It is easy to be fooled into thinking that property insurance is straightforward. That would be a mistake. There are many particulars that a novice will find perplexing without a careful review of the various types of policies that fall under the very broad term – property insurance.
What is the purpose of property insurance?
The purpose of property insurance is to provide critical financial assistance for a corporation in the event of a loss or damage to the assets of an enterprise. The objective is to allow the business to continue to operate with as little disruption as possible. Property insurance is a “first-party” coverage. It protects against losses related to a policyholder’s specific assets, earnings and expenses derived from those asset, plus added ancillary costs incurred due to a damaging event. This makes it distinct from casualty insurance which is a “third-party” coverage.
Casualty, while closely related to property coverage, provides protection for a policyholder against the claims of others.
What risks are covered?
3 basic types of policies
Named perils and all risks
Commercial property insurance policies cover the land and capital equipment owned by a particular company. However there are different types of coverage that are available to protect against property loss.
Policies protect against certain causes of loss—“perils” such as fire or theft. Coverage can be provided on an “all perils” basis, or a “named perils” basis.
- Named perils policies list exactly what is covered by the policy.
- Open perils (or all risk) policies will list what is excluded from coverage.
Named perils policies have fallen out of favor while the all-risk policy has become the standard. Even broad “all risk” policies may contain restrictions as to the type of property, coverages, limits and deductibles.
A third type of coverage is actually a combination of products and is appropriately named a commercial package policy and combines coverage for multiple perils, such as liability and property risk. Package products will include extensions that might be part of another group of covers. These are put together by underwriters to cover specific segments and niches.
Types of damage
Physical and consequential
The main purpose of any property insurance product is to cover both the physical and the consequential damage suffered as a result of catastrophic (CAT) perils (such as earthquake, flood, hurricane, and others) or non-catastrophic perils (fire, water damage, water damage, terrorism and others). Policies for such risk are one of the most common covers in the market and almost all insurance companies offer it. While not all carriers will offer CAT policies, virtually all will offer traditional property coverages.
Physical assets covered include among others:
- Buildings (including offices, factories or other facilities)
- Equipment/contents (including computers, furniture and other appliances)
- Raw materials or inventory, (including finished products or merchandise)
- Personal property of others in your care, custody or control (if the company is legally liable)
Consequential damage is a loss suffered as a consequence of damage covered under the policy. It is a loss that arises as a result of direct damage to property–for example, loss of rent after the destruction of a rental property. Note that certain consequential losses s/a pollution may not be covered under standard property forms.
Catastrophic (or simply “Cat”) perils produce losses of such magnitude as to be difficult to predict and therefore rarely self-insured or retained. They include, among others:
- Floods and storm surges
- Strong winds
- Volcanic eruptions
Non-catastrophic perils may produce losses of equal degree, however they are tend to be more predictable or man-made.
- Damage to electronic data processing equipment (EDP)
- Water damage
What risks are not covered?
Property policies will not protect against risks associated with deterioration, aging or lack of maintenance as well as any tests or experiments. Common exclusions include damage by mold, erosion, corrosion, pollution, etc. Examples:
- Equipment kept outdoors without necessary protection from the elements is generally exempt from coverage.
- A warehouse with poorly maintained and leaking roof may preclude coverage.
- Mold damage in an inadequately ventilated building will be exempt from coverage.
The property market is deep with a vast number of insurance providers in all countries.
Dealing with catastrophic losses
Despite the depth of the global property market, the limits available and the capacity of each insurer are limited by the risk’s specific operational and geographic characteristics. If the premises of the insured are in catastrophic areas (particularly earthquake, hurricane or flood zones) the limits will be more restricted and the premiums higher.
The insurance industry has developed several tools to calculate and assess the chances of loss occurrence in such areas.
Considering that a natural loss usually affects large areas, the industry has developed different tools, including predictive models, to help them manage probable maximum loss, as well as optimal deductibles and limits. These tools include:
- Maps exhibiting catastrophic areas (particularly earthquakes, hurricanes and floods) and exposure aggregation analysis.
- Detailed records of all major natural events—Loss record is one of the pillars of the whole insurance industry as it helps determine exposure, number and value of future losses.
- Exposures and accumulations—In order to limit and diversify their exposures, insurers map and count the risk they insure in specific areas. CRESTA (Catastrophe Risk Evaluating and Standardizing Target Accumulations) was established by the insurance and reinsurance industry in 1977 as an independent body for the technical management of natural hazard coverage.
