiting coverage to debris of covered property appears in dwelling flood policies, which cover removal of debris of, on, or from the insured property. Other special debris removal problems that may require attention: (1) Molten material the escape of molten material (metal, glass, plastic, etc.) from a vessel or container or its solidification within a container from the loss of heat or power can produce a sizable loss. If the cause is an insured peril, there is debris removal coverage, but the cost may well exceed the debris removal limit unless the exposure has been recognized and additional debris removal coverage purchased. (2) Toxic or radioactive contamination can involve severe and expensive debris cleanup and disposal problems. Toxic materials can be found in common use in many situations on supermarket shelves, stored in warehouses, in many industrial applications, to suggest only a few and when involved in a fire, explosion or other loss resulting in their spillage or dispersion as in the smoke from a fire or in the water used to extinguish it the cleanup cost can be astonishingly high and the time delay in making (3) Effect on business income or extra expense recovery business income and extra expense forms make no direct mention of debris removal nor do they impose any stated limitation. But failure to purchase a high enough insurance limit for either of these coverages taking into account possible delays in restoring operations because of prolonged decontamination or debris removal can result in exhaustion of the insurance limit and a partially uninsured loss, before normal operations can be resumed. When any such exposures are found to exist, the need for increased business income or extra expense coverage along with additional debris removal coverage should be considered. Also, the possibility of contamination of land or water by any of these materials must be considered, per the following discussion. Pollution Coverage The debris removal coverage of the commercial building and personal property form includes the extra cost of cleanup and disposal of hazardous materials following an insured loss (within the limits of coverage outlined above) but, as noted earlier in this article, the coverage does not apply to the cost to extract pollutants from land or water, or to remove, restore or replace polluted land or water. 6 ADJUSTINGTODAY.COM