Insuring Property and Liability Risks

Insuring Property and Liability Risks

Introduction

United Insurance Educators, Inc.

Introduction

This course is designed to provide credit hours for your state. This course should not be considered a selling tool and it is not our intention to provide legal advice. While we do strive for clarity, the information is gathered from multiple sources and it is always possible that opposing opinions may be printed. We believe all views should be expressed. Material is always subject to change, if laws or customs change. We encourage agents to read all company brochures and updates to keep abreast of current legislation. We require each agent to do his or her own work. It is never acceptable to copy another agents test or to receive help in any inappropriate way from another. All state requirements must be followed in order to receive a Certificate of Completion. No exceptions. Those who write these courses strive for perfection, but I’m sorry to say we are human. Despite constant revision, we inevitably miss something. If you find a misspelled word, a misused word, or inappropriate punctuation, please accept our apologies. We hope to reach perfection eventually. All of our course material is copyrighted. Please respect our rights by not copying or using any of our material without written authorization from us. All of our courses are the sole property of United Insurance Educators, Inc. We hope this course meets your expectations. Any suggestions are always welcomed.

Thank you for ordering from United Insurance Educators, Inc.

8213 – 352nd Street East Eatonville, Washington 98328-8638

Telephone: (253) 846-1155

FAX: (253) 846-7536 Email: [email protected]

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Table of Contents

Page 1 United Insurance Educators, Inc.

Table of Contents

Chapter 1 Why Do We Have Insurance?

6

What is risk? 7 Premium dollars: a certain loss. 9 Insurance takes away the worry. 11 Charge it! 12 Marine insurance keeps the goods moving 12 Insurance line development/There’s always a way 13 Fire insurance: one of the first forms invented 14 Making the policy practical 15 Standardization becomes necessary 16 Chapter 2 Understanding the Impossible

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There are 4 basic parts 22 Declarations 23 The Insuring Agreements 24 When is the policy effective? 25 Binders 26 Canceling the policy 28 What are the principle concepts of insurance? 32 Indemnity 32 Insurable Interest 33 Using the Mortgage Clause 35 When negligence or neglect is a factor 35 Proportional payment 36 When more than one mortgage exists 37 Chapter 3 Liability Limitations

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Insuring for logical amounts 39 Actual Cash Value 40 Repair or replace? 42 Policy language has specific meanings 44 Chapter 4 When Multiple Policies Exist

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Who pays what? 46 Companies who are not able to pay 47 “Other Insurance” alternatives 47 Non-concurrent policies 48 What happens when claimants refuse the offer? 50 Chapter 5 Insurance Doesn’t Always Pay Everything

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How coinsurance works 53 Why would a policyholder want coinsurance? 55


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Small versus large property owners 57 Coinsurance history/Consumer distrust 58 Coinsurance variety 60 Deductibles/Why are deductibles used? 61 Straight deductible/Convertible deductible 62 Cumulative and participating deductibles/Franchise deductibles 63 Progressively diminishing deductibles 63 Loss limitation clauses/Pro Rata Distribution clause 64 Deductibles 65 Types of deductibles 66 In closing 67 Chapter 6 What Are We Insuring Against?

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Perils/Defining the losses 69 “Loss and Damage by Fire” 70 Lightning/Removal of goods 73 Exceptions 75 Arson 77 Coverage for fire department charges/Debris removal 78 Exceptions to payment 79 Peril Expansion 81 Extended Coverage Endorsement 82 How the deductible applies 83 Windstorm and Hail 83 Beach Plans 84 Explosion 85 Riot and Civil Commotion 86 Aircraft & Vehicles/Smoke/The Apportionment Clause 87 Joint Loss/The Optional Perils Endorsement 89 Vandalism & Malicious Mischief Endorsement 90 Earthquake & Volcanic Eruption Insurance 91 Automatic Sprinkler Coverage 93 Water Damage 94 Flood Insurance 95 Chapter 7 Fire Insurance Forms

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Putting the policy together 97 Policy Forms 98 Residential Policy Forms (Dwelling forms)/Dwelling and Contents Form 99 Dwelling Coverage 100 Contents Coverage 101 Dwelling and Contents Broad Form 103 Replacement Cost Coverage/Dwelling Buildings Special Form 104 Dwelling Policy Program 105 Commercial Forms 106 Property Covered - Coverage A – Buildings 106 Coverage B – Personal Property of the Insured 107 Coverage C – Personal Property of Others 107


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It Doesn’t Cover Everything 107 Extensions of Coverage 108 How is the policy arranged? 110 Is your client adequately insured? 111 Chapter 8 Marine Insurance

112

What is marine insurance? / Is there a standard marine policy? 112 How are marine policies classified? 113 First group: loss or damage to conveyances 113 Second group: “Port Risk Only” policies 114 Third group: fleet policies 115 Fourth group: “Full Form” and “Total Loss Only” policies 115 Fifth group: Hull policies adapted to the type of vessel 116 Liability protection 116 Class 1 - Collision 117 Class 2 - Protection and Indemnity Insurance policies 117 Class 3 - Excess Protection and Indemnity insurance 118 Class 4 - Water Pollution liability 118 Chapter 9 Marine Insurance Marketing

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Cost, Coverage, and Sales / Rates: A judgment call 120 Client evaluation 121 Hull rates 122 Cargo rates 124 Considering Past Performance/International competition/Pleasure boats 125 Yacht Hull Coverage 126 Other coverage for yachts 127 First Coverage - Protection and indemnity insurance 128 Second Coverage - Federal compensation insurance 128 Third Coverage - Medical payments insurance 128 Reading the Yacht policy 128 Outboard policies 129 Chapter 10 Inland Marine Insurance

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Goods in transit / Why is it called “Inland Marine” insurance? 131 Growth of the Inland Marine insurance industry 131 Nationwide Marine Definition 134 Inland marine insurance characteristics 136 All-risks protection 137 Excessive hazard / Property normally covered by other insurance 138 Wear and tear 138 Dampness or extremes of temperature 139 Carelessness of the insured / Carelessness of others 139 Mysterious disappearance 139 Infidelity (a disloyal act) / Artificially generated electricity 140 Earthquake and flood / War, acts of war, and nuclear reaction 140 Underwriting: Moral and Morale Hazards 140 Assignment / Who is requesting coverage? 141


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Imports and exports (Categories A and B) 141 Domestic shipments (Category C) 141 Transportation policies 143 Parcel Post and registered mail policies 144 Registered mail policy 145 First class mail policy 146 Other forms: Armored car and messenger policy 146 Motor truck cargo insurance 147 Public trucker’s legal liability forms 148 Means of communication coverage 148 Chapter 11 Risks & Protection

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Personal property floater risks 149 Scheduled and unscheduled floaters 149 Standard provisions 150 Terminology of the personal property floater 150 Floaters: Personal property floater 152 Personal effects floater 154 Personal articles floater 155 Government service floater 157 Snowmobile floater 157 Nearly anything is possible 158 Commercial property floater risks 158 Livestock floater 159 Accounts receivable insurance 160 Valuable papers & records insurance 161 Floor plan merchandise policy 161 Signs and street clocks form 161 Dealer’s block insurance 162 Electronic data processing 164 Chapter 12 Consequential Loss Insurance

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Loss of business 166 Business interruption insurance 166 A separate and specific policy 167 Describing the property 168 Indemnity period 169 Forms 171 Gross earnings form 172 The agreed amount endorsement 173 Premium adjustment endorsement 174 Extended period of indemnity 175 Deferred loss payment endorsement 175 Payroll endorsements 175 Simplified earnings forms 176 Contingent business-interruption insurance 177 An earnings form of business interruption insurance 178 Extra expense insurance: business interruption means loss of business 179


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Business income coverage form 180 Policy definitions 181 Individual consequential loss insurance 182 Rent insurance 183 Forms/Coinsurance 184 Period of indemnity/Rates/Additional living expense 185 Leasehold insurance 186 Recovering profit losses 187 Chapter 13 Boiler and Machinery/Glass Insurance

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Boiler and machinery insurance/Premium 189 Inspection services 190 Application for coverage 191 Direct-Damage policy 192 Primarily property coverage 195 Exclusions 196 Endorsements/Business interruption endorsement 197 Extra expense insurance 199 Combined business interruption and extra expense 199 Consequential damage insurance/Utility interruption 200 Glass Insurance 200 Chapter 14 Insurance Ethics

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Principles of honor and morality 203 We are only sales people. 205 How did I become a moral person? 206 Is it really necessary to be ethical? 207 Egoism: Acting in our own self-interest. 209 Perception is everything. 211 Promoting ethics is a full time job. 212 Combining investment methods for a satisfying result 216 Where do I start? 217 Investment portfolios 219 How do I know what is ethical? 221 Mores 223 An agent’s ethical requirements/Education 224 Meeting the people 225 What is covered and for how long? 227 Policy replacement 230 Does the applicant understand what was said? 230 Validating premium cost 231 Applicant signatures 232 Keeping in touch with your clients 232 Commingling funds 233 Making personal choices 233 Why bother with ethical behavior? 236


Chapter 1: Why Do We Have Insurance?


Why Do We Have Insurance?

Many states mandate certain types of insurance for the protection of society in general. If an individual dies, society in general would not be harmed, but if an individual causes an automobile accident that injures others society may be injured. If the injured party has no medical insurance, tax dollars may be needed to care for them. If the injured person no longer can work, tax dollars may be needed for their support. Therefore, society would have no reason to mandate life insurance (although there may be cases where society would be affected), but there is a reason to mandate automobile insurance. Some types of insurance deal with many details and the property and casualty field is one of these. As a result, consumers often find it confusing. Although the property casualty agent has completed schooling that allowed them to receive their insurance license, we will still address this course from the standpoint of an individual with little practical experience. Why is there a need for insurance? If there were no risks in life there would be no need for insurance. If we knew for a fact that we would never be involved in an automobile accident or experience a house fire, we could save ourselves the trouble of investigating and purchasing a policy to protect ourselves from these losses. The possibility of loss is the reason for insurance. Although there are varied definitions of the word “risk”, as it relates to insurance risk is “the uncertainty of a financial loss.” We do not know whether or not we will experience a financial loss – that is the uncertainty. For some individuals the uncertainty is a substantial worry because they have accumulated many assets that would be at risk in the event they were sued for their part in the misfortune of another. This worry brings about our next point: there are two kinds of uncertainty: (1) the concept of the loss, which is a state of mind, and (2) the actual financial loss itself. Dealing with the uncertainty of a financial loss has become a business; it is the foundation of the insurance industry. There are many types of financial uncertainty and resulting insurance to cover that state of mind. There are policies to cover death, ill health, accidents, the physical inability to work, liability claims, and loss of property. In this course we will be looking only at two types of insurance: casualty and property.




What is risk? Risk is anything that will result in a physical or financial loss. As it relates to insurance, there is only risk if we perceive it. The man who has no fear of death does not perceive it to be a risk either physically or financially. Of course, his wife may well consider his premature death to be a financial risk. We especially see these differences of opinion when it comes to the purchase of nursing home insurance. The husband assumes his wife will be able to care for him in his old age so he does not see any risk involved with aging. The wife, on the other hand, doubts her ability to care for her husband as he ages. Therefore, she considers his failing health due to age to be a risk. He would never consider the purchase of a nursing home policy because he does not perceive the risk. His wife would purchase such a policy because aging does pose a threat to her both physically and financially. The perception of risk is the basis of insurance sales. The agent’s job is to point out the existence of risk. The first step is always identification of possible risks to individuals or a business. Once the risk is identified, an analysis of the risk is necessary. It is not usually considered prudent to try to insure all risks. Most people identify the risks that would pose a major hardship financially and insure based on those facts. The process usually is specific: 1. risk identification

2. risk analysis

3. risk measurement

4. risk prevention or treatment

5. review the measures taken

Insurance, of course, places emphasis on risk treatment, which is also risk prevention. Obviously, buying insurance will not prevent the risk itself, but insurance does prevent the financial results of risk. Or, at the very least, insurance will minimize the results. Buying a nursing home policy will not prevent a nursing home confinement, but it may prevent the financial devastation it would bring. On the other hand, it might even prevent the nursing home confinement under the right circumstances. Example: Bill and Helen bought nursing home policies. Bill becomes ill. Since they purchased a policy that pays benefits for care at home they consider this option. The doctor approves care at home, so instead of becoming institutionalized, Bill can remain where he is – outside of the nursing home.




In the property casualty field, such examples are harder to come by. It is more likely that the policy will simply prevent financial devastation, but not the results of the risk itself. There are usually only two ways to treat risk: control and financing. Some types of risk can be minimized by preventive measures. Fire alarms in buildings are a way of risk control. Although a fire may still happen, the alarm may prevent much damage. Risk control is as important as covering the financial loss that occurs. Preventing the loss in the first place keeps insurance rates down. Risk control covers several techniques: avoidance of the loss, prevention of the loss, loss reduction (such as the fire alarms), and non-insurance transfer. Insuring a potential loss is the best-known method of risk transfer, but there can also be non-insurance methods. In our example of Bill and Helen, they could have drawn up a contract with their daughter. Bill and Helen could have agreed to leave her their home in exchange for her care during their elder years. By this method, they have transferred the risk of institutionalization without the purchase of a policy. When it comes to home and auto insurance, non-insurance transfer of risk would be difficult. Although there are different definitions of insurance, the key concept is the anticipation of loss through prediction processes and the redistribution of the burden of financial loss. Insurance companies are perhaps the best predictors of financial loss. Through their studies they know who is most likely to experience loss and under what circumstances. From these studies of loss, the insurance companies establish an appropriate rate per unit of exposure, which redistributes the aggregate burden of losses and transfers expenses equitably among those who purchase the particular insurance for that type of loss. To put it in simple terms, many people with several apples will put one of their apples into a communal fruit basket. If one of the participants has all of their apples eaten by an intruder, they will be allowed to replace their lost fruit from the fruit basket. Since it is unlikely that the loss would happen to everyone, the fruit basket concept allows each person’s loss to be minimized to one apple. If they must replace their apples, they may do so without having to personally finance the replacement of all their fruit. Their predetermined loss is one apple (the price to participate). They have minimized their risk by agreeing to give up one apple, knowing all their apples would be replaced if necessary. The certain small loss is one apple. In exchange they have received protection from the uncertain potential large loss of all their fruit.




The purchase of insurance, while an important step, should be the final step. The first steps involve risk minimization through safety and preventive measures. Usually it is not possible to eliminate risk, so insurance will always be part of the solution. In the property casualty field, the risk is greater than the ability to minimize it. For example, as our highways get more congested, it would be impossible to eliminate the risk posed by other drivers. No matter how careful a person is he or she cannot be certain the other driver will not cause a financial loss to them physically or to their vehicle. Therefore, we must insure against both medical and property loss. According to the National Association of Independent Insurers (1994), the greatest amount of property and liability insurance is written for auto liability (including private passengers). A full quarter of the premium dollars written were devoted to this type of coverage, followed by Worker’s Compensation with 13.8 percent. The amount of admitted assets and policyholders’ surplus is important because they have a strong bearing on the U.S. economy. They indicate how much total capacity is available. “Capacity” refers to the availability of property and liability insurance for the public. One might guess that insurance companies will write whatever amount of insurance is sold. However, the amount of available insurance is determined by the amount of invested capital and retained earnings within the business of insurance. Therefore, the companies would not necessarily issue whatever amount of insurance is sold. It must be pointed out that insurance business does not stay within the U.S. It has been estimated that at least 20 percent of all marine insurance originating in the United States is exported directly to the alien non-admitted market by brokers and others selling policies. A considerable amount of business is exported to Lloyd’s of London. In addition, self-insurers account for a substantial amount of business. Self-insured plans and alien companies would not be included in most statistics. Consumers think of fire and casualty losses in terms of their insurance, but there are other outlays that affect us financially. Americans must support (through tax dollars primarily) fire department personnel and equipment, police department personnel and equipment, investigative units, and the creation and maintenance of water supply systems. Even our highways must be maintained for safety and accident prevention. Since there is no specific data collected regarding highway and water maintenance costs as they relate to accident prevention and related insurance costs, it is not possible to truly know the tax dollars and related premium dollars involved. Premium dollars: a “certain loss”. When it comes to insurance, there are certain and uncertain losses. Premium dollars are considered a “certain loss”. Premiums are the apple we




put into the fruit basket in anticipation of an uncertain loss. We each know that we are giving up one apple. What we do not know is whether or not we will need to replace our apples due to an uncertain loss. There has been lots of emphasis put on risk management by insurance companies and even our government agencies. It apparently has not been successful however. Statistics show that fire losses, for example, are on the rise. There are some professionals in the industry that feel insurance has actually contributed to the rising costs. It is felt that insurance takes away the pressure to actively work at risk reduction within industries and private enterprise. Of course, we are also seeing intentional fires rising in occurrence. Since it is obvious that insurance does not prevent financial loss and may even contribute to it, does insurance have any social value? Perhaps the only social value is the ability to lump specific types of risk and loss together to gather data. From this data it is possible that new solutions may come forward. Aside from any social value, the ability to change uncertain risks to certain risks (through increased knowledge) allows insurance companies to better predict future losses with greater precision using the law of averages. The less uncertainty involved, the less money is necessary from the insured groups. In other words, when insurance companies know how many apples are necessary to have in the fruit basket to cover future losses, they will not over-collect. Instead of putting in one apple each, perhaps it will be possible to only put in half an apple for the same amount of financial protection. When insurance becomes more affordable, more participants will join the group. As more join the group, it is likely that the cost of joining will go down. When insurance rates become more affordable, this is always a social benefit because it makes insurance available to those who might not otherwise be able to obtain it. Insurance has always had a social aspect to it. Prospective homebuyers must be able to afford the cost of insurance in order to obtain a loan from the bank. Those who wish to buy a new car must be able to afford the cost of the insurance or the bank will not make the automobile loan. Businesses need insurance to receive financing. Availability of insurance reduces the cost of practically all commodities by diminishing that part of the cost of production that a manufacturer must necessarily set aside as a fund for protection against financial loss. When a manufacturer does not have to set aside funds to cover risk, they can use those funds for product promotion, product development or employment opportunities. If the manufacturer does not have to set aside funds to cover risks, they can afford to lower prices, which encourages commerce which helps our economy.




Insurance takes away the worry The early American shippers had a great deal to worry about. Not only were there pirates that would steal what they were exporting, but weather could also sink them. Because there were so many elements that could cause a significant loss fees to move goods from one continent to another was very high. Since shipping costs were so high, once the goods arrived, the cost to buy them was also high. When insurance took away most of the worry of moving the goods, prices could come down. When prices came down, people who would not normally have been able to purchase the goods now could. Insurance helped people have more material possessions so insurance helped raise the standard of living. The value of insurance has been apparent for a long time. In 1601 the British Parliament (43 Elizabeth, C. 12) wrote the following regarding marine insurance:

“whereby it cometh to pass that upon the loss or perishing of any ship there followeth not the undoing of any one, but the loss lighteth rather easily upon many men than heavily upon a few, and rather upon them that adventure not, than upon those who adventure; whereby all merchants, especially those of the younger sort, are allowed to venture more willingly and freely.”

Most Americans have little or no idea of the social role insurance plays. Consumers think the goods are there because they wish to buy them. Few realize that the goods are in the stores because insurance makes it possible. Americans have always owned land more freely than most other countries. While there are many reasons for this and no one reason stands alone, a major reason allowing home ownership is insurance. Few people would be able to purchase a home with cash. Homes are bought over time through mortgages. Lending institutions only make such huge loans because the homes can be insured. If there is a financial loss, the lending institution can reclaim the loan amount through the insurance proceeds. Insurance reduces the gamble that the lending institution would otherwise be taking. Insurance also benefits our government. The catastrophic fire losses some cities have seen, or the hurricane losses experienced along the Gulf Coast, or the earthquake losses in the Western states would have greatly affected the finances of our government had there not been insurance in place. Immediate rebuilding was possible because money immediately came available through the claims of the insurance policies. Certainly our government has also made funds available, but there are only so many tax




dollars to hand out. Without the insurance proceeds, rebuilding could be slow in coming. Insurance is interwoven in nearly every particle of our economy. If the insurance industry was ever to collapse, it is possible that our way of living would go with it. Insurance is so interwoven with our private enterprise system that our economic well-being is clearly dependent upon the strength of the insurance companies. Without liability insurance, several types of industry probably wouldn’t even exist. Certainly, segments of our health care would not be the same if liability insurance were not available. Charge it! America’s credit system, while contributing to our national debt, has also been the reason we have one of the highest living standards in the world. Financial consultants everywhere have been working hard to bring the American people into reality so they will pay down their debt. There is no doubt that we charge too much too often. Despite the problems we have with debt in America, there is no doubt that it supports commerce and industry. Only about 10 percent of the world’s business is conducted on a cash basis. The remaining 90 percent is based on credit. Most debt is insured. In fact, debt has become a commodity in America. Debt is traded and sold like any other commodity. All parties involved in trading commodities, including debt, do so because they realize that the transaction is backed by an insurance policy. Marine insurance keeps the goods moving Special mention should be made regarding marine insurance. Huge amounts of goods are moved over the ocean making marine insurance a fundamental instrument of business and commerce. Marine insurance is an important part in the creation of what is called “place utility.” Place utility is the difference between the value of the goods at their starting point where they were manufactured and the arrival point where the goods will be sold. Countries that control the insurance of these transporting vessels have been able to control which countries receive what goods.




Insurance line development As we know, most companies tend to specialize in specific types of insurance. At one time, insurance companies were restricted by law to either (1) life and annuity business; (2) fire, marine, and allied lines; or (3) casualty and surety lines of insurance. It was not unusual for a company to have subsidiaries so that all the lines of insurance could be written. As time went by the laws have changed, but many companies continue their subsidiaries. Many companies, during the times of limitations, formed relationships with other companies so that each supplied the other with the lines needed. Currently it is possible for any insurer, except a life insurer, to engage in all lines of property and liability insurance with only one or two minor exceptions. The separation of life and annuity business is still separate from the property and liability business, but this has not seemed to pose any problem for the insurers since subsidiaries still exist in many companies. As the limitations were eliminated for the insurers, it was possible for a single policy to be issued by a single insurer (labeled a multiple-peril policy). A multiple-peril policy is any policy that combines coverage for more than a single peril so simply combining loss from fire and windstorm would make it such a policy. By definition, a multiple line policy combined fire and marine lines with casualty and surety lines. Today we often call these all line policies or contracts. The automobile policy is an excellent example of an all-line contract since it combines liability insurance and physical damage insurance. These are convenient since we can purchase protection for many risks under one policy jacket. There’s always a way Many insurers utilize a holding company so that they may have an all-line affiliation. When state laws prevent a life insurer from owning a property-liability insurer, the two entities can be owned jointly by a holding company. They may then operate as an all-lines group. The trend is likely to continue since there has been increased interest in broader financial services. Some major players in the insurance field have gone this way, including Prudential Insurance Company of America and John Hancock Mutual Life companies. All insurance activities tend to be closely regulated by the government. Much of the regulation has to do with consumer interest and protection. A great deal of property and liability insurance is sold by independent agents that contract with the insurer. Therefore, they are not an employee of the insurer. These agents sell products through a contractual agreement with the insurance company. Independent agents own their renewals (often known as expirations). The contractual agreements usually have a




mutually beneficial clause governing the agent’s business to protect each side. Compensation is typically in the form of commissions, although some companies may also have some type of other compensation to encourage the agent to leave the business with them. The other compensation may be in the form of office overhead, for example. Fire insurance: one of the first forms invented Although not the first insurance policy, fire insurance was one of the forerunners. Fire destruction has been documented for as long as humans have kept records. Although the figure does not include the indirect costs that would add, according to the U.S. Department of Commerce, another 25 percent in losses, figures do show direct losses to fire at more than $10 billion annually. Indirect losses are harder to measure. The indirect costs include lost wages, clean-up, legal fees, health costs, and loss of sentimental items. Worse yet, fire claims lives, many of them children and the elderly. Many more are permanently injured or scarred. Pets are also the frequent victims of fires. Of the fire losses, approximately 15 percent are thought to be the result of arson. It is likely that the true figure is much higher. Many of our present day policies still use practices developed in connection with fire insurance. This is true of both property and liability insurance as well as other lines. Fire insurance is one of the more economically significant types of coverage since it is a type of insurance widely purchased. It accounts for more than 21 percent of the premium volume of all property and liability insurance. Most give the credit for creating fire insurance to Nicholas Barbon of London. In 1666 a fire lasting five days destroyed 85 percent of the city. There had been other major fires, including Hamburg in 1640. Immediately following the London fire, Nicholas Barbon began a speculative business building homes. As part of his sales presentation he promised to rebuild any house purchased from him if it was destroyed by fire. The idea was so well received that he was encouraged to develop fire insurance as a business. In 1680 he opened his business called the Fire Office, which was later changed to the Phoenix Fire Office. His contract was simply stated, but it is remarkably similar to forms used today. At the time most homes were owned by investors who rented them out to others. Using that as his basis, Nicholas Barbon set the rate at ten times the annual rental fee. In addition there were two classifications: timber construction required a rate of 5 percent of the annual rental and the brick homes were rated at 2 ½ percent. That equates to $.50 per $100 and $.25 per $100 of fire insurance. His rates remain similar to the rates used today in some areas.




In the United States prevention and reduction of loss was the focus. Catastrophic fires in major cities prompted building codes to reduce loss and save lives. Benjamin Franklin was instrumental in founding several small local fire departments that primarily fought fires on members’ property. In 1752 Benjamin Franklin helped establish the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire. He obviously did not intend to put the company name on a business card! For the next 100 years most of the companies formed were for members of local chapters.

Making the policy practical As individuals became more familiar with the ups and downs of trying to develop a fire loss contract, several things became apparent: the insurer needed to protect itself from unwise risk, the insurer needed to protect itself from unethical people (including the writing agent), and it was necessary to require all information prior to issuing the policy. Other elements would also eventually enter into the equation. Early on it became evident that those who purchased the insurance realized they could cause the fire themselves and be paid. It became essential that the policy contain some type of requirement that the property be maintained in a safe manner. It also became evident that there would have to be a full description of what was insured. As more and more requirements became evident, some of the policies became very large. Another problem that evolved were the various wordings of policies. Each insurer used language of their choosing. Those who sought out the coverage had difficulty knowing what they were buying. Many policies defrauded the insured with restrictive language that could not be understood by the general consumer. Ironically, some of the court decisions on policies were as confusing as the policies themselves. The start of the consumer’s mistrust of insurance formed from policies that were different from company to company and with court decisions that did not follow much uniformity. The insured was often defrauded by companies whose direct intent was to avoid paying claims. The insurance companies were handed opposing court views so that writing a policy that adhered to each ruling was nearly impossible. As courts were called upon more frequently to decide interpretations of policy language we saw a system of court law developed on insurance that probably still has no parallel in any other line of business. Of course, we must realize that insurance is a business of language. Since insurance sells “peace of mind” rather than tangible goods, it is not surprising that language is the basis of it.




Standardization becomes necessary As consumers became increasingly upset with denial of claims and courts became increasingly burdened with determining policy language it is not surprising that our legal system saw the necessity of developing standardized policy language. Initially cities developed some standardization since many policies were servicing only local areas. Then states began to develop specific policy language. Uniformity in the use and meaning of terms were required. Eventually the standards developed were interpreted definitively by the higher courts. This benefited both the consumers who bought the insurance and the insurers who developed it. The first attempt at standardization is credited to the National Board of Fire Underwriters in 1867 and 1868, but others followed suit. By 1900 several areas had adopted some form of standardization. The early attempts were not entirely successful, but they did begin the foundation that later forms followed. After several attempts and re-makes of legislation, the National Convention of Insurance Commissioners (now known as the National Association of Insurance Commissioners) recommended a revised form known as the 1918 New York Standard Policy. This revision reduced the number of moral hazards and if violated, rendered the policy void. Changes in language changed the effect of noncompliance from complete avoidance to mere suspension. Of course, these changes only solved some of the problems. As time went by, more changes were made. Many policies continued to be a battle between the insured and the insurer when claims were made. Due to the many documented and understood inconsistencies in policies, a committee was appointed in 1936 by the National Association of Insurance Commissioners for the purpose of developing a standard fire policy that would fairly represent both the insured and the insurer. Many people were involved in this, including agencies and organizations that represented agents, brokers, buyers, and sellers of insurance. The result was the 1943 Standard Fire Policy Form. New York made it effective on July 1st, 1943. For the next forty years this fire form was used in almost all states, the District of Columbia and Puerto Rico. It is interesting to note how seldom new forms were developed. The first standard fire policy was not revised for 31 years, the second form was not revised for 25 years, and the 1943 form stood for forty years before revision took place. What changes were made in 1943? There were six primary changes made:

1. Damage caused by lightning or fire caused by riot is covered under the 1943 form.




2. Destruction by order of civil authority to prevent a conflagration is specifically covered under the 1943 form.

3. The 1943 form is an interest policy – it covers

whatever interest the insured may have in the property without regard to the extent of such interest. This is in contrast to earlier forms that limited coverage to sole and unconditional ownership.

4. The 1943 policy may be assigned with the written

consent of the insurer. 5. The insured premises may be vacant or unoccupied for

up to 60 days without suspension of coverage under the 1943 form. Beyond 60 days, coverage is suspended.

