1. Duties Following Loss
The conditions section of a property insurance policy lists the duties and rights of both the insured and the insurer.
We’ve already discussed the cancellation and misrepresentation provisions. Let’s consider some additional conditions often included in property insurance contracts.
Most contracts include conditions that specify what the insured and insurer must do when a loss occurs. Together, these provisions may be referred to as loss provisions.
The duties following losscondition lists the insured’s responsibilities after a loss, including:
■giving prompt notice of claim to the insurance company or agent;
■protecting the property from further damage;
completing a detailed ■proof of loss (an official inventory of the damages);
■making the property available for inspection by the company;
■submitting to examination under oath if required; and
■assisting the insurer as required during the claim investigation proce dure.
2. Valuation
The insurance company also has duties when a loss occurs.
Determining adequate indemnification is an important concern.
Such provisions are sometimes contained in the valuation or how losses will be paid condition.
In general, the insured can collect the lesser of:
■insurable interest;
■policy limits;
■actual cash value;
■cost to repair; and
■replacement cost.
We’ve already discussed the first two items on this list. The insured can never collect more than the policy limits or the insurable interest he has in the property.
.2.1 Actual Cash Value
Many losses are reimbursed on an actual cash value (ACV) basis.
Actual cash value is usually calculated by determining the item’s replacement cost (what it would cost to buy a replacement) and subtracting an amount for depreciation, as illustrated here:
But why isn’t the insured reimbursed for the full replacement cost?
Depreciation is subtracted because the insured has already had use of the property.
If the full amount were reimbursed so the insured could replace it with a new item, the insured would be better off after the loss than before. This violates the principle of indemnity.
Bill has a washing machine he bought eight years ago.
The machine depreciated $100 the first year, $50 the second year, and $10 each of the remaining six years.
When the machine was destroyed in a fire, Bill discovered that a new one would cost $800. The actual cash value of Bill’s old machine is $590: $800 − ($100 + $50 + $60), or $800 – $210.
2.2. Repair Cost
Although actual cash value is a common method for reimbursing a loss, the insured may be reimbursed on the basis of the item’s repair cost when this amount is less than actual cash value.
2.3. Replacement Cost and Functional Replacement Cost
In some policies, the insurance company agrees to automatically pay the replacement cost for covered losses with no allowance for depreciation, provided the insured meets certain conditions. This is known as replacement cost. .
Some policies pay losses on a functional replacement cost basis, in which damaged property is repaired or replaced with less expensive, but functionally equivalent, materials.
This method is used most frequently for losses to antique, ornate, or custom construction.
2.4. Market Value
Occasionally, property is insured for market value, or what it could be sold for at the time of the loss. Market value is different from ACV or replacement cost.
Suppose Ed spends $400,000 to build a fancy house in an open area, but then the land around it is zoned for heavy industry and a bad-smelling oil refinery is built nearby.
Because Ed might have trouble finding a buyer, his house may only have a market value of $250,000 in that location, even though it would still cost about $400,000 to rebuild it if it were destroyed.
3. Coinsurance
Insurance companies want to encourage their policyholders to insure their property for its full value.
Since partial losses are much more common than total losses, some insureds might purchase minimal insurance to take care of any possible small losses and take a chance that they would never have a total loss.
If a lot of insureds were to follow this practice, the insurance company would not be able to collect enough premium to pay for the actual losses of its policyholders.
The coinsurance condition encourages policyholders to insure property to value.
It lists the minimum amount of insurance the insured should carry on the property, which is expressed as a percentage of the property’s value.
For instance, a policy with an 80% coinsurance condition means the insured must insure the property for at least 80% of its value.
As long as the insured carries the amount of insurance required by the coinsurance condition at the time of a loss, the insurer will indemnify losses
up to the limits of the policy. If the insured does not carry enough insurance when a loss occurs, the company will pay only a percentage of what full contract reimbursement would otherwise have been.
The amount not paid by the company is sometimes called the coinsurance penalty.
Later in this course, you’ll learn a simple formula for determining the amount of reimbursement when the insured does not carry enough insurance to meet the coinsurance requirements.
