Property Potholes

The large number of natural catastrophes that have affected companies in all parts of the world in recent months demonstrates the need for businesses to double-check their property insurance policies and make sure they will respond as expected should a claim arise. Many firms don’t realize their property insurance programs might have gaps or potholes that can leave an insured with unanticipated and significant out-of-pocket costs in the event of a loss.

Uninsured or underinsured property exposures can result from a number of things, including policy exclusions, coverage definitions, misalignment of multiple policies and a lack of clarity related to deductibles and waiting periods. Taking some time to identify and address these “potholes” can shore up property insurance coverage and help companies avoid problems in the future should they need to file a claim. Here are some of the more significant potholes that businesses headquartered or operating in Canada should work to address.

Valuation Issues

A number of coverage issues can arise based on how assets are valued in insurance policies, particularly with respect to inventory and real property. For example, typical wording will cover finished goods manufactured by an insured at the insured’s selling price. But the wording may be silent about finished goods manufactured by third parties. If that is the case, valuation will likely revert to either actual cash value or replacement cash value. Actual cash value, unlike replacement cash value, includes a deduction for depreciation.

It is especially important to understand your operations along the entire supply chain, including their related exposures and relevant insurance coverages.

If your organization uses third parties – many organizations today rely on such contractor manufacturing to produce their goods – a significant loss could be underinsured based on the valuation specified under the coverage. Pay attention to this valuation. If third parties are used, the wording should be amended to refer to “… finished goods, whether or not manufactured by the insured …”

If the inventory is not valued at the selling price, make sure the exclusion in the “Business Interruption” section of the policy relating to inventory is deleted. This is a typical exclusion; it can often be overlooked if the valuation of finished stock is at replacement cost.

Regarding buildings and facilities, your property coverage should provide replacement cost if the building needs to be replaced, or it will likely specify actual cash value in other instances. You may choose to add the following wording to the policy to prevent an unintended “actual cash value” approach to valuation: “However, limitations imposed by federal, state, municipal or other governmental building codes shall not result in actual cash valuation.”

The following example highlights the need for this wording. A five-storey building is destroyed. Revised building codes state new buildings cannot exceed four storeys. In the absence of the wording suggested above, if the building is replaced, insurers may only reimburse the policyholder for replacement cost for four storeys and then actual cash value for the fifth story – hence the unintended “actual cash value.”

Insurance for buildings with historic landmark status also needs to be reviewed carefully. If properties have landmark status, the replacement cost value wording may not be adequate to replace the structure in a way that will maintain its landmark status.  Local historic preservation or heritage foundation committees can be very strict regarding adherence to requirements. If an organization wishes to maintain landmark status for its building, the time to rebuild can be longer; thus, the costs to meet the requirements will likely far exceed traditional replacement cost.   

Transit Coverage, Exclusion

Under most property insurance policies, “business interruption” is often excluded with respect to property in transit. This is because most inventory is valued at selling price; the profit component of the damaged inventory will be accounted for in that valuation when damage is exclusively to inventory.

A potentially serious coverage gap exists when business interruption applies to property in transit, such as machinery and equipment. Indeed, damage to machinery and equipment in transit may cause a disruption or delay in operations and result in a business interruption. To shore up this potential exposure, you should work to amend the relevant transit exclusion under the business interruption section to refer only to inventory. If the exclusion cannot be eliminated, specific “trip transit” policies may need to be arranged if and when key pieces of machinery and equipment are shipped.

In evaluating potential exposures related to the transit of inventory and other contents, firms also need to check any applicable coverage under their marine, inland marine and stock throughput policies. Having multiple policies covering similar property at different stages of the process can be beneficial, but it can also create overlaps and/or gaps.

Control of Damaged Merchandise

Similar to the treatment of the valuation of inventory, a number of potential coverage issues and gaps typically arise under property insurance policies with respect to the control of damaged merchandise. As with inventory, the wording can be limited only to goods “manufactured” by the insured. Of course, this is a potentially significant uninsured exposure for retailers, distributors and a wide variety of other firms that sell products made by third parties.

Businesses also need to make sure coverage for damaged goods applies to raw materials and work in process, all important considerations with respect to the wide range of hazards that can damage a company’s manufacturing and warehousing facilities and their contents. Firms also need to check their policies for any language specifying who shall determine whether goods are fit for sale or consumption. The insured should always be the one to make that determination. In reviewing their coverage, firms should work to eliminate any restrictive wording or communicate the potential issues to relevant stakeholders.

Restrictions on Debris Removal

As has been the case repeatedly in recent months across North America and in other parts of the world, hurricanes, tornadoes, severe storms, earthquakes, explosions and other disasters can cause widespread damage to facilities and infrastructure, uproot trees and leave extensive debris strewn across commercial properties. Clean-up costs alone can be substantial, especially if excessive debris prevents access to a facility and extends the length of a related business outage.

Therefore, it is worth taking a close look at policy language associated with post-event clean-ups. The wording in many property policies may state coverage is for removal of “covered property.” Many policies specifically exclude trees, as well as property of others. To help expedite a company’s recovery and transfer significant clean-up costs, you’ll want the debris removal to include coverage for the cost to remove these trees or property of others. Thus, you should seek to amend the coverage to eliminate the restriction for “covered property.”

Consider the following example, which occurred during Hurricane Katrina in 2005. A barge washed up onto the parking lot/entrance gate of a manufacturing facility. The policy for the manufacturer excluded “watercraft” and the debris removal wording specifically stated “removal of covered property.” The policy did not cover the (significant) cost to remove the barge.  

Policy Checking

When you receive your insurance policies, take the time to review them carefully. Compare the coverage, terms and conditions to what appeared in the binders, specifications and proposals. Check your coverage against that of your expiring policies.

Make sure all the endorsements and forms listed are attached and in order. Pay special attention to time-sensitive reporting requirements and any non-concurrencies that may occur with respect to multiple policies, especially those providing various layers of coverage that might apply to a single loss event.

By taking time to evaluate and address potential coverage gaps and issues in your property insurance and other applicable policies, you can eliminate or reduce a number of potential potholes that could result in serious uninsured or underinsured exposures. These efforts can add up to big savings for your company in the event of an insured loss affecting the organization’s property.