Chapter 3: Property Insurance Basics

First-party Insurance

Property Insurance becasue it provides coverage for loss to the insured’s own property from covered perils.

First-party Claimant

submits a claim to assert a reight to payment under the policy.

Fire Protection

is an essential covered peril for property insurance. Nearly all policies will cover damage resulting from a hostile fire,

Hostile Fire

which is a fire that burns outside of its intended boundaries or becomes uncontrollable.

Friendly Fire

does not cover damage from a fire that was intentionally set and that stays within its intended boundaries

Theft

is the broadest definition, and it includes any act of stealing, including burglary and robbery.

Burglary

is the taking of property from inside the premises, a locked safe, or a locked vault by a person who forcibly enters or exits the property.

Robbery

is the taking of property from the care and custody of a person who has been threatened with bodily harm or has been harmed.

Mysterious Disappearance

Sometimes property goes missing and the cause of loss is not known.

Unoccupancy

refers to a property that contains personal property, but has no occupants.

Vacancy

refers to property that contains no personal property and has no occupants. The Vacancy provision specifies how coverage is affected after an extended period of vacancy, typically for more than 60 days of vacancy.

Bailee

is a person or organization that has taken the property of another into their care, custody, or control for servicing, repair, or storage.

Because bailees are legally responsible for property in their care, property insurance policies exclude coverage that would benefit a bailee.

Bailor

The person who retains the ownership of the property that has been taken into a bailee’s care, custody, or control

Direct Loss

is one that is the immediate result of a peril. Property policies typically require a direct physical loss to covered property for coverage to be triggered.

Indirect Loss

also known as consequential loss, is a consequence of a direct physical loss. Indirect losses refer to financial losses, such as loss of income or additional expenses incurred while property is being repaired.

Property Losses may occur to:

• Real property, such as residential dwellings, commercial buildings, and other structures on the insured premises (for example, a detached garage)

• Personal property, which includes personal property in use (such as furniture or machinery) and personal property for sale (such as merchandise)

• Rights of possession or use

Primary Cause of Loss/Proximate cause

only one peril caused the loss, the proximate cause is the first event in the unbroken chain of events that resulted in loss—the peril directly caused the loss. If two or more perils caused or contributed to the loss, the efficient proximate cause is the peril having the most significant impact in generating the loss or damage. If a policy or insurer uses proximate cause to determine coverage, the proximate cause must be a covered peril.

Concurrent Causation

which says that when two perils simultaneously cause a loss (in other words, both perils are the proximate cause), the insurer must pay for the loss even if one of the perils is excluded by the policy.

Inherent Vice

refers to a quality within property that causes it to damage or destroy itself, such as spoiled food, rusting, or wear and tear. Inherent vice is not covered by property policies.

Named Perils

coverage is a type of coverage that only provides insurance for the causes of loss that are listed in the policy. If the peril is not named in the policy, no coverage applies for loss or damage caused by that peril, unless the insured purchases an endorsement to add that coverage. Under named peril policies, the insured has the burden of proof to demonstrate that a peril was caused by a peril insured against.

Open Perils

coverage, also called all-risk coverage, provides insurance for all causes of loss that are not specifically excluded under the policy. Under open peril policies, the insurer has the burden of proof to demonstrate that a loss was caused by an excluded peril.

Basic and Broad forms

provide named perils coverage, with the basic form insuring against fewer named perils than the broad form.

Special Forms

provide coverage on an open perils basis.

Loss Valuation

A property policy pays for losses to property based on the valuation method contained in the policy, as specified by the Loss Settlement condition, or the method chosen by the insured in an endorsement added to the policy.

Actual Cash Value (ACV)

When losses are settled on an actual cash value basis, the policy will pay for the cost to repair or replace the damaged property at the time of loss, minus depreciation.

ACV is the replacement cost of damaged property at the time of loss minus the amount of depreciation of the property.

