Rental Insurance/Business Income Insurance ACREL SPRING PROGRAM MARCH 22, Reverdy Johnson. Marilyn Maloney. Art Pape

Transcription

1 Rental Insurance/Business Income Insurance ACREL SPRING PROGRAM MARCH 22, 2003 Reverdy Johnson Marilyn Maloney Art Pape

2 Rental Insurance/Business Income Insurance Reverdy Johnson Marilyn Maloney Art Pape I. Although landlord/tenant and lender/borrower negotiations often focus on property and liability insurance issues, insurance to cover loss of income or rentals in the event of damage or destruction to the property is equally important. The landlord and its lender rely upon a stream of rentals; damage or destruction to the property interrupting that income stream can be as devastating as the loss of the building itself. A tenant whose business operations are disrupted due to inability to use the leased premises may not be able to continue in business until the premises are restored. As the events of 9-11 have indicated, both landlord and tenant can be damaged by catastrophic events on surrounding buildings that cause only minimal damage to their own premises. Although negotiating a business income claim has always been difficult, post 9-11 reports have confirmed the extent to which such a claim may be affected by events in the general economy, rather than simply by the physical event itself. Understanding the types of available insurance can assist counsel in planning and negotiating, as well as assisting clients following losses. Rental insurance has been addressed at previous ACREL programs. Reverdy Johnson has written two comprehensive articles that are reprinted as Parts II and II of these materials. Julie Williamson and Pat Morgan s excellent materials are available through ACREL and are listed in the bibliography at Part IV. Although Reverdy s materials specifically address rental insurance, they also deal with business income of a general nature, and we will not repeat in this Part I the subjects addressed in Reverdy s materials. Whether now or previously designated as Profit Insurance, Loss of Use and Occupancy, Business Interruption, Business Income, Rental Insurance or other like terms, insurance of this category essentially insures against loss of income, including loss of rentals, as a result of damage to particular property. This income is generally written as a rider to accompany a casualty policy or a boiler and machinery policy. It is helpful to think of business income insurance as being tied to and a part of the casualty policy itself. Those risks that are covered under the casualty policy may give rise to a business income claim if other terms and conditions are met. If the risk is not covered there would be no claim either for business income losses or loss of the property itself. Business income insurance typically carries a coinsurance requirement, similar to that found in the casualty property itself. Generally, if the coinsurance percentage multiplied by the projected net income and continuing expenses for the following twelve year period does not equal the insurance amount, the amount of insurance otherwise payable is reduced. -1-

3 Business income insurance typically covers net income as well as ongoing expenses that do not abate during the period of suspension. Although business income only pays on the net amount, rent insurance typically is calculated on the gross amount, namely the rentals that the lessor would have received absent the casualty. This difference is significant not only in the treatment afforded the different claimants, but it also highlights the difference in difficulty in documenting a claim for business income insurance, a difficulty that is somewhat reduced in rental insurance cases. As both the Price Waterhouse and Branigan articles listed in the bibliography indicate, substantiating a claim under a business income insurance policy is not easy since insurance will not cover losses arising for reasons other than the covered claim, such as a general economic downturn. The articles indicate the degree to which general economic factors will enter into settlement of these claims. Since business interruption insurance generally covers net income before taxes together with continuing operating expenses, the insured s pre-loss records are critical for establishing pre-loss net income. This highlights the need for businesses to back up their records and store them offsite. Business income insurance generally covers only the period of the necessary suspension of the insured s business. Necessary is a term that is obviously open to dispute. If the insured is slow to rebuild and return its business to operations, it may find portions of its claim denied. Additional questions may arise as to whether operations have been suspended. Although an insured may believe its work to be suspended for all practical purposes, even though some operations are shifted to other offices or employees work from home, some policies require that operations be totally suspended prior to allowing recovery. -2-

4 Part II RENTAL INSURANCE - AN IMPORTANT ADJUNCT TO PROPERTY INSURANCE By Reverdy Johnson Scheuer, Yost & Patterson Santa Fe, New Mexico October 16, 1999 Rental insurance is a form of commercial property insurance that insures the building owner against loss of rental income if the building is not usable by tenants because of some casualty that is insured against. All three traditional players in real estate have a stake in the existence and funding of rental insurance: the owner, because it provides a continuity of cash flow; the lender, because it services debt; and the tenant, because it allows its rent to be abated. Rental insurance has been referred to variously as rental interruption insurance, rent loss insurance, rental value insurance and use and occupancy insurance. It should be distinguished from rent guaranty insurance, which insures against the risk of a tenant s failure to pay rent and consequent breach. Rental insurance was apparently first written in the late 19 th century, which explains why most of the early cases involving such insurance are in the period from 1900 to It is now characterized in the industry generically as a type of time element coverage, and is treated as a subset of business income coverage. This presentation will describe the coverage, discuss what some of the obvious and notso-obvious issues and problems have been with the coverage, look at what current policies provide, and consider what opportunities exist for specialized coverage that can address particular exposures for the owner or help solve certain issues in lease negotiations. Two appendices are attached, the current Insurance Services Office standard form policy encompassing rental insurance as Appendix I, and a checklist of matters to be considered when dealing with rental insurance as Appendix II. 1. Rental Insurance Generally. Rental insurance is usually written as an endorsement to a property insurance policy, and the perils insured against in terms of rental loss are those perils of physical loss insured against under the property policy. If the property insurance is limited to the named perils under what used to known as fire and extended coverage, those will be the perils for which rental insurance will be available. Similarly, if earthquake coverage is in effect, rental insurance will apply to an -1-