6. If more than one insurance policy covers the same

property, the Standard Fire Policy provides for pro rata liability whether the other insurance is collectible or not. 1

It was not until the 1970’s that policy language began to be updated to reflect modern living. The intent was to make reading an insurance policy “user friendly”. Unfortunately, few consumers actually read their policies. It has been asserted that many of the selling agents do not read them. Despite the user-friendly intent, all insurance policies are still legal contracts, which mean that they must use legalese. The policy language must stand up in court and reflect the meaning that is intended. Policies deal with technical aspects and require precision language. Court interpretations will still be influential in deciding future policy language. Most of us appreciate any type of language that makes a policy user-friendly for those we sell to. Standardization is an advantage in most cases. When standardization (especially of language and terms) makes specific words mean specific things consumers will eventually understand at least some aspects of their policies regardless of whom they are insured with. This makes the agent’s job easier. Standardization is also considered a means of preventing misuse or even outright fraud by those involved in issuing the policy. Sometimes it also helps to prevent misuse and fraud by the consumers who buy them. Standardization saves court time because an “understood” meaning prevents 1 Property and Liability Insurance by S. S. Huebner, Kenneth Black, Jr., and Bernard L. Webb. Page 22




consumers from filing court cases. New court interpretations are not as likely on matters that have already had a court ruling. Standardization is helpful to the insurers since it makes agent training uniform and less haphazard. On the other side of standardization comes the disadvantage of complacency. As we have seen, long periods of time seem to pass before policies are reevaluated and updated. In these changing times, many professionals feel standardization allows those in charge to ignore problems that exist in current policies. Insurance has seen some changes that probably have not been adequately addressed due to standardization. Insurance companies may not want to see changes since past court cases have already established procedure. Setting new legal procedures can be costly. A unique feature of the Standard Fire Policy is its incompleteness. Additional forms and endorsements are required to make it a complete policy.

The Standard Fire Policy

Concealment, fraud. This entire policy shall be void if, whether before or after a loss, the insured has willfully concealed or misrepresented any material fact or circumstance concerning this insurance or the subject thereof, or the interest of the insured therein, or in case of any fraud or false swearing by the insured relating thereto. Uninsurable and excepted property. This policy shall not cover accounts, bills, currency, deeds, evidences of debt, money or securities; nor, unless specifically named hereon in writing, bullion or manuscripts. Perils not included. This Company shall not be liable for loss by fire or other perils insured against in this policy caused, directly or indirectly, by: (a) enemy attack by armed forces, including action taken by military, naval or air forces in resisting an actual or an immediately impending enemy attack; (b) invasion; (c) insurrection; (d) rebellion; (e) revolution; (f) civil war; (g) usurped power; (h) order of any civil authority except acts of destruction at the time of and for the purpose of preventing the spread of fire, provided that such fire did not originate from any of the perils excluded by this policy; (i) neglect of the insured to use all reasonable means to save and preserve the property at and after a loss, or when the property is endangered by fire in neighboring premises; (j) nor shall this Company be liable for loss by theft. Other Insurance. Other insurance may be prohibited or the amount of insurance may be limited by endorsement attached hereto.




Conditions suspending or restricting insurance. Unless otherwise provided in writing added hereto this Company shall not be liable for loss occurring: (a) while the hazard is increased by any means within the control or knowledge of the insured; or (b) while a described building, whether intended for occupancy by owner or tenant, is vacant or unoccupied beyond a period of sixty consecutive days; or (c) as a result of explosion or riot, unless fire ensue, and in that event for loss by fire only. Other perils or subjects. Any other peril to be insured against or subject of insurance to be covered in this policy shall be by endorsement in writing hereon or added hereto. Added provisions. The extent of the application of insurance under this policy and of the contribution to be made by this Company in case of loss, and any other provision or agreement not inconsistent with the provisions of this policy, may be provided for in writing added hereto, but no provision may be waived except such as by the terms of this policy is subject to change. Waiver provisions. No permission affecting this insurance shall exist, or waiver of any provision be valid, unless granted herein or expressed in writing added hereto. No provision, stipulation or forfeiture shall be held to be waived by any requirement or proceeding on the part of this Company relating to appraisal or to any examination provided for herein. Cancellation of policy. This policy shall be cancelled at any time at the request of the insured, in which case this Company shall, upon demand and surrender of this policy, refund the excess of paid premium above the customary short rates for the expired time. This policy may be cancelled at any time by this Company by giving to the insured a five days’ written notice of cancellation with or without tender of the excess of paid premium above the pro rata premium for the expired time, which excess, if not tendered, shall be refunded on demand. Notice of cancellation shall state that said excess premium (if not tendered) will be refunded on demand. Mortgagee and interests and obligations. If loss hereunder is made payable, in whole or in part, to a designated mortgagee not named herein as the insured, such interest in this policy may be cancelled by giving to such mortgagee a ten days’ written notice of cancellation. If the insured fails to render proof of loss such mortgagee, upon notice, shall render proof of loss in the form herein specified within sixty (60) days thereafter and shall be subject to the provisions hereof relating to appraisal and time of payment and of bringing suit. If this Company shall claim that no liability existed as to the mortgagor or owner, it shall, to the extent of payment of loss to the mortgagee, be subrogated to all the mortgagee’s rights of recovery, but without impairing mortgagee’s right to sue; or it may pay off the mortgage debt and require an assignment thereof and of the mortgage.




Other provisions relating to the interests and obligations of such mortgagee may be added hereto by agreement in writing. Pro rata liability. This Company shall not be liable for a greater proportion of any loss than the amount hereby insured shall bear to the whole insurance covering the property against the peril involved, whether collectible or not. Requirements in case loss occurs. The insured shall give immediate written notice to this Company of any loss, protect the property from further damage, forthwith separate the damaged and undamaged personal property, put it in the best possible order, furnish a complete inventory of the destroyed, damaged and undamaged property, showing in detail quantities, costs, actual cash value and amount of loss claimed; And within sixty days after the loss, unless such time is extended in writing by this Company, the insured shall render to this Company a proof of loss, signed and sworn to by the insured, stating the knowledge and belief of the insured as to the following: the time and origin of the loss, the interest of the insured and of all others in the property, the actual cash value of each item thereof and the amount of loss thereto, all encumbrances thereon, all other contracts of insurance, whether valid or not, covering any of said property, any changes in the title, use, occupation, location, possession or exposures of said property since the issuing of this policy, by whom and for what purpose any building herein described and the several parts thereof were occupied at the time of loss and whether or not it then stood on leased ground, and shall furnish a copy of all the descriptions and schedules in all policies and, if required, verified plans and specifications of any building, fixtures or machinery destroyed or damaged, The insured, as often as may be reasonably required, shall exhibit to any person designated by this Company all that remains of any property herein described, and submit to examinations under oath by any person named by this Company, and subscribe the same; and as often as may be reasonably required, shall produce for examination all books of account, bills, invoices and other vouchers, or certified copies thereof if originals be lost, at such reasonable time and place as may be designated by this Company or its representative, and shall permit extracts and copies thereof to be made. Appraisal. In case the insured and this Company shall fail to agree as to the actual cash value or the amount of loss, then, on the written demand of either, each shall select a competent and disinterested appraiser and notify the other of the appraiser selected within twenty days of such demand. The appraisers shall first select a competent and disinterred umpire; and failing for fifteen days to agree upon such umpire, then, on request of the insured or this Company, such umpire shall be selected by a judge of a court of record in the state in which the property covered is located. The appraisers shall then appraise the loss, stating separately actual cash value and loss to each item; and, failing to agree, shall submit their differences, only, to the umpire. An award in writing, so itemized, of any two when filed with this Company shall determine the amount of




actual cash value and loss. Each appraiser shall be paid by the party selecting him and the expenses of appraisal and umpire shall be paid by the parties equally. Company’s options. It shall be optional with this Company to take all, or any part, of the property at the agreed or appraised value, and alto to repair, rebuild or replace the property destroyed or damaged with other of like kind and quality within a reasonable time, on giving notice of its intention so to do within thirty days after the receipt of the proof of loss herein required. Abandonment. There can be no abandonment to this Company of any property. When loss payable. The amount of loss for which this Company may be liable shall be payable sixty days after proof of loss, as herein provided, is received by this Company and ascertainment of the loss is made either by agreement between the insured and this Company expressed in writing or by the filing with this Company of an award as herein provided. Suit. No suit or action on this policy for the recovery of any claim shall be sustainable in any court of law or equity unless all the requirements of this policy shall have been complied with, and unless commenced within twelve months next after inception of the loss. Subrogation. This Company may require from the insured an assignment of all right of recovery against any party for loss to the extent that payment therefore is made by this Company. In Witness Whereof, this company has executed and attested these presents; but this policy shall not be valid unless countersigned by the duly authorized Agent of this Company at the agency hereinbefore mentioned. The use of this standardized form has been an important step in the marketplace. It allows coverage to be both personal and commercial in nature, depending upon the need.


Chapter 2: Understanding the Impossible


Understanding the Impossible

For as long as there have been insurance policies consumers have complained about the difficulty in reading them. Even insurance agents have sometime voiced this complaint. We have come a long way to correct the situation. Language has been simplified, although the contract must still follow legal guidelines. Wording has been standardized, especially as it relates to insurance and claim terms. Consumers have been educated so that they are more likely to know what to expect in a property casualty policy. The standard fire policy set the stage, so to speak, for many other forms of insurance. Therefore, the consumer (and agent) that fully understands this type of policy is more likely to also understand other types. The basic concepts of all types of property and liability insurance originated with the fire policy, primarily the 1943 fire form. There have, of course, been terms added since then and policy language has changed. Even so, the basic format remains the same. There are four basic parts The fire insurance form has four basic parts to the policy. Those parts are: 1. Declarations 2. Insuring Agreements 3. Conditions 4. Exclusions. Many policies also have endorsements. Some policies may consider this section to be a fifth part, while others merely show them as an addition. Endorsements actually modify one of the four basic parts so technically they would be an addition and not a fifth part. Fire policies generally do not specifically identify the four separate parts. Other types of property casualty insurance do. Those policies, such as auto policies, that specifically identify the four parts are easier to read. However, recognition that the four parts exist, even if not specifically identified in the policy, is important to the understanding of how the policy works. Each of the four parts will have what could be considered subsections. That is, each part (declarations, insuring agreements, conditions, and exclusions) will be further broken down in the policy.




The first page of the policy will have some basic facts. The first page is typically called the face page. The heading identifies the insurer (the company selling the policy) and supplies the location of their home office. It will also state whether the insurer is a stock, mutual, or reciprocal company. Following this basic insurer information will be blanks that are filled in stating the perils covered, the premium charged, and the rate per $100 of coverage. The amount of insurance issued is the company’s maximum amount of liability. Declarations The declarations are made by the insured to the insurer. The person purchasing the insurance is telling the issuing insurance company specific facts necessary to the issuance of the policy. This includes the buyer’s name, mailing address, location of the insured property, a description of the property, and the amount of insurance purchased. The standard fire policy reads “the property described hereinafter while located or contained as described in this policy, or pro rata for five days at each proper place to which any of the property shall necessarily be removed for preservation from the perils insured against in this policy, but not elsewhere.” Following this statement a paragraph or couple of sentences is inserted specifically stating the description of the property insured. Should this paragraph that was inserted be accused of ambiguity when a claim arises, the policy is typically interpreted in favor of the insured by the courts. As a result, insurance companies try to be very specific in their description. The location of property is a determining factor when setting premium rates. Some areas experience more loss in property than do others. Because premium rates relate to location, policies typically state exactly where property is insured. Transferring insured property from one location to another can void the policy if it is done without the consent of the insurer. The courts distinguish location as either “description” or “definition of risk”. A mere description error may not alter the policy, but if the location does have risk attached to it, the policy would be considered altered. If the policy is altered, it becomes void and the insured may not receive compensation for their loss. There is an exception to property movement. If it becomes necessary to remove property in order to prevent its loss in a fire that is permissible under the policy. The property would be covered pro rata for five days. Obviously, the buyer must honestly represent the property to be insured so that the seller can adequately assess the possible risks involved. The




Standard Fire Policy requires states that the entire policy is voided if the buyer has purposefully concealed or misrepresented any material facts or circumstances relevant to the insurance policy. This is true whether a claim has been filed or not. The seller of fire insurance is so absolutely at the mercy of the buyer in the case of fraud that it is felt a buyer who misrepresents themselves would also consider arson or other unethical acts. There is a difference between misrepresentation and concealment. Misrepresentation is the changing of facts or risks. Concealment is the withholding of pertinent information that should have been revealed. Ethical standards do, of course, require that all relative information be given when buying insurance. Courts have ruled that insurance policies are contracts involving the need for good faith from both the buyer and the seller. Early court cases ruled that insurance contracts were based on the chance of loss (risk) so any withheld information changed the relevance of the possible loss. Therefore, underwriters would be unable to properly assess the risk and their liability. When concealment is alleged by insurers the legal test is typically whether or not the withheld information would have changed the premium rate or the insurability of the peril. Often the final decision is made by legal authorities and not the insurance company. Currently, when it concerns non-marine insurance, concealment of information that has not been specifically inquired about does not usually void a policy, unless the concealment is considered to be fraudulent in nature. It is surprising the types of fraud insurers have experienced. Some buyers have actually misrepresented who they were. In the Haywood case, the actual insured represented himself under the name of his minor son. When a fire loss occurred the insurance company denied the claim because his action was certainly fraudulent. He had used his son’s name because there were outstanding judgments against him and the policy would not probably have been granted. He took his case to court and lost. The court ruled that knowing the insured’s identity is valid when determining risk. The Insuring Agreements The Insuring Agreement is a brief and general statement of the purpose of the contract. It may begin with words such as “in consideration of the provisions and stipulations herein or added hereto and of the premium specified above . . .” It will point out that the consideration necessary for a binding legal policy contract involves two things: agreement to the contract provisions and a promise to pay the premium charged. Agreement to the policy provisions means the insured must agree to adhere to the obligations he or she has in the policy. When it comes to fire




insurance, the insurance company must feel that the insured will take proper precautions to prevent a fire from happening. If the insurance buyer takes no precautions at all because they feel the insurance company will reimburse them anyway it may place more risk on the insurer than they would be willing to assume. Therefore, the policy contains “considerations” that the insured must take on. The insured must sometimes adhere to these considerations before the policy becomes valid. For example, he or she may be required to install fire alarms. There will also be considerations that must be followed after the policy takes effect. For example, he or she may be required to keep fire escapes maintained and free of debris. Finally, there will be considerations that are required of the insured regarding claims. Obviously the company is not going to pay a claim unless the insured complies with the requirements of information needed to validate the loss. Payment of premium is seldom an issue. Both the buyer and the seller realizes that the policy must be paid for. The only issue may be at what point the premium was paid. This is usually specifically stated in the policy. Money does not always have change hands if credit was assumed. It is not unusual for credit to be extended when binding a policy. When is the policy effective? Every contract has a starting and ending point. Fire insurance policies typically run for a one-year period. However, this time period is not in stone. Policies can be written for one month or for three years, as long as both the buyer and seller agree to the duration. It is possible to obtain a perpetual policy that runs without a time limit, although premiums must still be paid in some manner. These are usually paid for by a deposit premium, with no further payment being necessary unless there is a change in the risk. Continuing premiums are paid from the investment income earned on the deposit premium. If the investment income produces more money than necessary to keep the policy in force, the excess may be returned to the insured. If the insurance company cancels this type of policy, the entire deposit premium would be refunded. If the buyer cancels the policy it is possible that only 90 percent of the deposit premium would be returned. Normally the starting and ending point of a policy is not an issue. Only when a claim happens on the borderline will it become one. Many policies state not only a date of beginning and ending, but a time as well. Commonly policies will state effective dates such as June 1 at 12:01 a.m. It may even list such things as time zones or “saving time” in those states where daylight saving time applies.




Insurance buyers have won cases even though specific dates were applied to the policy. If the buyer has reason to believe that he is covered, and his reasoning is adequately demonstrated, the insurer may have to pay a borderline claim that is outside of the time stated on the policy. In such cases, the acceptance of the risk was considered the beginning date rather than the date stated on the policy. The actual delivery date of a policy to the buyer is not considered legally relevant to the beginning date of coverage. Of course, the buyer should certainly expect delivery of the policy. Without it, he or she cannot be certain that the contract represents what they intended to purchase. Binders Binders do not apply to all types of insurance. Many types do not allow an agent to “bind” a policy. However, where applicable, when policies cannot be delivered at once, the representative of the insurer makes the insurance binding in favor of the insured by issuing what is called a “binder”. Binders are a product of the property casualty field, not necessarily the life and health field. Binders can be either oral or written. It should be noted that even insurance contracts that have not actually given the agent authority to bind them have been obligated to pay claims when the legal system felt it was natural for the buyer to assume the contract was in effect. As early as 1876, the U.S. Supreme Court recognized the need for oral binders as they applied to insurance. Even so, binders are a form of contract and must therefore adhere to all the essential elements of one. That includes full disclosure on the part of the insured. Legally, binders end upon issuance of the policy or at 12:01 a.m. on the next business day after the risk has been declined by the insurer. Binders are merely a convenience for the buyer and seller. Since binders may be oral as well as written, what exactly does a “binder” look like? In today’s business world, speed has become a requirement. Some written evidence of insurance coverage may be needed on short notice. The binder issued will include identification of who is to be insured, the location and type of property, the risk that is being insured, the precise time the insurance began, the maximum length of time the binder is good for (a policy will either be issued or declined), and a statement of all the terms and conditions that will apply. Binders and policies are assumed to have the same initiation date. That is, the effective date of the binder and policy are assumed to be the same. The binder is merely a temporary statement of coverage.




Payment is not necessarily collected with the binder. Premium collection will depend upon various factors, including the practice of the issuing company. If coverage becomes effective (the risk is accepted) and no payment has been collected, it is presumed that credit has been extended and the promise to pay has been made by the buyer. Many companies do not want payment with a binder because it strengthens the consumer’s position that they were covered should a claim arise during this period. A risk that the company intended to turn down may have to be covered if money was collected. Since a binder is issued on the premise that coverage is possible, the consumer would consider themselves covered regardless of underwriting. In fact, the binder allows the company to underwrite and determine whether or not they actually want to insure the risk. If they do, the individual or company was covered from the effective date of the binder. If the seller does not want to accept the risk, the binder becomes invalid. The actual beginning and ending of a policy is often an important legal point. The claim as it relates to these dates is equally important. If a policy expires at 12:01 a.m. and a fire begins at 12:02 a.m. the owner of the property is not covered. If the fire begins at 12:00 the entire claim is covered even though the policy expired one minute later. Typically a policy continues as long as premiums are paid and as long as one of the parties does not intentionally cancel the policy. By agreement, fire policies generally do not specify an ending date, but they do specify a date that premium will again be due. When the ending date is left blank it is called an open policy. In marine insurance, nearly 90 percent of all policies are open policy form. Open policies may be canceled by either party at any time, usually with a specified notification period. Unless the hazards insured change, a policy renewal is typically a matter of simply paying the premium. Most policies do state that the policy would become void if the hazards changed and the insuring company was not notified of the change. Many times, when policies are renewed only the declarations page is replaced. The policy itself remains in place as originally printed. The insurer, if there is no substantial change, will simply furnish a premium notice with the coverage shown in abbreviated form. Even though the policy does not change, legally a renewal is a new contract. A new policy is not issued, though, because the new contract is still based on the same terms and conditions that were contained in the original policy. The renewal must pertain to the exact same property originally insured. Any change or increase in hazards that were not disclosed at the time of renewal will void the new policy, even if that new policy was only represented by a premium notice. As each renewal period expires, the risk




also expires and is then renewed by the renewal premium. Any change in the risk must be noted in the new coverage. There is equal obligation on the part of the insurer. If any change in the policy renewal is made part of the policy, they must notify the buyer. Canceling the policy Even though each policy is an individual contract, most allow either party to cancel at any time with appropriate notice. A basic principle of contract law is that each party must carry out the agreement even if one of them changes their mind. In other words, the buyer and seller may only cancel according to the terms of the contract. It may be possible to cancel outside of the terms for specific reasons, including performance, inability to perform, bankruptcy, breach, or by mutual agreement. The contract itself may make specific options for cancellation without having to name any specific reason for doing so. Unless the policy does make specific options available for cancellation, the right to cancel does not exist, except by mutual consent. There are specific reasons why the seller would cancel the policy after it was issued. While a company may not cancel due to an approaching claim (that would be fraudulent), they may cancel because they discover an undesirable moral hazard that was not known when the policy was issued. After a suspicious partial loss, the seller may want to remove themselves from further liability before a final settlement of the loss can be made. If a company discontinues certain types of policies (and the policy in question is one of them), they might exercise their right to cancel. Whatever the reason, as long as the seller follows the contract requirements for cancellation, they may do so without explanation to the insured. The buyer may also cancel the policy as long as they follow the procedures outlined in their policy. Usually the insured may cancel the policy at any time. The cancellation would become effective when notice of such was received by the company or agent. Generally, neither the return of the policy nor the return of any unearned premium by the insurer is necessary to effect cancellation by the insured. Recently many states have passed legislation that supercedes contractual agreements regarding cancellation of policies by the insurer. Most of the legislation affects automobile coverage, but some of it does also affect fire coverage. While there are variances from state to state, typically the laws provide that after the policy has been in for from 45 to 60 days (depending on the legislation), cancellation can only happen when there is clear justification, such as fraud or strong evidence of changes in the insured risks.




There are justifiable reasons in the auto industry. For example, a driver who has had his or her license suspended or revoked for driving under the influence would justify cancellation of his or her insurance. Criminal negligence resulting in a death could allow the company to cancel their insurance. Any type of action that changed the liability for the insurer could justify them canceling the policy. Of course, the insuring company must still follow legally acceptable guidelines when canceling the policy. As it applies to fire insurance, a conviction of arson would justify cancellation of the policy. There has been recent controversy over the practice of canceling or even denying coverage based on an individual’s credit rating. From an insurance standpoint, it is felt that someone who is a credit risk is more likely to attempt a fraudulent claim or cause a claim for financial gain. From a consumer’s standpoint, refusing auto or fire insurance to them based on their credit rating is a form of discrimination. Individual states will be addressing this issue if they have not already done so. Insurance agents do not like the practice of “credit scoring” (using a person’s credit rating as an indicator for insurance risk). Agents are frustrated at having to cancel longtime clients due to their credit history. Credit scoring is not a new element when establishing risk. Banks and credit card companies have used credit scores for years to assess their risk when issuing credit. However, agents correctly point out that a bad history in credit does not mean the individual is a health or driving risk. While some insurance companies began the practice as long as twenty years ago, the majority only began using credit scoring in 1998 and 1999. Although agents and state insurance commissioners do not like the practice, according to the Insurance Information Institute (an industry-funded company), studies have found a strong link between credit ratings and the likelihood of auto and homeowner losses. The insurance industry feels that good credit risks should not have to help shoulder the losses of those that are bad credit risks. Although many states will be putting legislation in force to guide these practices, Washington state’s proposal is one of the strongest so far. It would stop insurers from using the absence of a credit history, the number of inquiries to a credit-reporting agency, and credit problems caused by health care costs in their rate calculations. Neither will insurance companies be able to use the purchase of a home or car or a customers’ total line of available credit in their calculations. Larry Kibbee of the Alliance of American Insurers called Washington’s proposed legislation “realistic” and the insurance industry has decided to back the legislation, though they are not totally happy with it.




As of 2002, twenty states are investigating the practice of credit scoring. Washington is requiring a year long study before any actual legislation would be passed. It will be 2003 and 2004 before most states have such legislation in place. Dealing with credit scoring may be more important than most consumers realize. We have an escalating problem with identity theft. As good credit risks have found, their identity as a good credit risk is something worth stealing. Although the practice is most often seen in specific states, it can happen anywhere. When an identity is stolen, credit is usually taken out using the stolen social security number and birthdate. With just those two items, a thief can take out credit cards, buy cars, and rent apartments. It can be months before the victim realizes what is happening. Since a different address is used (usually a mail drop), they will not be aware until their credit rating is ruined. Whatever the reason for cancellation it must be done according to contract language. Although there may be no clear distinction as to how notice of cancellation may be delivered, insurance companies must be able to show that notice was received by the insured. If the insured has a claim and can prove that he or she did not receive the cancellation notice, the insurance company may still be liable for the claim. Therefore, companies tend to send notices by registered mail with a receipt returned to them for proof of delivery. In some cases, the receipt must be signed by the insured or their legal representative. The 1943 New York Standard Fire Policy allowed five full days of coverage following the notification so that the insured could seek coverage elsewhere. Depending upon the interpretation of the policy, unearned premium may or may not be returned with the cancellation notice. Some courts have ruled that unless premium is returned on a pro-rated basis, the policy is still in effect even if notice of termination has been received. The 1943 New York Standard Fire Policy made three distinctions regarding the return of unused premium:

1. Cancellation may be effected by the company “giving to the insured five days’ written notice with or without tender of the excess of paid premium above the pro rata premium for the expired time.”

2. Secondly, it states that the “excess, if not tendered, shall be refunded on demand.” In this case, the insured would have to request the refund of unused premium.

3. Lastly, it stipulates that the “notice of cancellation shall state that said

excess premium (if not tendered) will be refunded on demand.” If




there is no excess premium to be returned, stating the third option does not invalidate the cancellation notice.

When policies are canceled, the refund of unused premium can appear to be less than would be anticipated. This lower refund amount is called “short-rating.” The 1943 New York Standard Fire Policy stated that when the policy is canceled by the insured, the insurer need only “refund the excess of the paid premium above the customary short rates for the expired time” subject to any minimum retained premium limitations. Refunding a short amount according to the short rate tables is justified. Much of the administrative expenses in running an insurance company happen immediately upon issuing a policy rather than over the course of the insured period. For example, the cost of underwriting a policy is incurred immediately at policy issue. Even though premiums may be rated for a 12-month period, the initial expense has already happened. Another reason for using short-rating tables has to do with adverse selection. Adverse selection is a very real risk for insurers. Adverse selection is the process of eliminating the best risks, ending up with the worst. The tendency for insurance contract applications to include a preponderance of “poorer than average for the class” risks is found throughout the insurance field, but some areas can be more affected than others. Health insurance especially has to watch out for adverse selection. The worst risks will be more apt to apply for insurance coverage because their risk of loss is the highest. The best risks will be less likely to apply for coverage because they are least likely to have claims. For the insurer, this means that they will be taking on more liability than economically advisable. The rule of insurance is to have a large, safely diversified, profitable group of risks. A reason for using short-rating tables is to offset the possibility of adverse selection. Most types of risk are not even throughout the year. The majority of house fires, for example, happen during the cold months. If a consumer knew this, they might only buy insurance during the winter months, letting it lapse during the summer months. Those who buy health insurance might only purchase such coverage prior to certain events (if such events could be predicted). Using short-rating helps companies to offset this possibility. Even though our current policies have been updated in its language to become more consumer friendly, cancellation provisions have remained fairly constant. Short-rating is still used, but in a different manner. Today’s policies often state a percentage. For example, the policy may state: “If the named insured cancels the policy, the return premium shall be ninety percent of the unearned premium computed on a pro rata basis.” Even though this is still short-rating, it gives the buyer a precise knowledge of what to expect.




What are the principle concepts of insurance? Reading an insurance policy means the reader must have some idea of the concepts under which insurance works. Otherwise, understanding the policy would be difficult. Not everyone agrees that insurance works on “principles”, but those in the industry know that principles are part of the business. INDEMNITY A major principle of insurance is that of indemnity. Indemnity means reimbursement for an actual financial loss. Insurance cannot replace any loss that is not financial in nature, although some types of policies may claim to do so. “Peace of mind” really means financial peace of mind. If our spouse must go into a nursing home, long-term care insurance can pay the cost, but it cannot bring “peace of mind”. The person is still in the nursing home whether they want to be or not. The idea that every insurance policy is about replacing financial loss is not agreeable to many people. In fact, it may not be agreeable to many insurance agents. Obviously, life insurance cannot replace the person that has died. It can only replace the financial security that person brought to their family. The idea of placing a dollar value on someone we love is not socially acceptable and yet, that is what life insurance does. Liability insurance presents a different twist on indemnity. These policies pay (on behalf of the insured) claims for which the insured has become legally obligated. The key words here are “legally obligated.” The insured need not agree to the reason the insurance is paying. The insurer typically makes the payment directly to the claimant, so there is no way for the insured defendant to see any financial gain as a result. When the individual is found legally liable to the claimant, the decision is never based on whether or not liability insurance is in place. Even if no insurance exists, the person is still legally liable to the claimant. Insurance or no insurance is merely an indication of whether the insurance company will pay or the person themselves must pay the claimant. Even though the insured will not personally see the insurance payment, since they would otherwise be personally liable, they may still be considered as indemnified for that loss. There are two primary purposes in the principle of indemnity. (1) By limiting the payment to the loss sustained, the insured individual is not going to personally gain anything. If the person could financially gain, insurance would simply be a gamble of winning or losing. (2) If a person could gain financially from the loss, the probability of a loss would certainly go up. Obviously fraudulent acts would greatly increase and the cost of insurance would follow. Eventually, the industry would not be able to continue.