Actual Cash Value

CRC-DEP=ACV

Mark has a house he paid $30,000 cash for. he has had the house for 10 year. The house deprecates by $500 a year. What is the ACV if the house is worth $50,000 now

 Step. 1 Find DEP

$500 (DEP) x 10 years (Length of Ownership) =  $5,000 (DEP)

Step 2. FILL IN EQUATION

Current Replacement Cost(CRC) – Deprecation(DEP) =ACV

$50,000 CRC - $5,000 DEP =

Step 3. Solve Equation

$50,000 CRC - $5,000 DEP = $45,000(ACV)

Replacement Cost

is the full cost to repair damaged property or replace damaged property with property of like kind and quality, at current pricing, without a deduction for depreciation. Many property policies providing loss valuation at replacement value require covered property to be insured to a certain percentage of its replacement value, such as 80%. This loss valuation basis may be available by endorsement for policies that automatically pay losses on an ACV basis.

Functional Replacement Cost

Some properties, like older dwellings or Victorian homes, use outmoded or obsolete materials and construction techniques that would make replacing them in their original condition too cost-prohibitive. These properties are often insured on a functional replacement cost basis, meaning the insurer will pay the cost of replacing the property with its functional equivalent.

Agreed Value

Some policies insure covered property for an agreed-upon policy limit that is paid in the event of a total loss, regardless of the actual cash value of the property at the time of loss. This basis is useful for articles that are difficult to replace or value, such as fine arts, paintings, and classic automobiles. Policies that are written on an agreed value basis are sometimes called valued policies.

Stated Value

Stated amount valuation means that the insurer bases the policy premium on the insured’s statement of the property’s value. However, unlike in agreed value policies, the insurer will pay the lesser of the stated amount and the actual cash value at the time of the loss. This basis is more affordable than agreed value policies, though the property may not be fully insured.

Market Value

Though it is less common than the other valuation methods, some policies will value covered property at the market value, which is the price a willing buyer would pay for property purchased from a willing seller under fair market conditions. This basis may be used for goods and commodities whose value fluctuates with market conditions, such as agricultural products.

Salvage Value

The amount for which property can be sold at the end of its useful life is the salvage value. In property insurance, the salvage value is the scrap value of damaged property.

Specific Limit

insures a single item of property for a single limit of insurance. For example, a Dwelling policy insures one dwelling for $100,000.

Blanket Limit

insures multiple items of property for a single amount of insurance that applies to all covered property. The properties could be located at different locations (such as two buildings at separate locations), different types of property (such as the building and the personal property it contains), or both. For example, a $1 million blanket limit applies to two separate buildings at two separate locations, including the business personal property contained in each building.

Deductible

is a specified amount of each loss that the insured must bear as a way to share the cost of a loss, often applicable to each occurrence. Deductibles are common to property insurance, but significantly less common for casualty (liability) coverage. Deductibles are an underwriting tool that the insurer uses to reduce the number of small claims. A large number of small claims may increase the likelihood of moral hazards, increase the financial costs of the policy, or take away from the insurer’s ability to pay larger, more urgent claims. By accepting a larger deductible, the insured’s premium may be reduced.

Straight Deductible

is a flat amount retained by the insured, regardless of the amount of loss

Franchise Deductible

states that the loss must equal or exceed a specified amount, after which the loss is paid in full

Precentage Deductible

calculates the amount retained by the insured as a percentage of the property value or a percentage of the policy limit. Percentage deductibles are often used with windstorm and hurricane losses.

Coinsurance

Insurance to value is the amount of insurance sufficient to cover a total loss to the insured property. For example, if a home is valued at $500,000, but the owner only carries $300,000 in coverage, it lacks full insurance to value, as the amount of insurance is not enough to cover a total loss. This puts the insured at a greater danger of financial loss in the event of a total property loss.

To encourage insureds to purchase and maintain insurance to value, many property policies include a Coinsurance provision. This provision requires an insured to carry a certain percentage of the property’s total valuation (usually 80%) in order for losses to be paid in full. If the insured carries less than the required percentage, the policy will only pay an amount proportionate to the amount of insurance carried. The coinsurance formula is:

Coinsurance Percentage  x  Current Replacement Cost   =   Amount of Insurance Required

(Amount of Insurance Carried  ÷  Amount of Insurance Required)  x  Amount of Loss   =   Amount Payable before deductible

Coinsurance only applies to partial losses. In the event of a total loss, the policy would pay up to its specified limit of insurance.

Loss Settlement

This condition specifies which loss valuation method will apply to the property insured under the policy. Though the claim payment will be based on the appropriate valuation method, the insurer will not be liable beyond the actual amount necessary to repair, rebuild, or replace the damaged property. Claim payment is also subject to the appropriate policy limit.