5 earthquake-caused casualty. One should review the Declarations page on the property policy to see what the casualty coverage is and review the policy text to determine what the exclusions from coverage are. It is important to note that property insurance on a building does not automatically include insurance on rents. The property policy must be specifically extended to include rental insurance. While it is theoretically possible that rental insurance could be written independently of the underlying property policy, it is not in the interest of the insurer to do so. The insurer needs to control administration of the property claim. Otherwise its rental insurance exposure could be adversely affected by delays in adjusting the property loss and that would in turn delay the commencement of restoration. Unless the policy limits are reached, the rental insurer s loss is contained only when the property is again tenantable. If the rental insurance is written with a maximum period of indemnity as well as a dollar limit, it would also not be in the interest of the insured to have separate insurers. The insured could successfully argue for an extension of the indemnity period based on property loss adjustment delays if there were a single insurer, but not if the delays were caused by someone other than the rental insurer. Rental insurance is customarily written with an aggregate dollar limit of liability on the part of the insurer. Some business income coverage is now being written with monthly indemnity limits as well as aggregate limits; it is unclear whether this underwriting practice is being extended to rental insurance as well. The cost of rental insurance is largely a function of the risk elements reflected in the pricing of the underlying property policy - location, construction type, protective systems, etc. The rate for rental insurance is commonly 60% of the property rate for rental insurance with extra expense coverage and 55% for rental insurance without extra expense coverage. If coverage is purchased for 12 months rent, the declared annual rental value is multiplied by the rental insurance rate to arrive at the premium cost. For example, if the property rate were.20 (i.e. 20 cents per $100 of value), the rental insurance rate would be either.12 or.11. Assuming annual value of $1,000,000, the cost of the rental insurance would be either $1,200 or $1,100, depending upon whether extra expense coverage was purchased or not. 2. Recurring Issues. What is the rent that is the measure of the insured loss? Is it the rent not received, or is it that rent less the expenses not incurred? By analogy to business income coverage, where expenses avoided are deducted in calculating loss, one would assume that rental insurance means net rental insurance, but this is not necessarily the case. Compare Chronicle Bldg. Co. v. New Hampshire Fire Ins. Co., 94 S.E.2d 1043 (Ga. Ct. App. 1918) and Arley v. Liberty Mutual Fire Ins. Co., 388 P.2d 576 (Nev. 1964) (allowing recovery for net rents) with World Fire & Marine Ins. Co. v. Palmer, 182 F.2d 707 (5 th Cir. 1950); Whitney Estate Co. v. N. Assur. Co., 101 P. 911 (Cal. 1909); and Am. Ins. Co. v. Mattox, 120 So. 912 (Ala. 1929) (allowing recovery for gross rents). If avoided expenses are to be taken into account, at least one case holds that depreciation is not a non-continuing expense to be deducted. See N. High Ltd. v. Cincinnati Ins. Co., 599 N.E.2d 352 (Ohio Ct. App. 1991). In theory it should be easier to justify a recovery of gross rents when space is leased on a fully-serviced basis, for a lease with separately identified pass- -2-