INSURABLE INTEREST Insurance agents, especially in the life field, work with insurable interests in every contract. Exactly what is considered an “insurable interest” can depend upon the contract and the definition it has applied. As it relates to the property and liability field, it is every interest in property or potential loss of assets arising from a legal liability of such a nature that a contemplated peril may lead to an economic loss for the insured. A common insurable interest would be a company that leased equipment to a business. The leasing company has an insurable interest because their equipment is located at the business address. Insurable interests typically include ownership or possession, liability or bailee interests, creditors where a debt is ongoing, contractual interests, and expectation. Obviously, the insurable interest must be a legal interest. Those with the insurable interest do not necessarily have a legal or equitable title to the property. The party would have the expectation of profit or benefit in some way from the subject of interest. Like the concept of indemnity, the concept of insurable interest includes the idea of limiting the amount of recovery to the actual loss sustained. 1 Some insurable interests are obvious. The company that holds the mortgage to our home obviously has an interest in the property. The legal system fully recognizes this insurable interest. Both the mortgage company and the homebuyer may insure the property. However, how they insure the property may differ. The mortgage company may insure the property to the limits of their interest in it (the amount owed to them), while the homebuyer may insure the property to the extent of its value or expected value. Each party may insure the property without notifying the other. The courts hold that in a case such as this, each party may secure insurance without consulting the other and without giving notice to the other. Since each pays their own premium, the other party is considered a stranger to the transaction so has no claim on any proceeds that might result from a loss. As we know, mortgage companies generally require that the homebuyer carry insurance and pay the premiums for that insurance. If the homebuyer fails to do this, the mortgage company may (if the contract so states) purchase the insurance on their behalf and charge the premium to the homebuyer. This may also be the case on automobile loans financed through banking institutions. The policy is intended to protect the lending company. If the home burns down or otherwise sustains a loss that might threaten the lenders ability to collect what is owed them, the insurance policy would pay off the outstanding balance before making any payment to the homebuyer. 1 Property and Liability Insurance, Page 45




For Example: Bob and Martha bought their home for $150,000. That is the amount they borrowed from their bank, so that is the amount they must pay off over the next thirty years. They insure their home for its true assessed value of $175,000. Unfortunately the home burns down one year later and is a total loss. Their insurance first pays the lender the balance owed them and then pays the difference to Bob and Martha. Therefore, Bob and Martha do not receive $175,000. They receive the difference between that figure and $150,000 or approximately $25,000.

Most homes are not total losses. Most fires only partially destroy the structure. In that case, the insurance would repair the damage and Bob and Martha would continue to pay their lender for the home over the thirty-year period. Whenever possible, insurance companies prefer to issue a policy in the name of the homebuyer and then to join the two interests. Doing so reduces the possibility of fraud and eliminates complications that can happen when two interests exist in the same piece of property. There are several ways to assign insurable interests. These include: 1) As previously stated, the interests of the homebuyer and lender may

be joined in one policy. 2) The policy may contain a provision, such as found in the New York

Standard Fire Policy, providing for 10 days’ notice to the lender before the policy is canceled. The lender may make a claim under the policy if the buyer fails to do so.

3) The policy may be assigned to the lender with the consent of the

insurer. This method, like the joined interest method, allows the buyer to receive any excess claim funds after the lender is paid. If the homebuyer violates the terms of the policy, however, the lender could find themselves unprotected. In addition, since the lender is not a contracting party, they have no legal rights with respect to participation in any negotiations after a loss. Most lenders consider this method unsuitable because they do not retain control of the property.

4) The policy may be assigned without consent of the insurer. This

means the policy may be pledged as collateral security without the consent of the insurance company.

5) The policy may be endorsed by a loss-payable clause. There is

some legal confusion regarding this method but if it is correctly set up, it




can be an excellent avenue for the lender. Since the lender is not bound by the conditions of the policy, the acts of the homebuyer cannot be set up as a defense against the lender even though they possess all the rights of the mortgagor. This loss-payable clause is widely used when personal property is given as security for a loan. Auto loans especially use this form taken from the fire insurance mortgage clause.

6) The policy may be endorsed by a mortgage clause. Like the first

method, it joins the interests of both the lender and the buyer. In this method, however, a special clause is endorsed in the contract itself. This is the form most widely used by lenders.

Using the Mortgage Clause The mortgage clause joins two interests: those of the lender and buyer. Since it is necessary to protect the interests of the mortgagee (lender) against forfeiture of the policy due to acts of negligence by the buyer a mortgage clause is used. The buyer takes out a policy in his or her name, but a special clause is endorsed on the contract. The insurer agrees to protect the interests of the lender regardless of any acts of negligence on the part of the buyer. The clause may be part of the form (as it is on the Homeowners’ forms and the Dwelling Policy Program) or it may be attached to the policy as a separate endorsement. Fire policies often have large sections devoted to the mortgage clause. There is good reason this type is so widely used. By indorsing the mortgage clause on the buyer’s policy, the insurer is specifically protecting the lender by giving them legal rights in the coverage. In only a few states where the loss-payable clause has been interpreted as an independent and unconditional agreement between the lender and the insurance company does it provide better coverage for the lender than would be given under the mortgage clause method. Consequently, the loss-payable method would be used in those cases. When a loss occurs, insurers typically make out a joint draft to both the lender and the buyer. Release from both parties is obtained when the draft is endorsed and cashed. When negligence or neglect is a factor The Mortgage Clause stipulates that the insurance is not voided by the buyers’ acts of neglect. However, when the mortgagor is guilty of misrepresentation of the facts prior to the issuance of the policy, or if he or




she has purposely concealed relevant information in the insurance application, the policy may be open to invalidation. The lender may be protected as long as they upheld their responsibilities. The mortgage clause requires the lender to notify them of any change of ownership or occupancy, or increase of any type of hazard that they might be aware of. They would also be required to notify the insurer of any knowledge of concealment of information or misrepresentation of facts on the application for insurance. Lender’s Responsibility: In the mortgage clause it will state that the lender will be required to pay the premiums if the buyer does not. Although the lender cannot be held liable for the premiums, if they are not paid, the policy will lapse and the mortgagee will have no protection. The mortgage clause also states that the lender (mortgagee) or trustee must notify the issuing insurance company of any change of ownership or occupancy or increased hazard relating to the property. It also gives the insurer the right to increase premium cost due to any changes. If the insurer cancels the policy under the terms of the contract, it must still give the lender ten days notice so that they may seek other insurance coverage. Cancellation can occur in two ways: by cancellation of the policy itself, or by cancellation of the mortgagee clause. Either way, the ten days still apply. In some states or in some situations, the insurer must give the lender up to 30 days notice. The exception to this would be nonpayment of the premium, which typically requires only five days notice under the terms of the Standard Fire Policy. Proportional Payments Although it is not generally recommended to “over-insure”, there are occasions when more than one policy on the same property exists. The Standard Fire Policy stipulates that each insuring company will pay only that part of the loss that is represented by the proportion that its policy bears in relation to the total insurance granted under all combined policies. This will probably not make for a happy client. Unfortunately, the insured often believes that each policy will pay fully allowing him or her to make a profit. Insurance is not designed for profit. It is designed to merely pay the specific loss and not a penny more. There have been court cases that made exception to the standard rule that refused profit from insurance policies. However, these court cases involved policies taken out independently of each other and were purchased as a specific protection for a lender. As a result of these court cases, it has




become common to add a contribution clause to the mortgage clause. Therefore, there are two forms of standard mortgage clauses used. One is called the non-contribution mortgage clause and the other is called the full-contribution mortgage clause. The full-contribution clause adds the following:

In case of any other insurance upon the within described property this company shall not be liable under this policy for a greater proportion of any loss or damage sustained than the sum hereby insured bears to the whole amount of insurance on said property, issued to or held by any party or parties having an insurable interest therein, whether as owner, mortgagee, or otherwise.

Although the intent of this addition was to avoid misunderstandings, there have still been conflicting court decisions regarding it. Perhaps the joke about insurance is correct: it takes one attorney to write the policy, a second attorney to dispute its meaning, and a third attorney to decide who is right. When more than one mortgage exists In this day of equity offerings all over television it is common for individuals to take out a second mortgage, usually referred to as an equity loan. In fact, it is now possible to take out a second mortgage that makes the total due add up to more than the value of the home. Equity loans that allow greater amounts to be borrowed than actually exists in equity are seldom a good financial move. The interest charged is nearly always higher when the equity borrowed against does not equal the loan amount. When second and even third mortgages exist on the same home, the insurance solutions are seldom uniform. The homebuyer may not realize all their options, sometimes not even insuring the second and third equity loan. It is possible to incorporate the standard mortgage clause in the name of the first lender, attaching a loss-payable clause for the equity loans. This would give the second lender less protection than the first. If there is a third lender, they would receive even less protection than the second. Another option is to use one standard mortgage clause and list all the lenders involved, giving each protection under the policy. However, the first lender may veto this option feeling that they could be short-changed in the event of a loss.




A third option would be a separate policy for each lender. If this avenue were chosen, the question of contribution could be an issue, however, following a loss. When one policy is used for all lenders, the proceeds are divided in proportion to their claims.


Chapter 3: Liability Limitations


Liability Limitations

Insuring for logical amounts If it were possible to insure a $200,000 home for a million dollars, there are those consumers who would do so. Because insurers only wish to be liable for exact costs, there is liability limitations placed in policies. In the Standard Fire Policy, more than one provision limits liability. Limits may be expressed in several ways:

1) Actual cash value 2) The cost to repair or replace 3) Original cost 4) Interest of the insured 5) Pro-ration with all insurances involved 6) Subrogation.

Insurance payout is typically based on the face amount, no allowance for loss of use, the doctrine of proximate cause, excluded perils and included perils, coinsurance, and deductibles. All of these would be stated in the policy. Coinsurance and deductibles are not necessarily found in the Standard Fire policy but they are often made a part of the policy by use of endorsement. The most basic limitation in a policy is the face amount stated. Generally the wording is stated as “to an amount not exceeding $______.” The insured usually selects the exact dollar amount and pays a premium accordingly. The insurance company will put parameters on the amount offered. As we said, they do not wish to insure a $200,000 for a million dollars. In the underwriting process, the insurer will set maximum limits by class of property or by geographic area. It may be possible to exceed limitations by purchasing more than one policy. Minimum amounts may also be stated by the insurer. This would apply where a lender has an interest. If that $200,000 home is mortgaged for $175,000 the lender would expect that much insurance be purchased to protect their interests. In this case it is the lender that sets minimum limitations of insurance. The actual premium is determined by dividing the face amount of insurance by $100 to determine the units of insurance purchased. The number of units is multiplied by the appropriate rate per unit. This process is called




policy rating. It is not the same as ratemaking, which encompasses the entire procedure of rate per unit determination. At one time it was viewed that the face amount of a policy constituted the maximum liability of the insurer for the policy period. The reasoning was that when a part of the property had been destroyed, the amount left at risk was reduced. Unless the buyer rebuilt, he or she would then be over-insured. When this method became a consumer issue other alternatives were tried. One method was to charge an additional premium by applying the basic fire rate to the total premium. This was, in effect, insuring the insurance premium. It was called unearned premium insurance. When a loss happened, the unearned premium insurance bought back the original face amount of the policy. If a total loss happened, the added coverage provided a refund to the insured of the unearned premium for the policy period. This worked well as long as agents remembered to add the unearned premium insurance. Unfortunately, agents did not always do so. When a loss occurred in those cases, consumers sometimes ended up underinsured. Actual Cash Value As every agent knows, the most common complaint comes from the way losses are replaced. If it costs $100 to replace an object, but the company only supplies the consumer with $50 the agent is sure to hear about it. Many policies limit the insurer liability to the actual cash value of the property at the time of loss. Just as an automobile loses value the moment it is driven off the car lot, other items also lose value immediately upon purchase. The principal objective of the fire insurance contract is to furnish indemnity for values actually lost. A sofa that is five years old is not valued the same as a new sofa would be. Unfortunately for the agent who deals with the telephone calls, actual cash value is not the same as replacement value. The policy does not define what the actual cash value will be, but the courts often have. Except for some exceptions, the courts have agreed that actual cash value is not the same as replacement value. The courts consider actual cash value to be replacement value at the time of loss less physical depreciation. In other words, the courts look at the current replacement cost and then deduct for age and wear. Neither the policy nor the courts require that the property destroyed actually be replaced; merely that the value of them at the time of loss be paid to the insured.




Actual cash value is not derived from the same accounting procedures used for taxation. An accountant starts with the original cost and writes off this cost at set intervals for the useful life of the property. As they relate to taxation, depreciation may have little to do with true values. Depreciation as it relates to insurance must consider the age of the destroyed property at the time of loss, without consideration to taxation depreciation. The insurance companies consider the age of the property at the time of loss, obsolescence, quality of the property’s maintenance, and any other factors that would affect value. The purpose is to follow the principle of indemnity as closely as possible. Understanding the concepts of actual cash value would probably be easier for the consumer if the same principles were more widely used. Consumers often confuse actual cash value with market value, for example. Market value is the amount the property could be sold for. While that may mirror actual cash value, it does not necessarily do so. This especially can be an issue as it applies to damaged automobiles. Market value will give a reasonable approximation of actual cash value, but since the item was not actually sold prior to damage, there can be disagreement on what the market value would have been. As it applies to cars, insurers use standardized pricing, which may not be what the insured feels is the fair value. There are often opposing opinions as to vehicle values. As it applies to buildings, actual cash value does not consider the value of the land it sits on. Therefore, market value, which would reflect the land, would be higher than actual cash value. Because of this, market value has insurance limitations. Despite the limitations of market value, some court cases have stated that the two are synonymous. Some losses have some interesting results. For example, a building catches on fire and burns to the ground, but the building had already been scheduled for demolition. Does that then give the building a negative value? Courts generally uphold that insurers are not liable for something that is valueless. Personal property is easier to assess values to (in most cases) than is real estate. The distinction between market and actual cash value, as a measure of indemnity, may or may not be easier. Some personal property, like real property, may hold its value or even appreciate at a rate greater than its depreciation. Other personal property, such as computers for example, quickly lose their market value as new technology moves ahead. The measure of loss would still be the cost to replace the item, less depreciation or obsolescence. Clothing may be market value to replace if it is still usable to the insured on the same basis as new clothing. On the other hand, if the clothing is not fairly new, styles may have changed which would either (a) indicate it was less valuable, or (b) due to demand as a collectible, create a higher market value.




When loss is not total, the actual cash value can become more complicated. Although the same principle would apply, the amount of loss can be harder to determine. Depending upon the type of loss, the courts have applied an “enhancement of value” rule, which states that if the replacement of new for old does not increase the value of an identifiable unit, then deprecation should not be part of the equation. This would primarily apply to such things as a home that was partially damaged or a car that experienced a minor accident. Sometimes replacing the loss is not practical or even economical. In buildings, for example, some types of replacement would not be practical from an economic standpoint. A home that is located in an area that is quickly moving to commercial zoning may not be practical to replace since it would soon be sold for commercial reasons and torn down anyway. Some types of replacement are not practical for reasons of cost. An antique bar, while replaceable, would perhaps be cost prohibitive by today’s standards. Purchasing insurance that would replace substantially in situations that are not economically practical would be too expensive. Therefore, replacement value policies are more likely to be used in business or commercial policies while actual cash values are usually seen in residential policies. Repair or replace? Most policies leave the decision of whether to replace or repair an item up to the insurer. It is true that most companies find it easiest to simply pay the insured the cost of their choice and then leave the actual decision up to the insured. They are most likely to opt for repair, paying the costs directly to those who do the work, when the insurer has been unable to come to a satisfactory settlement with the insured. When a satisfactory settlement cannot be made monetarily, restoring the goods or building to their original condition at the time of loss is simply easier. When this is the decision made by the insurer, settlement typically is considered acceptable by the insured. If the insured is not happy with their goods or building being restored to the condition at the time of loss, the consumer may be hoping to gain at the insurer’s expense. Unfortunately for the insurance companies, many court cases favor the insured even when companies feel the consumer is trying to profit (which policies are not designed for). Court cases often come about because there is disagreement between the insured and the insurer as to what constitutes restoration. This might especially be true in specific situations involving unusual property. For example, many older buildings have unusual features, such as decorative designs from special types of wood.




Companies try to avoid opting for restoration for another reason. Few of them are set up to oversee restoration projects. The time and complications of such projects are usually not worth it to the insuring companies. The increased costs associated with building today versus even just ten years ago can make restoration more complicated. Most cities have passed requirements for building in an effort to increase safety. This may especially be true in areas that have experienced wind damage, earthquake activity, or other “mother nature” problems. In high congestion areas, there may also be requirements concerning sidewalks for public use, hydrants for fire safety, or bonds for public use affected by building, such as schools or parks. New construction standards nearly always increase building costs. Even when a building is only partly damaged, the city may require that the entire building be brought up to safety codes when repaired. Insurers that feel new safety codes may affect replacement costs are likely to include a Building Ordinance Coverage endorsement in their policies, which of course will result in a higher premium. This endorsement covers the value of the undamaged portion of the building that must be upgraded to comply with current codes, the cost of demolishing and removing the undamaged portion, if necessary, of the building, and the increased cost of repair or reconstruction that might be necessary. The insurer, unless a special agreement is in the policy, will typically limit their liability by stating there is no allowance for loss of use. The wording may vary, but generally it will state the coverage is “without compensation for loss resulting from interruption of use” during the time of damage and repair. The intent is to limit the company’s liability since loss of use can be a wide area. Some policies specifically allow the insurer to seek compensation from other parties if the loss can be proven to be their fault. Equity clauses state that the insured should not be able to collect from both the insurance company and the party that caused the loss. Since the insurance company paid for the loss, it stands to reason that they should be the ones to gain from the party causing the loss. Again, it is never the intent of an insurance policy to allow someone to “profit” from a loss. Profiting from a loss is a clear violation of indemnity principles. In policies the third party causing the loss is typically referred to as “the other party.” If the other party is held responsible for the loss because of either a contractual relationship or a negligent act, the insurer that covered that loss will seek financial recovery from them. The third party, especially in contractual relationships, may have insurance that will handle this so that one insurer is essentially paying another insurer.




When the loss is due to negligence by a third party, there may also be insurance in place. Again, if this is the case, it may be a situation of one insurer paying another insurer for their loss. If no liability insurance was in place by the other party, then the insurer may seek legal recourse to recover what they have paid out. So, when a loss happens, the insurance company pays the insured, and then under the rights of the contract stands in the place of the insured to proceed against the liable party. Once the insured accepts the money from their insurer, they give up their rights to collect from another party that is deemed legally responsible for the loss. There will be some exceptions to this, especially where personal injury is concerned, but for the purposes of fire insurance, this would be the case. Policy language has specific meanings Every agent must be aware that policy language is legal language. As such, it has specific meanings. This is certainly apparent in the Doctrine of Proximate Causes. The word “direct” in the phrase “against all direct loss by fire” can have a dual meaning. The concept of cause, while always important legally, is especially important when insurance is involved. Insurance deals with a cause-and-effect relationship between insured perils and loss. This concept is called the Doctrine of Proximate Cause. As it applies to insurance, each event that causes a financial loss had a cause. It may be a domino effect, with one loss caused by an event that was caused by another event, but regardless of the chain, the loss is caused by something. While the law is not concerned with analyzing the chain of events that occurred, it does affect what company pays what claims and to who. Insurance merely looks at the immediate reason they paid for a loss. The doctrine of proximate cause is specifically looking at whether the loss resulted from negligence or an insured peril. Such deciding factors make a difference as to whether or not the insurance company must cover the loss. If a fire was the result of arson by the insured, obviously the insurer will not cover the loss. Personal arson by the insured is excluded under the contract. On the other hand, if arson was committed by a third party, the insurer would cover the loss (unless it was proven the insured hired the arsonist). The insurer is liable for only the loss and damage to the property insured and not for all the consequences that may spring from such a loss or damage.


Chapter 4: When Multiple Policies Exist


When Multiple Policies Exist

It is not unusual for an insured to purchase more than one policy. While this is most likely to occur with health insurance, it can happen with any type. In the policy, the ownership of more than one policy will be referred to as “other insurance.” It specifically refers to more than one policy that covers the same perils or the same possible loss. To qualify as “other insurance”, the policy must be for the same insurable interest, it must cover the same insurance subject, and it must assume coverage for at least some of the same perils. As we have repeatedly said, insurance is not designed for consumer profit. Although buying more than one policy for the same risk is not illegal in itself, it may increase the probability of a loss because of the moral hazard involved. There are two types of moral hazard. The first (spelled moral) is a subjective characteristic of the insured that increases the probability of loss. This would include the person who uses arson for their personal financial gain. The other morale hazard (spelled morale) refers to indifference to financial loss. This would include an individual who is careless in safety issues, although their intent is not that of producing a loss. They merely increase the chance of loss through their carelessness. Although underwriters may lump the two together, their distinction is important. There is certainly a difference between an arsonist and a person who carelessly throws down a lit cigarette. The arson would be termed a moral hazard while the careless smoker would be termed a morale hazard. The insurance underwriters consider both a problem since both actions result in claims. When an insured purchases more than one policy to cover the same peril, underwriters do consider this a possible attempt to profit from insurance claims. Therefore, policies address this situation in an attempt to reduce the moral hazard involved. If no policy provision were made, it is conceivable that many people would over-insure. Even though the indemnity principle states that a person cannot profit from over insuring, the courts could rule differently if the situation were not covered in the policy. The method preferred by insurers is to eliminate the ability to purchase multiple policies, but that is not always possible. Even so, through their application process, their intent is to learn of the presence of other existing policies by clearly asking. In this manner, if information is concealed, they may void the policy. The 1918 New York Standard Fire Policy approached this head-on by prohibiting other insurance policies unless express permission (in writing) was obtained by the insured. In 1943 the New York Standard Fire Policy




provision was changed to permit other insurance as follows: “Other insurance may be prohibited or the amount of insurance may be limited by endorsement attached hereto.” Who pays what? When more than one insurance policy exists on the same property, what amount is paid by which company has the potential of becoming complicated. Some cases may be easily determined, but others will be complex. Most policies contain what is termed a pro rata liability clause. It may also be called a contributing provision. Whatever name is used, it means that the company will only be liable proportionate to their part of the total loss. The actual policy language will depend upon the company, but it will either be based on the New York Standard Fire Policy or it will use the simplified updated language. Either way, the intent will be the same: to limit the claim payout to their portion of the loss. Some policies adhere to actual cash value as a limiting factor, while others will be based on a replacement cost basis. When two different values are used in two different policies covering the same property, loss adjustment problems can certainly arise. Usually the insurance companies will work together to determine each insurer’s liability, but that is not always the case. Each insurer may simply determine what they believe their portion of the loss to be and offer that as payment to the claimant. Unfortunately, many claimant’s end up in court because they feel they have been cheated by their policies. Some of the overlapped coverage is the result of “no-fault” laws governing auto insurance. Automobile first-party medical benefits may overlap with any health insurance carried by the injured person, although many medical policies state they will initially pay, but expect to be reimbursed by the auto policy when the claim is settled. Some medical claim forms ask if the injury is due to an accident. If it is, they may refuse payment altogether since they expect the auto coverage to pay the claims. When there are several policies covering the same risk that are basically alike in all their terms, they are called concurrent plans. In this case, the application of the contribution rule is simple: each company pays a pro rata proportion of the loss. So, if Company A has issued a policy for $10,000 and Company B has issued a policy for $20,000, they would pay according to the liability issued. If the loss is $30,000, the equation is simple: each company would pay up to their limit. It gets more complicated when the loss does not come out so evenly. In that case a formula is used as long as the companies




agree that the policies are essentially the same and contain no special limited clauses. Let’s consider a loss of $25,000 with each company insuring up to 80% of the loss. The total insured amount is $30,000. The equation would be set up as follows: Company A: 10,000 30,000 X $25,000 = payment amount Company B: 20,000 30,000 X $25,000 = payment amount Since we are merely supplying the formula, we did not actually list the payment amount. It is the equation that is important: Insured amount of company Total of all insured amounts X Amount of loss = Payment due from specified company Companies who are not able to pay We don’t like to think about it but it can happen: a company is no longer solvent. When more than one company is covering the same loss, all companies are considered in the equation, whether solvent or not. Special consideration should be given to the section of the contribution clause that provides for pro rata liability. There it will state “whether collectible or not.” This means each policy is considered even if the claimant will not be able to collect from the company issuing the policy. Originally, this clause was included because it was common for people to buy policies from companies with cheap rates and unstable financial standings. Financially stable insurers wanted to protect themselves from companies who were financially weak. Today there is less validity in this thinking since companies must now justify their finances and rates with regulatory agencies. “Other Insurance” alternatives There are various ways that a policy may deal with the possibility of other insurance. They may simply prohibit it altogether. They may also establish their liability on the basis of contribution by equal shares. The policy may




declare itself as “excess” in the event that other insurance is involved. When there are two or more policies each declaring themselves to be “excess” coverage, typically claims will be settled on a contributory basis. Because this course is dealing with agents in multiple states, it is always important to know the laws of your individual state. While most states seem to have much in common, court cases often create variations that are important to understand. While the first thought that may come to mind when a buyer has multiple policies is that he or she is trying to profit from a loss, it is more likely that he or she is attempting to cover all that is owned. When a desired insurer will not fully cover a perceived risk, it is common for the insured or the insured’s agent to simply submit the risk to multiple insurers. Eventually the insured felt adequately covered. While this is not necessarily an efficient way to insure, it is a common way. Today we are seeing a layering of insurance products. That is, each policy is designed to only take effect when a previous layer of insurance has been exhausted. This has been the result of many things, but primarily the use of higher deductibles, higher limits, and new policy types. Consumers have been encouraged to use higher deductibles (absorbing first dollar losses themselves) in order to keep their premium rates down. This is true in all types of insurance. The layering of insurance has been effective for many consumers. The initial policy that pays first will be the most expensive. Each subsequent policy is less expensive since it will only have to pay once the first policy has been exhausted of benefits. Non-concurrent policies When policies are issued for the same risk, but do not agree in their terms, they are non-concurrent policies. It is much more difficult to assign payment of loss when the policies have different terms of coverage. The differences can involve multiple things including the property description. Policies may be blanket, which covers all items under one sum of money, floating insurance, which covers the stated property at any location within policy specifications, or excess insurance which may be either contributing or non-contributing. Excess coverage, as you’ll remember, only covers a loss that is in excess of a given figure. Non-concurrent policies may differ in where the property will be covered (property location). The interests insured may also be different.




When such differences are involved in various policies covering the same risk, settlement of claims can be time consuming and frustrating for the policyowner. Where possible, policies should be constructed so that they will work together as much as possible. In the past, it was common to find a major risk subdivided into several policies. Today, agents try to put multiple policies together in a working format. Where it was difficult in the past to find one policy that would adequately cover all risks, doing so is easier with today’s policies. This is due to several factors including companies that will insure to higher limits, utilization of reinsurance, independent agents with greater knowledge of what is available, and the role played by corporate risk managers. Account underwriting has lessened the difficulties of non-concurrent policies. Even so, agents still need to be sure that written portions of all policies work together and not against each other. When Homeowners and other package policies became increasingly common under multiple-line underwriting laws, an effort was made to resolve the problems that had previously been experienced with overlapping policies and principles. Individual agreements addressed to correct specific problems often no longer worked effectively. A decision was reached to establish new Guiding Principles. In June of 1959 committees appointed by the National Board of Fire Underwriters, the Inland Marine Underwriters Association, and the Association of Casualty & Surety Underwriters began the job of establishing the new guidelines necessary to alleviate some of the previous problems experienced. They consulted other organizations, including the National Automobile Underwriters Association, during their decision making process. The committee worked on rewriting the new guiding principles for four years. During this time, those on the committee sometimes changed due to death or retirement, but despite these changes the work continued. Once unanimous accord was reached, the New Guiding Principles were submitted to the executive committees of the various organizations participating. Once approved by the organizations, they were recommended to the insurers. Each insurer had the option of following the new guidelines; adherence was not mandatory. As hoped, the vast majority of insurers did adopt the New Guiding Principles in nearly every respect, despite the size of the loss that would result. Even companies that were not members of the participating organizations adopted the new principles. Since the new principles established procedures for quickly determining primary and excess coverage, settlement of claims was much faster for the insurers. It is likely that this did save time and money, even when it meant that claims paid were higher. Adjusters have mostly been instructed, when overlapping policies exist, to adjust the loss by application of the New Guiding Principles, utilizing their




purpose and intent, which avoids differences that would otherwise exist between insurer’s policies. The New Guiding Principles are generally referred to as simply the Guiding Principles. What happens when claimants refuse the offer? When an insurer offers settlement of a claim, there is no guarantee that the claimant will accept it. Although many disagreements do end up in court, settlement is typically a better option for both the claimant and the insurer. To come to a settlement outside of court, arbitration is typically the method used. As it applies to insurance, arbitration has more than one meaning although all meanings have a common goal of saving premium dollars. One definition of arbitration could more accurately be called the appraisal process. When the insurer and the insured are not able to come to an agreement on the actual cash value or the amount of loss, each party will hire an appraiser. The two selected appraisers will select a third appraiser to act as an umpire. The three appraisers will then do only one thing: determine the dollar amount of the loss. Once that loss is determined their job is done, but their decision, because it is a contractual agreement, will become binding on both parties – whether they agree with the decision or not. Assuming no fraud was involved; the courts will recognize and accept as fact the amount of loss determined by the arbitrators. Since few courts would have the factual knowledge that the arbitrators have, this is the most satisfactory route since the amount of loss established is likely to be accurate. When the courts must determine the amount of loss it is not only a long process, but typically an expensive one as well. The uninsured motorist section of the private automobile policy contains the Arbitration Clause, which is similar to the appraisal process in that appraisers are still selected. Past that it can be very different. When the uninsured motorist coverage is applicable, the insured’s own company could be put in the position of a legal adversary. Since the determination of negligence should probably not be left up to the insurer in such a situation, the use of appraisers is an advantage for the insured. In spite of the common sense of using appraisers to determine loss, the legal community has generally not accepted it. Some states have been receptive to appraisers to determine loss, but not all of them. Some states permit arbitration of all issues whereas others place limitations on their use. While the two previous uses of arbitrators are similar, the final type is very different. Arbitration is now becoming a method of settling inter-insurance company claims. This is not a new process. It has been used since 1944.




