It is easy to be fooled into thinking that commercial property insurance is straightforward. Particularly when it can be seemingly easy to buy online.
However, there are many factors that a buyer might find perplexing, especially as the various types of policies that could be relevant all fall under the very broad term – commercial property insurance.
In this article we try to explain:
- The Purpose of Commercial Property Insurance
- The types of risks and insurance
- How to decide which insurance you need
- Why using a broker is beneficial compared to buying online
WHAT IS THE PURPOSE OF COMMERCIAL PROPERTY INSURANCE?
The purpose of commercial property insurance is to provide critical financial assistance for a business or organisation in the event of a loss or damage to the assets of an enterprise.
The objective is to allow the business to continue to operate with as little disruption as possible. It protects against losses related to a policyholder’s specific assets, earnings and expenses derived from those assets, plus added ancillary costs incurred due to a damaging event. This makes it distinct from casualty insurance which is a “third-party” coverage.
Casualty Insurance, while closely related to property coverage, provides protection for a policyholder against the claims of others.
WHAT RISKS ARE COVERED?
There are three basic types of policies:
- Named Perils
- All Risks
- Commercial Packages
Named perils and All Risks
Commercial property insurance policies cover the land and capital equipment owned by a particular company. However, there are different types of coverage that are available to protect against property loss.
Policies protect against certain causes of loss—“perils” such as fire or theft. Coverage can be provided on an “all perils” basis, or a “named perils” basis.
- Named perils policies list exactly what is covered by the policy
- Open perils (or all risk) policies will list what is excluded from coverage
Named perils policies have fallen out of favour while the all-risk policy has become the standard. Even broad “all risk” policies may contain restrictions as to the type of property, coverages, limits and deductibles.
Commercial packages
A third type of coverage is actually a combination of products and is appropriately named a commercial package policy and combines coverage for multiple perils, such as liability and property risk. Package products will include extensions that might be part of another group of covers. These are put together by underwriters to cover specific segments and niches.
Types of Damage – Physical and consequential
The main purpose of any property insurance product is to cover both the physical and the consequential damage suffered as a result of catastrophic (CAT) perils (such as earthquake, flood, hurricane, and others) or non-catastrophic perils (fire, water damage, water damage, terrorism and others). Policies for such risks are one of the most common covers in the market and almost all insurance companies offer them. While not all carriers will offer CAT policies, virtually all will offer traditional property coverages.
Physical assets covered include among others:
- Buildings (including offices, factories or other facilities)
- Machinery
- Equipment/contents (including computers, furniture and other appliances)
- Raw materials or inventory, (including finished products or merchandise)
- Personal property of others in your care, custody or control (if the company is legally liable)
Consequential damage is a loss suffered as a consequence of damage covered under the policy. It is a loss that arises as a result of direct damage to property – for example, loss of rent after the destruction of a rental property. Note that certain consequential losses may not be covered under standard property forms.
Catastrophic perils
Catastrophic (or simply “CAT”) perils produce losses of such magnitude as to be difficult to predict and therefore rarely self-insured or retained. They include, among others:
- Hurricanes
- Typhoons
- Earthquakes
- Tsunamis
- Tornados
- Floods and storm surges
- Storms
- Landslides
- Strong winds
- Hail
- Volcanic eruptions
Non-catastrophic perils
Non-catastrophic perils may produce losses of equal degree, however, they tend to be more predictable or man-made.
- Fire
- Collapse
- Terrorism
- Strikes
- Damage to electronic data processing equipment (EDP)
- Explosions
- Water damage
WHAT RISKS ARE NOT COVERED?
Property policies will not protect against risks associated with deterioration, ageing or lack of maintenance as well as any tests or experiments. Common exclusions include damage by mould, erosion, corrosion, pollution, etc.
Examples include:
- Equipment kept outdoors without necessary protection from the elements is generally exempt from coverage
- A warehouse with a poorly maintained and leaking roof may preclude coverage
- Mould damage in an inadequately ventilated building will be exempt from coverage
MARKET CHARACTERISTICS
The commercial property insurance market is wide and varied with a vast number of insurance providers in all countries.
Dealing with catastrophic losses
Despite the depth of the global property market, the capacity of each insurer is limited by the risk’s specific operational and geographic characteristics. If the premises of the insured are in catastrophic areas (particularly earthquake, hurricane or flood zones) the limits will be more restricted and the premiums higher.
The insurance industry has developed several tools to calculate and assess the chances of loss occurrence in such areas.
