Property and Business Loss Insurance: Planning for Nature's Surprises

ISO Building and Personal Property Coverage Form #CP 00 10 is the common ISO form that describes the building and property that are insured (as well as the property that is excluded). Another form must be added to spell out the events that will trigger the insurance company's payment of losses ' the “Covered Causes of Loss.” There are generally three types of commercial property “Causes of Loss” policies and forms for those policies: Basic Form, which covers listed, common perils such as fire (ISO Form #CP 10 10); Broad Form, which provides Basic Form coverage plus coverage for listed additional perils (ISO Form #CP 10 20); and Special Form, which is the replacement for the old “All Risk” form and which covers “all risks of direct physical loss” except to the extent excluded or limited in the policy (ISO Form #CP 10 30).

Whether a policy covers windstorm loss or imposes a higher deductible for this type of loss depends on the wording of the policy. In coastal areas, owners must find out whether they need express coverage for windstorm in their area or if they need special coverage to have the same deductibles for windstorm that they have for other risks.

Flood insurance is the best-known exclusion from all three types of property insurance policies. At this time, property owners can obtain flood insurance for both residential and commercial properties through policies issued by private commercial insurers ' this insurance is, however, sponsored by the National Flood Insurance Program, a FEMA program. National Flood Insurance Program policies have a $500,000 limit for a commercial building and a $500,000 limit for its contents, although additional flood coverage can be purchased from a private insurer, such as a Lloyds of London entity.

But the National Flood Insurance Program, like many federal programs, has been under Congressional fire. After a few years of short-term extensions of the program, on July 6, 2012, the Biggert-Waters Flood Insurance Reform Act of 2012 became effective and extended the National Flood Insurance Program's authority through Sept. 30, 2017. See Federal Emergency Management Agency, Section on the National Flood Insurance Program, National Flood Insurance Program: Reauthorization Guidance (July 16, 2012), available at www.fema.gov/national-flood-insurance-program/national-flood-insurance-program-reauthorization-guidance.

This Act made several changes to the existing program, including phasing out certain subsidies for severe repetitive loss properties and allowing greater annual premium increases. Property owners can probably expect Congress and the program administrators to make additional changes in the program in the future to satisfy budget constraints and in reaction to new natural disasters like the recent Hurricane Sandy.'

As in the past, a flood insurance policy will not generally be issued to a buyer of property in the Gulf region if a named storm is then in the Gulf. Consequently, when a buyer contracts to buy property in a coastal or flood-prone area, the buyer should include in its purchase agreement a provision stating that if for some reason flood insurance is not available on the closing date, then the buyer may extend the time for closing until it becomes available. Of course, the seller will want to limit this extension and perhaps permit the buyer to terminate the purchase agreement if no flood insurance becomes available before a specified outside closing date.

Earthquake coverage is also needed in many regions, but it too can be expensive.

The most comprehensive ISO form of generally available property insurance is provided by Building and Personal Property policy form (ISO CP 00 10) with the Special Form Causes of Loss (ISO CP 10 30) and with added coverage for otherwise excluded risks (such as flood, windstorm if it is a policy exclusion, earthquake, and volcanic eruption).

Loss of Business/Loss of Rents Coverage

A Basic, Broad, or Special Form policy will reimburse the insured only for the repair or replacement cost of the physical property (up to the policy limits, and subject to coinsurance and other special coverage amount provisions) ' not for loss of use or profits. National Flood Insurance Program insurance also does not cover business loss or interruption. What about a retail operator's loss of business and a landlord's loss of rents? What about the expenses that remain payable while the property is not being operated?

If an owner wants to have coverage for business losses and loss of rents, this owner must carry express business income coverage. This can be provided through an endorsement to the property damage policy or a separate business income policy. See ISO CP 00 32 24 02, ISO CP 00 30 04 02.

In most cases, the proceeds of this business income coverage will be payable only if the business income losses are actually the result of damage caused: 1) by one of the specified perils, 2) to the specified property, which is generally the property in which the business is operating. Id. These days, however, a business can also obtain coverage for income losses caused by civil authority (for example, governmental restrictions after a hurricane), loss of ingress and egress, or damage to another property on which the insured's business relies for its operation, such as a convention center. See generally Timothy J. King, The Next Level of Business Income Coverage, IRMI.com, November 2011,' available at http://www.irmi.com/expert/articles/2011/armc11-insurance-claims-management.aspx%20'(last visited March 6, 2013); William K. Austin, Limiting the Interruption in Business Interruption, IRMI.com, October 2010, available at http://www.irmi.com/expert/articles/2010/austin10-commercial-property-insurance.aspx%20'(last visited March 6, 2013).