6 through recovery items provides a ready road map for an adjuster to find all of the occupancy costs that are not being incurred by the landlord when the space is not occupied. Although rental income insurance is normally thought of as landlord insurance, it makes sense for a tenant to purchase it when it is in the position of a sublandlord as to subtenants. In one case, the tenant carried such insurance and the court was quite comfortable finding the tenant s recovery on its policy was based on the gross sublease rent irrespective of whether the tenant s master lease obligation was abated. Mattox, 120 So. at 912. In addition to the question of gross rent versus net, there is the issue of rental value versus actual rent. If a property is not fully leased and occupied at the time of a casualty loss, or if space is leased on a month-to-month basis or a lease otherwise expires before restoration is completed, is the rental loss claim reduced? If the test is the actual rent loss, the claim is reduced, and if the test is rental value, it is not. Compare DeCrescenzo v. Capital Mut. Ins. Co., 589 N.Y.S.2d 669 (N.Y. App. Div. 1992) and Whitney Estate Co., 101 P. at 912 (providing coverage for loss in amount of actual rent) with Simon v. Girard Fire & Marine Ins., 57 S.W.2d 559 (Ark. 1933) and Gray v. Merchants Ins. Co., 125 Ill. App. 370 (2d Dist. 1906) (providing coverage for loss in amount rental value). See also Palmer, 182 F.2d at 707 (discussing ability of co-insurance to limit exposure to rent loss on occupied portion of building). If a building owner s property management office is untenantable by reason of the insured casualty event, is the owner able to claim the rental value of that office even though it was not producing rent? Again, there is not loss of actual rental income but clearly a loss of value. Rental insurance can be open-ended as to time, and therefore capped only by the aggregate dollar limit, or subject to a time limitation as well. The time limitation can be a maximum period of indemnity, or a maximum period of restoration, or both. More common is simply the restoration period, which is expressed in terms of period to return the building to tenantable condition, assuming reasonable speed and diligence. See Palmer, 182 F.2d at 708; Palatine Ins. Co. v. O Brien, 71 A. 775 (Md. 1908). What is tenantable? Does it mean simply the building shell or does it also include the period of time for installation of tenant improvements and fixturization? The general rule is that tenantability is the state of improvement at which space is normally delivered to a tenant, but special circumstances may justify a higher level of finish for a particular tenant. See Nat l Tea Co. v. Commerce & Indus. Ins. Co., 456 N.E.2d 206 (Ill. Ct. App. 1983). If the restoration is delayed because of acts of the insurer, it is no surprise that the time limitation will be extended. See Landes v. State Farm Fire & Casualty Co., 907 S.W.2d 349 (Mo. Ct. App. 1995)( recovery allowed for post-restoration period because repairs not completed within 120 days due to insurer delays and tenant elected to terminate lease); N. High Ltd., 599 N.E.2d at 355. But what if there are delays in permitting or other action by local government? Absent policy provisions to the contrary, the permitting risk is the building owner s. Compare First Investment Co. v. Vulcan Underwriters, 33 F.2d 785 (D.Or. 1927) and Amusement Syndicate Co. v. Prussian Nat l Ins. Co., 116 P. 620 (Kan. 1911) (refusing to extend repair period when delay was caused by permitting problem) with Palmer, 182 F.2d at 710. (extending repair period when policy had provision that provided coverage for delay caused by enforcement of a state or municipal law). -3-

7 Should the owner not elect to restore or be unable to restore due to changes in codes, the property coverage will still pay the replacement cost of the building, less depreciation, or the value of the building, See, e.g., Nat l Tea Co., 456 N.E.2d at 211, but what about the rental loss? Per Palmer, 182 F.2d at 708, the rental insurance policy should pay for the rental loss that would have been incurred during the permitted restoration period. Id. Who can claim under a rental insurance policy? Clearly the insured, but what if the insured declines to do so. In Jones v. Aetna Casualty and Surety Co., 33 Cal.Rptr.2d 291 (Cal. Ct. App. 1994), a tenant, not an additional insured, sought to claim as an implied beneficiary because rent abatement was conditioned upon rental insurance proceeds, but the court found that the tenant was neither an implied beneficiary nor a third party beneficiary. The lesson to be learned from Jones is that the tenant should be named as an additional insured, and that either the abatement entitlement should be independent of the funding of rental income proceeds or the landlord should be obligated to pursue a claim under its rental insure policy. It should be noted that rental insurance, as with property insurance itself, insures against negligence. The insurer is not relieved of its indemnity obligations if the physical loss was caused by landlord or tenant negligence. Thus there is no insurance justification for any lease to condition the availability of rent abatement on the tenant s non-negligence, for the rental insurance proceeds will be payable irrespective of such negligence. 3. ISO Policy Forms. The Insurance Services Office (ISO) simplified commercial property program incorporates rental insurance as part of business income coverage. Indeed, the 1995 form revisions contemplate a check-the-box procedure on the Declarations page to elect one of three alternative coverages: business income with rental value, business income without rental value, or just rental value. A common endorsement covers all three, and the endorsement text (CP )is attached as Appendix I. (The endorsement can also be purchased with or without extra expense coverage, which are expenses that would not have been incurred but for the loss so long as they reduce the total amount of the loss. Although extra expense probably has more application to business income losses than rental losses, the coverage text is nonetheless included in the attachment.) The incorporation of rental insurance in business income insurance has been at the expense of readability of the policy form. Since of the text of CP deals with many matters relevant only to business income coverage, it is necessary to sort through the form to find what applies to rental insurance as opposed to business income, and the search is complicated by the fact that some provisions deal with rental income as part of business income. On the positive side, the current ISO form has addressed many of the issues that have previously been open or litigated, and also includes a several new features: Rental Value is defined as the total anticipated rental income from tenant occupancy of the insured building, and is not limited to the actual rental loss. It includes the recovery of pass-through items as well as the value of owneroccupied space. There is no deduction for costs not incurred. -4-