Since it is sometimes difficult to predict property values accurately enough to avoid the possibility of a coinsurance penalty, some policies contain an agreed value or stated amount provision.
This provision specifies a certain value that will meet the coinsurance requirement. As long as the policy limit equals or exceeds this amount, the insured will not be assessed a coinsurance penalty.
4. When Losses Are Paid
Although it may not be specifically stated in the policy, the insurer is obligated to pay covered claims promptly.
Some policies provide that a claim must be paid within a certain number of days after the insurer has received proof of loss and the parties have reached agreement on the amount of the loss. Others state only that the loss must be settled within a “reasonable” time.
5. Pair or Set
The pair or set condition is a loss settlement condition that appears in many property contracts. It states that if part of a pair or set is lost or damaged, the loss will be valued as a fair proportion of the total value of the set, giving consideration to the importance of the damaged article to the set.
The insurer is not obligated to pay for the loss of the whole set when only one part has been damaged.
Suppose burglars stole a pair of diamond earrings from the insured’s home. Later, one of the earrings is found, apparently because the burglar dropped it before fleeing the home. According to the pair or set condition, the insured would be entitled to reimbursement for the stolen earring as a fair proportion of the pair’s full value, recognizing the importance of the missing earring to the value of the set.
6. Deductible
Many property insurance policies have a deductible.
This means the insured pays the first part of every loss up to the amount of the deductible.
This reduces the cost of insurance by reducing the number of small claims. The amount of the deductible is specified in the declarations.
Suppose Li has insurance protection for her home.
Her policy has a $500 deductible. One night, a windstorm tears off part of the roof, causing $750 in damages. The insurance company will pay Li $250 ($750 − $500).
7. Salvage and Abandonment
Many property insurance policies contain a salvage condition that provides that the insurance company can take possession of damaged property after payment of loss.
Salvaged goods can reduce the cost of the claim to the insurance company.
While the insurance company may retain the right of salvage, it does not allow the insured to relinquish property to the company at the option of the insured.
The abandonment condition states that the insured may not abandon property to the company and ask to be reimbursed for its full value.
Suppose the insured hits a deer, causing major damage to his 10-year-old vehicle.
The abandonment condition prohibits the insured from abandoning the car to the insurance company and collecting a settlement for the total loss of the automobile.
However, the salvage condition allows the company to settle with the insured by taking possession of the car and reimbursing the insured for the loss of the auto.
8. Subrogation
Most policies give the insurance company subrogation rights.
Suppose an insured suffers a loss for which he is not at fault, and the party that caused the damage has no insurance or refuses to pay for the damages.
The insured’s insurance company may step in and pay for the damages and then bring suit or file a claim against the other party or the other party’s insurance company on the insured’s behalf.
This transfer to the insurance company of the insured’s right of recovery against others is called subrogation.
The subrogation condition may also be called transfer of right of recovery against others to us.
Suppose Mat throws a brick through the glass window at Deermont’s. Mat refuses to pay the damages. Deermont’s insurance company pays for the
repairs and then goes to court to collect from Mat. This is an example of subrogation.
9. Appraisal and Arbitration
There are times when the insured and the insurer cannot agree on the amount of indemnification.
The appraisal condition provides that either party may demand an appraisal of a loss. In this event, each party chooses an appraiser.
The two appraisers then select an umpire. If the appraisers fail to agree on an amount, they submit their differences to the umpire.
The decision agreed to by any two of the three is the final amount of indemnification. Each party pays its own appraiser and shares the costs of the umpire.
The arbitration condition is worded similarly, but it is not limited to disputes over the value of the loss.
It may also be used to resolve other areas of disagreement between the insured and the insurance company, between the company and a third party in the case of liability insurance, or between two insurers.
Suppose an insured owned an antique organ that was destroyed in a fire. The insurance company says it will pay the insured $500.
The insured believes it is worth at least $800. Two appraisers and an umpire are called in.
One appraiser calculates the loss at $400, the other at $700.
The umpire agrees that reimbursement should be for $700. This is the amount the insured will be paid.
10. Other Insurance
10.1. Primary and Excess
The other insurance condition sets out how other insurance the insured may have on the same property affects reimbursement under the policy in question when a loss occurs.