Loss of rents coverage is a type of business income coverage that is intended to provide coverage for the fair rental value (less operating costs) of the insured property or the portion of that property that is either rented or is offered for rent. See DePhelps v. Safeco Ins. Co. of America, 65 P.3d 1234 (Wash. Ct. App. 2003). Loss of rents coverage is often provided as part of broader coverage that includes all loss of business income ' or at least loss of business income to the extent that it is not excluded and to the extent that the insured can prove the loss. See ISO CP 00 32 04 02. It is important that a landlord understand that in a form like ISO CP 00 04 02, rental loss will be part of the covered business income only if the insured selects ' and the policy declaration page shows the selection of ' the rental loss coverage option.

Coverage Amounts

The dollar limits of coverage set out on any property or business income policy's declarations page are the most that an insurer will pay in any single occurrence.

Unless a building is very old and its replacement cost exceeds what the owner wants to spend on replacing it, the owner generally asks that the property insurance be issued on a “replacement cost” basis. Most lenders also require “replacement cost” coverage. If the policy covers the “replacement cost” of the improvements, then if there is a loss, the policy will require the insurer to pay the cost to replace the lost or damaged property with other comparable property, with no deduction for depreciation.

An alternative to “replacement cost” coverage is coverage for the “actual cash value” of the improvements. For a partial loss, “actual cash value” coverage will pay the cost of repairing, rebuilding, or replacing the property, less a deduction for depreciation. Of course, neither “replacement cost” nor “actual cash value” coverage will pay more than the insured limits.

A business income policy, on the other hand, does not reimburse the owner for the full sales amounts lost by reason of the covered event since this is not the owner's actual loss. This policy covers only the insured's “net income” loss ' the loss of: 1) the insured's gross sales or other gross receipts, less 2) the operating expenses of the business. See, e.g., Morton M. Goldbert Auction Galleries, Inc., v. Canco, Inc., 650 So. 2d 801 (La. App. 4 Cir 1/31/95). Courts have held that if the insured's business was not operating at a profit before the casualty, then no business interruption insurance proceeds will be payable for the period after the casualty ' business interruption coverage is not a guaranty of recovery. See Dictiomatic, Inc. v. U.S. Fid. & Guar. Co., 127 F. Supp. 2d 1239 (S.D. Fla. 1999). Most business income policies include coverage for the insured's “continuing normal operating expenses” incurred during the specified period. See ISO CP 00 32 24 02. The overall coverage limits will also cap the amount that the owner may recover under this policy.

Loss of rents insurance is also limited in amount (frequently set out in the coverage limits) or duration, or both. If the landlord has the obligation of rebuilding the leased premises and rent abates during the rebuilding, then it can determine the amount of rental loss coverage it needs by estimating the time it needs to rebuild, then being sure that it has coverage for any additional free rent period the tenant receives under the lease for re-fixturing and the like. The landlord should be sure that the tenant's free rent period is no longer than the period covered by the landlord's rental loss insurance policy.

If a lease is a ground lease that obligates the tenant to continue to pay rent even during damage periods, the tenant needs to be sure that its insurance limits and policy language cover this rent obligation as part of the “continuing normal operating expenses” of the property.

All businesses should also explore additional “extra expenses” coverage to reimburse them for the necessary expenses incurred during the restoration period that would not have been incurred had there been no physical loss of property, such as the additional costs of operating at a temporary location. Compare ISO CP 00 30 24 02 to ISO CP 00 32 04 02.'

Most policy forms also contain coinsurance (underinsurance) policy provisions that can limit an owner's recovery both for property damage and for loss of business income. If the policy contains a coinsurance provision and the policy limits specified are too far below the aggregate amount that could have been insured, then the insured's recovery will be reduced by a coinsurance calculation. An agreed amount stipulation with a waiver of coinsurance should eliminate this issue, at least for a specified period. IMRI, Glossary of Insurance and Risk Management Terms, available at www.irmi.com/online/insurance-glossary/terms/a/agreed-value-coverage-option-or-provision.aspx.

Conclusion

Of course, insurers have made many changes in their insurance coverages by reason of their risk experience during the last 20 years, and insurance companies are continuing to refine their policies and coverages all the time. Property and business owners need to evaluate the ways in which their property or business may be damaged by natural occurrences, explain these risks and the anticipated types and periods of loss to their insurance advisors, and at least consider all types of coverages that address these real loss possibilities.

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Marie Moore is a Partner in the New Orleans firm of Sher Garner Cahill Richter Klein & Hilbert, L.L.C. She can be reached at 504-299-2100 or [email protected].

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Last year's tornadoes, flooding and fires, the periodic earthquakes in some parts of the country, and recent hurricanes have forced property and business owners to be more knowledgeable than ever about the ways they can protect their investments. Insurance is the best protection for unexpected casualties, and owners need to understand the basic coverages that are now available so that they can obtain policies that protect them from both property and business income losses. They also need to understand that many changes in these coverages have been made during the last few years.