8 There is no extension of the restoration period for governmental delays, but one can purchase an ordinance or law endorsement that will provide such an extension. There is no coverage for the time to refixturization or otherwise restore the property to tenant occupancy, but an extension (referred to in the policy form as Extended Business Income coverage) can be purchased to cover the time required for such activity. The extension, however, is limited to 30 days after improvements are completed. No rental loss is recognized for a general decline in rental rates in the area resulting from the casualty. This provision was in response to claims from Hurricane Andrew that attempted to recover for loss in rental value caused by the depressed rental values in a widespread area that were attributable to Hurricane Andrew. There is a time deductible whereby the policy is not applicable to losses incurred in the first 72 hours following a casualty. In the event of a disagreement as to the amount of the loss, at the election of either the insured or the insurer, there can be an appraisal of the loss by three appraisers, one impartial appraiser appointed by each party and a third (an umpire ) appointed by the other two. The insurer retains the right to deny the claim, a recent case has held that this is not a unilateral right not to be bound by the amount of the loss as determined by the appraisal, but rather merely a right to deny the claim if there are grounds for denial pursuant to other provisions of the policy. See High Country Arts and Craft Guild v. Hartford Fire Insurance Co., 126 F.3d 629 (4 th Cir. 1997). 4. Specialized Coverage. There are two more or less specialized forms of rental insurance that are not included in the standard form and may have important application in appropriate circumstances: offpremises services coverage and contingent business income. Off-premises services coverage (also called utility services - time element) is available by endorsement to insure against the loss of rental income resulting from the interruption of services caused by physical losses beyond the insured s building. The recognized types of utility services include water, communication and power. The insured need not own the facilities that are damaged, and the location of the damaged facilities can be proximate, as in the explosion of a transformer in a vault below the sidewalk or the break in a water main, or distant, as in the collapse of or lightning strike on a transmission tower, the rupture of a water reservoir or a partial meltdown in a nuclear power plant. -5-

9 The attractiveness of the off-premises services coverage is that it provides a solution to at least part of a contentious issue in lease negotiations - who bears the risk of the loss of utility service and the inability to conduct business. Neither landlord nor tenant is responsible for it, and neither wants to shoulder the cost, either uncovered abatement by the landlord or the ongoing obligation of the tenant to pay rent without the services necessary to operate. If a casualty event causes the services interruption, the endorsement can provide the proceeds to cover abatement for the tenant. Should the power system crash because of excess demand and overloading, however, it is unlikely that the coverage would apply. An insured may have an economic dependency on the continuation of another business, and suffer loss if that business itself is the subject of a casualty loss. In the shopping center context, for example, consider the position of the mall owner who does not own the site of the anchor department store. If the department store is damaged and closed during restoration, the traffic to the mall may be adversely affected with a consequent loss of percentage rent generated by the owner s in-line mall tenants. Contingent business income coverage will insure against that rental income loss. The potential application of this coverage is much broader than simply the shopping center example, and extends to the premises of a supplier or large customer as well. 5. Conclusion. Although buried in endorsement text dealing primarily with business income coverage, and burdened with somewhat confusing provisions as a result, rental insurance remains an important component in the insurance package for improved commercial real estate. Many of the issues concerning application of the coverage have been resolved in favor of the insured through policy text, or are capable of being covered through specific extensions. The insurance industry has also showed itself to be responsive to the need for new types of coverage tailored to newly perceived risks, such as utility service interruptions and losses to non-owned properties. * * * * * -6-

10 APPENDIX I SAMPLE COMMERCIAL PROPERTY CP BUSINESS INCOME (AND EXTRA EXPENSE) COVERAGE FORM Various provisions in this policy restrict coverage. Read the entire policy carefully to determine rights, duties and what is and is not covered. Throughout this policy the words you and your refer to the Named Insured shown in the Declarations. The words we, us and our refer to the Company providing this insurance. Other words and phrases that appear in quotation marks have special meaning. Refer to SECTION G -DEFINITIONS. A. COVERAGE Coverage is provided as described below for one or more of the following options for which a Limit of Insurance is shown in the Declarations: (i) (ii) (iii) Business Income including Rental Value. Business Income other than Rental Value. Rental Value. If option (i) above is selected, the term Business Income will include Rental Value. If option (iii) above is selected, the term Business Income will mean Rental Value only. If Limits of Insurance are shown under more than one of the above options, the provisions of this Coverage Part apply separately to each. We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your operations during the period of restoration. The suspension must be caused by direct physical loss of or damage to property, including personal property in the open (or in a vehicle) within 100 feet, at premises which are described in the Declarations and for which a Business Income Limit of Insurance is shown in the Declarations. The loss or damage must be caused by or result from any Covered Cause of Loss. If you are a tenant, your premises is the portion of the building which you rent, lease or occupy, including: 1. All routes within the building to gain access to the described premises; and -7-

11 2. Your personal property in the open (or in a vehicle) within 100 feet. 1. Business Income Business Income means the: a. Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred; and b. Continuing normal operating expenses incurred, including payroll. 2. Covered Causes of Loss See applicable Causes of Loss Form as shown in the Declarations. 3. Additional Coverages a. Extra Expense. Extra Expense means necessary expenses you incur during the period of restoration that you would not have incurred if there had been no direct physical loss or damage to property caused by or resulting from a Covered Cause of Loss. (1) We will pay any Extra Expense to avoid or minimize the suspension of business and to continue operations : (a) (b) At the described premises; or At replacement premises or at temporary locations, including: (i) (ii) Relocation expenses; and Costs to equip and operate the replacement or temporary locations. (2) We will pay any Extra Expense to minimize the suspension of business if you cannot continue operations. (3) We will pay any Extra Expense to: (a) (b) Repair or replace any property; or Research, replace or restore the lost information on damaged valuable papers and records; -8-