Although not initially used widely, the growth in its use has prompted the method to be called the world’s largest private judicial system. Insurers use inter-insurance company arbitration when the amount of money owed by each insurer involved in the claim is in dispute. The actual insured person will probably never realize this type of arbitration has even been used since it is an established principle that the loss payment should be made prior to arbitration. By paying the claim prior to the inter-insurance company arbitration, the companies involved can avoid an unhappy claimant. If it is necessary for one company to repay the other following the arbitration process, this will be done. The client will never even realize that loss may have been reevaluated later on. In nearly every case, participation in arbitration is a voluntary action. Since arbitration is considered a means of avoiding costly legal action, it makes sense to participate. If a participant does elect to use arbitration, by the terms set down, the decision is legally binding. Arbitration is used in virtually every aspect of insurance, including (but not necessarily limited to) automobile damage, fire and allied lines, third-party claims, no-fault benefits, and workers’ compensation claims. For the insured, arbitration is an alternative that should not be overlooked. Hiring attorneys is expensive and time delays are numerous. Even if the amount of the claim turns out to be less than desired, when legal fees are factored in it is probably still the best financial route.


Chapter 5: Insurance Doesn’t Always Pay Everything


Insurance Doesn’t Always Pay Everything

The Standard Fire Contract does not have any clause relating to coinsurance. Even so, coinsurance is part of many types of policies. It is most likely to be seen in policies protecting manufacturing and mercantile firms. Outside of property and casualty policies, coinsurance is frequently used. This is especially true in medical policies. Coinsurance is not typical in dwelling fire contracts. When coinsurance does exist in property and casualty policies, its intent is to limit the insurer’s liability.

Even though coinsurance is not necessarily used, the concept has been in insurance since policies were first created. It was first used in the marine insurance field. Today coinsurance is so ingrained in marine insurance that it is not considered necessary to even refer to it. It is simply known that the amount of insurance carried is equal to the full value of the property insured. Anything less and the insured must bear a proportional share of any incurring loss.

The actual coinsurance term is not necessarily the same in every type of policy. As a result, it is necessary to refer to the list of terms in each type of policy. Coinsurance may be referred to as Average Clause, the Reduced Rate Average Clause, the Standard Average Clause, the Reduced Rate Contribution Clause, and the Percentage Value Clause. Whatever term is used, it limits the insurer’s liability. Again, whatever term is used, coinsurance intends to limit the insurer’s liability. The use of coinsurance is widely accepted by consumers. Whether it is called coinsurance in the policy or stated as an average clause, the results are the same. The application of the 1963 Guiding Principles actually reduced any real difference between the two terms. The exception might be when coinsurance is involved in a non-concurrent loss situation. Briefly, the coinsurance or “average” clause provides that the property owner has any loss paid only in the proportion that the amount of insurance purchased bears to the minimum amount of insurance that the contract requires the insured to carry. The insured, of course, is free to buy as much or as little insurance as they desire.




Simply stated, coinsurance restricts recovery on partial losses if the insured did not insure the property for a given percentage of its actual cash value at the time of the loss. Coinsurance is required in some policies and optional in others. A typical coinsurance clause would read:

“In consideration of the reduced rate and/or form, it is expressly stipulated that in the event of loss this company shall be liable for no greater proportion than the amount hereby insured bears to ___ percent of the actual cash value of the property at the time of loss nor for more than the proportion which this policy bears to the total insurance thereon.”

Most homeowner policies insure for 80 percent of the home’s value. The other 20 percent would be a coinsurance. This provides a reduced premium rate. In Illinois, for example, an 80 percent clause in a fire policy on a fire resistant building may reduce the rate by as much as 70 percent in some central locations. A 50 percent coinsurance may reduce the rate by as much as 56 percent. The actual premium reductions depend upon multiple factors, of course. Most rate reductions come with strings attached. For example, for a rate reduction the insured might agree to protect the property for an amount equal to at least the stated percentage of the actual cash value of the covered property at the time of loss, with the provision that if the percentage is not met, the insured becomes a coinsurer to the extent of the difference between the amount of insurance required and the amount of insurance owned. On that basis, the insured will contribute pro rata to incurred losses. The complexity of adjusting losses under more than one type of coinsurance clause is more than we would want to attempt here. That issue could be a course in itself, but one that few agents would want to tackle. Some things are better left to the actuaries. How Coinsurance Works Coinsurance is typically expressed as a percentage. Most fire policies cover up to 80 or 90 percent, but there are no percentage requirements. Regardless of the percentage used, the insurer will never cover more than the policy’s face amount. There is a formula that is used to figure coinsurance amounts and the amount of insurance that should be purchased. Amount of insurance required:




Actual cash value of the property at the time of loss X Coinsurance percentage

= Amount of insurance required. To determine how much the insured would receive from a covered loss, the following formula is used:

Amount of insurance owned X Loss = Maximum amount of recovery Amount of insurance needed The amount of insurance owned would be the face amount of the insurance in force. The amount of insurance needed would be the actual cash value of the property at the time of the loss multiplied by the coinsurance percentage that is stated in the policy. There are two situations that would make this formula wrong:

1. If the insured carried more insurance than that required by the application of the coinsurance percentage, payment would not exceed the amount of the loss.

2. The insured can never recover more than the face amount of the

contract. Probably the majority of fire policies written are for 80 percent coinsurance clause. Assuming this fact, there are some important points to consider:

1. If the insured fails to insure at least 80 percent of the value of the property the coinsurance amount is more than might be expected. It is unfortunate that the term coinsurance has been used to the point of misunderstanding on the part of the consumer. Since different types of policies may apply the term differently, the insured may easily misunderstand how it affects their fire policy. If the insured under-insures their property, there is no recourse once the loss has occurred.

2. The property owner determines the amount of insurance in place.

Even though the selling agent may recommend a higher amount, the amount actually purchased is determined by the buyer. Exact property values may not always be known by either the agent or the owner. We generally assume the owner will know the value of their property, but since values change often this is not necessarily the case. In addition, a person who does not deal with property values is not always in a position to assess property value.

Insurance companies and their agents do periodically send out notices to their clients expressing the need to update their coverage. While this is appreciated by many it is ignored as often as it is acted




upon. When the property owner experiences a loss it is too late to correct the problem if they failed to act on the company’s earlier recommendations.

3. The 80 percent coinsurance clause does not mean that the company will pay only 80 percent of any loss. It does not mean that the insured is prohibited from taking insurance beyond the 80 percent level of the property value. The property owner is free to insure the property to the full 100 percent of its value if they so desire. If the property owner has insurance amounting to the full extent of the loss, losses will be paid as though the policy contained no coinsurance clause.

4. The coinsurance clause becomes inoperative if the loss is equal to or

exceeds the stipulated percentage of value. In other words, while the policy will never pay beyond the face amount, it will pay up to the face amount. If the loss is substantially greater than the face amount, the policy will pay that full face amount as though no coinsurance existed. For example, Thomas buys a policy for $5,000 on property valued at $10,000. Even though his policy states 80 percent coverage, since the value is so much higher than the policy, the full $5,000 will be paid without regard to coinsurance amounts.

5. It is not necessary to fully insure with one carrier, unless the policy

disallows other insurance. It is wise to purchase policies with uniform coinsurance clauses. Where multiple policies exist, each will pay on a pro rata basis.

6. If a policy with a coinsurance endorsement to insure more than one

item, it is recommended to make the clause apply to each item separately. For example, to the building and separately to the contents. When this is the case the wording is typically similar to: “if this policy be divided into two or more items, the foregoing conditions apply to each item separately.”

Why would a policyholder want coinsurance? At first glance, coinsurance clauses would seem only beneficial to the insurers who are using them to limit their liability. While it certainly is true that coinsurance does limit their liability, it is also beneficial to the consumer. Although the theory behind coinsurance is applicable to any type of coverage, fire insurance provides a clear example of how coinsurance helps achieve rate equity and adequacy for the insured. Most fire losses are partial




rather than total. Less than 2 percent of the fires result in a total loss. More than 80 percent produce losses of less than 10 percent of the total property value. As a result only 2 percent of the time is it actually necessary to fully insure a property’s actual value (of course, if you are in that 2 percent total loss amount this argument will not seem realistic). Typically, agents recommend insuring 80 percent of the value. This is a reliable approach since few people will actually lose everything. However, it would also be realistic, if one were willing to gamble on the statistics, to only insure up to 10 percent of the home’s actual value. Most of the time it would be adequate coverage. The problem with this view, of course, is that those who do experience losses greater than 10 percent of the property value would be very unhappy if their agent had recommended such a low coverage amount. For those who do want to insure up to 80 percent, as normally done, having a coinsurance provides a “rate credit.” In other words, it keeps premium rates down. Without coinsurance amounts, full coverage would cost ten times the rate for 10 percent coverage even though the chance of loss is not 10 times as great. With equal rates per $100 of insurance, persons buying full coverage for their losses would pay an inequitable premium considering the low statistics on total losses. By utilizing coinsurance amounts, it is possible to buy 80 percent coverage that is affordable. There is another factor involved. When a mortgage is held it is usually required that a certain percentage of the home’s value be covered by insurance. Typically the lending institutions require the amount of the outstanding loan be insured. At least initially, that is nearly the full value of the property.

Coinsurance allows insurers to give a fair cost for the insurance purchased. Coinsurance allows companies to collect premiums from all types of people with different levels of risk tolerance while still keeping premium costs accessible to each situation. It is a well-known fact that few fire losses are total in cities with good fire protection. The danger is greater in rural areas with poor fire protection. Even then, comparatively few fires result in a total loss. If there were no coinsurance provisions fire coverage would be much more costly. Without the option of coinsurance, it is likely that many people would purchase small

amounts of fire protection, given the higher cost. This might especially be true if the homeowners were aware of these statistics. Those who had to buy nearly full coverage because of mortgage or other contractual agreements would be unfairly penalized with high premium rates. The




companies must still collect the same aggregate premium income to meet their claims. This fact would result in huge premiums for those property owners who do not wish to underinsure or, because of mortgage agreements, are forced to purchase insurance insuring the full cost. Without coinsurance, rates would be very high. Insurance professionals often compare premium rates with tax rates. Each is based on factors that should apply to all equally (although some could successfully argue that fairness is not always an issue in either case). Both taxes and premiums should be paid in proportion to the value of the property. Of course, some may elect to fully cover their property while others elect to insure only a portion. As it relates to insurance, those that elect to gamble by only partially insuring their property should only receive claim payments according to the same percentage if it is to be fair to those who elect to fully insure. Just as states and cities adopt a uniform method of assessment in levying taxes to prevent discrimination, fire insurance must have some of the same uniform factors of assessment. There must be some effort to prevent discrimination between those who fully insure and those who only partially insure their property. Rates of premium are the result of many factors, including the type of building construction (wood, brick, and so forth), types of fire prevention available, and existing hazards. Insurance factors are governed by the laws of averages. Given like situations, comparing losses to premium allows insuring companies to arrive at a cost that covers claims and still allows them to stay in business. Small versus large property owners There are many types of property owners from those that own a small home to those who own large industrial and mercantile corporations. Coinsurance protects the small owners from the efforts of large industrial and mercantile corporations to pay less for their coverage. Don’t misunderstand. Industrial and mercantile corporations are not necessarily trying to put their portion onto someone else. They merely try to keep their insurance costs down in whatever manner is available to them. The result would still be, however, unfair to small owners if coinsurance were not part of the policies. Corporations often have different situations than would small property owners. The property is likely to be located in different localities than would single dwellings, contents may be in different locations than the main home office, even within the same building contents may be stored in different compartments with fireproof walls separating them, or contents may be protected from fire in some manner not commonly used by the small




property owner. Because of these conditions, a total loss would be unusual. Therefore, Corporations may try to insure differently than would a small property owner. To prevent large owners from buying full protection on numerous items of property simply by taking out a policy equal in value to the most valuable item, insurance companies require that a blanket policy include at least 90 percent coinsurance and, in some cases, even 100 percent. Coinsurance history Some countries, understanding the financial advantages of coinsurance, have actually made the practice a matter of law. France, Italy, Spain, Belgium, Japan, and other countries have made the practice compulsory by law. As stated, the principle has been used in marine insurance from very early times. It wasn’t until about 1890 that the United States made any serious attempt to apply coinsurance to fire policies. Even today, however, Americans do not seem to fully appreciate the practice of using coinsurance to minimize rates. In the early 1900’s there were actually anti-coinsurance laws. Typically, anti-coinsurance laws exist in states that also have valued policy laws. States having anti-coinsurance laws have dwindled as the financial advantage of coinsurance has been accepted. As of 1996, only Iowa, Missouri, and Texas still had anti-coinsurance laws on the books for some types of policies. Consumer distrust Agents are aware of one major problem with coinsurance and deductible provisions: consumers dislike having to pay any part of a loss. Clients often do not understand coinsurance, especially the more complicated types. They often express a feeling of deception and “fine print.” Seldom does a consumer understand how coinsurance lowers their premium rates, nor do they understand the reduction of loss through the imposition of coinsurance. Because of these common feelings, it is vital that the insurance agent fully disclose anything that limits a payment for a loss. That includes both deductibles and coinsurance. Such explanations must always take place at the point of sale (prior to the loss). Many professionals feel a yearly reminder of how the policy works is also vital. Consumers typically only appreciate the insurance they have purchased when a loss happens. If they suffer no misfortune, consumers often feel the insurance companies have somehow cheated them out of their premium




dollars. It is more reasonable for consumers to realize that they purchased protection that was delivered by the insurance company. Whether or not a loss provided benefits is not an issue. The protection was provided. Another consumer problem arises when inflation has changed the value of the insurance protection they bought. The amount of insurance may have been sufficient at the time of purchase, but due to inflation or rising property values they find themselves underinsured when a loss happens. The first person blamed is usually their agent. It is true that an agent needs to keep in touch with their clients and suggest additional insurance when necessary, but ultimately each consumer must be responsible as well for their financial security. Because it was such a widespread problem, the Businessowners’ Program uses an “amount of insurance clause” rather than coinsurance. The insured submits annually a sworn statement of property values. The figure submitted is then covered at 90 percent and becomes the amount of insurance clause. The insurer’s liability is the proportion that the actual amount of insurance carried bears to the agreed amount entered in the clause. This type of coverage is likely to be eventually applied to other forms of insurance although its success or failure will depend upon careful underwriting and loss adjustment. Without those two factors, competition could produce exactly the same inequities that the coinsurance clause was designed to eliminate. Residential property policies do not usually have coinsurance clauses. Policies must still keep the amount of insurance in a reasonable relationship to the value of the property. There have been public campaigns to educate consumers on their insurance policies, but it is not known how effective this has been. When underwriting a policy, there are basically two things that must be done. First, before accepting the risk, the underwriter is likely to require some minimum percentage of insurance to value. Company policy often sets this at 75 to 80 percent, although the actual amount may vary. Approximation of the value, to which the percentage is applied, is obtained from the agent, from building cost indices, or from an appraisal service organization. Second, during the contract term, the underwriter gets some assistance from the widespread use of the inflation guard endorsement. Some companies use a renewal increase schedule that automatically applies some percentage increase to all existing policies. Both methods help keep the amount of insurance in a reasonable relationship with the property values. Homeowner policies use a replacement cost provision that, while not a coinsurance clause, does help to keep insurance to value relationships in line. It helps to limit recovery if the insured carries less than 80 percent of insurance to replacement cost.




Coinsurance variety Coinsurance clauses vary in wording as well as in their application in policies. Some companies use coinsurance clauses individually, adapting them to the policy conditions, the special needs of their clients, and the type of property being insured. Other companies may use a more standardized form of coinsurance throughout their policies. There may be times when a provision called the 5 percent waiver clause is used in connection with the coinsurance clause. While the exact wording can vary, it typically reads as follows:

In the event that the aggregate claim for any loss is both less than $10,000 and less than 5 percent of the limit of liability for all contributing insurance applicable to the property involved at the time such loss occurs, no special inventory or appraisement of the undamaged property shall be required provided that nothing herein shall be construed to waive the application of the first paragraph of this clause (i.e., the basic coinsurance clause limitation). If insurance under Section I (property damage) of this policy is divided into separate limits of liability, the foregoing shall apply separately to the property covered under each such limit of liability.1

The 5 percent waiver clause merely waives the special inventory or appraisal of the undamaged property. It is not intended to waive the operation of the coinsurance clause itself. Even so, the coinsurance clause is usually not applied when content losses are small and a waiver of inventory clause exists. Without knowing the value of the insured property, the insurer may have trouble applying the coinsurance clause. It is actually an advantage for an insurance company to use the waiver clause. When the insured values are large and the loss is small, the fire policy requirement of furnishing a complete inventory of both the damaged and the undamaged property may be a financial burden to the client (the insured). It is possible that the cost of the total inventory could exceed the amount of the loss. The insured may find that the cost of obtaining property values exceeds the amount that would be reduced in the benefits paid under the coinsurance clause on small losses. Dispensing with the hassle of obtaining values may also improve customer relations.

1 4th edition Property and Liability Insurance by S. S. Huebner, Kenneth Black, Jr., and Bernard L. Webb Page 106




The final provision of the 5 percent waiver clause states that if two or more types of property are specifically covered, then the $10,000 and 5 percent applies to each type. Deductibles Also called waiting periods, deductibles relate to losses that are not covered by the insurance policy. Whether it is called a deductible or a waiting period will depend upon the type of policy. Health policies usually call time or losses not covered “waiting periods.” These deductibles can be stated as multiple things. For example, in a long-term care nursing home policy, the deductible applies to time not covered, such as 30 days. This means the first thirty days of institutionalization would not be covered by the policy. Coverage would begin on the 31st day of confinement. This can be translated to money, however. If the policy pays a benefit of $200 per day, then a 30 day waiting period equals a $6,000 deductible. Disability riders in life insurance policies often require a six-month waiting period before benefits are payable. Of course, there are shorter waiting periods usually available for additional premium. Some states require a waiting period following an injury to establish eligibility for workers’ compensation benefits. In some states, compensation benefits become retroaction if the worker’s disability continues beyond a stated period. Why are deductibles used? We know that deductibles keep premium costs down. When insurers pay less out, they can charge less for the policies. Deductibles are based on sound financial insurance theory. Deductibles reduce the cost of insurance by eliminating frequent small losses that would otherwise be covered by insurance. Deductibles also reduce morale hazards. When an individual knows they must pay the first initial cost of a loss, they tend to be more careful. Insurers typically see better loss experience in policies that have deductibles. Unfortunately, not all deductibles discourage carelessness or loss experience. Franchise deductibles may actually encourage losses in the form of exaggerated claims. By exaggerating the claim amount, the insured may try to collect the entire loss. Disappearing deductibles suffer the same results.




Insurance agents often try to minimize or eliminate deductibles for their clients. Unfortunately they, or their clients, may believe that deductibles are bad. Agents often consider them bad public relations. Clients often believe that insurance should cover every loss from beginning to end. Educated agents, who have done the math, generally find that deductibles are in the best interest of their clients. Whether or not they are able to relay this to their clients may be another matter. Deductible clauses may be mandatory in some policies and optional in others. Deductible clauses serve an important purpose in insurance. Some insurers use these clauses to eliminate coverage for small losses. Whether required or optional, the clauses often provide a choice of deductible amounts. Straight Deductibles: This is the type of deductible clause commonly used. It is often found in automobile collision coverage. The deductible amount is usually expressed as a dollar figure, such as $100 or $250. The actual amount may vary from $50 up. Most consumers are familiar with the straight deductible. In automobile insurance, if Jimmy Jones wrecks his car, he knows he has to pay his deductible before his auto insurance kicks in. If his deductible is $250, he must pay this amount before his auto policy will pay anything. This deductible applies to every loss. Straight deductibles are used in most medical policies. It is common have a $250 to $500 deductible for hospitalizations. This may be per occurrence or a calendar year deductible. Some straight deductibles are a percentage of value rather than a fixed dollar amount. In aviation hull insurance, for example, a deductible of 2.5 to 10 percent of the insured value of the plane may exist. It would apply to all losses except those caused by fire and theft in most cases. Earthquake insurance also has a percentage deductible based on the actual cash value of the property. Convertible Deductibles: When this deductible type is used, the insured pays an initial rate that is less than the manual rate. If no loss happens, the insured has saved premium. If a loss does occur, he or she must pay an additional premium for the right to collect indemnity. While the reduced rate will vary, in automobile insurance the initial premium is usually around 50 percent of the full cost. That would mean the insured would have to pay an amount equal to the original premium before a claim would be paid by the insurer. Once that




additional premium is paid, no additional amount would be due to collect on successive losses. Cumulative and Participating Deductibles: Although this is referred to as a deductible, it is not truly one, as losses are paid in full after the insured has accumulated losses equal to the premium paid. When this type of policy is written, the insurer writes a 50-50 or cumulative and participating deductible under which the insured pays 50 percent of the standard premium, then assumes losses until they equal an additional 50 percent of the standard premium. Then full coverage is available for future losses during the life of the policy. This is different than the convertible deductible since all losses apply toward the additional 50 percent of the premium. In no case is the insured required to pay an additional premium. We sometimes see this deductible used in glass insurance. Franchise Deductibles: Ocean marine insurance uses the franchise deductible. Marine policies are written with either franchise or straight deductibles, but the franchise deductible is the most common. The franchise deductible is different from the straight deductible in that if the loss exceeds the franchise (deductible amount), the insurer pays the entire loss, not just the excess. If the loss is not higher than the deductible percentage, the insurance company has no liability to cover. Progressively Diminishing Deductibles: This type of deductible combines the franchise and straight deductibles. While there may be variations, the typical version used in automobile collision insurance plans states that no loss less than a stipulated amount will be paid. If the loss is twice the stipulated amount, it would be paid in full. Losses more than the stipulated amount, but less than the maximum for full coverage, are paid twice the amount by which the actual loss exceeds the stipulated amount (and we wonder why the layperson finds insurance difficult to understand!). For example, Joan has a policy, which states the stipulated amount as $50. No loss for $50 or below would be covered. Losses of $100 or more would be paid in full. Losses between $50 and $100 are partially indemnified. A $60 loss is paid at $20, which is twice the amount by which $60 exceeds $50 ($60 less $50 = $10. $10 X 2 = $20). A $90 loss would be paid at $80 ($90 less $50 = $40. $40 X 2 = $80), and so forth. As the loss increases, the deductible diminishes. Not just automobile policies use this type of deductible. Homeowner policies also use them. No loss to which the deductible applies is paid unless




the loss exceeds the policy deductible. HO policies often use two types of deductibles. Deductible clause 1 applies only to damage to the dwelling and to personal property in the open caused by windstorm or hail. Deductible clause 2 adds the deductible to losses caused by all perils other than fire and lightning. Sometimes the deductibles are at the insured’s option. Of course, not all homeowner policies use the progressively diminishing deductible method. They may be replaced with a straight deductible amount, such as $100, since progressively diminishing deductibles can work for the benefit of the insured. As an alternative to raising the rates, insurers have switched to the straight deductible. The amount of the straight deductible ($100, $250, $500, etc.) will affect the amount of premium charged. Loss Limitation Clauses Insurers may use other types of clauses to limit their losses in fire insurance policies. Some are added at the client’s option as a means of lowering their premium, but others may be mandatory in some circumstances. Pro Rata Distribution Clause: This clause will state something similar to: “This policy shall attach in each building or location in the proportion that the value in each bear to the value in all.” This clause distributes the insurance automatically over the multiple items insured in proportion to their respective values. How inflation or other factors affect the value of the insured property or items will not affect how the policy pays. Buildings are not generally affected by great swings in value, so how the policy pays will stay relatively stable. Because of this there is not much need of this clause. Fluctuations are more likely to occur with machinery, goods, and other items. Goods or machinery that is routinely moved from one location to another can have wide value variations. In these cases, this clause is extremely useful since it would not be practical or maybe even impossible to keep a record of the changing values. Clauses such as these tend to be more frequent in some policies and rare in others. Pro Rata Distribution clauses are often used in connection with blanket policies. Eighty percent coinsurance clauses are also used in blanket policies. The two clauses are a safeguard for the company and the insured (if sufficient amount of insurance was purchased), because they are protected from the possibility of inadvertently having insufficient protection. The insured must still (1) make sure he or she has purchased enough insurance to meet the necessary requirements and (2) make the insurance




bear such relation to the aggregate value as to comply with any coinsurance requirement endorsed on the policy.2 Deductibles Some types of insurance are more likely to use deductibles. Medical insurance made consumers familiar with deductibles, but of course, many other types of coverage also use them. A deductible clause requires the person or entity insured to bear the first part of any loss that would be covered under their policy. Obviously, if the loss were not covered by the policy it would not satisfy the policy deductible clause. Marine insurance was the first to use a deductible clause, but it has been widely accepted, even by the consumer, in most insurance lines. Deductibles do not affect the actual insurance amount in most cases; rather deductibles affect the claim payment. For example, a policy that has a $500 deductible would pay nothing on a loss until the insured has paid the first $500 of the loss. If the loss were less than that $500, the policy would not pay anything at all. Deductible clauses are used to reduce the insurance company’s liability since they remove the smaller claims entirely and reduce the larger ones by the amount of the policy deductible. There can be variances in how deductible clauses work, but usually the deductible applies to the first dollar losses. In some policies the deductible applies to every loss, no matter how often they occur. In others, deductibles may be an ongoing process until the specified dollar amount has been exceeded. Some policies have both a deductible clause and a coinsurance clause. When this is the case, there are two ways of handling them. The coinsurance limit can be applied first to the loss, and the deductible amount subtracted second. Or it can be the other way around: the deductible amount applied first, with the coinsurance applying second. Policies usually specifically state which clause applies first and which applies second. Although deductible clauses certainly are intended to limit the insurer’s liability, they benefit the insured as well. As every agent knows, it is not necessarily easy to convince a consumer that a deductible is in their best interest. All too often, consumers feel deductibles rob them. In fact, deductibles are instrumental in keeping insurance rates down. Because deductibles eliminate many small claims, insurers save in two ways: first by eliminating the claim itself, and secondly by eliminating the administrative cost of paying the claim. Because this saves the insurer money, they are

2 Property & Liability Insurance (4th Edition) by S.S. Huebner, Kenneth Black, Jr., and Bernard Webb




able to keep rates lower than would otherwise be possible. Agents realize that most insurance policies are not intended for the small claims. They are intended to prevent catastrophic financial loss by paying the big claims. It is not unusual for business insurance to have deductibles of $5,000 in order to keep premiums low (and therefore affordable). In today’s financial climate, we are seeing business policies offering deductible amounts of even $10,000 and higher. Large deductibles absolutely reduce premium rates. When deductibles are small the policyholder pays higher premium rates. This may prevent purchasing enough coverage to handle the really big losses. Most consumers would not suffer permanently from small losses. It is those big losses that would most likely damage them financially. Since the point of insurance is to transfer the most damaging losses, it makes sense to select larger deductibles in order to afford the cost of purchasing larger amounts of coverage. In some cases there may be tax considerations when purchasing insurance. Although losses are often tax-deductible, it would be hard to imagine a person or business underinsuring for the tax considerations. Usually tax considerations relate to the premiums paid for coverage. Since tax laws do change and state laws vary, it might be necessary to consult with a tax expert when premiums would be high or the need for a type of coverage may be questionable. Types of deductibles Deductible clauses do vary from contract to contract and from insurance type to insurance type. Usually deductible variations have characteristics that are particular to certain types of coverage. Depending upon the policy line, deductibles may apply to each property item, each accident, each year (those that refer to each year are called aggregate deductibles), each location, or other variations. Although there are multiple variations of deductibles, they tend to fall into one of three categories:

1) Straight: this may be stated as a specified amount of money, a percentage of a value, a percentage of the amount of insurance applicable, or a waiting period before benefits may be received.

2) Franchise: a fixed amount or percentage of value or insurance

applied. In this type, if the loss exceeds the required amount, then the entire loss would be paid in full.

3) Disappearing: losses over a specified amount are paid at a rate in

excess of 100 percent so that at some level the deductible is eliminated.