Physical Loss or Damage

Property owners expect their property insurance to provide compensation for the loss of, or damage to, their property. This coverage can be on an insurance company form or can be a “manuscript” policy, which is a policy that is customized for a particular insured. The Insurance Services Office, Inc. (ISO) publishes forms for its underwriter clients. These forms (when a lawyer can get a copy of them) provide good examples of the industry-sanctioned coverages customary on the date of the form.

ISO Building and Personal Property Coverage Form #CP 00 10 is the common ISO form that describes the building and property that are insured (as well as the property that is excluded). Another form must be added to spell out the events that will trigger the insurance company's payment of losses ' the “Covered Causes of Loss.” There are generally three types of commercial property “Causes of Loss” policies and forms for those policies: Basic Form, which covers listed, common perils such as fire (ISO Form #CP 10 10); Broad Form, which provides Basic Form coverage plus coverage for listed additional perils (ISO Form #CP 10 20); and Special Form, which is the replacement for the old “All Risk” form and which covers “all risks of direct physical loss” except to the extent excluded or limited in the policy (ISO Form #CP 10 30).

Whether a policy covers windstorm loss or imposes a higher deductible for this type of loss depends on the wording of the policy. In coastal areas, owners must find out whether they need express coverage for windstorm in their area or if they need special coverage to have the same deductibles for windstorm that they have for other risks.

Flood insurance is the best-known exclusion from all three types of property insurance policies. At this time, property owners can obtain flood insurance for both residential and commercial properties through policies issued by private commercial insurers ' this insurance is, however, sponsored by the National Flood Insurance Program, a FEMA program. National Flood Insurance Program policies have a $500,000 limit for a commercial building and a $500,000 limit for its contents, although additional flood coverage can be purchased from a private insurer, such as a Lloyds of London entity.

But the National Flood Insurance Program, like many federal programs, has been under Congressional fire. After a few years of short-term extensions of the program, on July 6, 2012, the Biggert-Waters Flood Insurance Reform Act of 2012 became effective and extended the National Flood Insurance Program's authority through Sept. 30, 2017. See Federal Emergency Management Agency, Section on the National Flood Insurance Program, National Flood Insurance Program: Reauthorization Guidance (July 16, 2012), available at www.fema.gov/national-flood-insurance-program/national-flood-insurance-program-reauthorization-guidance.

This Act made several changes to the existing program, including phasing out certain subsidies for severe repetitive loss properties and allowing greater annual premium increases. Property owners can probably expect Congress and the program administrators to make additional changes in the program in the future to satisfy budget constraints and in reaction to new natural disasters like the recent Hurricane Sandy.'

As in the past, a flood insurance policy will not generally be issued to a buyer of property in the Gulf region if a named storm is then in the Gulf. Consequently, when a buyer contracts to buy property in a coastal or flood-prone area, the buyer should include in its purchase agreement a provision stating that if for some reason flood insurance is not available on the closing date, then the buyer may extend the time for closing until it becomes available. Of course, the seller will want to limit this extension and perhaps permit the buyer to terminate the purchase agreement if no flood insurance becomes available before a specified outside closing date.

Earthquake coverage is also needed in many regions, but it too can be expensive.

The most comprehensive ISO form of generally available property insurance is provided by Building and Personal Property policy form (ISO CP 00 10) with the Special Form Causes of Loss (ISO CP 10 30) and with added coverage for otherwise excluded risks (such as flood, windstorm if it is a policy exclusion, earthquake, and volcanic eruption).

Loss of Business/Loss of Rents Coverage

A Basic, Broad, or Special Form policy will reimburse the insured only for the repair or replacement cost of the physical property (up to the policy limits, and subject to coinsurance and other special coverage amount provisions) ' not for loss of use or profits. National Flood Insurance Program insurance also does not cover business loss or interruption. What about a retail operator's loss of business and a landlord's loss of rents? What about the expenses that remain payable while the property is not being operated?

If an owner wants to have coverage for business losses and loss of rents, this owner must carry express business income coverage. This can be provided through an endorsement to the property damage policy or a separate business income policy. See ISO CP 00 32 24 02, ISO CP 00 30 04 02.

In most cases, the proceeds of this business income coverage will be payable only if the business income losses are actually the result of damage caused: 1) by one of the specified perils, 2) to the specified property, which is generally the property in which the business is operating. Id. These days, however, a business can also obtain coverage for income losses caused by civil authority (for example, governmental restrictions after a hurricane), loss of ingress and egress, or damage to another property on which the insured's business relies for its operation, such as a convention center. See generally Timothy J. King, The Next Level of Business Income Coverage, IRMI.com, November 2011,' available at http://www.irmi.com/expert/articles/2011/armc11-insurance-claims-management.aspx%20'(last visited March 6, 2013); William K. Austin, Limiting the Interruption in Business Interruption, IRMI.com, October 2010, available at http://www.irmi.com/expert/articles/2010/austin10-commercial-property-insurance.aspx%20'(last visited March 6, 2013).

