The Big I Virginia Winter 2022-23

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all costs are covered by the CPP coupled the necessary Ordinance or Law and other endorsements. ORDINANCE OR LAW COVERAGE “Standard” Ordinance or Law endorsements (such as the CP 04 05 promulgated by Insurance Services Office (ISO)) contains three coverage parts: • Coverage A pays the value of the undamaged portion of the building; • Coverage B pays the amount necessary to tear down and remove the debris of the undamaged portion of the building; and • Coverage C pays the increased cost to bring the entire building (damaged and undamaged) into compliance with the current building code. Coverages A and B focus on and pay for the undamaged part of the building for one key reason – the property policy pays replacement cost to cover only those costs associated with the damaged part of the building. Only by endorsing these coverage parts onto the policy are these expenses covered. Coverage C applies to the entire building, damaged and undamaged. For the damaged portion of the building, Coverage C pays the difference between replacement cost and the cost to rebuild in compliance with the current building code. For the undamaged section of the structure, Coverage C pays the difference between Coverage A and the cost to bring that part of the building into compliance with building codes. Proprietary ordinance or law endorsements may apply different coverage parts. Rather than “Coverage A,” the policy may simply state, “Value of the Undamaged Portion.” Regardless how delineated, ordinance or law coverage generally provides these three coverage parts. COST OF ORDINANCE OR LAW COVERAGE When ordinance or law is endorsed onto a commercial property policy, as is common with all endorsements, an additional premium is required. The relative “cost” of an ordinance or law endorsement is low compared to the outof-pocket costs that may be suffered when it is not present. Coverage for the Value of the Undamaged Portion increases the building part of the property premium about 15%. The same rate applicable to the building coverage applies to Coverages B and C (debris removal and increased cost of construction). Let’s apply these costs to the building in the New Hampshire case briefed above. Because assumptions must be made regarding construction and protection to estimate a rate, for this example, the estimated rate is $0.50 per $100. The resulting premium at this rate is $10,000 for $2 million or replacement cost coverage. Value of the undamaged portion increases the premium approximately $1,500. The cost for debris removal of the undamaged portion applies the building rate to the limit chosen. A coverage amount must be assumed to estimate the premium. For this example, this limit is assumed to be $100,000. The additional premium for this limit is $500. The increased cost of construction (remember, this is applicable to the entire building) is estimated in this example at $500,000. For this amount of coverage, the additional cost is approximately $2,500. Total additional premium for this over simplified example is estimated to be $4,500. In the New Hampshire sample case, this $4,500 would have purchased the necessary $900,000 of required additional coverage. DEVELOPING ORDINANCE OR LAW COVERAGE LIMITS Value of the undamaged portion of the structure is the easiest limit to estimate because in standard ordinance or law endorsements, no estimation is necessary. The working of this coverage part (Coverage A in the ISO endorsement) states that this part pays the difference between the amount of damage and the coverage on the building. This is logical because there is no way to estimate how much will or will not be damaged so the limit must be able to fluctuate. Removal of the undamaged portion of the building is somewhat more complex to estimate for the same reason the value of the undamaged portion does not have to be estimated. There is no way to know before a loss how much will be damaged and how much of the building won’t be damaged. This is a pure estimate. A safe estimate may be between 5% and 10% of the building’s IRV. Where removal of the undamaged portion is a guess, developing the limit for the increased cost of construction (Coverage C) is an estimate of irreducible complexity. There is no “standard” or proven way to calculate the necessary limit. Only a best-guess estimate is possible. The estimation is a function of the age and condition of the building coupled with the changes in building codes over time. Although estimating the increased cost of construction is complex, some methodology must be behind the best guess estimate. One explainable method addresses age, condition and code changes applying a type of “dollar cost averaging” to developing the limit. Following is a reasonable and explainable methodology for developing an increased cost of construction limit. 28 THE BIG I VIRGINIA WINTER 2022-23
1. Choose a percentage of building value based on the age band; 2. Multiply the applicable percentage by the value of the building; and 3. Multiply the answer in “2.” by the age of the building. Example: 20-yr-old building valued at $1 million applying the 2% per year cost average. ($1,000,000 * .02) * 20 = $400,000 Coverage C Limit The applicable age bands are: • 0-10 years: 1% • 11-20 years: 2% • 21-30 years: 3% • 31-40 years: 4% • 41-50 years: 5% • 51+ years: 6% Rather than choosing individual limits for removal (Coverage B) and increased cost of construction (Coverage C), the better choice is to combine these two coverages under one limit. This way if one is less than anticipated and the other is more costly than anticipated, the limits can be used for either expense. RECONSTRUCTION COST – BEYOND ORDINANCE OR LAW Ordinance or law is the primary method for “guaranteeing” (as much as possible) reconstruction cost. As a disclaimer, full reconstruction cost can never be guaranteed, but applying the proper methodologies and coverages allows the insured to get as close as possible. Other coverage options often necessary to accomplish the goal of reconstruction cost include: • 100% insurance to value (ITV); • Replacement cost; • Blanket limits; and • Inflation guard protection. INSURANCE TO VALUE (ITV) A provision within the CPP allows the insured to purchase less than the property’s 100% replacement cost to be fully insured for partial losses. The coinsurance provision allows the insured to carry 80% of the total insurable value and still be fully covered for any loss less than the limit carried. As is evident, the gap in this allowance is that the insured is not fully protected if the loss exceeds the limit of coverage purchased. The maximum paid by the insurance carrier is the policy limits carried. If the insured purchases limits less than the 100% insurable value, reconstruction cost cannot be obtained. REPLACEMENT COST Two valuation methods are common to insurance: 1) actual cash value; and 2) replacement cost. Actual cash value, in simplest terms, is the remaining life value of the property. Replacement cost, as the term suggests, does not consider the “used up” value, it values the property based on what a new piece of property would cost. BLANKET LIMITS When protection is provided on a blanket limit basis, one limit applies to multiple properties, multiple types of properties or a combination of the two. For instance, a blanket limit can apply to: • Multiple buildings; • Business personal property (contents) located within multiple buildings; • Combined values of real and personal property in one building; or • Combined values of real and personal property across multiple buildings. The advantage of blanket limits is that the entire limit is theoretically available for any one loss. If coverage for real property (the building) is miscalculated and too low, the difference may be made up by the remaining blanket amount. Obviously, the advantage of blanket limits is reduced when multiple properties or multiple types of property included in the blanket limit are damaged in one loss. However, there is a potential limitation to blanket limits that must be considered – the Margin Clause. Insurance Services Office (ISO) introduced the Margin Clause in 2007. More specifically known as, Limitation on Loss Settlement-Blanket Insurance (Margin Clause), the endorsement limits the payout for any one property or property type to a specific percentage of the limit provided by the insured in a statement of values for that building or business personal property. ISO’s available options are: • 105% • 110% • 120% • 130% The percentage is applied to the insurance value in the statement of values to develop the maximum payment for that particular property. Applying this limitation takes away the ability to use the entire limit for any one loss. For instance, if the property covers three buildings as follows: • Building 1: $200,000 • Building 2: $250,000 WINTER 2022-23 THE BIG I VIRGINIA 29
Page 1 and 2: WINTER 2022-2023 VIRGINIA THE MAGAZ
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The Big I Virginia Winter 2022-23

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