12 to the extent it reduces the amount of loss that otherwise would have been payable under this Coverage Form. b. Civil Authority. We will pay for the actual loss of Business Income you sustain and necessary Extra Expense caused by action of civil authority that prohibits access to the described premises due to direct physical loss of or damage to property, other than at the described premises, caused by or resulting from any Covered Cause of Loss. The coverage for Business Income will begin 72 hours after the time of that action and will apply for a period of up to three consecutive weeks after coverage begins. The coverage for Extra Expense will begin immediately after the time of that action and will end: (1) 3 consecutive weeks after the time of that action; or (2) When your Business Income coverage ends; whichever is later. c. Alterations and New Buildings. We will pay for the actual loss of Business Income you sustain due to direct physical loss or damage at the described premises caused by or resulting from any Covered Cause of Loss to: (1) New buildings or structures, whether complete or under construction; (2) Alterations or additions to existing buildings or structures; and (3) Machinery, equipment, supplies or building materials located on or within 100 feet of the described premises and: (a) (b) Used in the construction, alterations or additions; or Incidental to the occupancy of new buildings. If such direct physical loss or damage delays the start of operations, the period of restoration will begin on the date operations would have begun if the direct physical loss or damage had not occurred. d. Extended Business Income. (1) Business Income Other Than Rental Value If the necessary suspension of your operations produces a Business Income loss payable under this policy, we will pay for the actual loss of Business Income you incur during the period that: -9-

13 (a) Begins on the date property (except finished stock ) is actually repaired, rebuilt or replaced and operations are resumed; and (b) Ends on the earlier of: (i) The date you could restore your operations with reasonable speed, to the level which would generate the business income amount that would have existed if no direct physical loss or damage occurred; or above. (ii) 30 consecutive days after the date determined in (1)(a) However, Extended Business Income does not apply to loss of Business Income incurred as a result of unfavorable business conditions caused by the impact of the Covered Cause of Loss in the area where the described premises are located. Loss of Business Income must be caused by direct physical loss or damage at the described premises caused by or resulting from any Covered Cause of Loss. (2) Rental Value If the necessary suspension of your operations produces a Rental Value loss payable under this policy, we will pay for the actual loss of Rental Value you incur during the period that: (a) Begins on the date property is actually repaired, rebuilt or replaced and tenantability is restored; and (b) Ends on the earlier of: (i) The date you could restore tenant occupancy, with reasonable speed, to the level which would generate the Rental Value that would have existed if no direct physical loss or damage occurred; or above. (ii) 30 consecutive days after the date determined in (2)(a) However, Extended Business Income does not apply to loss of Rental Value incurred as a result of unfavorable business conditions caused by the impact of the Covered Cause of Loss in the area where the described premises are located. Loss of Rental Value must be caused by direct physical loss or damage at the described premises caused by or resulting from any Covered Cause of Loss. 4. Coverage Extension -10-

14 If a Coinsurance percentage of 50% or more is shown in the Declarations, you may extend the insurance provided by this Coverage Part as follows: Newly Acquired Locations a. You may extend your Business Income Coverage to apply to property at any location you acquire other than fairs or exhibitions. b. The most we will pay for loss under this Extension is $100,000 at each location. c. Insurance under this Extension for each newly acquired location will end when any of the following first occurs: (1) This policy expires; (2) 30 days expire after you acquire or begin to construct the property; or (3) You report values to us. We will charge you additional premium for values reported from the date you acquire the property. This Extension is additional insurance. The Additional Condition, Coinsurance, does not apply to this Extension. B. EXCLUSIONS AND LIMITATIONS See applicable Causes of Loss Form as shown in the Declarations. C. LIMITS OF INSURANCE The most we will pay for loss in any one occurrence is the applicable Limit of Insurance shown in the Declarations. The limit applicable to the Coverage Extension is in addition to the Limit of Insurance. Payments under the following Additional Coverages will not increase the applicable Limit of Insurance: 1. Alterations and New Buildings; 2. Civil Authority; 3. Extra Expense; or 4. Extended Business Income. D. LOSS CONDITIONS -11-

15 The following conditions apply in addition to the Common Policy Conditions and the Commercial Property Conditions. 1. Appraisal If we and you disagree on the amount of Net Income and operating expense or the amount of loss, either may make written demand for an appraisal of the loss. In this event, each party will select a competent and impartial appraiser. The two appraisers will select an umpire. If they cannot agree, either may request that selection be made by a judge of a court having jurisdiction. The appraisers will state separately the amount of Net Income and operating expense or amount of loss. If they fail to agree, they will submit their differences to the umpire. A decision agreed to by any two will be binding. Each party will: a. Pay its chosen appraiser; and b. Bear the other expenses of the appraisal and umpire equally. If there is an appraisal, we will still retain our right to deny the claim. 2. Duties In The Event of Loss a. You must see that the following are done in the event of loss: (1) Notify the police if a law may have been broken. (2) Give us prompt notice of the direct physical loss or damage. Include a description of the property involved. (3) As soon as possible, give us a description of how, when, and where the direct physical loss or damage occurred. (4) Take all reasonable steps to protect the Covered Property from further damage, and keep a record of your expenses necessary to protect the Covered Property, for consideration in the settlement of the claim. This will not increase the Limit of Insurance. However, we will not pay for any subsequent loss or damage resulting from a cause of loss that is not a Covered Cause of Loss. Also, if feasible, set the damaged property aside and in the best possible order for examination. (5) As often as may be reasonably required, permit us to inspect the property proving the loss or damage and examine your books and records. Also permit us to take samples of damaged and undamaged property for inspection, testing and analysis, and permit us to make copies from your books and records. -12-