Loss of rents coverage is a type of business income coverage that is intended to provide coverage for the fair rental value (less operating costs) of the insured property or the portion of that property that is either rented or is offered for rent. See DePhelps v. Safeco Ins. Co. of America , 65 P.3d 1234 (Wash. Ct. App. 2003). Loss of rents coverage is often provided as part of broader coverage that includes all loss of business income ' or at least loss of business income to the extent that it is not excluded and to the extent that the insured can prove the loss. See ISO CP 00 32 04 02. It is important that a landlord understand that in a form like ISO CP 00 04 02, rental loss will be part of the covered business income only if the insured selects ' and the policy declaration page shows the selection of ' the rental loss coverage option.

Coverage Amounts

The dollar limits of coverage set out on any property or business income policy's declarations page are the most that an insurer will pay in any single occurrence.

Unless a building is very old and its replacement cost exceeds what the owner wants to spend on replacing it, the owner generally asks that the property insurance be issued on a “replacement cost” basis. Most lenders also require “replacement cost” coverage. If the policy covers the “replacement cost” of the improvements, then if there is a loss, the policy will require the insurer to pay the cost to replace the lost or damaged property with other comparable property, with no deduction for depreciation.

An alternative to “replacement cost” coverage is coverage for the “actual cash value” of the improvements. For a partial loss, “actual cash value” coverage will pay the cost of repairing, rebuilding, or replacing the property, less a deduction for depreciation. Of course, neither “replacement cost” nor “actual cash value” coverage will pay more than the insured limits.

A business income policy, on the other hand, does not reimburse the owner for the full sales amounts lost by reason of the covered event since this is not the owner's actual loss. This policy covers only the insured's “net income” loss ' the loss of: 1) the insured's gross sales or other gross receipts, less 2) the operating expenses of the business. S ee, e.g., Morton M. Goldbert Auction Galleries, Inc., v. Canco, Inc. , 650 So. 2d 801 (La. App. 4 Cir 1/31/95). Courts have held that if the insured's business was not operating at a profit before the casualty, then no business interruption insurance proceeds will be payable for the period after the casualty ' business interruption coverage is not a guaranty of recovery. See Dictiomatic, Inc. v. U.S. Fid. & Guar. Co. , 127 F. Supp. 2d 1239 (S.D. Fla. 1999). Most business income policies include coverage for the insured's “continuing normal operating expenses” incurred during the specified period. See ISO CP 00 32 24 02. The overall coverage limits will also cap the amount that the owner may recover under this policy.

Loss of rents insurance is also limited in amount (frequently set out in the coverage limits) or duration, or both. If the landlord has the obligation of rebuilding the leased premises and rent abates during the rebuilding, then it can determine the amount of rental loss coverage it needs by estimating the time it needs to rebuild, then being sure that it has coverage for any additional free rent period the tenant receives under the lease for re-fixturing and the like. The landlord should be sure that the tenant's free rent period is no longer than the period covered by the landlord's rental loss insurance policy.

If a lease is a ground lease that obligates the tenant to continue to pay rent even during damage periods, the tenant needs to be sure that its insurance limits and policy language cover this rent obligation as part of the “continuing normal operating expenses” of the property.

All businesses should also explore additional “extra expenses” coverage to reimburse them for the necessary expenses incurred during the restoration period that would not have been incurred had there been no physical loss of property, such as the additional costs of operating at a temporary location. Compare ISO CP 00 30 24 02 to ISO CP 00 32 04 02.'

Most policy forms also contain coinsurance (underinsurance) policy provisions that can limit an owner's recovery both for property damage and for loss of business income. If the policy contains a coinsurance provision and the policy limits specified are too far below the aggregate amount that could have been insured, then the insured's recovery will be reduced by a coinsurance calculation. An agreed amount stipulation with a waiver of coinsurance should eliminate this issue, at least for a specified period. IMRI, Glossary of Insurance and Risk Management Terms, available at www.irmi.com/online/insurance-glossary/terms/a/agreed-value-coverage-option-or-provision.aspx.

Conclusion

Of course, insurers have made many changes in their insurance coverages by reason of their risk experience during the last 20 years, and insurance companies are continuing to refine their policies and coverages all the time. Property and business owners need to evaluate the ways in which their property or business may be damaged by natural occurrences, explain these risks and the anticipated types and periods of loss to their insurance advisors, and at least consider all types of coverages that address these real loss possibilities.

'

'

Marie Moore is a Partner in the New Orleans firm of Sher Garner Cahill Richter Klein & Hilbert, L.L.C. She can be reached at 504-299-2100 or [email protected].

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