Working through a commercial property loss closely mirrors the process involved in developing the loss payment for a homeowners' property loss. However, the number of steps required to calculate a commercial property loss is double the number necessary for a homeowners' claim. One of the main reasons for the additional steps is coinsurance. Attached is a flowchart detailing the CPP loss payment calculation.
Coinsurance applies to both the building coverage and the contents coverage following a commercial property loss. Nearly 75 percent of the steps in the commercial property loss payment calculation flowchart relate to coinsurance.
A detailed explanation and comparison of the differences between the application of coinsurance in the homeowners' and commercial property policy was provided in the previously posted coinsurance series. The discussion of coinsurance in this article focuses on how to use the information in the flowchart to calculate the amount of loss payable.
Before the payment calculation process can begin, six specific pieces of information are required, the:
- Total damage amount for both or either the building and contents;
- Applicable policy limits for each type of coverage;
- Coinsurance percentage;
- Deductibles that apply;
- Whether the specific property is insured on a replacement cost or actual cash value (ACV) basis; and
- The value of the covered property, at whichever valuation method is employed, at the time of the loss.
Most of this information can be pre-filed before the calculation process begins. Policy limits, the coinsurance percentage(s), deductibles and how the property is valued can all be input before the process begins. But without the amount of damage, nothing can be calculated. Below are the instruction for completin the attached commercial property payment flowchart.
Total Damage Amount
Following a loss, the insurance carrier supplies the insured with a "proof of loss" form. The proof of loss provides the insurance carrier the specifics surrounding the loss plus a detailed analysis of the amount of loss being claimed - the "total damage amount." Once the proof of loss is filed with the carrier, the total damage amount can be transferred to the flowchart and the calculation can then be completed in a matter of minutes.
Both the commercial property policy (CPP) and the homeowners' policy allow the insured 60 days following the insurance carrier's request to complete the proof of loss. Generally, the request for this information is considered made when the carrier provides the insured with the proof of loss form.
Notice once again that the policy does not state that the proof is due 60 days from the date of loss; it is due 60 days after requested.
Obviously, the total damage amount can exceed the policy limits. In the flowchart, the policy limits are requested in box "1" for two reasons: 1) to later calculate any coinsurance penalty that may apply; and 2) because the ultimate payout cannot exceed the policy limits. Do not lower the "total damage amount" to match the policy limits as the insured will be penalized when the deductible is ultimately subtracted.
Insurance Services Office's (ISO's) CPP specifically lists 17 types of property excluded from protection (AAIS and proprietary forms may differ). Endorsements are available to add back coverage for some property on this list; some of the property in this schedule are completely excluded, but then coverage is given back in small amounts as an "additional coverage;" and some of the excluded property is simply excluded with essentially no standard way to get coverage back.
If any of this excluded property is included in the total damage amount reported on the proof of loss, the value must be deducted from the insurable loss value to arrive at the actual insurable damages. Box "3" is used to schedule the specific property, classify it as building (B) or contents (C) and subtract the value from the total damage amount. The result is the actual insurable damages.
As noted in box "2," if: 1) none of the excluded property is on the proof of loss; or 2) coverage for an otherwise excluded type of property is given back by endorsement, the user can completely skip the deduction process in box "3."
Most of this article's remaining paragraphs focus on the coinsurance function and its part in calculating the total amount of eligible payment. This section of the discussion is broken into three parts: 1) Developing the "Insurance Required" ("IR"); 2) Comparing the insurance carried ("IC") with the "IR" (the classic coinsurance calculation); and 3) Applying the coinsurance penalty.
Developing the "Insurance Required" ("IR")
Valuation method, the building's or contents' value at the time of loss and the applicable coinsurance percentage are needed to develop the "insurance required." Lacking any part of this information will not allow the coinsurance calculation to be correctly completed. In ability to correctly complete the coinsurance calculation impedes the ability to correctly establish the amount payable.
The valuation method and the value at the time of the loss are fully linked. Without knowing the valuation method, there is no way to estimate the value of the building or the contents. If the proof of loss is completed using replacement cost when the policy provides coverage at actual cash value, the "IR" and entire coinsurance calculation will be inappropriately skewed (potentially resulting in the undue application of a penalty). Having and applying the correct valuation method and value are paramount for the rest of the calculation.
Not only is the valuation method critical, the time at which the property is valued is just as important. When calculating the "insurance required," the damaged property is valued as of the date of the loss; not when the original policy was written, the inception date of the policy or any other date - only the date of loss.
