Insure This!
by Various Authors
Q. What is coinsurance?
A. Apartment owners’ package policies, which include coverage for the property itself, may contain a coinsurance clause that pertains to property losses to your building. Unlike medical insurance, this does not refer to an amount that you must automatically pay, like a deductible, in the event of loss. Rather, it is an agreement to keep your
property insured to the accurate replacement cost—the coinsurance percentage listed in the policy—or a penalty can be assessed at the time of loss.
If your policy has a percentage shown under coinsurance, this refers to the amount that you, as the insured, agree to carry in relationship to the actual insurance to value. For example, if the true replacement cost of your building is $500,000, and you have a 90% coinsurance, you must purchase insurance in the amount of at least 90% of that value (or $450,000) in order to avoid the co-payment penalty in the event of loss.
If a covered property claim arises and, in the above scenario, the limit of insurance carried in your policy is $450,000 or more, you will not suffer a coinsurance penalty for being underinsured. The carrier will pay the replacement cost but only up to the actual policy limit.
On the other hand, in the same example, should you carry less than the required limit—such as $400,000—and the replacement cost of your building is determined to be $500,000, then a penalty will be imposed because you are not insured to the 90% as required in the coinsurance agreement of your policy.
Generally, the following factors are applied and then the loss is paid at the discounted amount:
Amount of Insurance Carried x Loss Amount
Coinsurance % x Actual Replacement Cost
Many people tend to think 100% coinsurance is better. With this scenario, while the rate for insurance might be a little lower, you are actually not allowing any room at all for adjustment in your value. You are agreeing to be insured exactly (100%) to the correct value at the time of loss or suffer a penalty for being underinsured.
Consequently, if your policy contains a coinsurance clause, you need to make sure you are purchasing the adequate amount of insurance. This can be done by obtaining an appraisal from a qualified appraiser. There are also various methods to do this calculation, including special software that is designed particularly for this function.
– Alicia Smith
Q. Why do I need building ordinance and laws’ coverage?
A. This is an absolutely critical coverage, especially for older buildings; and unless you ask for it, it is often not included on standard policies. The Three Parts to Building-ordinance Coverage Are:
Part A: This part pays for the undamaged portion of a building that the building department requires to be demolished after a covered loss and before they will allow repairs to begin. The limit of coverage is the full building limit if this is included.
Part B: This part pays for the cost to demolish the undamaged portion of the building if required by building laws as in Part A above.
Part C: This part covers the additional cost to rebuild the damaged structure with one conforming to current codes, if that cost would be higher than normal repairs. Examples would include the need to add sprinklers, widen doorways or change the foundation.
Examples
When a loss such as a fire occurs, the insurance policy should pay to replace “what was there at the time of loss.” Since this is not a discussion on replacement-cost versus actual cash-value (used value) policies, the focus will not be on the details of how much is paid to replace “what was there at the time of loss.” Instead, the focus will be on what items are covered. In the case of a fire, for example, the city building department advises us that they will not allow us to rebuild unless we bring our building—one that lacked sprinklers—up to current code by including automatic fire sprinklers. This would likely also mean increasing the size of the building’s main water supply to accommodate those sprinklers. Since there were no sprinklers there at the time of loss, the policy will not pay to install sprinklers, even though there may be plenty of building coverage to include that cost. Without building-ordinance coverage, no payment would be made to update the building to conform to codes, unless that update were the only available option, such as replacing a damaged fuse panel with circuit breakers.
The same could hold true for other major, required improvements such as updating the building’s foundation or bolting the building to the foundation where it was not bolted before.
The other exposure involves Part A and B of building-ordinance coverage. In this example, assume there was a large fire on the third floor of a three-story building and that the other floors only had water damage but were still salvageable. The city may refuse to allow you to rebuild on top of the existing structure because it does not meet current codes. In this case, since the first and second floors were not seriously damaged, the insurance company would only pay for the water damage; and you, as the owner, would be out the value of those two floors, unless you have building-ordinance coverage, Parts A and B. Part B pays the cost to demolish the “undamaged portion.” The demolition of damaged portions of a building is covered when it is necessary to do the demolition due to the loss. But, in this example, the demolition only occurs because it was mandated by the governmental jurisdiction, so normally there would not be any coverage unless you have the building-ordinance coverage included.
How Much is Enough?
Generally, if you buy building-ordinance coverage, Part A is included up to the full value of the building as stated on the declarations. Part B is then limited to amounts you choose. Since Part B is only for demolition of the undamaged part of the building, a small amount, such as 2% to 5%, is usually sufficient. The maximum exposure would be what it would cost to have a part of the building demolished and removed, which is done quickly with the aid of machinery.
Since Part C covers the additional cost to rebuild to code, the cost can be quite high, and owners usually take between 10% and 25% of the building amounts.
Some policies sell the building-ordinance option to include all coverage under a single limit and do not give you choices in terms of the amounts of coverage. Conversely, some policies include full building-ordinance coverage without limitation or with extremely high limits at no extra cost, but these are the exceptions, not the rule.
Summary
You are not safe to assume that merely having enough coverage on your building will protect you even when the peril, such as fire, is covered. Losses that arise from the application of building ordinances are not covered unless you have the property endorsements on the policy.
Building-ordinance coverage is sold in different ways as outlined above, so you should take the time to review your potential exposure and find a carrier willing to sell you the coverage you need. Some companies limit the building-ordinance coverage they will write on older buildings—where it is needed the most. And others do not limit what you can buy.
The most important point for you to understand is what is and what is not
covered by your policy regarding potential building-ordinance exposures. Your
insurance broker can help you determine what you need based on your property’s age, construction type and the local building department. Ignorance may be bliss, but it can also be expensive.
– David Gordon
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. Consult the advice of an insurance agent for any specific problem. To submit questions for this column, please email them to editor@sfaa.org. Alicia Smith is with Commercial Associates Insurance, 888-299-2554. David Gordon is with Gordon Associates Insurance Services, Inc., 877-877-7755, gordon-insurance.com. Copyright © 2005 by the San Francisco Apartment Magazine. All rights reserved.