As we have stated, there are costs associated with claim payments. In addition, deductibles are believed to reduce moral hazards (people are thought to be more careful when their actions will affect them financially). These two reasons alone are justification for the use of deductibles. These reasons especially apply to the Franchise and Disappearing deductibles. On the other hand, the franchise deductible may encourage the insured to inflate their claims in order to receive payment from their policy. The same may be said for the disappearing deductible. Companies experimented with the disappearing deductible in Homeowner’s programs to see if it would reduce the company’s liability and keep premiums down. After ten years it was abandoned in most states and replaced with the straight deductible. Companies found that consumers quickly realized how the disappearing deductible worked and began to inflate their claims in order to force payment under their policies. Today homeowner policies tend to use the disappearing deductible only when the specified deductible amount is quite high. In closing Insurance companies do not issue blank checks. The limitations in policies are limitations on the amount of recovery. Policies are written to benefit not only the consumer, but the insurance company as well. Insurers intend to make a profit so they use clauses that limit their liability. This is not a bad thing. In the process of making a profit (allowing them to stay in business), consumers pass the threat of catastrophic loss to another entity – the insurance company. Limitations on recovery refer to (1) extent of the insurable interest; (2) actual cash value of the loss; (3) policy limits; (4) other insurance; (5) coinsurance, contribution and average clauses, and (6) deductibles. A limitation establishes the maximum amount the insurer will pay for a covered loss. As previously stated, only a “covered” loss applies. Consumers often see their policies as an adversarial situation: they consider it a case of them against the insurance company. That is why we hear consumers speak of the “small print.” In reality, there is no so-called small print. Rather, it is a matter of consumers not understanding the insurance they have purchased. Additionally, many consumers believe all losses should be paid for by their policies. They fail to realize that it is the limitations in their policies that allow them to be affordable so that the big losses may be covered. Because consumers view their policies in an adversarial way, it is very important that agents continue to remind their policyholders how their insurance works for them. Only when consumers understand why they want




deductibles and coinsurance and other limiting factors will they realize how to best use their policies. Certainly there have been instances when insurance companies did attempt to minimize payable claims. That still happens today. However, deductibles and coinsurance clauses do make sense for both the consumers and the insurers.


Chapter 6: What Are We Insuring Against?


What Are We Insuring Against?

Perils Everyone faces perils. Webster’s dictionary defines a peril as “danger.” There are dangers all around us. Whether we are crossing a street, riding a bicycle, driving a car, or simply plugging in an appliance we face danger. Obviously, it would be impossible to insure against every peril or danger. We buy policies that protect us only from specific dangers. No policy can protect an individual from the emotional stress of a loss. Insurance policies only attempt to protect us financially from such losses. While monetary payment will help with the financial stress, it will not protect us from the emotional stress when we lose someone we love, or from the loss of personal items burned in a fire. Agents often provide what is called “peace of mind.” In reality, agents provide “peace of financial loss” rather than peace of mind. Of course, that is a reference to the lack of worry about a loss, but when a loss occurs there really is no way to relieve the stress of the loss itself. Policies merely make life easier by replacing physical items or replacing lost income. Defining the losses For most consumers, when they purchase insurance they want to know primarily three things: (1) Which items are covered? (2) How do I collect on a loss? and (3) How much does the policy cost?

Consumers expect very simple answers, but sometimes these questions cannot be simply answered. The main source to the questions is contained in the policy itself. Few policy-owners (or even agents) read their policy in its entirety. Fortunately losses are few compared to the number of policies written. Even so, consumers often do not realize what is and is not covered

until a loss happens. Consumers find themselves pouring over their contract as their house burns or as a tow truck hauls their car off. At this point the policy becomes a source of anger for the consumer as they realize that “everything” is not covered. The truth is, no policy covers “everything.” As we said, it would be impossible to purchase a policy that covered every possible loss. With the possible exception of marriage, insurance is probably




the only contract entered into without examining the contents. We tend to read the warranties on our toasters better than we do our insurance policies. No policy pays for everything. This cannot be stated often enough. All coverage is subject to limitations of some kind. Policyholders have the responsibility of reviewing these limitations in advance of a loss. Agents have the responsibility of advising of these limitations at the time of purchase. If both are done, clients can avoid both over-insuring and under-insuring. Every policy lists the perils (dangers) that are covered. Some are obvious. For example, life insurance policies insure against a premature death. Consumers know this when they purchase the policy. Other policies are more complicated, such as health insurance. Whereas a life insurance policy is fairly simple (one is either dead or alive), health coverage is very complex containing deductibles, coinsurance, and other limitations. A property policy may appear to be straightforward but actually contain subtleties that may not be recognized by the consumer. It is important to realize that every insurance policy is a contract and must, therefore, contain legal wording that can have specific meanings not readily recognized by the general consumer. Such legal wording is required in policies since they are a legal document. There is the joke regarding insurance policies which states: Every policy requires three attorneys: one to write it, one to contest it, and one to decide who is right. “Loss and Damage By Fire” Fire, as a peril, is not defined by the Standard Fire Policy. Therefore it is given its ordinary meaning by the courts. Specifically, fire is defined as oxidation of a degree sufficient to produce a visible flame or glow. Exactly when the flame or glow is produced can be significant in some cases. Such is the case of fires in stored food products. One example has to do with what is called “bin burn.” This is the organic heating of agricultural crops stored for extended periods of time. Since the storage areas are getting larger and larger and the value higher and higher, the potential loss from fire (or anything else for that matter) is great. Insurance claims become complicated in the event of fire because it can be very difficult to establish when a flame or glow actually began. If the stored food lost value (due to age or exposure to degenerative elements) prior to the actual flame, this affects how the insurance company would compensate for the loss. By contract terms, the insurer is liable only for the value at the time of fire (an actual flame or glow) although there could have been a loss of value prior to that due to extensive exposure to the elements that caused the fire. Again, the insurer is liable for the fire loss only. Although scientific evaluation will




produce some insight, the final decision will depend upon negotiation and probably some compromise. There can be an additional limitation on loss due to fire. Fire is divided into two categories: hostile fire and friendly fire. A hostile fire is one that is uncontrolled, whereas a friendly fire is one contained in a proper receptacle. If a friendly fire moves from its proper place to an improper place, it changes from a friendly fire to a hostile fire. This is what happens when a campfire becomes a forest fire. The campfire is friendly but once it leaps its proper boundaries into the forest it becomes a hostile fire.

No policy benefits are available as long as a fire remains “friendly.” For example, John, Ralph, and Mike are camping. They are sitting around a campfire (contained so therefore friendly) when John accidentally drops his camera into the fire. It probably would not be covered by his policy because the camera was destroyed by a friendly fire. If the camera were lost to a hostile fire, it probably would be covered. John’s policy also would not cover any damage resulting from the friendly fire to surrounding items, such as camping equipment.

Using the same example, if John accidentally dropped Ralph’s camera into the friendly fire, it is likely that his insurance would cover Ralph’s loss since John would be legally liable for it. Policies generally do not cover loss due to intentional use of fire. The first thing that comes to mind is arson. Policies specifically exclude coverage if the policyholder intentionally burns his own property or pays someone to burn his own property. There are other situations that would also apply. If heat is mismanaged, such as in a manufacturing plant, the policy is not likely to cover the damage sustained as a result of that mismanagement. One authority stated it this way:

If a fire is used for culinary and heating purposes, or for the purpose of generating power, the fire being confined within the limits of certain agencies for producing heat, or if it is used by chemists, artisans, and manufacturers as a chemical agent, or as an instrument of art or fabrication, or for any of the other numerous purposes of like character, and if in such cases it is used or applied by design, and a loss occurs in consequence of over heating or by unskillfulness or negligence of the operator, and his mismanagement of heat as an agent or instrument of




manufacture or other useful purpose, this is not a loss within a fire policy. 1

To make this clear, if the fire or heat remains within the confines it is supposed to be in, any damage sustained to surrounding areas or items is not covered. However, if the fire or heat spreads outside of the intended confines, damage to surrounding areas or items would then be covered by the policy. Friendly fires are those flames within the intended confinement; hostile fires are those flames that spread outside of the intended confinement. Friendly fires are not a covered peril; hostile fires are a covered peril.

Borderline situations can occur where it is uncertain whether the damage would be considered the result of friendly or hostile fires. Cigarette burns often fall into this category. Often cigarette burns are covered for two reasons: (1) Swerdling versus Connecticut Fire Insurance Company stated such burns were hostile fires even though no actual flame or glow existed and (2) for public relation purposes. Another area that may be borderline when it comes to losses concerns overheating. Whether or not damage from overheating will be covered may vary according to specific situations. There have been successful legal arguments that when there are thermostatic controls and the heat from a fire that was restricted to its normal confines causes damage, the fire is still hostile (rather than friendly) if it was due to a malfunction. Because the fire is then considered hostile, the resulting damage would be a covered peril. The doctrine of proximate cause states that any loss caused by a hostile fire is a covered peril providing the loss is a direct result of the fire and not a remote consequence. Under this doctrine, when covered property has been damaged by smoke, heat, by the efforts of firefighters, by water used in extinguishing a fire, or damage caused by falling walls or other building structures, insurance companies have commonly been held liable for damages. Courts often settle the extent to which insurance companies are liable.

1 Couch on Insurance p. 4395 Couch Cyclopedia of Insurance Law, The Lawyer’s Cooperative Publishing Company




Lightning Although lightning often causes loss by fire, lightning itself is a peril separate and distinct from fire. However, since fire is so often the result, the two perils are treated together in many cases. Surprisingly, few statistics have been kept on lightning on a segregated basis (statistics lump lightning in with fire claims in general). One company did keep segregated statistics from 1958 through 1960 in the Midwest. Those figures dealt with an area experiencing 40 to 50 thunderstorm days per year. Florida actually leads the country with 90 thunderstorm days per year. However, 40 to 50 thunderstorm days is considered our nation’s “average.” Based on those three years statistics, the total number of fire and lightning losses amounted to 11,118. Of these, 8,848 or 79.5 percent were the result of lightning; 22.8 percent of the total dollar losses were the result of lightning.2 Removal of goods The Standard Fire Policy is a fixed, named location coverage. While it may be possible to literally move buildings from one location to another that is not the usual scenario. Typically, removal of goods refers to types of property that can be moved without severe difficulty. The only variation on the fixed location is found in the section of the insuring agreement, which states “and by removal from premises endangered by the perils insured against in the policy.” This statement allows for removal if it is to protect the property from insured perils. It is important to note that this specifically restricts removal based on “insured” perils. This is important to the insurance company since they based their premium rates on the location of the property. Coverage during the process of removal is held to be virtually “all risk.” At one time, theft was excluded during the removal process, but the courts have generally disallowed this exclusion. Breakage and exposure to weather is typically covered during the removal process. The doctrine of proximate cause provides the rationale during this period of time. Removal of goods is based upon Line 22 of the policy contract that requires the insured to “use all reasonable means to save and preserve the property at and after a loss.” Removal of insured property is often the only way to preserve it. For example, if one’s home were burning, it would make sense to remove valuable jewelry and art. Of course, even removing furniture and clothing is preserving insured property, but no insurance company would recommend endangering life in order to preserve property. Since the policy 2 May 1962 issue of the Mutual Insurance Bulletin.




specifically allows the removal of property in order to preserve it, it stands to reason that the company would also insure it during this period of time. There are restrictions involved. The policies typically provide a window of time during and immediately following a loss that coverage would be active. Companies realize that it would be impractical to expect an insured to arrange for a change of location endorsement, so the insuring agreement provides coverage as follows: “pro rata for five days at each proper place to which any of the property shall necessarily be removed for preservation from the perils insured against in this policy, but not elsewhere.” This includes several situations. First, pro rata means that if property is removed to more than one location, coverage is prorated to each of the locations in relation to what the value at the particular location bears to the total remaining value of the property. This qualification is not so important now because how the policies are written has changed. Originally policies were non-continuous. Non-continuous policies are those in which the amount of coverage is reduced by the amount of loss. Today’s policies are continuous. That means any loss paid under the policy does not reduce the amount of insurance remaining. Newer policy forms omit any reference to pro rata distribution and simply state that property removed is still subject to the same policy limits as those that applied at the original location. The time limitation of five days still applies because it is felt that this provides enough time for the property owner to arrange coverage at a new location. If a home fire is the result of the property transfer, the newer forms include an endorsement that allows thirty days to establish a new location. Under the Standard Fire Policy, once property is removed from the original location and located elsewhere, the coverage reverts back to exactly the same perils as those provided for in the original contract. That is, the “all risk” coverage applies only during the removal process. Newer policy versions are likely to state that the coverage is for direct loss from any cause for up to thirty days. Americans are a mobile group of people. We tend to move often. As it relates to insurance, this mobility affects how policies are written. Rates are based, in many types of policies, upon the location of the property. Due to the American mobility, policy language has been adapted in recent years. Most policies have adopted rules covering residential contents that provide automatic protection of household contents at new locations if:

1) It is the insured’s residence and not simply a place of storage, and 2) It is in the same state as the previous location.

In those areas where policies have this new language, this provision is made automatic by the liberalization clause, so no extra premium is required.




The Liberalization clause provides that any such alterations that might broaden or extend the policy without causing additional premium is automatically available for the benefit of the insured. If the items insured are not household items or if the policy covering the items does not include the extension available under the liberalization clause, then a change in location may require an endorsement for insurance coverage to be effective. It is important to remember that coverage does not extend to damage due to the actual physical moving of the insured items. There is no trip transit protection. There are policies that do specifically cover the move itself. Some Homeowner Policies include insuring agreements which read:

We cover personal property owned or used by an “insured” while it is anywhere in the world. At your request, we will cover personal property owned by: 1) Others while the property is on the part of the “residence premises”

occupied by an “insured”; 2) A guest or a “residence employee,” while the property is in any

residence occupied by an “insured.” This insuring agreement contains a dollar limitation on coverage for property usually located at an “insured’s” residence other than the one specified in the policy and for property used for business reasons. Exceptions No policy covers everything. The Standard Fire Policy does not cover everything. It specifically lists several causes of loss that would not be covered under the policy. Those include:

1) Loss by fire or other perils insured against in the policy caused directly or indirectly by: enemy attack by armed forces, including actual or an immediately impending enemy attack; invasion; insurrection; rebellion; revolution; civil war; usurped power; order of any civil authority except acts of destruction at the time of and for the purpose of preventing the spread of fire, provided that such fire did not originate form any of the perils excluded by the policy (lines 13-21). The types of losses enumerated in the preceding sentence are not included for the following reasons: they represent a catastrophe exposure which the insurer is unwilling to assume; they are usually extraordinary losses occurring under conditions that make the extinguishments of fire difficult; and in many cases,




they may be recovered from the state, or municipality. The readable policy changes are editorial only for this and or number 2 that follows.3

2) Loss caused by “neglect of the insured to use all reasonable means

to save and preserve the property at and after a loss, or when the property is endangered by fire in neighboring premises.” It is not always easy to prove neglect on the part of the insured. The purpose of this exception is to reduce the payable loss due to the insured’s neglect or carelessness.

3) Losses caused by theft. This exclusion often applied to “Removal of

Goods” which Line 24 expressly excluded. The added peril of theft occurring during the confusion at and following a fire is very high. Unfortunately, there are people who look for the opportunity to steal at this time. Insurance companies are aware of this unusually high risk of theft and wish to limit their liability. When loss to fire is extensive it is hard to prove what was lost to fire and what was lost to theft. However, in the case of multiple-line policies that cover this peril, there is no theft exclusion.

4) Loss “as a result of explosion or riot, unless fire ensures, and, in

that event for loss by fire only” (lines 36-37). In early legal cases the courts ruled that insurance companies were liable for certain types of explosions that caused fires and combustion losses. To avoid these payments, underwriters inserted clauses either excluding explosion losses entirely, or, as is currently done, excluding only the concussion loss. Proximate cause states that if an explosion is merely an incident of a preceding fire, the entire loss is recoverable even if the principal damage resulted from the explosion, and this is true despite an exception in the policy against explosion. However, the fire must be established as “hostile.” Otherwise, there may not be any coverage. Fire must happen due to a flame or glow that escaped its original “friendly” state into a “hostile” state. In that case, only if fire ensues is there coverage and then only for the fire loss. This is an important point and should not be overlooked. Explosion losses present difficult cases for adjustment because where fire immediately follows an explosion it can be impossible to determine the amount of loss due to the explosion and the amount of loss due to the fire. Since only the fire is covered this is an important point for the insured. Loss by riot is not covered by the policy except where fire results from the riot. Like losses from explosion, the insurance company’s liability is limited to the damage actually caused by the fire rather

3 Property and Liability Insurance p. 117




than by the riot. Both explosion and riot may be covered if there is an endorsement on the policy including them. Newer policies, again, are now multiple-line so they include a sizable number of perils. These policies include riot and explosion (except boiler) so no endorsement would be necessary.

5) Losses caused by the intentional acts of the insured are not

covered. If it can be proven that the insured purposely caused a fire or other peril for the purpose of collecting on their insurance policy, such losses would not be covered. However, mere negligence or fault by the insured or his or her employees or agents or even the willful act of his or her agents or employees (without the insured’s knowledge) would be covered by their policy.

Arson

Arson is the malicious burning of a building and, understandably, it is illegal. It is estimated that approximately 11.4 percent of the residential fires and 26.7 percent of the nonresidential fires in the United States are suspected arson (some estimate a more conservative number of 25 percent). The dollar loss exceeds $1 billion annually. By 1991 the number of arson fires had reached 98,000, with resulting damage of more than $1.5 billion. 4 There were also deaths resulting from arson. How does one place a value on human lives?

There are different reasons for arson. Some are due to property owners attempting to collect on their insurance policies. They may set the fires themselves or (and this is more likely) hire someone to do it for them. This type of arson is the most common. Financial arson is done for several reasons: to obtain cash from their policies, to terminate a lease, to allow relocation of a business, or a desire to terminate an unprofitable contract.

Third parties commit arson on the property of others for several reasons including: (1) a desire to hide another crime against the property or a person, (2) jealousy, (3) revenge, (4) during the commission of a riot or during vandalism, (5) terrorism or protest, (6) thrills, (7) pyromania, or (8) sexual excitement.

Fire insurance policies will pay losses caused by third parties with the right to seek recovery from those responsible. Fire insurance policies will not pay for losses that can be proven against the insured.

4 National Fire Protection Association




Coverage for fire department charges Sometimes fire departments charge a fee for answering alarms outside of specified areas. If this is the case, property owners will be charged for their services, which can run to several hundred dollars. Unless there is an endorsement on the policy, these charges for the fire department will not be covered. Such charges are considered to be consequential rather than direct physical damage to the property.

Agents who work in rural or extended areas must be aware of the existence of such fire department charges. Otherwise, when fire department charges are denied there could be some anger towards their agent. Agents can offer the addition of the fire department charges endorsement to their policy. Usually this additional coverage has no deductible. Coverage will be limited to those situations where the fire department was required “to save or protect covered property from a peril insured against.” It will not pay if the fire department is called for any other reason. Even though the Homeowners Policy labels this as an “additional coverage” such payments do not increase the face or total amount of coverage.

Debris removal

When there has been a fire, there is likely to be debris that must be removed. Obviously, restoration cannot take place on top of the burnt home. In addition, county requirements may make it mandatory to remove debris in a timely manner.

Debris removal is not the same thing as “Removal of Goods.” Removal of Goods refers to moving insured items to protect them from pending perils. Debris removal is the moving of damaged or destroyed material following a fire or other peril. Some insurers have contended that the policy covers removal of debris only to the extent that is necessary to repair or replace the damaged property. If the policy reads this way, it may mean that it will not pay for the full cost of debris removal. To clarify the issue, a debris removal clause has been added to some forms or is available as an endorsement. Even though this clause may add little or no additional premium to the policy, it does do several things: (1) with the clause attached, there is no question as to coverage for the cost of removal. (2) It makes it clear that coverage is limited to the cost of removing debris of covered property. (3) The cost of debris removal is not considered when determining the value of the property. This means that the cost of clearing the debris is added to and becomes part




of the amount of the direct physical damage, but it is not added to the value of the property itself. This is logical when one realizes that there would be no way to predetermine the cost of debris removal. Therefore, it would be difficult, if not impossible, to determine how much insurance would be necessary to purchase for this purpose.

Debris removal clauses should not be confused with demolition insurance. This type of coverage is used after a fire when a building must be destroyed because of building code requirements. This would be a consequential loss. Exceptions to Payment Even claims that are covered under the policy may be denied for specific reasons. Fraud, concealment, or misrepresentation would actually void the policy.

A policy may also be suspended. Voiding a policy and suspending it are two different things. When a policy is voided it is rescinded or “taken back.” No claims would be paid. Some insurers may choose to merely not automatically reinstate the policy (rather than rescind it). Others may be rescinded all the way back to issue, with premiums refunded. How a policy is voided will depend upon the policy type, the age of the policy, and the situation that caused the policy to be voided. A policy suspension will have the same effect of claim denial, but once the conditions causing the suspension are removed, the contract will automatically revert back to full force. Losses following the reinstatement would be paid. Denial of payment, whether through voiding the policy or suspending it, may be seen in Line 31 of the Standard Fire Policy, which states: “While the hazard is increased by any means within the control or knowledge of the insured.” The premium rate acknowledges a specific amount of risk involved (that’s why there is insurance), but the risk level may not be increased purposely by the insured. Exactly what establishes grounds for suspension has been determined over time by business practices and court decisions. It is understood that suspension can be exercised if the increase in hazard is substantial and exists over a sustained period of time. Specifics of suspension can and do vary from jurisdiction to jurisdiction. Of course, illegal activity, such as arson, automatically voids the policy.

It is difficult to specifically identify reasons for suspension. As we said, there are variations in how it is applied, based on jurisdictions and law. Additionally, simple knowledge of an increased hazard may not be sufficient




reason for the insurer to claim suspension of the policy. In an Illinois case of Triple X Chemical Laboratories v. Great American Insurance Company, the insured knew of a hazardous situation, but the court said this knowledge had not increased the hazardous situation. Mere knowledge had not changed the circumstance. Therefore, the insurance company was compelled to cover the loss.

Policies give the insured permission to use the premises in the manner considered normal as it relates to the occupation or occupancy. The work and materials clause specifically allows the use of the premises insured in the manner usual to the type of occupancy. Therefore, in the case of the chemical company, their use of the premises, even if it presented a hazard, was covered as long as use was typical of the business type insured. The work and materials clause may or may not increase coverage but it certainly clarifies the intent. Under this clause if the insured adopts a new manufacturing process, but that process is typical or usual to their type of occupancy, the policy unquestionably remains in force. Policies that cover dwellings have a similar clause called the permission-granted clause. This allows “for such use of premises as is usual or incidental to the described occupancy.” As long as the dweller uses the home for purposes that a home is normally used for, the insurance will cover insured losses. If a business is located in the home, that may or may not be covered, depending upon endorsements. Since a business is not the normal use of a home, an endorsement would be needed. The same section of the Standard Fire Policy states the owner is permitted “to make alterations, additions and repairs and to complete structures in the course of construction.”

Line 33 of the Standard Fire Policy states: “. . . while a described building, whether intended for occupancy by owner or tenant is vacant or unoccupied beyond a period of sixty consecutive days.” A distinction must be made between unoccupancy and vacancy. Unoccupancy means the absence of people whereas vacancy means the absence of both people and contents. Homes may be unoccupied while the owners are on vacation. A home would be vacant if no one lived in the home at all. The sixty-day restriction is an important one for insurance companies. Structures that are vacant (empty of both people and contents) for an extended time period have an increased moral hazard. The hazard represented may have some variances depending upon location, but all of them have the potential of trespassers vandalizing the structure or moving into them. With either vandalism or unauthorized occupancy, the danger of fire increases.




Policies usually have a clause that suspends coverage when a structure is empty for more than sixty days. The building and contents form, which is typical for commercial buildings, does not include this. For buildings that routinely are empty on a seasonal basis (a fruit stand, for example) the policy typically includes permission for unoccupancy for part of the year. When it is not routinely typical for unoccupancy on a seasonal basis, it may be necessary to obtain special permission to prevent policy suspension.

If a business experiences an unanticipated vacancy or unoccupancy due to a business or operational termination there may be increased hazard. Even if the business is not sure this is the case, it would still be advisable to obtain permission from the insurer to continue the policy. By advising the insurer of the situation, the company can be sure their coverage continues. The Standard Fire Policy provides that suspension of coverage may happen if property is removed from the stated location, even if the removal is temporary. Under “Removal of Goods”, there is a thirty-day period that provides coverage if the removal was to prevent increased hazard (during or following a fire, for example). During this time period coverage would continue. If the property was removed voluntarily, with no relation to increased hazards, coverage may not exist, unless the policy was modified by endorsement or an attached form. Reinstatement of coverage is automatic when the property is returned to the named location covered by the insurance contract. The Standard Fire Policy in lines 7 to 9 excludes several items: “This policy shall not cover accounts, bills, currency, deeds, evidences of debt, money, or securities.”

Many businesses purchase specific coverage for some items. For example, a business may buy coverage to insure their Accounts Receivable. Without specific coverage, it would be very difficult to determine a value on some of these items.

Peril expansion

It is possible to include perils beyond what is normally covered by the Standard Fire Policy. Permission to do so is given in line 38, which states: “Any other peril to be insured against or subject of insurance to be covered in this policy shall be by endorsement in writing hereon and added hereto.”




It is because of this statement that the Standard Fire Policy once formed the basis for insuring the majority of real and personal property. It allows a wide range of risks to be covered by one basic policy with attached endorsements or forms. Lines 42 to 48 carry this concept further. It states: “The extent of the application of the insurance under this policy and of the contribution to be made by this company in case of loss, and any other provision or agreement not inconsistent with the provisions of this policy, may be provided for in writing added thereto, but no provision may be waived except such as by the terms of this policy is subject to change.” This statement allows the addition of riders, clauses, permits, endorsements, and whatever else the insurer is willing to include. Extended Coverage Endorsement Although we think of the Standard Fire Contract in terms of fires, it can be used for perils other than fire, as a separate endorsement. As a result, the Standard Fire Policy may be converted into a separate earthquake policy or whatever. This is accomplished through the use of a conversion endorsement. The Extended Coverage Endorsement is fairly uniform nationwide, although there will be variations with regard to deductibles and coverage. When this form is attached to the fire insurance policy, it includes coverage for windstorm, hail, explosion, riot, riot attending a strike, civil commotion, aircraft, vehicles, and smoke. The insured must accept all or none, since no deletions are permitted. The rate for this extended coverage is usually fairly low since all perils covered by the extension are insured for like amounts. This spreads the risk over many perils of varying incidence and severity. The amount of coverage for these added perils is the same as the amount of fire insurance. If all these perils were insured individually, the cost would be much higher. Of course, the perils could probably be insured separately and some consumers choose to do so. When insured separately, only some of the perils are selected rather than all of them. Some consumers realize that they have virtually no risk for some perils but want coverage for others.

Due to a court case of Oller v. New York Fire Insurance Company, the addition of the Extended Endorsement has no effect on the amount of insurance carried. It broadens the fire policy with regard to perils only. This is accomplished by a clause in the endorsement that allows the substitution of each additional peril in place of the word “fire” found in the insuring




agreement of the underlying Standard Fire Policy. The only exception to this would be the limitations of any deductible applying to windstorm and hail losses.5 The additional perils do not increase the insurer’s liability. In one loss, the face amount acts as one overall limit, no matter how many perils were insured or apply to the loss. How the deductible applies A straight deductible is usually required for extended coverage endorsements. This deductible would apply to the fire as well as the perils of the extended coverage. The deductible would not apply, however, to additional living expense or rental value coverage. The mandatory deductible typically ranges from $50 to $100 although the insured may select a larger amount. There is no provision for removing the deductible entirely. The typical deductible clause will read: “This deductible shall apply separately to each building or structure including its contents; separately to contents in each building or structure if such building or structure is not covered hereunder; and separately to all personal property in the open.”

Windstorm and Hail Like fire, wind is not defined in the insurance contract. At one time, policies attempted to define wind velocity, but since that was often difficult to determine, that practice has been abandoned. Today’s policies use effect rather than condition. If the wind is strong enough to cause damage, it is considered to be a windstorm, which means the loss is covered. These policy changes often happen because of court decisions. In this case it primarily was the result of Fidelity Phoenix Fire Insurance Company of N.Y. v. the Board of Education of the Town of Rosedale.

Hail is a phenomenon associated with thunderstorms. Most hailstorms are limited in area and usually have a short duration. These storms will cover ten to twenty square miles and last from thirty to sixty minutes. Some areas are prone to hailstorms due to the air currents in the region. Balls of ice have been known to be as large as baseballs. Hailstones of the baseball size can be expected in sections of Kansas, Nebraska, South Dakota, Colorado, and Wyoming. Golf ball size hailstones are capable of breaking windows, awnings, signs, and antennas. They will dent aluminum and wood siding as

5 4th Edition Property & Liability Insurance p. 125




well as cars. In 1995, Texas experienced hailstones the size of softballs that caused “insured damage” of over a billion dollars. Total damage (insured plus uninsured) was higher. In addition, the storm caused several deaths and multiple physical injuries to people and animals. Unlike lightning, which we consider not to strike twice in the same place, hail does often strike twice in the same location.

The other provisions of the Extended Coverage Endorsement applicable to windstorm and hail specifically exclude loss caused by frost or cold weather and by ice (other than hailstorm), snowstorm, waves, tidal wave, and high water or overflow whether it is driven by wind or not. Most policies will include a clause clarifying the intent of the coverage in situations where there may be a question regarding the actual cause of the loss. For example, interior damage would only be covered if an insured period (hailstorm, for example) actually made a hole in the building, roof, or wall allowing the hailstones to damage the exposed interior. If the damage happened because the insured left a window open, the loss would not be covered under the terms of the policy. Policies commonly exclude coverage for specified items, such as crops or plants, silos, or buildings under construction. Antennas for television and radio are also commonly excluded from coverage. Most coverage of this type is part the Extended Coverage Endorsement, but separate coverage can often be purchased as an attachment to the fire policy. Whether purchased through a separate policy, optional policy, special form, or endorsement, the usual conditions found in the Standard Fire Contract applies to windstorm insurance. In most states, a $50 or $100 deductible will apply.