16 (6) Send us a signed, sworn proof of loss containing the information we request to investigate the claim. You must do this within 60 days after our request. We will supply you with the necessary forms. (7) Cooperate with us in the investigation or settlement of the claim. (8) If you intend to continue your business, you must resume all or part of your operations as quickly as possible. b. We may examine any insured under oath, while not in the presence of any other insured and at such times as may be reasonably required, about any matter relating to this insurance or the claim, including an insured s books and records. In the event of an examination, an insured s answers must be signed. 3. Limitation - Electronic Media And Records We will not pay for any loss of Business Income caused by direct physical loss of or damage to Electronic Media and Records after the longer of: a. 60 consecutive days from the date of direct physical loss or damage; or b. The period, beginning with the date of direct physical loss or damage, necessary to repair, rebuild or replace, with reasonable speed and similar quality, other property at the described premises due to loss or damage caused by the same occurrence. Electronic Media and Records are: (1) Electronic data processing, recording or storage media such as films, tapes, discs, drums or cells; (2) Data stored on such media; or (3) Programming records used for electronic data processing or electronically controlled equipment. This limitation does not apply to Extra Expense. Example No. 1: A Covered Cause of Loss damages a computer on June 1. It takes until September 1 to replace the computer, and until October 1 to restore the data that was lost when the damage occurred. We will only pay for the Business income loss sustained during the period June 1 - September 1. Loss during the period September 2 - October 1 is not covered. Example No. 2: -13-

17 A Covered Cause of Loss results in the loss of data processing programming records on August 1. The records are replaced on October 15. We will only pay for the Business income loss sustained during the period August 1 - September 29 (60 consecutive days). Loss during the period September 30 - October 15 is not covered. 4. Loss Determination a. The amount of Business Income loss will be determined based on: occurred; (1) The Net Income of the business before the direct physical loss or damage (2) The likely Net Income of the business if no loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses. (3) The operating expenses, including payroll expenses, necessary to resume operations with the same quality of service that existed just before the direct physical loss or damage; and (4) Other relevant sources of information, including: (a) (b) (c) Your financial records and accounting procedures; Bills, invoices and other vouchers; and Deeds, liens or contracts. b. The amount of Extra Expense will be determined based on: (1) All expenses that exceed the normal operating expenses that would have been incurred by operations during the period of restoration if no direct physical loss or damage had occurred. We will deduct from the total of such expenses: (a) The salvage value that remains of any property bought for temporary use during the period of restoration, once 11 operations are resumed; and (b) Any Extra Expense that is paid for by other insurance, except for insurance that is written subject to the same plan, terms, conditions and provisions as this insurance; and (2) All necessary expenses that reduce the Business Income loss that otherwise would have been incurred. c. Resumption of Operations We will reduce the amount of your: -14-

18 (1) Business Income loss, other than Extra Expense, to the extent you can resume your operations, in whole or in part, by using damaged or undamaged property (including merchandise or stock) at the described premises or elsewhere. (2) Extra Expense loss to the extent you can return operations to normal and discontinue such Extra Expense. d. If you do not resume operations, or do not resume operations as quickly as possible, we will pay based on the length of time it would have taken to resume operations as quickly as possible. 5. Loss Payment We will pay for covered loss within 30 days after we receive the sworn proof of loss, if you have complied with all of the terms of this Coverage Part and: a. We have reached agreement with you on the amount of loss; or b. An appraisal award has been made. E. ADDITIONAL CONDITION Coinsurance If a Coinsurance percentage is shown in the Declarations, the following condition applies in addition to the Common Policy Conditions and the Commercial Property Conditions. We will not pay the full amount of any loss if the Limit of Insurance for Business Income is less than: times a. The Coinsurance percentage shown for Business Income in the Declarations; b. The sum of: (1) The Net Income (Net Profit or Loss before income taxes), and (2) All operating expenses, including payroll expenses, that would have been earned or incurred (had no loss occurred) by your operations at the described premises for the 12 months following the inception, or last previous anniversary date, of this policy (whichever is later). Instead, we will determine the most we will pay using the following steps: 1. Multiply the Net Income and operating expense for the 12 months following the inception, or last previous anniversary date, of this policy by the Coinsurance percentage; -15-