While a property policy will provide protection for business’ physical assets, there are other important types of insurance that protect an insured’s premises that may not be included in a general property policy. These include:
- Terrorism – Policy providing coverage to individuals and businesses for potential losses that might occur due to acts of terrorism.
- Real estate funds/portfolio – Master-sponsored program providing various coverages for properties held in an organization’s proprietary residential and/or commercial real estate funds.
- Construction: builders risk – Policy that covers property in the course of construction and provides indemnification against damage to or destruction of buildings while construction is in progress.
- Lender placed: real estate owned – Protects lenders against direct physical loss or damage to properties in which the lender holds an interest.
- Lender placed: forced place – Provides coverage to the lender in the event the borrower allows coverage to lapse.
- Mortgage impairment – Provides coverage for the lender’s interest in mortgaged property in the event of uninsured or underinsured damage to the property.
- Earthquake – Coverage for loss of property or damage due to an earthquake.
- Flood – Protects property owners from flood damage to the structure and/or contents of their property.
- Windstorm – Coverage that protects property owners from losses incurred as a result of damaging winds produced by storm storms such as hurricanes
Property coverage is generally either valued on a replacement cost basis or an actual cash value basis.
- Replacement cost is defined as the cost to replace the property with materials of like-kind and quality.
- Actual cash value is the replacement cost less actual physical depreciation or obsolescence (this can differ substantially from the accelerated accounting depreciation).
If your property is brand new, and without depreciation, there should be no difference between the two valuation methods.
Unless the property itself is a complex or large facility, selecting an appropriate limit of coverage for your building is usually relatively straightforward. The limit is simply the cost to rebuild a similar structure to the one that is being insured. “Building” will be defined in the policy, but generally means the structure itself, as well as completed additions and fixtures, and permanently installed machinery and equipment.
Emerging property issues:
- The breadth of cyber coverage
- The impact of climate change
- Terrorism and related governmental subsidies
- Drones and the Internet of Things
The most common problems faced in property claims generally center around the following five concerns:
Problems often result because of insufficient limits or troublesome sublimits. Another area of conflict can be the determination of business interruption costs.
Because catastrophic losses are treated separately how they are determined and calculated are critical.
Losses resulting from flooding are frequently the cause of conflict between insured and insurers. It is critical to clearly determine whether deductibles and limits will be applied by location or occurrence, by initial damage or over time.
It is vital to clearly understand what is, and is not, covered by business interruption. Many factors, including expediting costs involved in re-establishing a business after a major loss make such calculation difficult and a point of possible contention unless carefully delineated.
Multiple policies / concurrency
Conflict between policies can cause disputes unless carefully managed. Additionally, cross-border and international claims create added difficulties unless well planned from the offset.
Despite the near half-millennium history of property insurance, new issues are constantly arising. Some of the areas that are likely to garner considerable attention in the near future include:
- ever broadening concerns regarding the breadth of cyber coverage
- the impact of climate change on flood and storm damage
- unceasing terrorism and related governmental subsidies
- not to mention the still emerging area of drones and the Internet of Things
All of these areas will be the subject of court cases and possibly years of heated negotiation between insured parties in the years to come.
[i] A first-party claim is one which is paid directly to the insured. A claim for property damage is an example of a first party claim: the insured has suffered a loss of his own property and, if covered, the insurance company will pay him directly for it.
[ii] A third-party claim is one that involves damage or harm to someone other than the insured party. When settled monies will be paid to the claimant (the third party) rather than to the insured. A typical example of a third party claim is a claim is brought against an insured party for negligent driving resulting in injury.
[iii] Property insurance, in its strictest sense, is limited to protection for physical property such as commercial buildings and vehicles, while casualty coverages protect against legal liability. The two coverages are often purchased together, but it is important to understand the essential differences.
[iv] A Business Owner Policy or BOP is a type of commercial package. It is an insurance package that assembles the basic coverages required by a business owner in one bundle. It is usually sold at a premium that is less than the total cost of the individual coverages. Business Owners Policies usually target small and medium-sized businesses and may contain business interruption insurance including reimbursement for lost revenue resulting from an insured property loss.
This post was co-authored by Steve Quinterno. Steve Quinterno has over 30 years of underwriting / brokerage experience, specializing in structure and placement of complex property programs for domestic and global clients. His experience spans many industries including; tech/media, real estate and financial services. Steve is an expert in emerging coverage issues involving placement of risk with global markets. He serves on various carrier councils and property practice roundtables.