A Question of Coverage

Important steps to obtain, preserve and maximize insurance coverage for fire-related loss.

BY JOHN A. GIBBONS (left) and KENNETH BERLINE TROTTER (right)

Fires are one of the greatest risks facing retail establishments, and some common causes include electrical failures and wildfires. Fires may cause significant property damage, including damage to a business’ brick-and-mortar structures, inventory, equipment, machinery and important business records. Fires also may disrupt business operations, causing partial or complete cessation of business activity for indefinite periods of time.

Even the most prepared business can suffer fire-related loss beyond its control. For example, adjacent properties may not have taken the same fire protection measures and may not have adequate fire suppression systems. If a fire starts in such adjacent properties, it may spread. A business that does not sustain property damage from the fire may still sustain property damage due to smoke or water and lost revenue if customers are unable to access the business’ premises. Therefore, savvy business owners and managers should follow the steps discussed below to ensure they purchase and maintain adequate insurance coverage to protect their business against property damage and losses as a result of fires.

1. Obtain the Proper Amount of Coverage for Real and Personal Property

In order to ensure that a business purchases the proper amount of coverage, it is important to determine the value of real and business personal property. Real property value can be determined in two ways: market value or replacement cost. Market value reflects how much money a business would get if it sold its business’ real property. Replacement cost reflects how much it would cost to replace a business’ real property based on current construction prices. The value of a business’ personal property can be established by examining inventories, including equipment and machinery, which should be complete and current. After assessing the value of the business’ real and personal property, compare that value with any limit of insurance to determine whether the proper amount of coverage has been purchased to replace lost or damaged property in the event of a fire.

In assessing coverage provided by the policy in the event of loss, determine whether the policy will reimburse the insured for loss based on “actual cash value” or “replacement cost value.” “Actual cash value” has been construed to mean the cost to replace with materials of like kind and quality, less depreciation. “Replacement cost value” is typically defined as the cost to replace lost or damaged property with materials of like kind and quality. Policies may provide the insured with the option of choosing reimbursement for loss under either an “actual cash value” or “replacement cost value” basis, and that decision may depend on many factors such as whether the insured actually decides to replace insured property that has been destroyed by fire.

In some instances, the policy may provide that the value of property is determined based on the amount designated on a schedule submitted to and accepted by the insurance company. It is imperative that any such schedules be current and complete.

2. Consider Purchasing Coverage for Business Interruption-related Losses

The most basic first-party property policy indemnifies the insured for the value of the covered property that has been lost or damaged. Business owners, however, should also consider purchasing additional coverages to compensate the business for loss of income that may occur as a result of damage to the insured’s property or the property of its customers and suppliers. Business Interruption coverage may indemnify the insured for the income that is lost as a direct result of damage by an insured peril to insured property. Contingent Business Interruption (CBI) coverage protects against income loss or increased expenses suffered as a result of damage by an insured peril to the property of another business or individual upon which the insured depends. For example, CBI coverage protects against economic losses caused by a “direct” supplier’s inability to get its goods to the insured because of damage to or destruction of the supplier’s property by an insured peril. CBI coverage comes in many forms with a variety of limitations, so insureds need to choose carefully based on their particular critical business relationships.

In addition, other important coverages for economic loss arising out of a fire may be added to the insurance policy. An experienced broker or attorney may be able to provide further information and assist the business owner or manager in determining which coverages are right for a particular company.

3. Understand the Policy’s Co-Insurance Requirements

In exchange for a rate credit, most commercial property insurance policies contain a coinsurance provision that requires the insured to insure the covered property to a specified percentage of its full value — usually 80, 90 or 100%. If the insured sustains a loss, and it is determined that the limits carried are less than those required by the coinsurance provision, the insured’s recovery for loss will be limited to the same percentage of loss as the ratio of the amount of insurance carried to the amount of insurance required. An insured’s failure to update its property valuation and to purchase the amount of coverage required by the policy’s co-insurance provision will essentially reduce the value of the insurance that the business has purchased, likely resulting in the business having less insurance available in the event of a loss. Businesses may be able to avoid this issue by obtaining a policy with an agreed value provision. An agreed value provision typically provides that the requirements of the coinsurance clause have been met by the insurance amounts shown in the policy. The insurer will typically require the insured to submit a signed statement of the property values as a condition of including an agreed value provision in the policy. The insured may be required to provide a recent appraisal or explanation to the insurer setting forth how the values were determined.

4. Maintain Any Protective Devices or Services as Required by the Insurance Policy

One condition of an insurance policy may be that the business maintain specific protective devices or services, such as automatic sprinkler systems and dry chemical fire suppression systems. Such devices and services may be identified in a schedule that forms part of the insurance policy. If the insured fails to have and maintain such systems in operating order, loss or damage caused by fire may be excluded under the terms of the insurance policy. Thus, it is critical that businesses understand and adhere to any conditions in the insurance policy requiring that the business maintain certain protective devices or services.

5. Comply with the Insurance Policy’s Requirements in the Event of Loss

Of course, insurance is not a one-sided contract. In addition to paying a premium, the insured is expected to meet certain requirements and deadlines in order to recover under the policy. An insured should always review the insurance policy and be aware of potentially applicable requirements and deadlines. There are some fairly standard obligations that insureds will be expected to perform in order to obtain and maintain insurance for its fire-related loss:

• Provide written notice of the loss to the insurance company as soon as practicable.

• Protect the property against further damage, if possible.

• Provide a “proof of loss,” signed and sworn to by the insured, that presents information to substantiate the losses claimed under the policy (some policies require a “proof of loss” be submitted within as few as 30 or 60 days).

• Submit to an examination under oath “as often as may be reasonably required” about any matter relating to the insurance or the loss.

• Produce relevant books and records to the insurer for examination, if reasonably requested.

Insureds also should actively participate in the claims process and pursue their insurance after the loss. Some insurance contracts may limit the time in which an insured may file a lawsuit, if there is a coverage dispute. Time may also be limited by statutes that set cut off dates after which an insured may not bring a lawsuit to seek coverage for the loss. For a host of reasons, companies should not wait or passively rely on their insurance company to process the claim.

6. Consider Claims against Third Parties Who May Have Legal Responsibility for Fire-related Loss

Once the insurer pays a loss on behalf of its insured, the insurer may have a right to take legal action against a third party that may be legally responsible for the loss. This is known as the right of “subrogation.” Property losses may implicate the potential for subrogation against any third party that could bear responsibility for the loss and the resulting damages. This is true even when the cause of loss is unknown or when the property losses appear to be initiated by an “act of God.” For example, a careful factual investigation may reveal that the extent and scope of the insured’s damages as a result of an “act of God” would not have occurred but for human negligence, such as negligent construction of a restaurant or shopping center. A “cause and origin of loss investigator” may be required to determine certain facts such as the origin point of the loss and the cause of any resulting damages. Insureds should be careful not to take any positions with respect to a third party’s liability or release any claims against a third party without first providing the insurer an opportunity to protect any subrogation rights.

7. Seek Legal Advice as Appropriate

In some instances, it may also be prudent to seek legal advice, because an attorney may be needed to analyze how issues, such as those discussed above, will impact the business’ insurance recovery. The attorney also may be able to help the business describe the claim in a way that will maximize protection under the insurance policies in light of the coverage issues. In this way, the business can best maximize insurance recovery for its fire-related losses. Seeking advice early in the claim process, after a loss has occurred, may enable companies to avoid early mistakes that may otherwise limit or delay the recovery.