The Three Deadly Sins of Property Insurance

Our furnace malfunctioned last week causing smoke damage to our building, machinery and inventory. We already paid our deductible, but now the insurance company is telling us that they will only pay for one- half of the damages.

 My building burned down last month, but now the insurance company refuses to pay for the fire loss because the fire sprinkler valve was not chained and locked in the full-open position.  My company occupies three offices in our building and has placed the remaining nine offices up for rent. Yesterday we discovered that a pipe had broken over the weekend and water leaked through all three floors. Our insurance company refuses to pay the claim since the building was not “sufficiently occupied” at the time of the loss.house-on-fire Many insureds are surprised to learn that their insurance policies include hidden penalty clauses buried deep within the fine print. Insurance  companies  are  quick  to  invoke these clauses in order to reduce or deny coverage following a loss. The  purpose  of  this  Special  Report  is  to review the three main penalty clauses found in most property policies and discuss how these clauses ultimately affect coverage.

COINSURANCE

What  do  you  mean  the  insurance company is only going to pay for one-half of the damages? A coinsurance clause allows the insurance company to automatically reduce the amount of their property loss settlement if, in their opinion, you did not maintain adequate insurance values at the time of a loss. Most policies that include a coinsurance provision  will  display  a  coinsurance percentage on the declarations page (usually80%). At a minimum, this percentage is the proportion of the replacement value that the insured promises to maintain. Put another way, the insured is promising the insurance company that it will maintain insurance values of at least 80% of the actual replacement cost of the property. As long as the insured keeps their promise, there is no penalty. On the other hand, if the insured did not maintain an insurance value of at least 80% of the actual replacement cost, the insurance company will reduce the amount of their loss settlement in proportion to the amount they were underinsured. Since a pre-loss replacement cost value is nearly impossible to calculate with any degree of   certainty,  the   insurance  company  will always try to reduce their loss payment based on their own post-loss assessment of the replacement cost. By way of example, assume that you suffer a $300,000 fire loss under a property policy that has  a  building  limit of $500,000. After  the loss, the insurance company determines that the actual replacement cost of  the building was $1,000,000, not the $500,000 that you insured. In this case, the policyholder only insured 50% of the actual replacement cost when  they  should  have  maintained  at  least 80%. The insurance company will then reduce their loss settlement by the amount the policyholder was underinsured).    For a $300,000 fire loss, the insurance company would only pay $187,500. But my insurance agent told me that I don’t have a coinsurance clause and my policy says that I have a “blanket limit.” Does this mean I am covered? Instead of a coinsurance provision, some policies include what is called a “margin clause.” This language can be quite deceiving in that it often leads the insured to believe that they have a blanket limit of insurance that can be applied to any location. This is not the case. A  margin  clause  allows  the  insurance company to limit the amount of coverage available for each location by a certain percentage,   despite   any   appearance   of   a blanket limit. For example, if the policy shows an insured value of $300,000 and it actually costs $500,000 to rebuild the structure, the most an insurance policy with a 20% margin clause  will  pay  is  $360,000 (i.e.  120%  of 300,000) even if there is a $2,000,000 blanket limit. Since  replacement costs  vary  depending on the  construction  costs  and  material availability, property policies should never include a coinsurance provision or a margin clause. But my insurance agent promised me that the margin clause would not apply to certain properties even though the policy seems to say otherwise. In Michigan, the insurance agent is the agent of the policyholder, not the insurance company. AutoOwners Ins Co v Michigan Mut Ins Co  223  Mich  App  205  (1997).  Statements made by insurance agents on behalf of the insurance company are not binding on the carrier. Regardless of what the insurance agent may have said, the policy must be enforced in accordance with its terms. Farm Bureau Mut Ins Co of Michigan v Nikkel, 460 Mich 558 (1999); Devillers v. Auto Club Ins Ass’n, 473 Mich 562 (2005).

