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Important Considerations when Purchasing Insurance to Protect
By John E. Heintz and Kenneth Berline
The week of May 27 through June 2, 2012 has been declared National Hurricane Preparedness Week. According to the National Weather Service, “history teaches that a lack of hurricane awareness and preparation are common threads among all major hurricane disasters. By knowing your vulnerability and what actions you should take, you can reduce the effects of a hurricane disaster.” In addition to preparing to protect human life and minimize property damage in the event a storm strikes, businesses also should consider in advance whether they have purchased adequate first-party insurance for hurricane-related loss.
First-party insurance policies are a valuable asset that can protect your business from loss arising from hurricanes. Such policies may provide coverage for property damage, coverage for the extra expenses incurred in dealing with the effects of a disaster, losses resulting from the interruption of your business or the business of a supplier or vendor upon which your business relies, and even expenses incurred in advance to minimize any damage or loss.Careful consideration of the following issues by you, in consultation with your broker or an insurance coverage attorney, will help ensure that your business procures adequate insurance to protect it from loss associated with a hurricane.
1. Determine Whether the Insurance Policy Provides Insurance Coverage for Damage due to both Wind and Flood.
It is essential that you carefully review all aspects of your property policy, including policy exclusions, to determine if loss from both flood and wind is covered. Standard property insurance policies used by the insurance industry typically do not provide coverage for damage to or loss of real or personal property caused by flood. In some locations, insurance companies also may exclude coverage for windstorms, such as hurricanes. Do not be misled by a characterization of an insurance policy as an “all risk” or “all peril” policy—such policies still may contain exclusions for flood and windstorm. Accordingly, it is critical that you carefully examine any exclusions or limitations in the policy for flood and windstorm. If loss for flood and windstorm is excluded, you may want to purchase supplemental coverage or a separate policy to cover loss from these perils. If you decide to purchase coverage for one of these perils (e.g., you buy insurance for windstorm, but not flood), pay careful attention to any language in the policy that may purport to bar insurance recovery entirely if your business sustains loss due to both covered and uncovered causes of loss.
2. Consider Purchasing Coverage for Loss of Business Income and Other Coverage Extensions.
The most basic first-party property policy indemnifies the insured for the value of the covered property that has been lost or damaged. Business owners, however, should also consider purchasing additional coverage to compensate the business for loss of income that may occur as a result of damage to the insured’s property or the property of its key customers and suppliers. Business interruption coverage may indemnify the insured for the income that is lost as a direct result of damage by an insured peril to insured property. Contingent Business Interruption (CBI) coverage protects against income loss or increased expenses suffered as a result of damage by an insured peril to the property of another business or individual upon which the insured depends. For example, CBI coverage protects against economic losses caused by the inability of a “direct” supplier to get its goods to the insured because of damage to or destruction of the supplier’s property by a peril covered under the insured’s policy. CBI coverage comes in many forms with a variety of limitations, so insureds need to choose carefully based on their particular critical business relationships.
In addition, other important coverages may provide a valuable source of recovery. These coverages may include: extra expense, interruption by civil authority, ingress/egress, accounts receivable, leasehold interest, rental value, royalties, course of construction, demolition and increased cost of construction, decontamination costs, debris removal, and service interruption. In particular, you should consider the scope of losses your business could suffer if an evacuation order is issued in advance of a storm and the extent to which such losses would be covered.
Your broker should be able to provide further information regarding all these coverages and assist you in determining if these coverages are right for your business. Similarly, your counsel should be able to assist in providing you with an assessment of particular policy wordings that often receive various interpretations by courts after disputes have arisen.
3. Consider the Amount of the Deductible.
In the event of a loss, you may be required to pay a “deductible,” which is the amount that you must pay toward your losses before you can recover from your insurance company. For example, many policies set a specific deductible for loss due to windstorm and flood. In addition, some policies also may require that a deductible be paid for each affected location. The amount of the deductible and whether it applies on a “per occurrence” basis typically are negotiable terms that should not be overlooked during the renewal process. Although a higher deductible may result in a lower premium, carefully consider whether your business will be in a position to pay the deductible if disaster strikes.
4. Consider the Per Occurrence Limit, Aggregate Limit, and Sublimits.
Your policy will have a limit on the amount of coverage that will be paid by your insurance company for a covered loss. A “per occurrence” limit is the maximum amount that the insurance company will pay for one particular incident. An “aggregate limit” is the maximum amount the insurance company will pay for the entire policy period, meaning the entire duration of the policy. A “sublimit” is any limit of insurance which exists within another limit. For example, your policy may have a sublimit for “flood” or “windstorm,” which limits recovery for loss arising out of such events to a specified dollar limit per occurrence, even though the policy has a higher overall limit. Your policy also may have a provision limiting the amount of coverage for loss due to a “named windstorm” (i.e., a storm that has been declared by the National Weather Service to be a hurricane, typhoon, tropical cyclone, or tropical depression) regardless of the number of coverages, locations, or perils involved including, but not limited to, both flood and wind.
5. Compare the Value of Your Property with Policy Limits and Analyze the Policy's Valuation Provision.
In order to ensure that you purchase the proper amount of coverage, it is important to determine the value of the business’s real and personal property. Real property value can be determined in two ways—market value or replacement cost. Market value reflects how much money you would get if you sold your business’s real property. Replacement cost reflects how much it would cost to replace your business’s real property based on current construction prices. The value of a business’s personal property can be established by examining inventories of personal property, including equipment and machinery, which should be complete and current.After assessing the value of the business’s real and personal property, compare that value with any limit of insurance to determine whether the proper amount of coverage has been purchased to replace lost or damaged property in the event of a hurricane. In assessing coverage provided by the policy in the event of loss, determine whether the policy will reimburse you for loss based on “actual cash value” or “replacement cost value.” “Actual cash value” has been construed to mean the cost to replace with materials of like kind and quality, less depreciation. “Replacement cost value” is typically defined as the cost to replace lost or damaged property with materials of like kind and quality. Depreciation is the primary difference between replacement cost value and actual cash value. In some instances, the policy may provide that the value of property is determined based on the amount designated on a schedule submitted to and accepted by the insurance company. It is imperative that any such schedules be current and complete.
6. Consider Whether Your Property Is Underinsured.
In exchange for a rate credit, most commercial property insurance policies contain a coinsurance provision that requires the insured business to insure the covered property to a specified percentage of its full value—usually 80, 90, or 100 percent. If the business sustains a loss, and it is determined that the limits carried are less than those required by the coinsurance provision, the insured business’s recovery for loss will be limited to the same percentage of loss as the ratio of the amount of insurance carried to the amount of insurance required. Your business may be able to avoid this issue by obtaining a policy with an agreed value provision. An agreed value provision typically provides that the requirements of the coinsurance clause have been met by the insurance amounts shown in the policy. The insurer typically will require you to submit a signed statement of the property values as a condition of including an agreed value provision in the policy. You may be required to provide a recent appraisal or explanation to the insurer setting forth how the values were determined.Careful consideration of the above issues and, if necessary, consultation with an experienced agent, broker, or attorney, will help assure that you have done all you can to purchase insurance to protect your business from hurricane-related loss.
About the Authors:
John E. Heintz and Kenneth Berline Trotter are attorneys in Dickstein Shapiro LLP’s Insurance Coverage Practice, and both have represented clients in securing coverage for property and business interruption losses arising out of hurricanes and other catastrophic events. Mr. Heintz may be reached at email@example.com, and Mr. Trotter may be reached at firstname.lastname@example.org.
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Dickstein Shapiro LLP
John E. Heintz
Kenneth Berline Trotter