This condition may also be called other sources of recovery or insurance under two or more coverages.
Some policies provide that when other insurance exists they will pay only the excess beyond what the other insurance pays for a loss. So if Company Y’s policy would pay $10,000 of a $15,000 loss, Company X would pay no more that $5,000 of the loss.
In this example, Company Y’s policy is considered primary insurance and Company X’s policy is excess insurance.
10.2. Pro Rata
Probably the most common method for handling other insurance is to agree to pay only a proportion of any loss that is also covered by other insurance.
This is known as the pro rata method.
For instance, if the insured carried 30% of the total insurance coverage on her house with Company X, Company X would not pay more than 30% of a loss.
The amount paid by each company is determined by adding the limits of all policies that cover the loss and then dividing the limit of the first policy by the total amount of insurance available.
The figure that results is multiplied by the amount of the loss to determine that policy’s payment amount. The previous steps are then repeated for each applicable policy. Here is how it looks as a formula:
Here’s an example: Two policies cover a $50,000 loss. Policy A’s limit of liability is $100,000; Policy B’s is $300,000. With the pro rata method, Policy A would pay $12,500 and Policy B would pay $37,500. Here is how we calculated these amounts:
Sometimes an insured may have two or more policies on the same property that do not provide coverage to the same extent.
Such an arrangement, called nonconcurrency, can result in coverage gaps or disputed payments and should be avoided.
11. Liberalization
The liberalization condition provides that if the insurer broadens coverage under a policy form or endorsement without requiring an additional premium, then all existing similar policies or endorsements will be construed to contain the broadened coverage.
12. Assignment
The assignment condition specifies that a policy may not be transferred to anyone else without the written consent of the insurer unless the named insured dies.
In this case, the rights and duties under the policy are transferred to the insured’s legal representative. This condition is sometimes called the transfer of rights or duties under this policy condition.
13. No Benefit to Bailee
A bailee is a person or organization that has temporary possession of someone else’s personal property. Examples of bailees include dry cleaners and storage facilities.
The no benefit to bailee condition states that the bailee is not covered under the insured’s policy while the bailee has possession of the insured’s property.
14. Mortgage Condition
We mentioned that lenders or mortgagees may have an insurable interest in property. The mortgagee is generally named in the declarations.
The mortgage condition, or loss payable condition, specifies the rights and duties of the mortgagee, or loss payee, under the policy.
For instance, if an insured fails to file a proof of loss, the mortgagee must do so after being notified by the insurer to protect its rights under the policy.
In addition, the mortgagee may be expected to pay the premium if the insured fails to do so.
The policy may provide that if some condition caused by the insured would result in the insurer denying coverage for a loss it would otherwise have covered, the mortgagee may still have protection under the policy.
Or the insurer may have the option of paying off the mortgage and requiring the mortgagee to assign all rights to the company, eliminating the mortgagee’s interest.
15. Policy Period and Policy Territory
The policy period and policy territory provisions state that a loss will not be covered unless it occurs within the policy territory while the policy is in effect.
The territory may vary, but a typical policy includes the United States, Puerto Rico, and Canada. The effective date and time of coverage are listed in the declarations.
16. Vacancy and Unoccupancy
Because of the increased chance of loss, property insurance policies may exclude or limit coverage for losses when property is vacant or unoccupied.
Vacant means the absence of both people and property from the premises; unoccupied is the absence of people.
17. Reporting Forms
Property contracts may be issued on a nonreporting or reporting basis.
You are familiar with nonreporting policies: these are contracts for which a flat premium is charged every time the policy is renewed. Auto and homeowners policies are examples of nonreporting forms.
Policies are issued on a reporting basis when it is difficult to determine in advance what amount of coverage should be purchased.
Instead of paying a flat premium, the insured pays a deposit premium, or estimated premium, and then periodically submits reports to the insurer showing the status of those factors on which the premium is based.
After the insurance company has calculated the premium, it is charged against the deposit. When the deposit
is used up, the insured begins to pay the premium calculated by the insurance company at the end of each reporting period.
The insurance company may conduct a premium audit of the insured’s records before calculating a final premium and making a final adjustment.
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