PROTECTIVE SAFEGUARDS

 Do not be fooled. The policyholder is not the one being protected by a “protective safeguards provision.” A protective safeguards provision allows the insurance company to deny coverage if certain conditions are not satisfied at the time of loss. For example, if the fire sprinkler system does not operate properly, there is no coverage. If the  burglar  alarm system  does  not  go  off, there is no coverage. If the smoke detectors do not work, there is no coverage, and so on.  A common protective safeguards provision that is included in most property policies is included below. Protective Safeguards:

We will not pay for loss or damage caused by or resulting from fire if, prior to the fire, you: 1. Knew of any suspension or impairment in any protective  safeguard  listed  in  the  Schedule above and failed to notify us of that fact; or 2. Failed  to  maintain  any  protective  safeguard listed in the Schedule above, and over which you had control, in complete working order. If part of an Automatic Sprinkler System is shut off due to breakage, leakage, freezing conditions or opening of sprinkler heads, notification to us will not be necessary if you can restore full protection within 48 hours.

 In Burmac Metal Finishing Co. v. West Bend Mut. Ins. Co.,1  the insurance company denied coverage for damage caused to the insured’s building after a natural gas explosion based on the insured’s failure to properly maintain its automatic sprinkler system as required by the protective safeguards endorsement to the policy. In other cases, insurance companies have attempted to deny coverage if the water valve for the fire suppression valve was not chained in the full open position prior to the loss. You should never have a protective safeguards endorsement on a property insurance policy. 

VACANCY

A  vacancy  clause  allows  the  insurance company to reduce or deny coverage if the structure was not sufficiently occupied at the time of a loss. Most   vacancy   clauses   limit   coverage   as follows:

Vacancy: a.     Description Of Terms (1)  As  used  in  this  Vacancy  Condition,  the term building and the term vacant have the meanings  set  forth  in  (1)(a)  and  (1)(b) below: (a)   When this policy is issued to a tenant, and   with   respect   to   that   tenant’s interest in Covered Property, building means  the  unit  or  suite  rented  or leased to the tenant. Such building is vacant   when   it   does   not   contain enough business personal property to conduct customary operations. (b)  When  this  policy  is  issued  to  the owner or general lessee of a building, building  means  the  entire  building. Such building is vacant unless at least 31% of its total square footage is: (i)   Rented to a lessee or sub-lessee and used by the lessee or sub- lessee to conduct its customary operations; and/or (ii)   Used by the building owner to conduct customary operations. (2)  Buildings under construction or renovation are not considered vacant. b.           Vacancy Provisions If the building where loss or damage occurs has been vacant for more than 60 consecutive days before that loss or damage occurs: (1)  We will not pay for any loss or damage caused by any of the following even if they are Covered Causes of Loss: (a)  Vandalism; (b)  Sprinkler   leakage,   unless   you   have protected the system against freezing; (c)   Building glass breakage; (d)  Water damage; (e)  Theft; or (f)   Attempted theft. (2)  With respect to Covered Causes of Loss other than those listed in b.(1)(a) through b.(1)(f) above, We will reduce the  amount otherwise pay for the loss or damage by 15%.

In Mallett v Farm Bureau Ins Co, the insurance carrier denied all coverage since the rental property was vacant for more than 60 days prior to it being destroyed in a fire. Under the terms of the policy the property owner was not entitled to insurance benefits because the policy did not offer coverage for properties vacant for over 60 days. In Alexander 1776, LLC v St. Paul Travelers, the insurance  company  denied  coverage  for  an $800,000 water damage claim from a pipe break since less than 50% of the total square footage of the building was occupied at the time of the loss. You should never have a vacancy clause on any property policy.

CONCLUSION

 Insurance companies often rely on the fine print of obscure penalty clauses in order to reduce or deny the coverage after a loss. Some insurance companies will waive these clauses if the agent requests it. If the insurance company refuses, the policyholder should consider it an indication of how that carrier will respond to any claim brought under the policy. Please sign up for the digital downloads.  You will gain access to over a hundred special reports related to both personal and commercial insurance. For any of your personal or commercial insurance needs, please contact us. Contact Us

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