Assessment tools
Considering that a natural loss usually affects large areas, the industry has developed different tools, including predictive models, to help them manage probable maximum loss, as well as optimal deductibles and limits. These tools include:
- Maps exhibiting catastrophic areas (particularly earthquakes, hurricanes and floods) and exposure aggregation analysis
- Detailed records of all major natural events – Loss record is one of the pillars of the whole insurance industry as it helps determine exposure, number and value of future losses
- Exposures and accumulations – In order to limit and diversify their exposures, insurers map and count the risk they insure in specific areas. CRESTA (Catastrophe Risk Evaluating and Standardizing Target Accumulations) was established by the insurance and reinsurance industry in 1977 as an independent body for the technical management of natural hazard coverage
Ancillary coverages
Whilst a commercial property policy will provide protection for the business’ physical assets, there are other important types of insurance that protect an insured’s premises that may not be included in a general property policy. These include:
- Terrorism – Policy providing coverage to individuals and businesses for potential losses that might occur due to acts of terrorism
- Real estate funds/portfolio – Master-sponsored program providing various coverages for properties held in an organisation’s proprietary residential and/or commercial real estate funds
- Construction: builders’ risk – Policy that covers property in the course of construction and provides indemnification against damage to or destruction of buildings while construction is in progress
- Lender placed: real estate owned – Protects lenders against direct physical loss or damage to properties in which the lender holds an interest
- Lender placed: forced place – Provides coverage to the lender in the event the borrower allows coverage to lapse
- Mortgage impairment – Provides coverage for the lender’s interest in a mortgaged property in the event of uninsured or underinsured damage to the property
- Earthquake – Coverage for loss of property or damage due to an earthquake
- Flood – Protects property owners from flood damage to the structure and/or contents of their property
- Windstorm – Coverage that protects property owners from losses incurred as a result of damaging winds produced by storm storms such as hurricanes
APPROPRIATE LIMITS
Property coverage is generally either valued on a replacement cost basis or an actual cash value basis.
- Replacement cost is defined as the cost to replace the property with materials of like-kind and quality
- Actual cash value is the replacement cost less actual physical depreciation or obsolescence (this can differ substantially from the accelerated accounting depreciation)
If your property is brand new, and without depreciation, there should be no difference between the two valuation methods.
Unless the property itself is a complex or large facility, selecting an appropriate limit of coverage for your building is usually relatively straightforward. The limit is simply defined in the policy, but generally means the structure itself, as well as completed additions and fixtures and permanently installed machinery and equipment.
COMMERCIAL PROPERTY INSURANCE PITFALLS
The most common problems faced in property claims generally centre around the following five concerns:
- Valuations
- CAT costs/deductibles
- Flood
- Business Interruption
- Multiple Policies/Concurrency
Valuations
Problems often result because of insufficient limits or troublesome sub-limits. Another area of conflict can be the determination of business interruption costs.
CAT costs/deductibles
Because catastrophic losses are treated separately how they are determined and calculated is critical.
Flood
Losses resulting from flooding are frequently the cause of conflict between the insured and insurers. It is critical to clearly determine whether deductibles and limits will be applied by location, occurrence, initial damage, or over time.
Business interruption
It is vital to clearly understand what is, and is not, covered by business interruption. Many factors, including the unexpected costs involved in re-establishing a business after a major loss, make such calculations difficult and a point of possible contention unless carefully set out.
Multiple policies/concurrency
Conflict between policies can cause disputes unless carefully managed. Additionally, cross-border and international claims create added difficulties unless well planned from the offset.
EMERGING ISSUES
Despite the near half-millennium history of commercial property insurance, new issues are constantly arising. Some of the areas that are likely to attract considerable attention in the near future include:
- Ever-broadening concerns regarding the breadth of cyber coverage
- The impact of climate change on flood and storm damage
- Unceasing terrorism and related governmental subsidies
- The still-emerging area of drones and the Internet of Things
All of these areas will be the subject of court cases and possibly years of heated negotiation between insured parties in the years to come.
CLAIMS
A first-party claim is one which is paid directly to the insured. A claim for property damage is an example of a first-party claim: the insured has suffered a loss of his own property and, if covered, the insurance company will pay him directly for it.
A third-party claim is one that involves damage or harm to someone other than the insured party. When settled monies will be paid to the claimant (the third party) rather than to the insured. A typical example of a third-party claim is when a claim is brought against an insured party for negligent driving resulting in injury.
Property insurance, in its strictest sense, is limited to protection for physical property such as commercial buildings and vehicles, while casualty coverages protect against legal liability. The two coverages are often purchased together, but it is important to understand the essential differences.
A Business Owner Policy or BOP is a type of commercial package. It is an insurance package that assembles the basic coverages required by a business owner in one bundle. It is usually sold at a premium that is less than the total cost of the individual coverages. Business Owners Policies usually target small and medium-sized businesses and may contain business interruption insurance including reimbursement for lost revenue resulting from an insured property loss.
BUYING ONLINE
In our opinion, the renewal of commercial insurance should be approached very differently to personal insurance as some of these insurance policies are obligatory and required by law, whilst other policies within your insurance programme may be based on a thorough risk management review during which your business operations are assessed and the likelihood of an incident occurring factored into the requirement for insurance protection.
Most businesses change and diversify over time and an online form will not ask the in-depth questions a broker will ask about your future business plans or the contract types you might be looking to commit to. An online policy is an off-the-shelf product, and, as we know, no one business is the same. Talking to an insurance broker makes you more confident that your insurance program will offer the proper protection.
HOW CAN BLYTHIN & BROWN HELP?
Our commercial property insurance specialists offer a flexible range of insurance policies and will help you to understand your risks so that you can select the most suitable policies to meet your needs.
Our knowledgeable and experienced team will work with you to build a bespoke policy helping with cover, service, and premiums. In addition to working with you on excess liability, professional indemnity, and ensuring you have the right insurance programme in place.
If you would like further advice or a review of your current arrangements please get in touch.