19 2. Divide the Limit of Insurance for the described premises by the figure determined in step 1; and 3. Multiply the total amount of loss by the figure determined in Step 2. We will pay the amount determined in step 3. or the limit of insurance, whichever is less. For the remainder, you will either have to rely on other insurance or absorb the loss yourself. In determining operating expenses for the purpose of applying the Coinsurance condition, the following expenses, if applicable, shall be deducted from the total of all operating expenses: 1. Prepaid freight - outgoing; 2. Returns and allowances; 3. Discounts; 4. Bad debts; 5. Collection expenses; 6. Cost of raw stock and factory supplies consumed (including transportation charges); 7. Cost of merchandise sold (including transportation charges); 8. Cost of other supplies consumed (including transportation charges); 9. Cost of services purchased from outsiders (not employees) to resell, that do not continue under contract; 10. Power, heat and refrigeration expenses that do not continue under contract (if form CP is attached); 11. All ordinary payroll expenses or the amount of payroll expense excluded (if form CP is attached); and 12. Special deductions for mining properties (royalties unless specifically included in coverage; actual depletion commonly known as unit or cost depletion - not percentage depletion; welfare and retirement fund charges based on tonnage; hired trucks). Example No. 1 (Underinsurance): -16-

20 When: The Net Income and operating expenses for the 12 months following the inception, or last previous anniversary date, of this policy at the described premises would have been $400,000 The Coinsurance percentage is 50% The Limit of Insurance is $150,000 The amount of loss is $ 80,000 Step 1: $400,000 x 50% = $200,000 (the minimum amount of insurance to meet your Coinsurance requirements) Step 2: $150,000 divided by $200, Step 3: $ 80,000 x.75 = $60,000 We will pay no more than $60,000. The remaining $20,000 is not covered. Example No. 2 (Adequate Insurance): When: The Net Income and operating expenses for the 12 months following the inception, or last previous anniversary date, of this policy at the described premises would have been $400,000 The Coinsurance percentage is 50% The Limit of Insurance is $200,000 The amount of loss is $ 80,000 The minimum amount of insurance to meet your Coinsurance requirement is $200,000 ($400,000 x 50%). Therefore, the Limit of Insurance in this Example is adequate and no penalty applies. We will pay no more than $80,000 (amount of loss). This condition does not apply to the Extra Expense Additional Coverage. F. OPTIONAL COVERAGES item. If shown in the Declarations, the following Optional Coverages apply separately to each 1. Maximum Period Of Indemnity a. The Additional Condition, Coinsurance, does not apply to this Coverage Form at the described premises to which this Optional Coverage applies. -17-

21 b. The most we will pay for loss of Business Income is the lesser of: (1) The amount of loss sustained during the 120 days immediately following the direct physical loss or damage; or (2) The Limit of Insurance shown in the Declarations. 2. Monthly Limit Of Indemnity a. The Additional Condition, Coinsurance, does not apply to this Coverage Form at the described premises to which this Optional Coverage applies. b. The most we will pay for loss of Business Income in each period of 30 consecutive days after the beginning of the period of restoration is: Example: (1) The Limit of Insurance, multiplied by (2) The fraction shown in the Declarations for this Optional Coverage. When: The Limit of Insurance is $120,000 The fraction shown in the Declarations for this Optional Coverage is 1/4 The most we will pay for loss in each period of 30 consecutive days is: $120,000 x 1/4 = $30,000 If, in this example, the actual amount of loss is: Days 1-30 $40,000 Days ,000 Days ,000 $90,000 We will pay: Days 1-30 $30,000 Days ,000 Days ,000 $80,000 The remaining $10,000 is not covered. -18-

22 3. Business Income Agreed Value a. To activate this Optional Coverage: (1) A Business Income Report/Work Sheet must be made a part of this policy and must show financial data for your operations : (a) (b) of this Optional Coverage. During the 12 months prior to the date of the Work Sheet; and Estimated for the 12 months immediately following the inception (2) The Declarations must indicate that the Business Income Agreed Value Optional Coverage applies, and an Agreed Value must be shown in the Declarations. The Agreed Value should be at least equal to: by (a) The Coinsurance percentage shown in the Declarations; multiplied (b) The amount of Net Income and Operating Expenses for the following 12 months you report on the Work Sheet. b. The Additional Condition, Coinsurance, is suspended until: (1) 12 months after the effective date of this Optional Coverage; or (2) The expiration date of this policy; whichever occurs first. c. We will reinstate the Additional Condition, Coinsurance, automatically if you do not submit a new Work Sheet and Agreed Value: (1) Within 12 months of the effective date of this Optional Coverage; or (2) When you request a change in your Business Income Limit of Insurance. d. If the Business Income Limit of Insurance is less than the Agreed Value, we will not pay more of any loss than the amount of loss multiplied by: Example: (1) The Business Income Limit of Insurance; divided by (2) The Agreed Value. -19-