Notice that the "IR" is developed separately for the building and contents; this is because one could be replacement cost while the other is ACV. Also, since separate limits are chosen, one class of property could fully meet the coinsurance requirements while the other falls short.
"Insurance required" (the "should" amount) is actually the product of a two-step process. Boxes "5" through "10" walk the completer through the "insurance required" calculation process to aide in the overall coinsurance calculation process.
The building "IR" is found in box "7;" box "10" contains the contents "IR." Box "11" provides the coinsurance calculation comparative (found at the bottom of the first and top of the second page in the flowchart). Information from box "7" is placed in the space labeled, "Building Cov. Required (IR);" The amount developed in box "10" is placed next to, "Contents Cov. Required (IR)" found in box "11."
Comparing Insurance Carried with Insurance Required
Insurance Carried (IC) represents the policy limits the insured actually purchased. In the flowchart, the IC is requested/provided in box "1" (below the amount of damage claimed). Simply place the amount of coverage carried in their respective spots in box "11."
Having IC and IR together in box "11" makes answering the questions found in box "12" and "16" rather simple. Box "12" to the top right of box "11" asks if the building's IC is greater than its IR; and box "16" found below box "11" asks the same question, but related instead to contents coverage. The answer to both questions leads the completer through the rest of the coinsurance-related section found in boxes "13"-"15" and "17"-"19."
Unlike the homeowners' policy, the CPP applies coinsurance as a penalty. If the insured does not carry enough coverage, the most it will ever be paid is the result of the coinsurance formula:
- IC / IR x Loss
As indicated in boxes "13"-"15," if the insured does not carry more than the insurance required (IR), it gets the lesser of the actual damages or the result of the coinsurance calculation. The same penalty applies to the contents coinsurance calculation provided in boxes "17"-"19."
Combined Total Amount of Insurable Damages
All the necessary coinsurance steps are now complete. The total amount of insurable coverage resulting from the comparison and any applicable penalty for both the building and contents damage can be added together to provide the "combined total amount of insurable damages" presented in box "20." This is the first point at which the amount of insurable building damage and insurable contents damage merge.
From here, only one step remains - the application of the deductible. Once the deductible is subtracted, the "amount of eligible loss" is finally calculated.
Property deductibles are subtracted from the amount of eligible loss, not the coverage limit or necessarily the amount of the original claim. This is why the deductible appears so late in the flowchart.
The CPP states that only one deductible applies to a loss event; however, it also reads:
- When the occurrence involves loss to more than one item of Covered Property and separate Limits of Insurance apply, the losses will not be combined in determining application of the Deductible. But the Deductible will be applied only once per occurrence.
Essentially this means that if the insured has a scheduled CPP (one limit for building and a separate limit for contents) with a $1,000 deductible, the policy will subtract the deductible from the amount of insurable damage that will result in a "penalty."
Assume for example sake that the building limit ("IC") is $100,000 and the contents "IC" is $50,000. After completing the worksheet, the "Total Amount of Insurable Building Damage" is $102,000 and the "Total Amount of Insurable Contents Damage" is $49,000. What this policy provision means is that the $1,000 deductible will be subtracted from the contents loss and the building damage is subject to the policy limit; this results is a total loss payment of $148,000. Without this provision, the payment would be the full loss amount of $149,000.
This step is not represented in the flowchart, the completer must remember to subtract the deductible from amount that penalizes the insured the greatest. A note is provided in the flowchart as a reminder.
Obviously, this only applies when there is a total loss and the coinsurance penalty does not apply. Also, this step is only necessary when there are scheduled building and contents limits; blanket limits are not subject to this provision.
Amount of Eligible Loss
After the application of the deductible to the "combined total amount of insurable damage" (subject to the deductible penalty described above) the "amount of eligible loss" is produced and inserted in box "22." The total is compared to the policy limits to assure compliance with the policy language. If the policy limits are greater than this amount, the entire amount is paid. If, however, this amount exceeds the policy limits, the insurance is limited to the amount of coverage purchased (the policy limits).
Again, notice the phrase, "Remember to add all applicable 'Additional Coverages' to this amount." Several additional coverages in addition to the limits are found in the CPP. Those amounts are added to and paid in addition to the "amount of eligible loss."
Examples of additional coverages include debris removal, reasonable repairs, increased cost of construction, fire department service charge and pollutant clean-up and removal. A complete list of additional coverages and coverage extension, along with each of their amounts conditions, is found in the CPP.
The Next How-To Calculate
Liability coverage is the focus of the next "how-to" flowchart. The upcoming flowchart walks the user through calculating the coverage available to pay all types of liability losses from personal auto to commercial general liability and even professional liability.