Beach plans Property located on a beach, especially in some high risk areas, have often found insurance difficult to come by. Beach property that routinely experiences loss due to windstorm exposure is often a risk that insurer’s have not wanted to cover. In the early 1970’s insurance pools were formed. Insurers operating in the high risk areas were required to share proportionally in the underwriting of property in these so-called “beach” areas. The intent was to see that the perils of fire coverage and extended coverage were available to those who would otherwise have difficulty obtaining coverage on the open market.

Participating states include Alabama, Georgia, Florida, Louisiana, Mississippi, North Carolina, South Carolina, and Texas. All real and personal property is eligible when it falls within specified areas. There are some exceptions such as mobile homes and motor vehicles in most of the




territories. There are maximum coverage amounts available, usually $100,000 on personal dwellings and $500,000 on commercial property, although some states do allow this to be increased. Deductibles do apply, usually in amounts of $250 or $500.

Explosion Again, like fire, explosion is not defined in the fire policy or its endorsements. In the absence of a specific definition, the courts apply a broad definition of any event of sudden and violent bursting. As is so often the case, these definitions applied by the courts came as a result of a legal battle between an insured and the insurer. Loss by explosion or riot is specifically excluded in line 36 by the Standard Fire Policy. It is possible to attach a form to the fire policy that will cover dwellings and their contents using an Inherent Explosion Clause. This clause offers protection on the insured dwelling from loss by explosion from hazards inherent within the building. The insured would then not be liable for such things as steam boilers, pipes or other items that are owned or operated by the insured. The Inherent Explosion Clause is often used by business properties.

Although there are some variations between the two, the Extended Coverage Endorsement closely parallels the Inherent Explosion Clause. In the Extended Coverage Endorsement, coverage is not limited to losses resulting from explosions occurring in the insured building as it is in the Inherent Explosion Clause. Secondly, the Extended Coverage Endorsement is more specific in detailing those occurrences that are not explosions within the intent of the clause. To make these differences easier to understand, the 4th Edition of the book Property and Liability Insurance uses this example: An insured home uses city gas. There is an explosion in the gas main outside of the insured dwelling. The Inherent explosion coverage would not cover the loss since it occurred outside of the dwelling, whereas the Extended Coverage Endorsement would. If the explosion occurred inside the home’s wall, either clause would cover it. Both types do not consider the following to be explosions, so coverage would not fall under either of these clauses: electrical arching, bursting of water pipes, rupture or bursting of pressure relief devices. The Extended Coverage Endorsement also excludes “shock waves caused by aircraft, generally known as sonic boom.” Sonic booms are covered in all risks forms and in the broad named perils in Dwelling and Homeowner’s forms. It may also be added by endorsement to the fire policy. There is typically a $500




deductible applying separately to each building and separately to personal property.

Riot and Civil Commotion

Prior to the 1960’s coverage for riot was part of the general policy. It represented very little cost to the insured. The risk was considered to be very small. As the nation saw riot and civil commotion surge in the ‘60’s and early 70’s into a very real threat to property, 27 states allowed a special civil disorder rate to be charged. The inclusion of riot perils as part of the Extended Coverage Endorsement supersedes the specific exclusion of this in the Standard Fire Contract. Today, some professionals feel the rate increases in the 1960’s and 1970’s may have been an overreaction to a threat that never really developed into anything long lasting. Surprisingly, no detailed records were kept. Coverage for riot and civil commotion cover all physical damage, including looting and pillage that result. Also covered are sit-down strikes where damage may be caused by employees. The policy would not cover changes in temperature or humidity or interruption in business income. Not all jurisdictions define riot and civil commotion the same. Usually there must be the threat of violence, actual violence, and involvement by more than one person. In most states, at least three people must be involved in the riot or civil commotion. Both riot and civil commotion is the open defiance of authority through the threat or actual use of violence. Civil commotion is generally defined to be a riot for an extended period of time. Because of this definition, it can be redundant in the policy. Riot or civil commotion is not the same as an armed revolt. An armed revolt is considered to be an elevated situation.

It is not the intent of the policy to cover vandalism and malicious mischief under the riot and civil commotion clauses. Because the line between them is not always clear, some states define riot as at least three persons engaged in a lawless act by violence or breach of public peace. However, insured’s must be aware that even if three people are involved, if there are no witnesses and no public disturbance was noticed, the courts will consider the damage to be vandalism rather than riot or civil commotion. Therefore these damages would not be covered under the Extended Coverage Endorsement.




Aircraft & Vehicles The Extended Coverage Endorsement does cover direct loss due to aircrafts or from objects falling from aircrafts. The term vehicle refers to vehicles running on land or on tracks. In order for the damage to be covered, there must be direct physical contact, which is not required in most Homeowner’s policies. Damage to fences, driveways, sidewalks, or lawns are specifically excluded, no matter who is driving the vehicle. The insured would be covered if the damage done were by an aircraft operated by the insured or his or her tenant.

Smoke Under the Extended Coverage Endorsement, smoke is covered if it is caused by the sudden, unusual, and faulty operation of an onsite heating or cooking unit, as long as the unit is connected to a chimney by a smoke pipe or vent. Smoke damage of this sort would come from a “friendly” fire rather than a “hostile” fire. Therefore, a smoke clause would be necessary to have coverage for the loss.

The wording is very specific in the smoke clause. By requiring a smoke pipe or vent, damage from such things as kerosene heaters, which are known for causing damage, are excluded from coverage. The “sudden, unusual and faulty” requirement excludes losses that are more of an occurrence than an accident. The normal wear and tear that comes from smoke from heating or cooking would not be covered. This would include such things as discoloration of walls or drapes, damage from sparks, and grease splatters. Smoke damage from fire places are specifically excluded since this is a common occurrence and often related to how the insured used it. Although the smoke clause does have some value, it is probably one of the most restrictive in language. It is very important that agents be specific with their clients about this coverage. The Apportionment Clause Apportion means to divide into sections. The Extended Coverage Endorsement usually includes the following in boldface type:

When this form is attached to one fire policy, the insured should secure like coverage on all fire policies converting the same property.




The intent of the Apportionment Clause is to limit the insurer’s liability by the application of two formulas:

• Formula 1 states that the company is not liable for a greater

proportion of loss from one of the extended coverage perils than the amount of insurance this particular policy bears to all fire insurance covering the same property.

• Formula 2 states that the insurer’s pro rate of liability will be

determined in relation to all other insurance covering the same peril.

Once these two formulas are both applied, the insurer will then pay the lesser of the two. The insured could be penalized if he or she had other fire insurance also in force without extended coverage. This could be critical if both policies were necessary to be adequately insured for the loss.

The following example shows how the formulas work:

Example 1 Policy A Fire and Extended Coverage: $10,000 Policy B Fire (no Extended Coverage): 5,000 Fire Loss totaling $3,000 Policy A Pays: $2,000 Policy B Pays: 1,000

Example 2 Policy A pays: $2,000 Policy B pays: Zero

Example 1 shows how apportionment of the loss would cover the total loss of $3,000. Example 2 shows a shortage of payment because of the apportionment with “all other fire insurance” even though the available amount of coverage in Policy A was greater than the actual loss.

Example 3 Policy A Fire and Extended Coverage: $10,000 Policy B Fire (no Extended Coverage): 5,000 Policy C Windstorm Coverage (only): 2,500 First Apportionment Policy A pays: $2,000 Policy B Pays: Zero Policy C (1/5 of loss) pays: 600




Second Apportionment Policy A pays: $2,400 Policy B pays: Zero Policy C pays: 600

In Example 3 the insurer issuing Policy A is only required to pay the lesser amount ($2,000). In this example, the insured would have been better off to only carry one policy for $10,000 of fire with Extended Coverage with company A. Had there been no other policies, he would have had the loss covered in full (less any deductibles under the policy). Another option to obtain full coverage would have been to purchase Extended Coverage on both policies A and B.

Joint Loss There is a third provision in the apportionment clause regarding situations where the extended coverage participates with specific insurance other than fire or windstorm. First, it is determined the limit of liability for each policy without regard to any other existing insurance. Any limitations on payment are figured in. Once the maximum limits are determined for each existing policy, apportionment among them on the basis of each policy’s limit of liability in relation to the combined limits for all policies is determined. Although policies do reflect this provision, statements are general and reflect the typical wording of the endorsement. Apportionment is not uniform among the jurisdictions. In addition, rules governing apportionment do change from time to time.

The Optional Perils Endorsement The Optional Perils endorsement may be added to the Standard Fire Policy, with or without fire insurance, but with the applicable property form. Since the Extended Coverage Endorsement covers specific, pre-packaged perils, there may be specific perils that the consumer does not want to purchase. The Optional Perils Endorsement offers an alternative. Under the Optional Perils Endorsement, the insured has four options:

• Option A: Explosion only • Option B: Explosion along with Riot and Civil Commotion




• Option C: Explosion, Riot and Civil Commotion, and Vandalism and Malicious Mischief

• Option D: Aircraft and Vehicle Damage to Property. Vandalism & Malicious Mischief Endorsement

The Vandalism and Malicious Mischief Endorsement may be added to the Standard Fire Policy. However, to do so the Extended Coverage Endorsement must be attached to the policy. The intent is to place a limit of sorts on the coverage of any peril that could cause adverse selection. Forms such as the “all risk” or the broadened Dwelling forms of the Homeowner’s plans automatically include vandalism and malicious mischief coverage. Vandalism and malicious mischief is not the same thing. Vandalism is the intentional destruction of another’s property. However, in Unhelsbee v. Homestead Fire Insurance Co., the courts held that in insurance contracts the term vandalism should be limited to things of beauty or art. Most contracts call vandalism the willful destruction of a thing of beauty. The term willful has also raised questions since vandalism is often the act of children who may or may not foresee the results of their acts. Although court cases have been divided, generally they hold that the insurance must cover the damage if those committing the act should have been aware of the consequences, even though they might not have had the specific intent of causing it. Despite this, some situations still may not come under the intent of vandalism. Children that are too young to understand or animals who would have no ability to understand the consequences of their acts would not be covered under vandalism or malicious mischief.

Due to the questions surrounding the definition of vandalism, the term malicious mischief was added. Malicious means evil intent. The two terms, vandalism and malicious mischief are combined in the endorsement. Not all policies read the same, so it is necessary to carefully review the terms. This endorsement does usually have some exclusions. Among these may be:

1. Glass that is part of a building or outside structure or sign.

However, glass building blocks would be covered. 2. Loss by pilferage, theft, burglary or larceny. When vandalism or

malicious mischief is part of theft, coverage under the vandalism and malicious mischief endorsement can be questionable. Often it depends upon whether or not items were actually stolen.




3. Losses from steam boiler explosion. 4. Losses if the premises have been vacant or unoccupied beyond

30 days. 5. Losses from change of temperature or from loss of market.

Some of these exclusions may be covered under other policies.

Earthquake & Volcanic Eruption Insurance Earthquake insurance is primarily purchased on the West coast and in Alaska where there have been several occurrences. In the West it is often an endorsement on a fire contract. Elsewhere, it tends to be written as a separate earthquake and volcanic eruption policy. There have actually been earthquakes in many parts of the country, including New England, New York, and parts of the Midwest. The Standard Fire Policy, and other endorsements attached to it, usually state that there is no coverage for any loss caused by, resulting from, contributed to, or aggravated by earthquake, volcanic eruption, landslide, or any other earth movement. Since loss by or because of an earthquake is a very real and present danger in many parts of the United States, there has been rising consumer interest. The lowest areas of risk are in those states adjoining the Gulf of Mexico and the highest risk areas are on the Pacific

Coast and in Alaska.6 There are actually about 400 damage-causing earthquakes in the United States each year, although some of the damage has been minimal. Even so the loss frequency is not regarded as high enough to be given any type of priority. That doesn’t mean there is not severe damage caused by them. The 1906 San Francisco earthquake measured 8.3 and the 1964 Alaskan earthquake registered 8.4 on the Richter

scale. Even lesser earthquakes as the one centered in Seattle, while not necessarily major, caused thousands of dollars in losses as far away as Olympia.

Earthquake insurance may be provided in several ways:

1. by extending the fire insurance policy to cover earthquake

losses,

6 Seismic Risk Map of the United States, as printed in The Spectator




2. by converting the fire policy into an earthquake policy, or 3. by using a separate policy designed for that purpose. It is

called an Earthquake and Volcanic Eruption policy.

The first two are used in the Pacific Coast territory, which includes Arizona, California, Idaho, Montana, Nevada, Oregon, Utah, and Washington. The first and third method is used in the rest of the United States.

Coverage is for direct damage caused by earthquake or volcanic eruption. Each loss by earthquake is a separate claim unless more than one shock occurs within a 72-hour period. In that case, all losses would be regarded as a single earthquake and therefore considered a single loss. Policies do not cover any loss or damage caused directly or indirectly by fire, explosion, or flood of any nature, or by tidal wave, regardless of whether caused by or attributable to the earthquake. Even though the fire policy excludes damage by earthquake, it does not exclude resulting fire following it. The flood loss is similar in that it attempts to avoid any duplication of coverage. Coverage written in the Pacific Coast territory has a minimum deductible, which is generally 5 percent of the property value, along with a minimum 70 percent coinsurance clause. Deductibles higher than the minimum can be selected for a reduced premium rate. Since most losses from earthquakes are partial (versus total), it makes sense to select a higher deductible. Lower coinsurance percentages (at least 50 percent) may be required elsewhere. Since all policies contribute to any loss, all policies should be concurrently written with earthquake coverage. Whatever method is used (which depends on whether it is written for the Pacific Coast territory or elsewhere) the earthquake contract is similar to the Standard Fire Policy except for the substitution of the word “earthquake” for the word “fire.” Earthquake, as a peril, is excluded from most of the new package policies. This has to do with the changing risk from area to area of the country. In those areas where the peril is greater, the additional premium would increase the cost for the package to a point where it would not be equitable. Consumers may not accept the higher rate. Perhaps more importantly, the addition of this peril requires special terms and conditions. The use of a deductible equal to 2 to 5 percent of the value of the insured property would be one example of this. Therefore, it is likely that the earthquake peril will continue to be an exclusion on basic coverage, but available by endorsement for those who wish to buy it.




Automatic Sprinkler Coverage There was a time when few buildings had automatic sprinkler systems. Today’s buildings must be built to current codes and even older buildings may have situations that require they be brought up to current code. With the current prominence of the sprinkler systems, insurance has had to address damage that results from them.

Coverage for automatic sprinkler systems may be purchased by adding a Sprinkler Leakage Endorsement to an existing Standard Fire Policy. It may also be written as an endorsement to a separate Standard Fire contract, which then provides coverage as a result of “direct damage by sprinkler leakage.” The definition section of the endorsement will explain how coverage will apply to those items insured, which typically includes such things as buildings, contents of the building, stock only, furniture and fixtures, machinery, property of employees, and improvements and betterments if they are the result of leakage or discharge of water or other substance from within the automatic sprinkler system. All of the items listed will not necessarily be covered. One must look in the policy to know. A sprinkler system is not just the water that falls from the ceiling. It also includes storage tanks, the pipes, fittings, valves, and sprinkler heads. Sprinkler Leakage Endorsements are named locations coverage although it is possible to sustain damage from the floor above or an adjoining premise. Therefore, under some circumstances, an insured that does not have a sprinkler system may still need sprinkler leakage insurance. This type of endorsement covers only water from a sprinkler system. It would not cover water damage that originated from some other source, such as a sink overflow, for example. It also would not cover damage from the sprinkler system if it resulted from an independent cause, such as fire, lightning, windstorm, earthquake, explosion, rupture of a steam boiler, riot, order of civil authority, war, or nuclear energy (its hard to imagine worrying about a wet carpet from the sprinkler system following a nuclear crisis). It is possible to purchase additional protection for business interruption, extra expense, and other consequential losses resulting from a sprinkler leakage.

The cost of this type of endorsement will depend upon the potential loss. This will be determined by the “damageability or susceptibility” of the loss. Damageability is a rough measure of the probable severity of a loss once it occurs. Susceptibility refers to the frequency with which the peril could originate. Several factors will determine these two elements: the building




area being occupied by the applicant, the floor construction, possibilities of water control, and watchman and alarm systems that are in place. A coinsurance clause is not required, but it is possible to use coinsurance as a way to reduce premium. When coinsurance clauses are used, they typically range from 10 percent to 80 percent. To better understand these percentage rates, let’s look at the following example:

A risk valued at $100,000, on which the rate without coinsurance is $1, will have the rate reduced to 40 cents per $100 of insurance if $90,000 insurance is required (10 percent coinsurance clause), and 10 cents per $100 of insurance if $80,000 is required (20 percent coinsurance clause). These rate quotes are examples and should not be assumed to necessarily apply to your applications.

Water Damage

The Basic Water Damage policy covers direct loss caused by:

1. the accidental discharge, leakage, or overflow of water or steam from plumbing and heating systems, tanks, industrial and domestic appliances, refrigerating and air conditioning systems; and

2. rain or snow admitted directly into the building through

defective roofs, windows, or open windows.

The Basic Water Damage policy may be purchased as a separate policy, but it has a limited market because the coverage is a part of the Dwelling, Homeowner’s, and Multi-Peril programs. The policy excludes water damage as a result of seepage through building walls, flood, backing up of sewers or drains, tides or surface waters, underground supply mains or fire hydrants, and any damage done by a sprinkler system. Also excluded is water damage from aircraft or falling objects.

Like other types of perils, the basic coverage can be expanded by use of endorsements, such as those covering:

1. loss caused by street water supply or fire hydrants, 2. damage caused by accidental discharge of refrigerants, and 3. loss caused by aircraft or objects falling from aircrafts.

Rates for policies covering water damage vary with damageability of contents. Discounts may be applied to individual risks, use of coinsurance,




superior floor construction, single building occupancy, watchman services, and for the use of a deductible clause. Flood Insurance Flood is one of the oldest perils faced by man. Only recently has it become an insurable peril for buildings and contents in fixed locations. The Water Exclusion Clause found in the coverage extensions to the Standard Fire Policy uniformly excludes the peril of flood.7 There are at least 3 reasons for this exclusion:

1. Private insurers were not able to achieve an adequate spread of

risk to safeguard company assets against catastrophic losses. 2. Because only those who fear the risk would purchase insurance,

without subsidy, the rates become so high that even those who desire such coverage cannot afford to buy it.

3. Finally, the lack of statistics regarding frequency and severity of

loss makes it difficult to price the coverage. Even average estimates of total annual damage do not help because losses can vary from practically zero in some years to several billion dollars in others.

Another concern is the potential of increased building in flood zones. If low cost insurance were available to cover losses from floods, it seems likely that more people would select locations that routinely experience flooding. There was little offered in the way of insurance for flood by private carriers until 1956 when Congress passed the Federal Flood Insurance Act. The plan did not have the total support of the insurance industry and Congress failed to appropriate the funds necessary to make it operational. In 1968 the National Flood Insurance Act, as part of the Housing and Urban Development Act, became law. It was amended by the 1969 Housing and Urban Development Act and then amended again by the 1973 Flood Disaster Protection Act. The purpose stated was to provide a limited amount of insurance that would be available at an “affordable” price, but only if the community involved exhibits a willingness to set up and enforce standards for future control of those areas that are subject to floods.

7 Property and Liability Insurance, 4th Edition




This was not done to provide coverage that would encourage increased building in flood zones. Rather the intent was to encourage development away from flood areas and also to create a positive program of flood control. Congress expects communities, through local restrictive measures, to hinder growth in areas that are known to flood. In addition, building codes were expected to encourage construction that would be less susceptible to flood damage and make similar improvements on existing buildings. Once a community had demonstrated that they had done these things, HUD (U.S. Department of Housing and Urban Development) ordered area studies and the setting of appropriate insurance rates. The 1968 Act permitted the federal government to be the sole insurer and servicing organization. HUD operated in a partnership for the first ten years with the private insurance companies through the National Flood Insurers Association. This association performed the sales, policy writing, and claims functions. HUD identified the areas of the country that were eligible for coverage and set the rates that would be charged. HUD also determined the maximum available policy amounts and the terms and conditions of benefit payment. Every licensed agent and broker was authorized to sell flood insurance through a single private insurer, which acted as a servicing company. The National Flood Insurer’s Association selected the company that would issue the protection. They wanted those in flood zones to purchase the insurance. To encourage sales, the 1968 Act provided that any property owner who was eligible for a year and failed to purchase the coverage would have any flood disaster relief benefits reduced by the amount of insurance he might have purchased. Detailed regulations were issued by the Federal Reserve System, the Federal deposit Insurance Corporation, the Federal Home Loan Bank Board, and the National Credit Union Administration. These regulations provided that if the property was in a special flood hazard area and had flood insurance available, the lender had to require flood insurance equal to the amount of the loan or at least to the maximum amount of insurance that was available. In 1977 Congress eliminated the partnership with private companies as well as many of the restrictions. Today flood insurance may be written on any single-family dwelling, including mobile homes, as long as they are on a foundation, any residence structure such as apartment buildings, or on a small business or nonresidential structure. Basically, flood insurance can be written on any building and its contents located in any place identified by the Federal Insurance Administration (FIA) of HUD.


Chapter 7: Fire Insurance Forms


Fire Insurance Forms

Putting the Policy Together The Standard Fire Policy tends to be general in nature by design. The policies are made up of the general form along with uniform groupings of basic terms, conditions, and definitions that need to meet the requirements of each policy issued. By using all the tools available, it is possible to transform the basic policy to meet the needs of the consumer. Many consumers have special circumstances that they wish to address through the insurance they buy. Their agents will typically modify the policy or add to it. The basic policy recognizes the need for this since it provides that “any other provision or agreement not inconsistent with the provisions of this fire policy may be provided for in writing added hereto, but no provision may be waived except such as by the terms of this policy is subject to change.” 1 Clauses and endorsements are added to the basic policy to satisfy the particular needs of the consumer. The clauses and endorsements are attached to the basic policy and become part of it. Insurance agents do this so often that many of the additions and modifications have become standardized and are, as a result, given to the agents in printed form. Unique situations may be able to be prepared using a manuscript endorsement. These endorsements must be submitted to the insurer for approval and rating. Insurance companies prefer to simplify the writing of policies by using standard forms that have been prepared for broad classes of property or types of coverage. These forms will include such things as definitions, clauses, and endorsements. Once attached to a policy, these take precedence over any provision in the contract that may conflict with the attached form or endorsement. Forms and endorsements typically are dated the same as the policy, but they may also have a later date. The dates on the forms or endorsements are assumed to represent the latest meeting of the company and insured, so they constitute the last agreement on the part of the parties represented. The state insurance departments must, of course, approve all forms and endorsements as well as the policies. The types of clauses that are available for use are numerous. There are hundreds of endorsements used to meet nearly every imaginable situation.

1 Lines 44-48, 1943 New York Standard Fire Policy Form.




Although every broker, agent, underwriter, adjuster or large buyer of insurance should try to keep up on all that is available, that would be a tall order. Luckily, there are professionals at the insurance companies that are able to advise, when necessary. Through the use of these endorsements and other options, property owners can usually obtain quality insurance to meet virtually every insurable need. The Standard Fire Policy is actually anything but “standard.” Policy forms Each insurance jurisdiction will develop forms that become standardized. This is necessary for several reasons, but one of the primary ones is financial. It is always less expensive to have a specific form that is used repeatedly in policies. Standardized forms also allow experience data to be collected from the various companies, which is then utilized for rating purposes. When these standardized forms are attached to the Standard Fire Policy, they make a complete contract. The General Property Form was designed for nonresidential property including stores, manufacturing plants, churches and so forth. Apartment buildings, hotels and motels use a different form called habitational properties form. The contents of offices are insured under a form called office personal property forms. Other forms that are used to insure non-dwelling forms include reporting forms and builders risk forms. There are also forms for insuring condominiums, cotton gins, farm property, petroleum property, and tobacco curing barns. In fact a form can be designed to insure virtually anything. Since there are hundreds of preprinted forms, this course will not attempt to mention all of them. We will look at some of the more commonly used forms.




Residential Policy Forms Dwelling Forms Most of the residential property in the United States is insured under some form of the Homeowners Policy. This makes sense because a major characteristic of this plan is that it combines in one package policy both the dwelling/contents and the liability coverage needed for the premises and personal acts of the insured. The Homeowners Policy does have eligibility requirements. When a residential property does not meet some minimum requirement or because the insured prefers specific selections in their coverage, an alternative approach is needed. Before the mid-70’s, one alternative was to attach a Dwelling and Contents form to the Standard Fire Policy, but today the Dwelling Policy Program is more likely to be used. This accomplishes the same thing as the Dwelling and Contents Form but does so in a form that is closer to the Homeowners Program. Dwelling and Contents Form The Dwelling and Contents Form, as the name suggests, insures a building and its contents when it is used principally for dwelling purposes. This form completes the Standard Fire Policy Contract. It cannot be used for structures that are used for purposes other than dwelling, such as manufacturing, farm purposes or multi-family housing (apartment buildings, for example). Some jurisdictions limit the dwelling to no more than one or two family structures. It is important to note, however, that this form may be used to insure contents even though the building itself may not be eligible. The dwelling or the contents could be insured alone. When both were insured, each was a separate policy item. If the property contained more than one structure, each building was a separate item. The building contents could be covered as one item or could be separately insured according to the buildings that contained them. The intent of the Dwelling and Contents Form is not difficult to understand, but borderline situations do tend to create problems. The general rule is that all equipment permanently attached to the building is real property, which means it is within the Dwelling Coverage. Although one might assume that everything else would be contents, the Dwelling Coverage specifically includes building equipment and outdoor equipment pertaining to the services of the premises if the property belongs to the owner of the building.




The same equipment could also be included in the contents, however. While this probably won’t affect an owner-occupant, it could affect an owner-tenant. Dwelling Coverage Dwelling Coverage covers the main structure, but it also covers additions to the building and building equipment and fixtures and outdoor equipment that pertains to the services of the premises, as long as they are property of the building’s owner. What do we mean by building equipment, fixtures and outdoor equipment? They would include such things as furnaces, air conditioners, built-in appliances (such as ovens or cook-tops), hot water heaters, or light fixtures that are attached to the ceilings or walls. In fact, the common factor of these items is the fact that they are attached to the building in some way. Simply being plugged in would not apply. Wall to wall carpet uses some special considerations:

1. Is it permanently installed?

2. Can it be removed without damaging it?

3. Was it installed in lieu of a finished floor?

4. Was the installed carpet specifically part of a mortgage? Trees, shrubs and other plants, including the lawn, are specifically excluded from coverage. In some cases, they may be covered under a special clause that is attached to the policy. When this is done, the insurer’s liability is often limited by a dollar amount for each tree, shrub and plant. Some forms may allow the insured to state at the time of purchase the amount of coverage they wish for each tree, shrub and plant. The main Dwelling Coverage usually has two optional extensions:

• 10 percent of the face amount may be applied to detached garages and other private structures located on the premises.

• 10 percent of the face amount may be applied to cover loss of rental

value, which is loss of use. This would apply not only to the dwelling, but also to any detached garage or other structure if it has a rental value.

The extensions would not apply to structures used for commercial, manufacturing or farming purposes. They also would not apply to structures




that are rented or leased to someone who is merely a tenant who has no connection with the occupants of the primary insured dwelling. This exclusion does not apply to a rented garage. To put this in dollar perspective: on a $20,000 policy, the insured may, at his or her option, apply up to $2,000 or any part thereof to any rental value loss. There is a limitation that states that not over 1/12 of the 10 percent ($166.67 on this example) can be applied for each month during which the dwelling is untenantable. So, in this case, the insured could collect up to $2,000 for damages to outbuildings and up to $2,000 for rental value loss along with the actual damage to the dwelling itself. These extensions do not represent additional insurance. Rather they are part of the total insurance purchased in the Dwelling and Contents Form (this would not apply to the Broad and Special Forms). These extensions are optional. They can be exercised by the insured following a loss, but they do not have to be. Obviously, if the primary dwelling ate up the entire amount of the insurance, there would be no point in exercising the extension option. It is always important to remember that these extensions do not represent additional insurance; merely a redirection of the insurance that already exists. Contents Coverage As the name suggests, Contents Coverage includes all household and personal property that would normally exist with dwelling occupancy. Not everything is covered. Animals, birds, fish, aircraft, and motor vehicles are specifically excluded. However, equipment associated with occupancy, such as a lawnmower, would be covered. The Dwelling and Contents Form does not specifically exclude business property, but it is usually considered excluded because the policy states: “usual or incidental to the occupancy of the premises.” Since a business is not usual or incidental to occupancy, an agent who has their business located in their home may want to purchase special coverage for it. Although there have been court cases on business losses within the home, there have not been conclusive decisions. It is better to purchase coverage and avoid the potential legal problem. Like the Dwelling Coverage, the Contents Coverage has two optional extensions available. Also like The Dwelling Coverage, these extensions in the Contents Coverage are not additional insurance; merely a redirection of existing coverage.




• The insured may apply up to 10 percent of the contents coverage on personal property to items that were not on the premises at the time. This is limited to the United States and Canada.

• If the insured does not own the dwelling, up to 10 percent of the

amount of contents coverage may be used to cover improvements and betterments made by the insured to the rented property. Most often this would be such things as built-in bookshelves, new (attached) carpeting, and so forth.

When a renter does built-in improvements ownership actually transfers automatically to the owner at the end of the lease. Until that time, the renter does still have an insurable interest in them, however. The Dwelling and Contents Form, in most states, includes the Extended Coverage Endorsement and the standard mortgagee clause.2 However, while they may be part of the form physically, that does not mean that they are in effect. This clause applies only if the declarations indicate it and a premium has been charged and paid for it. The declarations would have to include a reference to the mortgagee by name. This is commonly done, so it is a convenience for the insurer to print them on the Dwelling and Contents form. Some of the other clauses included in the form include:

1. the loss clause 2. the electrical apparatus clause 3. the inherent explosion clause 4. the permission-granted clause, and 5. the liberalization clause.