Loss Payment

This condition specifies how the insurer will make payment for loss and what applicable time frames must be honored when submitting claim documents.

Abandonment of Property

is when the insured surrenders damaged property to the insurer for repair or disposal. Property policies prohibit the abandonment of property, and the insurer will not accept it. Arranging for repair or disposal is the insured’s responsibility, unless otherwise elected.

Mortgage Clause

specifies how the policy protects a mortgagee’s financial interest. Payment can be made to mortgagees only up to its insurable interest in covered property and in order of precedence.

A mortgagee’s interest is separate from the insured’s. Mortgagees may receive loss payments even if the insured’s acts or omissions result in coverage denial. To collect under the policy despite denial of the insured’s claim, the mortgagee must comply with certain requirements:

• It must pay any premium due under the policy on demand if the insured fails to do so

• It must notify the insurer of any change in ownership or occupancy, or any substantial change in risk of which the mortgagee is aware

• It must submit a proof of loss to the insurer if the insured fails to do so, typically within 60 days after receiving notice that the insured failed to do so

If the insurer is cancelling or nonrenewing the policy because the insured failed to pay the premium, the insurer must provide the mortgagee advance written notice (typically 10 days’ notice) before cancelling or nonrenewing, giving the mortgagee the opportunity to pay the necessary premium.

The Mortgage clause protects the financial interests of a mortgagee (lender), and it does not give the lender all of the rights of a named insured, like making coverage decisions or assigning the policy. The clause's protection allows the mortgagee to pay due premiums, submit a proof of loss, and receive a claim payment, even if the insured fails to follow their obligations under the policy. The mortgagee must also receive any cancellation or nonrenewal notice sent by the insurer.

Loss Payable Clause

Similar to the Mortgage clause, the Loss Payable clause designates a loss payee as a beneficiary of the policy. A loss payee is a party that is paid first in the event of a loss to property in which it has insurable interest, such as a creditor, lender, or lienholder.

Pair or Set Clause

A Loss to a Pair or Set condition describes how the insurer will cover a partial loss to property that comes as a pair or set, such as a pair of earrings or a fine china dinnerware set. The clause recognizes that the value of the pair or set is comprised of the value of each individual part and the value of the pair or set as a whole—the total value is greater than simply the sum of its parts.

In the event of a loss to part of a pair or set, the insurer may either:

• Repair or replace any part to restore the pair or set to its original value

• Pay the difference between the actual cash value of the property before and after the loss

Appraisal

addresses disputes about the amount of a property loss, and it may be requested by either the insurer or the insured. Each party selects its own appraiser, and the appraisers select an umpire. Agreement by any two parties settles the loss. Each party pays the costs of its own appraiser, and the parties share the cost of the umpire and the appraisal process. Appraisal is not used to determine whether the policy provides coverage for a loss.

Recovered Property

the insured or insurer recovers lost or stolen property after the insurer has made payment under the policy, that party must notify the other party of the recovery. The insured may keep the claim payment (and give up their right to the recovered property) or retain the recovered property (and return the claim payment). If the insured chooses to retain the recovered property, the insurer will pay for recovery and repair expenses.

Standard Fire Policy

The standard fire policy (SFP) of New York is the foundation for almost all property insurance policies issued today. This policy is written based on 165 lines, which are standardized by law to describe coverages. States that use the standard fire policy enforce the requirement that insurers cannot write a property policy that is more restrictive than the 165 lines.

The SFP provides coverage for direct loss resulting from fire, lightning, and the removal of property from premises endangered by fire or lightning.

Standard Fire Policy (continued)

In the event of a loss, the insurer will pay the lesser of:

• The actual cash value of the property at the time of loss

• The amount actually necessary to repair or replace property with material of like kind and quality within a reasonable time after the loss. This does not include increased costs due to an ordinance or law regulating construction.

• An amount equal to the interest of the insured

Some items of property are considered uninsurable and will not be covered by the policy, including accounts, bills, currency, deeds, evidences of debt, money, and securities. Bullion and manuscripts are also generally excluded from coverage, unless they are specifically named in the policy.

If other insurance applies to the same property, the Other Insurance condition specifies that the insurer will use a pro rata liability basis to cover only its proportion of the loss compared to the total insurance covering the property.