23 When: The Limit of Insurance is $100,000 The Agreed Value is $200,000 The amount of loss is $ 80,000 Step (a): $100,000 divided by $200,000 =.50 Step (b):.50 x $80,000 = $40,000 We will pay $40,000. The remaining $40,000 is not covered. 4. Extended Period Of Indemnity Under paragraph A.3.d., Extended Business Income, the number 3011 in subparagraph (2)(b) is replaced by the number shown in the Declarations for this Optional Coverage. G. DEFINITIONS 1. Finished Stock means stock you have manufactured. Finished stock also includes whiskey and alcoholic products being aged, unless there is a Coinsurance percentage shown for Business Income in the Declarations. Finished stock does not include stock you have manufactured that is held for sale on the premises of any retail outlet insured under this Coverage Part. 2. Operations means: a. Your business activities occurring at the described premises; and b. The tenantability of the described premises, if coverage for Business Income including Rental Value or Rental Value applies. 3. Period of Restoration means the period of time that: a. Begins: (1) 72 hours after the time of direct physical loss or damage caused by or resulting from any Covered Cause of Loss at the described premises; and (2) Immediately after the time of direct physical loss or damage for Extra Expense Coverage; premises; and caused by or resulting from any Covered Cause of Loss at the described -20-

24 b. Ends on the earlier of: (1) The date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or (2) The date when business is resumed at a new permanent location. Period of restoration does not include any increased period required due to the enforcement of any ordinance or law that: (1) Regulates the construction, use or repair, or requires the tearing down of any property; or (2) Requires any insured or others to test for, monitor, clean up, remove, contain, treat, detoxify or neutralize, or in any way respond to, or assess the effects of pollutants. The expiration date of this policy will not cut short the period of restoration. 4. Pollutants means any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. Waste includes materials to be recycled, reconditioned or reclaimed. 5. Rental Value means the: a. Total anticipated rental income from tenant occupancy of the premises described in the Declarations as furnished and equipped by you, and b. Amount of all charges which are the legal obligation of the tenant(s) and which would otherwise be your obligations, and you. c. Fair rental value of any portion of the described premises which is occupied by CP Copyright, Insurance Services Office, Inc., 1994 Note: The foregoing Appendix A consists of information which is copyrighted by and proprietary to Insurance Services Office, Inc. ( ISO Material ). Use of the ISO Material is limited to ISO Participating Insurers and their Authorized Representatives. Use by ISO Participating Insurers is limited to use in those jurisdictions for which the insurer has an appropriate participation with ISO. Use of the ISO Material by Authorized Representatives is limited to use solely on behalf of one or more ISO Participating Insurers. -21-

25 APPENDIX II RENTAL INCOME CHECKLIST A. When purchasing rental insurance or reviewing an existing policy of rental insurance, determine the following: 1. Nature and extent of coverage on underlying property policy, since this will govern the covered losses for which rental insurance will be applicable. 2. Desired coverage, whether rental insurance only, or both business income and rental insurance. 3. Existence of any maximum indemnity period during which insurance proceeds will be paid. 4. Maximum indemnity amount (i.e. dollar limit of policy). 5. Coinsurance percentage, if any (shown on Declarations page), and whether the dollar limit of rental insurance is anticipated to satisfy coinsurance condition. 6. Desirability of ordinance or law coverage, for both property loss and rental insurance, if building is likely to be subject to significant code upgrade requirements on restoration. 7. Desirability of Extra Expense or Extended Business Income endorsements. The former is not likely to be of significance unless insured would need temporary relocation in order to minimize losses; the latter will be of benefit if there is a gap between the time the building is restored to tenantability and the time rental income recommences, although the 30-day limit to this coverage certainly lessens its attraction. 8. Desirability of off-premises services coverage. If building leases provide for abatement in event of interruption in utility services, or if the leasing market is heading in the direction of providing such abatement, this endorsement will cover building owner s risk to extent the interruption is caused by off-premises physical loss. 9. Desirability of contingent business income coverage, which insures against losses resulting from physical loss on non-owned property, most apt example of which is loss of percentage rent suffered by shopping center owner due to reduction in gross sales in center attributable to physical loss at non-owned anchor tenant s building. -22-

26 B. After a loss has occurred, 1. Read and follow the policy procedures with respect to Duties in the Event of Loss in the Loss Conditions section of the policy. 2. Determine if there are any loss mitigation measures that can or need to be adopted. 3. Determine scope of rent abatement provisions in leases and whether rental insurance proceeds will be adequate to cover abatement entitlements. 4. Determine estimated period of restoration, based on policy definition of a period that begins 72 hours after the time of direct physical loss or damage and ending on [t]he date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality. Also determine whether rental value of the property for this period will exceed the policy limit. Period of restoration is likely to be subject area of most contention with insurer, particularly if election is made not to restore. Keep track of time it takes insurer to adjust loss in order to substantiate later claim for restoration period extension, and develop prospective expert testimony to support insured s opinion as to proper duration of restoration period. 5. If it appears that loss is to be adjusted through appraisal, be prepared with selection of appraiser that satisfies impartial requirement but is nonetheless an advocate for the insured s position. Also discuss with prospective appraiser candidates appraiser would propose for third umpire appraiser. 6. Note that insurer is not obligated to pay for covered loss until amount of loss has been established by agreement or appraisal. This will leave insured without funding on current basis to replace abated rental income, and may necessitate some negotiated arrangement with insurer for partial funding pending resolution of amount of loss. -23-