There may also be some others besides those we have listed. The Loss Clause states that any payment made does not reduce the amount of insurance. The policy is continuous in other words. The face amount of the policy remains the same following a covered loss. The cost of this benefit becomes a part of the basic premium charge. The Electrical Apparatus Clause refers to electrical devices and appliances. This clause specifically excludes damage to appliances and devices caused by excessive electrical current due to artificial electrical phenomena, such as short circuits, unless a fire is the result, and then only the loss caused by the actual fire is covered. Loss caused by lightning is covered. 2 Property & Liability Insurance (4th edition) P. 148




The Inherent Explosion Clause extends coverage to cover explosions that happen within the dwelling or private structures from items that exist within the buildings. This would include such things as water heaters and furnaces. Explosions that originate within steam boilers, steam pipes, and other such items are specifically excluded. Two conditions must exist for the loss to be covered:

1. the explosion must occur within the building, and

2. the cause must be a hazard inherent in the occupancy. When explosion insurance is used in a business policy, there is typically an additional charge unless the cost is somehow figured in the published fire rates that were used to price it. The Permission-Granted Clause modifies lines 31 through 35 of the underlying Standard Fire Policy. Although this clause may not necessarily apply to vandalism, it does allow for the usual and incidental use of the premises as a dwelling, provides for unlimited vacancy and unoccupancy, and permits the insured to make alterations, additions and repairs and to complete structures in the process of construction. The Liberalization Clause allows alterations that could be used to broaden or extend a policy for no additional premium to automatically go to the benefit of the insured. This eliminates the necessity for insurance agents to endorse all outstanding policies every time a minor change is made in the standard forms. It is common for changes in forms, endorsements, rules, or regulations to be made by rating organizations as they find necessary and filed with the appropriate authorities. This clause makes that process more manageable. There will be other clauses besides those listed here. Dwelling and Contents Broad Form The Broad Form replaces the regular Dwelling and Contents form. It incorporates all the usual features and adds the perils of the Extended Coverage Endorsement. The coverage is expanded to provide for smoke damage caused by fireplaces or heating and cooking units that are not connected to a chimney. Dwelling and Contents Broad Form adds specific perils: sudden and accidental cracking, burning, or bulging of a steam or hot-water heating system; vandalism and malicious mischief, burglars, damage to the




premises; falling objects; weight of ice or snow; collapse of the buildings; accidental discharge, leakage, or overflow of water or steam; sudden and accidental cracking or bulging of hot-water appliances; breakage of glass; freezing of plumbing; sudden and accidental injury to appliances from artificially generated electrical current. Obviously, the list of added perils is extensive, but one of the most meaningful additions is the inclusion of Replacement Cost Coverage. Replacement Cost Coverage Although Replacement Cost insurance can also be written as a separate endorsement, as part of the Homeowners Policy, and in the Commercial Multi-Peril Policy, it is best known as part of the Dwelling and Contents Broad Form. The replacement cost applies to the dwelling item only. Early forms were called Depreciation Insurance and some of your older clients may still call it that. The addition of the Replacement Cost Coverage clause does basically expand the policy to include depreciation. Unfortunately, consumers often assume that their fire policy will automatically replace whatever is lost. It may not occur to them that only the value of the item is replaced – not necessarily the item itself (unless they have purchased insurance to replace the actual item). The insurer’s rationale of actual cash value is sound, but the application of depreciation to consumers can mean that the insured is unable to actually replace the items lost in a fire. Few consumers would set aside enough cash to make up the depreciation value. Therefore, it often makes sense to purchase replacement cost (versus actual value) coverage. The effect of buying replacement cost value is to modify the insuring agreement of the Standard Fire Policy, substituting replacement cost for actual cash value. All other provisions of the contract remain the same. Dwelling Buildings Special Form The Buildings-Special Form is only applicable to the structure of the building and not to its contents. This type deviates from the tradition of naming covered perils. The coverage basically gives coverage for “all risks of physical loss except as hereinafter excluded to the described property.” Benefits are, of course, subject to all provisions and exclusions in the contract. The exclusions listed will be similar to those found in any all risks policy. This all risks coverage and those similar to it provide the broadest insurance available for dwellings. The exact wording and provisions will vary depending on the jurisdiction. This type of coverage is not widely purchased. Cost is probably the main reason for this. All risks coverage either under a separate form or as part of




the Homeowner’s package is more expensive than is named-perils coverage. It may also be due to the use of Dwelling Policy Programs, which can give primarily the same coverage. Dwelling Policy Program The Insurance Services Office has developed a set of uniform dwelling forms to be used nationwide, which replaces the dwelling forms already listed. The intent is uniformity. These forms can be used as stand-alone policies. They do not need to be attached to the Standard Fire Policy, except in those states that may require it. All dwellings other than farms or apartments with more than four families are eligible. Even townhouses with four units or less may use this program. The structure may be rented, used by the owner, completed or under construction. Even mobile homes are eligible if they are used at a dwelling on a fixed location. Unlike the Homeowners Policy, which often excludes coverage for an in-home business, the Dwelling Policy Program will cover it under specific circumstances. The business must be a limited service business with no more than two people in the operation at any one time. This type of insurance is commonly used for beauty or barbershops, real estate agents and insurance agents who operate out of their homes. Property used for the business is insured up to the stated limits, if separately scheduled and rated. The Dwelling Policy Program is made up of three forms that are used with the Standard Fire Policy, providing coverage on dwelling buildings and/or contents through five insuring agreements. It should be noted that there is no theft coverage included in any of the five forms. Theft may be added by endorsement.

• Coverage A – Dwellings • Coverage B – Appurtenant Structures

(10% of item A) • Coverage C – Household and Personal

property • Coverage D – Rental Value • Coverage E – Additional Living Expense.

In the Dwelling Policy Program the amounts of coverage, unlike the Homeowners Program, are divisible, giving the various dwelling policies a degree of flexibility.




Under Coverage A, the Broad Form and the Special Form include the replacement cost provision and up to 5 percent of the amount of dwelling coverage on trees, shrubs, and plants with a limit of $500 per item. Under Coverage C, there is a supplementary coverage of 10 percent for contents away from the premises insured. In all forms there is 10 percent coverage for improvements. In the Broad Form and Special Form it is an additional amount of insurance. In Coverage D, there will be applied limits, which is typically 10 percent of Coverage A, with not more than one-twelfth of the 10 percent to be paid in any one month. In the Broad Form and Special Form, the 10 percent limit applies to Coverage D and Coverage E combined, but the one-twelfth limitation does not apply. The 10 percent limitation can be increased by endorsement.3 Under Coverage E, there will be applied limits. Additional living expense is not found in the Basic Form, but it can be added by endorsement. Commercial Forms Commercial property requires a form that is different in many ways from the Dwelling and Contents Form, but it still serves the same purpose. The General Property Form was initially used, although it is not in general use now. However, understanding how the General Property Form works is important to the understanding of forms currently used. The General Property Form designed to be attached to the Standard Fire Policy and was used this way most of the time. Three types of property were insured under this form: (1) buildings; (2) personal property of the insured; and (3) the personal property of others working under or with the insured. If included, each type would have a specific amount of insurance with its own coinsurance application. Property Covered Coverage A - Buildings This portion insures only the building that is listed on the declarations page of the policy. Included in this would be machinery, fixtures, and equipment that are permanently part of the building and pertain to the service of it.

3 Insurance of Property Exposures P. 152




Coverage B – Personal Property of the Insured Coverage B, since it relates in this case to commercial forms, is the business personal property that is owned by the insured. The property must be usual to the occupancy of the insured. An insurance agent could not list mechanics tools as part of his business inventory. The contents are covered as long as they are in the insured building and also when they are within 100 feet of the premises, in the open, in vehicles, or in railway cars. Coverage B also applies to any “use interest” in tenants’ improvement and betterments even if not specifically listed, provided these were installed by and at the expense of the tenant. The improvements are also subject to any applicable coinsurance requirements. Coverage C – Personal Property of Others This coverage is provided for the personal property of others in the care, custody, or control of the insured while in the insured building or within 100 feet of the premises. This coverage will have limitations ($2,000). Liability policies uniformly exclude coverage of this type. It usually requires the insured to utilize this section of the General Property Form. The insurer will retain the right to either settle with the named insured for the property loss or directly with the owner of the property. An extension to this coverage (not additional coverage) is debris removal following a loss by an insured peril. It Doesn’t Cover Everything No insurance covers everything. While some are very good, there is inevitably something that is excluded. Unless the following items are part of the business and for sale, they are excluded from coverage:

1. Animals and pets. 2. Watercraft, including motors, equipment, and accessories. 3. Outdoor trees, shrubs, and plants. 4. Any property covered by another contract of insurance.

Some items may be covered specifically in the declarations. The following items would have to be specifically listed or they would otherwise be excluded from coverage:




1. Vehicles designed for use on public thoroughfares. 2. Outdoor signs. 3. Outdoor trees, scrubs, and plants that were not for sale as part of the

business. 4. Swimming pools, fences, piers, docks, and roadways.

If the coinsurance applies, then the following property values are not covered by the policy:

1. The cost of excavations, grading, or filling. 2. Foundations that are below the lowest basement floor or if there is no

basement, below ground level. 3. Pilings, pipes, and drains.

Some items may be covered by endorsement, additional forms, or clauses. When this is done, it is necessary to be sure that the amount of insurance is increased to avoid any coinsurance penalty. Extensions of Coverage When a policy is written at 80 percent or higher coinsurance, Extensions of coverage may be used. Examples of Extensions of Coverage include:

• Personal Property of Others. • Off-Premises coverage. • Newly Acquired Property • Personal Effects • Valuable Papers and Records • Outdoor Trees, Shrubs, and Plants.

Personal property of others who are in the insured’s care, custody, or control can be covered for up to 2 percent of the amount of insurance included for Coverage B, which is Personal Property of the Insured or up to $2,000 (whichever is less). This is an additional amount of insurance, but it would not normally be elected if there were coverage under C - Personal Property of Others. Off-Premises coverage only provides a limited amount of coverage for certain types of real or personal property while temporarily off the premises for cleaning, maintenance, or repair. There is no coverage while in transit or while on any property owned, leased, or operated by the insured.




Newly Acquired property has a limited coverage of up to 10 percent of Coverage A – Buildings. It does not exceed $25,000 for new buildings under construction on the same premises or newly acquired buildings elsewhere in the United States if intended for similar occupancy. Newly Acquired Property coverage may be used to cover newly acquired personal property as well as buildings. It will cover up to 10 percent of Coverage B – Personal Property not to exceed $10,000. Both types of newly acquired property (buildings and personal property) are limited to not more than ninety days from the date of acquisition. Past 90 days it is no longer considered newly acquired. While Personal Effects are located on the insured’s premises, the insured may apply up to 5 percent (not to exceed $500) of the amount of Coverage B to cover direct loss to personal effects belonging to officers, partners, or employees of the insured by a peril insured against in the policy. Coverage B is coverage for personal property. If officers, partners, or employees are likely to have more than $500 in personal effects, additional coverage should be purchased. It is not uncommon for employees to have their own mechanic tools, their own laptop computer, or other expensive items in use at work. Obviously, $500 would not be sufficient to cover such a loss. Business enterprises often have records that represent large amounts of money. Valuable Papers and Records coverage represents a very limited amount of coverage to reimburse the insured for the cost of research in reproducing valuable papers or records that are lost to a covered peril, most often fire. Since the limit is again 5 percent, not to exceed $500, of the amount of Coverage B – Personal Property, many businesses would need to extend this coverage to a higher amount. A company such as ours that provides books and tests would certainly want to insure against the cost of recreating the manuscripts, for example. Outdoor Trees, Shrubs, and Plants may be insured for up to 5 percent, not to exceed $1,000, of Coverage A – Buildings and Coverage B – Personal Property. There is a limit of $250 for any one item. For any business that feels their outdoor plants are somehow an important part of their business, additional coverage may be desired.




The General Property Form also contains in Section IV a standard coinsurance clause that becomes operational when a percentage is stated on the declaration page and a rate reflecting that coinsurance is part of the premium calculation.4 It is standard to have a $100 deductible, which applies to all listed perils. It is applied separately to each building. It would be applied separately to the contents in each building if the policy did not also insure the buildings. It would be applied separately to contents in the open as well. There would be $1,000 combined deductible amount for losses arising out of any one occurrence. This is usually called an aggregate deductible. The General Property Form will contain a list of the perils insured against. The basic perils, like the Dwelling and Contents Form, will be covered (fire, lightning, and removal). The General Property Form will also list the extended coverage perils. However, this part applies only when a specific premium for extended coverage is shown on the declaration page. The General Property Form will include the Vandalism or Malicious Mischief (V&MM) clause, which will require a specified additional premium. The V&MM clause will contain some of its own exclusions:

• No coverage for building glass or glass on outside signs. • No coverage for theft, except willful damage to buildings by burglars. • No malicious mischief coverage if the building has been vacant or

unoccupied beyond thirty consecutive days. There will also be the general exclusions. These include artificially generated current, nuclear reaction or contamination, increased cost due to ordinance or law, loss caused by power failure, war risk, or flood. How is the policy arranged? There are three basic ways of arranging coverage: specific, blanket, and reporting. Specific Coverage writes a definite amount of insurance on any one item of property. Schedule Coverage is a variation of specific insurance. As a result, a number of risks of the same type may be insured under one policy rather than issuing separate, specific policies for each type of risk. Even though it is scheduled coverage, it is still specific in nature.

4 Property & Liability Insurance P. 155




Blanket Coverage makes one amount of insurance apply to two or more items that would otherwise be insured specifically. Blanket coverage is often used where it would be difficult to separate types of insured items. Is your client adequately insured? Over the past three or four decades we have seen inflation affect our spending dollar. As we know, bread is no longer fifty cents and gasoline is no longer under a dollar a gallon. Things cost more today. Clients who took out their insurance policies many years ago and failed to update them are often underinsured. While this may not affect them on smaller claims, should a catastrophic claim occur, it can have serious consequences. Insurance companies may be able to offset the effects of inflation on policies by insisting on insurance to value or by requiring coinsurance where appropriate. To help prevent loss to inflation, there are two standard forms. In the Homeowners program, the Inflation Guard Endorsement is available. For some commercial property insured under the Commercial Multi-Peril Program, the Automatic Increase in Insurance Endorsement is available. These two forms do not necessarily apply to all types of coverage. For example, if property is insured as contents, the increased value provision may not necessarily apply. Endorsements nearly always have limitations. The original amount of insurance purchased should represent the actual value of the items or property insured. An endorsement seldom corrects an undervalued policy satisfactorily. Even so, inflation endorsements can help to offset inflation as long as the original policy addressed appropriate levels of insurance and as long as the original policy is updated on a regular basis. Inflation endorsements have another benefit. By discussing with your clients the need for inflation guards in their policies, it may make them aware of the effects of inflation. By understanding what inflation can do to their policies, they may be more likely to keep their policies updated.


Chapter 8: Marine Insurance


Marine Insurance

What is marine insurance? As the name implies, the purpose of marine insurance is to indemnify interested parties against loss, damage, or expense caused by accidents with vessels, cargoes, and freight due to the perils of transportation by water. Modern policies offer very broad protection. Vessel owners are able, through marine insurance, to protect themselves against loss of hull, freight earnings, and every type of legal liability. The modern “warehouse to warehouse clause” allows cargo to be covered from the time they leave the shipper’s warehouse until they are delivered to their designation. Marine insurance may also be called transportation insurance. Marine insurance is divided between ocean (wet) and inland (dry). The inland coverage is a natural extension of the ocean coverage. Is there a standard marine policy? Unlike fire insurance, there is no specific form of marine insurance that is recognized by law in the United States. Even so, most companies that issue this type of coverage use policies and endorsements that are similar. We can give the credit for the similarity in the policies to Great Britain, who codified its marine insurance law in the Marine Insurance Act of 1906, followed by the Marine Insurance Act of 1909. All the necessary rules governing the writing of marine insurance were carefully defined by these two acts. The acts were set down in the Lloyd’s form of policy as an example, not a required form. Although the purpose was to provide consistent rules of interpretation, the forms designed were so useful that they were adopted by most other companies as a matter of convenience. Since it was so long ago that the Lloyd’s policy was designed, the language seems outdated and poorly adapted to today’s modern commerce. Even so, the policy has the advantage of certainty in its meaning with the stability of marine insurance transactions that have multiple legal decisions backing it up. This has enabled definite meanings in the policy so that today nearly every word it contains has been interpreted by the courts around the world. Ocean Marine Insurance, page 164, states: “It is the desire to have a definitive contract, the terms of which are known and understood by insurer




and insured, that has been responsible for the nearly verbatim inclusion of many of the Lloyd’s policy provisions in the policies of all U.S. marine insurers. Variations in language and provisions among the various contracts are only a minor concession to modernization.” How are marine policies classified? Marine insurance policies are classified into four primary groups. This is based on the nature of the interest covered.

• The first group contains the policies covering against damage to the conveyances on which persons or goods are transported.

• The second group contains the policies covering a carrier against liability to others for loss of or damage to their property.

• The third group, coverage is for damage to the various kinds of goods being transported.

• The fourth group covers the loss of freight and related losses resulting from the inability to use a particular vessel.

In ocean marine insurance, cargo refers to the property transported by a vessel and freight primarily refers to the compensation received by the vessel owner for transporting cargo. First Group: Loss or Damage to Conveyances The types of policies include:

1. builder’s risk policies; 2. port risk only policies; 3. fleet policies; 4. full form and total loss only policies; and 5. hull policies written according to the class and/or trade of the vessel.

Builder’s risk policies are essentially a shore cover with no marine hazard prior to launching. They relate to the construction, conversion, and/or repairing of hulls. The policy covers all risks prior to launching of the vessel. This would include fire, while under construction and/or fitting out, materials used in building the vessel, the workshops, yards, and docks of the insured, or on quays, pontoons, craft, and so forth. Also all risks while in transit to and from the site are covered. Risk of loss or damage through collapse of supports or ways from any cause whatever and all risks of launching and breakage of the ways are covered as well.




If the vessel fails to be launched, the underwriter is obligated to assume all expenses incurred in completing the launching. If an additional premium is paid, the coverage may be extended to include launching (following construction) and trial trips. No policy covers everything, of course. There are excluded risks in the Builder’s Risk Policy. The exclusions include:

• Worker’s compensation or employer’s liability acts;

• Strikes, locked-out workers, riots, and civil commotion, although the perils of Strike, Riot and Civil Commotion (SR&CC) may be covered;

• Capture, seizure, or the consequences of war;

• Consequential damages arising out of delay; and

• Earthquake.

If the vessel owner wishes, most of these exclusions could be covered under other types of policies. At one time, this type of policy would cover property being conveyed, but today’s policies typically exclude transportation of the finished vessel to the new owner’s location, unless extra premium was paid for this coverage. Generally, Builder’s Risk Policies coverage is limited to protection of materials in the port of manufacture. There will be special terms for military vessels regarding weapon testing and submarine diving tests. Second Group: “Port Risk Only” Policies There are situations that put a vessel in port for an extended period of time. This might be due to unemployment, repairs or sale of the vessel. Since it would not be necessary to insure the perils of navigation, many owners opt to carry “Port Risk Only” coverage. As one would guess, this coverage is less expensive than a full form policy would be. Premiums can usually be paid on a monthly basis, although it may be possible to pay them annually. When premiums are paid annually, the insured is usually given the option of cancellation on the basis of a published short-rate table. Although there can be variations, usually this type of policy covers all hazards that might happen while in port, including fire, collision, damage to machinery, and the risks attaching to the transfer of the vessel from one dock to another, or of placing it in dry dock for repairs. Some policies may, for extra premium, cover navigation for an occasional trip.




Third Group: Fleet Policies Today’s modern commerce involves companies that own and operate multiple vessels. As a result, the companies that own large fleets found it advantageous to insure the entire fleet under one policy rather than insuring them individually. This does not necessarily mean that one company carries the entire risk, although that could also be the case. It is just as likely that 20 to 50 (or even more) companies participate in the underwriting and insurance. When multiple companies participate in the underwriting, there typically is a formula used for distribution on a share basis. Usually, when the entire fleet can be insured under one policy (whether underwritten by one or multiple companies) the cost of insurance is lower. A fleet of vessels has usually been accumulated over time, so a single policy is an advantage to the owner. Vessels that are older would experience higher rates, if insurable at all. By using a Fleet Policy, all vessels are covered on an “all or nothing” basis. It is the same concept used for group medical underwriting. All are covered equally. The older vessels are covered under the same terms used for the newer vessels. Although there can be variations, the premium will probably be arrived at by segregating the vessels of the fleet into homogeneous groups and applying appropriate rates to each group, the final premium being the sum of the combined group rates. Brokers may even combine several fleets into a single large account, with the object being to get all insured (where an older fleet might otherwise be denied). Fourth Group: “Full Form” and “Total Loss Only” Policies There can be vast differences in exposure depending upon the type of vessel and where it is used. Blue water (oceangoing) ships are usually much larger than domestic ships. Domestic ships would include tugs, barges, dredges, fishing vessels, charter boats, and yachts. “Full form” and “total loss only” policies are usually limited to oceangoing or blue water ships. It is common for vessel owners to insure part of the value of their vessels, generally 25 percent, under “increased value” policies with the balance being insured under a “full form” policy. The “full form” is usually enough to cover even major partial loss claims. “Total loss only” insurance rates are often equal to only about 1/3 to ½ of the rates quoted for “full form” insurance (insurance that covers for partial losses as well as full losses). As is true for most insurance, partial losses are much more common than are full losses. Therefore, the insurer is more likely to pay claims on partial losses. In fact, partial losses, in the aggregate, represent more than two or three times the loss attributable to total losses.




Why would a vessel owner choose to purchase “total loss only” coverage? Sometimes it is the only insurance obtainable at a cost that is affordable when the vessel is old or in inferior condition. Often, it is merely to lower premiums (even on newer good condition vessels). The owner is risking the loss of partial claims so that the vessel can be covered against a total loss. If the vessel has a very high value, “total loss only” coverage may be easier to afford than the high cost of full coverage, which would include partial losses. In issuing full coverage contracts and excess collision liability coverage, it may be necessary to limit the amount of “total loss only” coverage that is purchased to a stipulated percentage of the total combined coverage carried. This is accomplished by use of a clause called the disbursements warranty clause. The point of this is to make the insured purchase what the underwriter considers a sufficient amount of “full form” protection. Fifth Group: Hull Policies Adapted to the Type of Vessel As we know, there are multiple types of vessels. There are four main categories: dumb (nonself-propelled; without sails), sail, auxiliary sail, and powered vessels. Each class has problems specific to the type of craft. The underwriters must deal with the problems presented and use specially adapted policies and endorsements to meet the needs of the policy. There may be additional classifications (as subcategories) depending upon the nature of the water type the vessel is used in and the type of vessel involved. The policies usually have a great deal in common with one of the four category types but they still have important differences that relate to the specific watercraft insured. Liability Protection Like land vehicles, vessels can be involved in accidents. Vessel owners need protection against liability for damage to others that are the result of the ship or acts of the crew. Marine liability is divided into four classes:

(1) collision,

(2) protection and indemnity,

(3) excess protection and indemnity, and

(4) water pollution.




Class 1: Collision The collision clause is also referred to as the “Running Down” clause for obvious reasons (another vessel has been run down). The collision clause protects the insured against claims arising from their vessel negligently colliding with, and causing damage to, another vessel. Although this protection is included, primarily for convenience, in the hull policy the protection is limited to liability for physical damage to the other vessel and its freight and cargo, and to loss of earnings due to loss of use of the damaged vessel. The amount of protection given is in addition to the insurance carried under the hull policy, but the face amounts or limits are equal. That means that if there is $5 million covering the hull of the insured ship, there is also another $5 million covering liability under the “running down” clause. Up to the value of the vessel will be covered in any one collision, in the proportion that the insurance carried bears to the value of the insured vessel. Class 2: Protection and Indemnity Even with the collision clause previously mentioned the hull policy will not protect the vessel owner against liability for damage to cargo in the custody of the insured, injury to passengers, members of the crew, or laborers handling the cargo. It also will not cover losses under the collision clause to the extent of one-fourth of the claim when this portion of the risk is not covered by the hull policy. Formerly it was the practice for the underwriters to word the collision clause so that the insured was required to assume that one-fourth themselves. This practice is not usually found in the newer contracts, but it is possible that some policies will still have this. The policy will also not cover damage to docks, piers, and other fixed objects or illness of passengers or crew members. The vessel owner may also be exposed to other liabilities such as quarantine expenses or crowding that causes other vessels to collide. At one time it was thought that vessel owners would be more careful if they had to assume liability risk for some items. Ship owners apparently disagreed because they organized ship owners’ mutuals called “protection clubs” or “indemnity clubs.” They have subsequently merged into “protection and indemnity clubs”. Their purpose is to protect their members against loss from liability that was previously not covered. The growth of the clubs made it necessary for marine insurance companies to offer similar protection, although separate policies are often used to achieve this. The protection and indemnity policy or clause may be written for more than the amount carried on the hull.




Class 3: Excess Protection and Indemnity There was a time when a merchant marine fleet was considered essential to a country’s economic stability. Even a country’s political position was considered affected by the nation’s fleet. As a result, subsidies existed that reflected this attitude. That is why a vessel owner could limit his liability to the value of his vessel rather than the actual liability cost that might exist. The liability of the shipowner was also limited by the Harter Act and the Carriage of Goods by Sea Act as far as cargo was concerned. Ship owners limited their liability even more by their selection of the registration flag and the practice of incorporating a vessel. Despite these protections, in recent years vessel owners have become aware that they could be assessed with more liability than the actual value of their ship. Therefore, a vessel owner may wish to purchase more insurance protection. Primary and excess insurance can be written as a single limit in one policy. Class 4: Water Pollution On April 3rd, 1970, the Water Quality Improvement Act of 1970 was signed into law. This Act was the result of increasing concern over pollution by ships and their cargo. Known as Public Law 91-224 of the 91st Congress, it assessed new liability on ship owners that directly affected marine underwriters. Amendments have followed that have extended the original act to hazardous substances, which are divided into two groups: “removable” and “non-removable”. Now, under these laws and amendments, whenever any oil is discharged into or on the navigable water of the United States, onto adjoining shorelines, or into or upon the waters of the contiguous zone, the government is authorized to arrange for the removal of the oil, unless authorities feel removal will be properly done by the vessel owner. The owner or operator of the vessel could be subject to a civil penalty not exceeding $50,000 for non-removable oils. Under specific circumstances, additional fines are possible. When the Exxon Valdez oil spill happened in Alaska in 1989, Congress realized that additional measures had to be taken to prevent severe pollution. What had previously only been a concern to a few environmental groups now became the concern of a nation. As a result, the Oil Pollution Act of 1990 put a great deal more risk on protection and indemnity insurers that cover oil tankers on U.S. waters. Not surprisingly, mutual clubs increased rates and tightened underwriting rules. Once cleanup became a requirement, marine underwriters banded together to create a syndicate to provide vessel owners and operators protection for




the cost of spills. This syndicate is known as the Water Quality Insurance Syndicate (W.Q.I.S.). It was official as of May 31st, 1971. W.Q.I.S., as part of its function, certifies to the Federal Maritime Commission that those who purchase this insurance have met the financial responsibility laws.


Chapter 9: Marine Insurance Marketing


Marine Insurance Marketing

Cost, Coverage, and Sales As is true with any coverage, finding the clients is a part of marine insurance. From the beginning, marine insurance has been an international business. Originally, only a few of the more economically developed countries had the financial and legal ability to handle marine risks. Marine insurance requires specialized underwriting ability and large financial resources because of the concentration of values involved. Since vessel owners traveled the world, they had the opportunity to seek coverage anywhere. Vessel owners knew the risks they wanted to be insured against and were typically knowledgeable when it came to such insurance. Since the inception of the coverage in 1603, Lloyd’s has been a dominant force in marine insurance both as a primary insurer and as a reinsurer. During Great Britain’s rein as the leader in international trade, Lloyd’s was the leader in the marine underwriting field. It was not until after World War I that other countries, especially Switzerland, Germany, France, Japan, and the United States began to engage in the underwriting of marine insurance. Of course, today there are many more countries writing this type of coverage. Rates A judgment call As every agent knows, premium rates are important to our clients. Marine insurance companies follow the practice common in other lines of insurance of determining premium rates on the basis of averages arrived at through the tabulation of statistical experience on many risks of the same kind over a considerable number of years.1 While this is a common procedure of determining rates for many types of products, this method can only establish a basis to work from. It must be additionally supported by factors common to marine insurance. The underwriter must look at the type of coverage

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being requested and consider the factors that will come into play. There is probably no other area of insurance that relies so heavily on the good judgment of the underwriter. He or she must successfully judge conditions and their importance to place a value on the product. Unlike other types of insurance, marine underwriters have no fixed bureau rates, except for outboard boats under sixteen feet, which are regulated by several states. Underwriters for life, fire and most other kinds of insurance coverage relate to only specific limited hazards. Marine insurance has a large number of perils, including:

1. The inherent character of a large variety of subject matters of insurance.

2. The effects of the seasons, adverse physical forces, and trade customs on numerous trade routes.

3. The immense variety of special policy provisions involved.

4. Finally, the effects of a constantly changing worldwide economic and political climate that affects multiple aspects of the shipping industry.

While most types of underwriting involve the underwriter’s judgment, the marine underwriter has fewer guidelines to help him or her make those judgments. A lead underwriter for Lloyd’s, or any of the established marine companies, is considered very valuable for his or her ability to take into consideration the numerous factors that will determine premium rates and make them work for both the insured and the insurer. Client Evaluation While most types of insurance look at the insured when determining risks and therefore rates, the insured’s individual record is extremely important in marine insurance. Even regulators seem to ignore the importance of the insured’s personal record in safety and training. When evaluating the past performance of two vessels that are alike in every way, the rates charged can be quite different with the determining factor being the management, operator, or both. If one operator or manager has performed well in the past regarding vessel upkeep and the crew’s performance, that operator or manager may get a lower rate than the vessel that has a poor past record. Underwriters develop a sense of vessel management style and respond to it. The industry considers this a fair way




to underwrite since it would be unfair to charge the well managed vessel as much for insurance as they charge the poorly ran one. This underwriting style has never been challenged since premiums charged depend on the results shown by the insured’s account, past experience, and management record. The same type of underwriting is applied to coverage on cargo. The underwriter will consider past performance when applying insurance rates. As it applies to cargo, such things as packaging, handling, and storage will affect cargo claims. It is only fair to reward the well managed vessels with lower insurance rates. Cargo insurance experiences a higher rate of dishonesty than might be realized. Since the shipping industry often experiences slim profit margins, there may be the desire to enhance their income by submitting false claims. Underwriters, knowing this, keep statistical information which will eventually indicate such practices. This will lead to either very high premium rates or refusal to insure. Hull Rates Although management is certainly important, underwriters must also consider other elements when determining hull rates. The character of the vessel’s route, the vessel’s construction, type and nationality are also important considerations. In addition the underwriter must consider the nature of the insurance being purchased, what would be covered and under what conditions a claim would be paid. The vessel’s route is extremely important to underwriting. Some routes are known for their risks, facing permanent or seasonal dangers of fog, storms, ice, shifting sandbars, narrow channels, and so forth. Currents, tides, tidal waves, and seaquakes are also natural forces that affect premium rates. Where the vessels will stop is also an underwriting consideration. Some ports are known for their dangers, whether it happens to be a difficult approach, shallow water, lack of protection from natural forces (such as wind or waves), or danger of theft and vandalism. It is not surprising that the quality and construction of the vessel would play a part in determining insurance rates. Just as home construction plays a role in risk, so does the construction and type of vessel. This would also be true




when determining cargo premium rates. When the underwriter is assessing the risk to his or her company, he or she will want to know the vessel’s builder and owner, structural plan, material used in construction, type of propulsion, structural strength, adaptability to various kinds of cargo, age, and physical condition at the time of insurance application. Various classification societies furnish information on vessels that are used by vessel underwriters. These societies were organized for the purpose of formally establishing rules for the construction of vessels, supervising the construction, assigning a “class” to each vessel, and publishing registers of those vessels coming within their jurisdiction. Nearly every vessel of any importance is classified in some register. Assignment to one of the registers carries with it responsibilities: the vessel must have periodic and necessary repairs as directed by the society. There are two leading societies: the American Bureau of Shipping and Lloyd’s Register of Shipping. The American Bureau of Shipping is referred to as the “Record” and Lloyd’s Register of Shipping is referred to as the “Register.” These are not the only societies. They also exist in France, Norway, Italy, Germany, Japan, and other nations. In fact, most ship owning nations have a classification society. All the societies are similar in that they chart each vessel of their own and others that enter their waters. The information will consist of the vessel’s name, nationality, construction material, registered tonnage, design detail (including its boiler equipment), dimensions, and the date of the last survey completed to determine present condition. The vessels are divided into separate classes in the registries and these classes are further divided into grades. Supplemental lists are regularly published in an attempt to keep the information current. These registries are literally a catalog of all vessels of any size or importance. Underwriters consider the nationality of the vessel when gauging risk (and therefore premium) because some nations depend economically on ocean commerce. Their citizens are traditionally seafaring people who are masters of the trade. Crews from such nations constitute the most skillful mariners, which is very important when assessing risk to the insurer. Unfortunately, another reason the vessel’s nationality may be important has to do with their record of commercial honor. Some are known for their lack of commercial ethics, especially in connection with the presentation of suspicious claims. Insurance uses policy conditions to limit the underwriter’s liability. This is also done in marine insurance. The clauses that may be used are numerous. Each policy must be individually assessed to see what clauses have been used. Those that are in the policy are there for the benefit of both the insured and the insurer. Limiting clauses benefit the insured because they




keep the cost of the policy down. They benefit the insurer because it limits their liability. Cargo Rates The cargo on vessels represents a substantial financial investment. Commonly, therefore, the cargo is insured against the risks faced by ocean commerce. The same risks outlined in the hull policy are often the same as those outlined in a cargo policy. If a storm damages a ship, it may also cause damage to the cargo, so both must be insured against the same risk. Although the risks insured against may be the same for both vessel and cargo, the application is often different. Just as the underwriter for a vessel must consider the condition of the ship, he or she must consider the condition and requirements of the cargo. Different types of cargo will require different types of storage and care. Hazards may be directly related to the type of cargo. Underwriters will consider not only the type of cargo but also the past record of the vessel for correctly handling and protecting it. Cargos face different types of hazard. Some types may be more likely to be stolen, for example. Whatever hazard the cargo brings with it, the underwriter will consider the likelihood of loss and base the premium rates on that risk. Obviously, the underwriter must know precisely what the cargo is that he or she is insuring. Just as some roads have a record for higher losses, so do some ocean routes. When insuring cargo, the same risks facing the vessels also faces the cargo. Therefore, the underwriter will assess these same risks when determining premium rates for the cargo. Storms, piracy, delays affecting cargo, and any other possibility will affect pricing. How often cargo must be handled will also affect the possibility of insurance claims. This is especially true of perishable cargo or cargo that may be easily broken, such as glassware. Obviously, the condition of the vessel used to transport the cargo is important to the underwriter. A vessel in poor condition or with a record of mismanagement is more likely to suffer a cargo claim than would a vessel in good repair with good management. Another element that one may not consider is the speed of the vessel. Even if in good repair, a slower vessel may have cargo damage due to the length of time it takes to move it from one place to another. This would certainly be a consideration if the cargo were perishable commodities. Even for nonperishable commodities, however, the longer the cargo is exposed to the risks of the ocean, the more likely a claim is to occur. That does not mean that slower vessels cannot




carry cargo effectively. It merely means that each element must be considered by the underwriter. Considering Past Performance Past performance of the vessel and management is a large consideration when insuring cargo. Although every factor is considered, the past performance is one of the best indicators of future performance. Vessels that have had few past cargo losses probably take the care necessary to keep the cargo safe from hazards. International Competition Unlike fire insurance in the United States that is usually fixed and enforced by a cooperative association of underwriters, marine insurance underwriters must deal with worldwide competition. For years brokers have acted as freelances in the insurance business, canvassing the world for the best rates for their clients. There are no cooperative actions in marine insurance that sets rates. Foreign competing underwriters have been given easy access to the business of writing marine insurance. The exportation of marine insurance, originating in the United States, to non-admitted foreign underwriters is freely permitted. Many American vessel owners have placed their business with foreign underwriters. This means that marine premium rates may be undercut both at home and abroad. Pleasure Boats Obviously someone insures large ocean vessels, but most agents are more likely to be insuring the smaller pleasure boats. The growth in the quantity of pleasure boats in the United States has been significant. Even during down turns in our economy, the number of pleasure boats continues to rise. In fact, the housing industry reports a growing number of new homes being constructed not only with a two-car garage, but with a third stall for either a boat or motor home. Apparently the pleasure industry has been successful. This means that more and more property/casualty agents will be asked to insure a boat. Traditionally boats with inboard motor power and sailboats have been insured according to ocean marine forms and practices. More companies are now developing policies with smaller crafts in mind, but the industry still is




largely unstandardized. Outboard motorboats under twenty-one feet in length are most likely to be insured under inland marine policies while those insured under ocean marine forms and practices are covered under “yacht policies.” Yacht Policies are used for inboard motorboats of any size, sailboats with or without inboard auxiliary power, and jet-powered boats. Keep in mind that there will be variances among the companies and even among the states, if legislation has been placed on this type of insurance. We will be covering “generalities” of boat insurance. It is always necessary to know your own state’s specific requirements. Many underwriters look at how a pleasure boat will be used. Those that routinely have a rotating passenger list or is rented to others have different risks than those that are only used within a family membership. When writing yacht policies, underwriters may require a private pleasure warranty to limit their liability. Generally pleasure boat coverage, whether yacht or motorboat, is not standardized. As a result this section can only be stated in generalities – not absolutes. Yacht policies usually consist of four sections of coverage on a schedule basis: hull, protection and indemnity, federal compensation insurance, and medical payments.2 Most underwriters will insist on using a basic hull policy before adding any other types of coverage. If the yacht is used only for pleasure (versus rental or commercial) the policy may be sold as a package by many insurers, even though the types of coverage may be rated separately. Yacht Hull Coverage Hull coverage protects the insured against physical damage to their yacht. It usually includes, besides the hull, coverage for spars, sails, boats, fittings, food and drink stored onboard, furniture, and machinery. Sometimes coverage will be extended to the boat trailer and other similar equipment. This additional property would be covered while on board and while laid up on shore. Coverage for property separately stored (off the boat) on shore, except sails, may be limited to some percentage, often 20% to 50% of the hull insurance amount. Whatever the percentage is, it usually reduces the hull insurance by the same percentage or amount.

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The insured perils tend to be the same as those for ocean marine policies. Because the oceans contain the same perils for any ship or cargo, insured perils will be the same for any ship or cargo.

Since the oceans contain primarily the same perils for any ship or cargo, insured perils will be primarily the same for any ship or cargo. The most common coverage for yacht insurance is “all risk.” When the coverage is “all risk” the typical exclusions are wear and tear, inherent vice, and theft of equipment. War damage is usually excluded by a Free of Capture and Seizure Clause. Some perils may or may not be excluded depending upon the policy. When there are additional exclusions they usually include loss from strikes, riot, and civil commotion. There may also be exclusions for damage to hull occurring during fueling, loading, hauling, launching, or moving. The first two, fueling and loading, are very important because of the increased risk during that time. Yachts that are less than ten years old may have a “valued” policy. Older yachts and most outboards may have an “actual cash value basis” policy. On valued policies an agreed value of the vessel is stated in the policy and the amount of insurance is separately shown. Most underwriters insist on insuring at least 75 percent of the vessel’s value. There is commonly a deductible that is stated as a percentage of the yacht’s value. If the policy contains a “repairs in full” clause, there is no depreciation on a partial loss. The insured will receive new for old except for sails, outboard motors, batteries, tender, and trailer. As in basic ocean marine hull policies, there will be a “running-down clause” in yacht insurance coverage. The owner of the insured yacht is protected, to the amount of hull insurance, for liability for damages to another vessel. There is no coverage for the insured’s property or for bodily injury liability. Other Coverage for Yachts There are three types of coverage that could be purchased:

• Protection and indemnity insurance • Federal compensation insurance • Medical payments insurance




Protection and indemnity insurance is bodily injury and property damage liability coverage. Federal compensation insurance is similar to state workers’ compensation except federal compensation is governed by federal law. Medical payments insurance is similar to that found in the automobile policy. First Coverage: Protection and indemnity insurance Protection and indemnity insurance has limits for loss of life and personal injury for any one person and for any one accident. The limitation that is imposed per person and per accident for loss of life or personal injury has similarities to automobile and other liability coverage in the United States. It is important that the coverage be greater than the value of the vessel since liability costs may run greater than the yacht’s value. Second Coverage: Federal compensation insurance The Jones Act for crewmembers and the longshoremen’s and harbor workers’ compensation is provided as a companion to the proteftion and indemnity coverage. Usually there is a single premium for these two coverages and the same limits apply to loss of life and personal injury.3 Third Coverage: Medical payments insurance Medical payments insurance is not part of the usual ocean marine insurance forms. Since yacht owners are often weekend and holiday sailors, the function of the yacht tends to be for entertainment for the owners and their guests. There is a feeling of obligation to those guests, just as there would be to passengers in an automobile. Some policies may include coverage for water skiers, but this should never be taken for granted. All policies should be read by both the agent and their clients. Reading the Yacht Policy As we know, every policy needs to be read. Yacht insurance policies are no exception. There will typically be six items of information on the declaration page, which are necessary for underwriting and premium determination. Those six items are:

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1. The vessel being insured, which includes its manufacturer, the year it

was built, the model and length of the yacht, horsepower. If it is a sail boat, the auxiliary power is also needed.

2. The speed of the vessel. Some underwriters may not be interested in

the yacht’s speed if it exceeds 35 miles per hour. 3. Hull valuations and the amount of the hull coverage. 4. Navigation area; that is, where the yacht will be used (lakes, ocean,

and so forth). a. Atlantic Coast (Maine to Cedar Keys, Florida) b. Great Lakes, including the St. Lawrence c. Pacific (Point Conception to Point Banda, Mexico)

5. Navigation period, including the layup warranty specifying dates. 6. Special credits, such as a. Insured has completed program of Power Squadron or U.S. Coast Guard b. Insured employs a qualified captain c. Ship-to-shore radio d. Diesel engines e. Equipped with fire extinguishers, depth finder vapor detection. Outboard Policies In most areas, outboard is not considered a standardized policy. Even so, with the numbers of outboards growing to more than 10 million, more standardization has occurred. Many states now regulate both forms and rates for outboard boats that are under sixteen feet in length. Most policies will cover outboard motors, outboard motorboats, accessories, and trailers. The boats must be used only for pleasure and not for business or hire. There is seldom any restriction as to where the boat may be used. The policy, like yacht insurance, will be either named perils or “all risks” coverage on the hull, motor, and accessories. In limited circumstances, “all risk” may apply to trailers. When the coverage is “named perils” the form follows the same format as it does for ocean marine. Policies covering outboard motorboats are typically restricted almost entirely to direct damage. Although there can be variances among policies, the typical policy pays on behalf of the insured all sums up to $500 that he or




she becomes legally liable for regarding property damage caused by accidental collision of the boat while afloat. Note the words “legally liable.” The policy may also pay up to another $500 for defense costs resulting from the same limited conditions. There may be other coverage under other policies (Homeowners policy) for bodily injury or property damage occurring as a result of ownership or operation of any outboard motorboat. Some policies may have limitations based on the horsepower of the boat motor. Liability for the trailer use would be covered under the automobile policy of the insured. Policy rates will vary. Costs will depend upon several factors, including the area in which the boat will be used, horsepower, loss history, boating qualifications of the insured, and the inclusion of a deductible. Deductibles are usually written for $25, $50, or $100 although a deductible may be written for any amount. Premiums may be anywhere from 3 percent to 10 percent of the insured values.


Chapter 10: Inland Marine Insurance


Inland Marine Insurance

Goods in Transit Over 150 years ago commercial transportation centered on the oceans and the ports that sent and received the goods. Obviously, those goods that ended up transported by ocean had to be transported to the ports for shipment. Inland marine insurance refers to the transportation over land. Primarily, the risks and coverage relate to goods in transit. Even so, risks have been added that have little or no transit characteristics. Why is it called “Inland Marine” Insurance? Originally it was the custom to insure goods only while on a vessel. Water travel was the principal means of transportation so the demand was for coverage for those circumstances. As inland transportation became more common the need for insurance beyond the vessel also became in demand. The ocean policy was extended by endorsement to cover the goods while on dock. Then it was extended by endorsement to cover the goods while they were on connecting land and water conveyances until they reached their destination. The next step wasn’t hard to make: adapt the ocean policy to cover inland transportation risks. They termed the policies Inland Marine Insurance. Growth of the Inland Marine Insurance Industry Inland marine insurance would not have developed had the inland transportation facilities not developed and improved. With each new improvement, new and varied transportation risks were recognized. These risks needed insurance. One of the major developments was the transportation of certain types of personal property, which the owners desired insurance for. The first major inland transporter was the railroad. Initially, the railroad practiced “self-insurance.” This worked well in most cases, but as private industry began to ship large cargos, it became evident that self-insurance




would no longer be the answer. Many private companies actually bought their own railroad cars and paid the railroad to move them. As this became more common the shippers realized that there were gaps in the railroad’s protection. They sought insurance as a result. Next came private transportation: automobiles, trucks, and airplanes. Although they were not typically used in major transportation of goods they did have a value that was substantial. The possibility of loss, therefore, was also substantial to their owners. As private inland transportation became increasingly common, owners requested insurance policies to insure against loss. Americans consider their economy as one of financial affluence. Our ability to spend on nonessential items has grown as our economy has grown. Of course we still have poverty, but America has less poverty to a less severe degree than nearly any other country. Even our “poor” have more dollars to spend than does the poor in most other countries. The result is an increase in personal property. Our personal property includes such things as jewelry and other high value items that require insurance against theft or other loss. Small items, such as jewelry and personal equipment (computers for example) present a high moral hazard because they are so easily sold. While kept at a residence such items are covered by homeowner’s insurance, which tend to be named-location and named-perils coverage. However, this coverage is not always adequate for the value needed and, in some cases, for the type of property owned. The need for broader coverage and off-premises protection may be considered by the inland marine insurer. Due to many reasons, including the need to adapt to new demands, some risks became better covered by marine rather than fire or casualty insurers. For those who are interested in a historical perspective, Franklin Tuttle’s Examination of Insurance Companies should be consulted. Many states have laws that restrict the types of items and coverage that a fire and casualty company may insure. Typically the insurance lines that must be followed are life, fire, casualty, or marine. These limitations made some types of coverage more easily underwritten by marine insurers. The charters and state laws gave marine insurers the power to assume liability against loss or damage to property originating from the perils of transportation. Since there was no precise definition as to what constituted a transportation risk, an ambitious marine underwriter could interpret transportation risk any way he or she saw fit. There were few (if any) objections from the fire and casualty insurers who did not wish to take on the additional broad coverages. Additionally, marine insurers had expertise from the hazards of transportation that were unique. They were accustomed to writing policies that were designed for specific situations. These underwriters




could zero in on specific circumstances in ways that the typical fire and casualty underwriter was not experienced in. Fire and casualty underwriters were restricted from the kind of experience that marine underwriters were exposed to routinely. The strict regulation of the forms and rates used by fire and casualty insurers (as required by state regulation) also restricted their underwriting experiences. The regulations promoted rigidity rather than flexibility in the policies. Since marine underwriters had never experienced such restriction they were experienced in the flexibility required to venture into new forms of coverage. It is unlikely that marine insurance will ever experience such rigid control since they compete in an international market where competition requires the ability to be flexible. Competition is the nature of the marine market.

New types of coverage can be difficult to write effectively in the beginning. Marine insurers, in some cases, issued very broad policies covering all risks, with few exclusions. Policies were issued for warehouses and property that were never in transit. Items such as stained-glass windows, organs, high-tension lines, bridges, and tunnels were insured. Obviously, a bridge or tunnel will not be in transit.

As the marine underwriters wrote a growing number of policies that had nothing to do with transportation, fire and casualty insurers began to protest. They felt their field of insurance was being invaded. The conflict became so pronounced that in 1932 the Insurance Superintendent in New York held hearings and issued a ruling as to the powers each type of insurer had. The National Convention of Insurance Commissioners (today called The National Association of Insurance Commissioners) adopted the “Nationwide Definition and Interpretation of the Insuring Powers of Marine and Transportation Underwriters” in June 1933, which is referred to as the “Nationwide Marine Definition”. This definition has been revised in 1954, 1956, 1959, and 1976. The various underwriters have agreed to abide by its provisions. A Joint Committee on Interpretation and Complaint was established under the agreement. It consists of representatives of the marine, casualty, and fire underwriters. They have the power to execute and carry out the provisions of the wide marine definition, although any insurer may appeal a ruling or interpretation. The Joint Committee on Interpretation and Complaint addresses questionable cases that come up and issues interpretive bulletins on questions that are submitted by insurers under the definition. The Nationwide Marine Definition has been modified periodically by individual




states. This is not a definition in the normal sense. Rather, it is a listing of the types of policies and risks that the NAIC has identified as making up the field of marine insurance.1 Primarily the purpose is to classify risks as either marine, inland marine, or transportation insurance. There is an abbreviated version of six divisions of coverage identified in the Nationwide Marine Definition:

1) Imports. As long as the goods remain segregated and identifiable and have not been sold by the importer, removed from storage and placed on sale, or moved into a manufacturing or processing operation they are considered to be imports.

2) Exports. From the time the goods are designated and being

prepared for export, they are considered to be in this category. 3) Domestic Shipments. This includes goods that are in transit, on

consignment, or otherwise in the custody of others that are not the owner. Such shipments are not covered at the manufacturing premises nor after arrival at the premises owned, leased, or operated by the insured.

4) Means of Communication. This includes bridges, tunnels, piers,

pipelines, power transmission lines and towers, radio and television equipment, and towers and outdoor cranes. Specifically excluded are buildings, their improvements, furniture and fixtures, and supplies held in storage.

5) Personal Property Floater Risks. This would include:

a. Personal effects b. Personal property c. Government service d. Personal fur e. Personal jewelry f. Wedding presents g. Silverware h. Fine arts i. Stamp and coin collections j. Musical instruments, including radios, TVs, and record-type

players that are not musical instruments k. Mobile machinery and equipment, excluding any items designed

for highway use l. Installment sales and leased property, excluding any items

designed for highway use 1 Development of Inland Marine Insurance, P. 217




m. Live animals

6) Commercial Property Floater Risks. In addition to the transit risks concerned with imports, exports, domestic shipments, and qualified communication items, there are business risk floaters.

a. Radium b. Physicians’ and surgeons’ instruments c. Patterns and dies d. Theatrical property that would travel with a troupe e. Film during production and on completed negatives and sound

records f. Salesmen’s samples g. Exhibition property in transit and while on exhibit h. Live animals i. Builders’ and/or installation risks j. Mobile articles, machinery, and equipment, excluding motor

vehicles designed for highway use k. Property in the custody of a bailee or in transit to or from

bailment l. Installment sales and leased property excluding motor vehicles

designed for highway use m. Garment contractors n. Furriers or fur storers’ of customers’ property o. Accounts receivable, valuable papers and records p. Floor plan merchandise held for sale by dealers under a plan of

reimbursement q. Signs and street clocks r. Fine arts held or owned by other than individuals s. Dealers who sell personal property that may be covered

specifically by floater policies after the sale. t. Wool growers u. Domestic bulk liquids including storage tanks v. Difference in conditions (DIC) coverage w. Electronic data-processing policies

The final section of the Nationwide Marine Definition identifies the exposures that do not qualify as marine risks unless specifically covered in the preceding sections.

• Storage of insured’s merchandise • Merchandise in the course of manufacture on the premises of the

manufacturer • Furniture and fixtures and improvements and betterments to buildings • Monies and securities in safes, vaults, safety deposit vaults, banks’ or

insureds’ premises, except while in the process of transportation




Inland marine insurance characteristics The Nationwide Marine Definition does not define inland marine insurance. Only the underwriting powers for the ocean and inland policies are described. The Nationwide Marine Definition is used to distinguish the powers of the marine and other types of insurers, but no dividing line between the ocean marine and inland marine insurance is given. The term, Inland Marine Insurance, while used by those in the business, actually has no stated meaning. While it is possible to state the inland marine insurance lines, it is difficult to define the subject in a definite manner that would exclude other lines of coverage. Why? It is the nature of inland marine insurance to cover a wide variety of risks. The chief characteristic of inland marine insurance is coverage of property inland during transit. Inland transit is transportation of property by means other than sea. That could include transportation by land, air, or even water (but not the ocean). This statement contains some important exceptions or modifications:

1. Sometimes protection against the hazard of transportation by sea is made in inland marine policies. An example of this is the Jewelers’ Block policy.

2. Usually the insured property is the cargo and not the actual

transportation vehicle. Insurance policies on hulls used on lakes, rivers, and canals, and insurance policies covering other types of inland carriers, such as aircraft or trucks designed for highway use are not considered to be inland marine items for coverage. However, railroad rolling stock and off-the-road contractors’ equipment would qualify for inland marine coverage.

3. Many policies cover the legal liability of the insured rather than direct

damage to property. For example, in contracts issued to motor, railroad, and air carriers, the policy gives protection against legal liability for loss and damage caused by the perils insured against while the goods are in the possession of the carrier.

4. Some policies may be issued to cover non-portable property, such as

bridges or tunnels. Such items were considered an aid to transportation so this class of business was given to inland marine insurers. Additionally, fire and casualty insurers were originally unable to provide coverage for the perils these items faced.

5. Coverage against the risks faced by property while it is stationary is

also available under inland marine policies. These floater policies are common in the protection of portable property, both of the business




and personal type. These floater policies were the first items that caused problems between other insurers and inland marine insurers.

A very important characteristic of inland marine insurance (perhaps the most important characteristic) is the willingness of this type of underwriter to venture into new and previously untried fields of insurance. Of course, it helps that marine underwriters are legally able to venture into new fields. The lack of regulatory restrictions and the past experience of marine underwriters in new areas created a unique ability to try new fields. “Probably no single contribution, however, has been as significant as the development of all risks coverage by the marine and inland marine underwriters.”2 All-risks protection The development of all-risks coverage is a development that is relatively new. It came about when organized land transportation companies became a major mover of goods. These companies needed protection from the risks of land transportation. Besides needing coverage, they needed coverage in an amount that would protect the actual value of the goods. The types and quantities of the goods being moved required protection from a wider variety of risks than previously provided for. The all-risk policy was developed through recognition of these facts. The all-risk protection was necessary because a major loss is still a financial loss whether it results from fire, theft, or a gas leakage. This fact had already been recognized in the ocean marine business. It took longer to be recognized for goods transported across land. Since marine underwriters had vast experience underwriting transportation of goods, it made sense that they would underwrite land transportation, too. It is important to remember, however, that although there is all-risk protection available for inland marine policies, that does not necessarily mean all policies are written as such. There are many inland marine policies that cover only specified perils named in the policy. Both an inland marine policy and a fire policy could be written on either a specified peril basis or an all-risk basis. When written on a named peril basis, each peril is specifically named. If it is not named, it probably is not covered. Under an all-risk policy, protection is provided against all fortuitous causes of loss subject to any exceptions specially stated in the policy. Even when named peril policies seem broad (because so many perils are named), it is impossible to compare it to an all-risk policy. It is the nature of things to

2 Property and Liability Insurance by Huebner, Black & Webb, P. 220




have hazards that were not anticipated. Why would the insured go with a named peril policy when an all-risk policy gives better protection against loss? Because a named peril policy is less expensive than the broader all-risk policy premium. All-risk policies do not all have the same wording. Older policies state that they cover against “all risks of direct physical loss”, or “all risks of loss or damage to the insured property except as hereinafter provided.” More recent policies may state they “cover external risks of direct physical loss unless the loss is limited or caused by a peril that is excluded.” Whatever the wording, the courts have held that the all-risks type of policy covers only those losses that are direct rather than consequential, fortuitous, and accidental in nature. Losses intentionally caused by the insured would not be covered. No policy covers everything. Even all-risk policies have exclusions. The exact exclusions will be listed in the policy. Exclusions are used to clarify coverage, eliminate risks that cannot be insured against based on reasonable rates, or to reduce the likelihood of carelessness on the part of the insured. Excessive Hazard Excessive hazards are typically excluded from coverage. An excessive hazard may be, for example, property that is on exhibition exposing it to a large number of people. This peril may be able to be covered for additional premium. Some hazards, such as war, cannot be covered even for extra premium. Property normally covered by other insurance It is not unusual for property to be covered under more than one policy. When it would be normal for the risk to be covered by another policy, it may be excluded under an inland marine all-risk contract. An example of this would be an automobile that would typically be covered under a separate policy specifically designed for this purpose. Wear and Tear Most items have routine use that causes “wear and tear.” Such routine use is typically excluded from policies. Otherwise, consumers would never have to personally replace anything as it ages. Normal use that produces the




natural aging (and wear and tear) of an item is not considered normal coverage for a policy. A related type of loss arising out of “inherent vice” is also excluded. Inherent vice is loss due to the natural quality of the item. For example, food will spoil normally as it ages even if no actual damage has occurred. Some contracts also exclude loss due to insects and vermin. The terms may not be specific, but typically it includes moths, and rats. There has been some debate as to whether or not squirrels are included in the exclusion. Dampness or Extremes of Temperature Exclusions for dampness and temperature extremes are likely to be found in floaters that deal with property that is susceptible to such things. This is very similar to the wear and tear exclusions. Carelessness of the Insured A major cause of loss is carelessness. As a result, some policies exclude loss due to policyholder carelessness. Language may differ, but often refers to “marring and scratching” of fragile articles. Any loss that is within the control of the insured may be excluded. The number of claims filed may also determine whether or not carelessness is considered by the company. Carelessness of others When insured items are being worked on by others, underwriters do not want to be insuring their actions. Therefore, loss or damage that is the result of the item being worked on (whether employees of the insured or not) may be excluded. This exclusion is related to moral hazard. If it is the job of employees to work on equipment, there is likely to be a policy in place for that specific purpose. Mysterious Disappearance One of the major risks faced by businesses today is the disappearance of property with no provable reason. The moral hazard this represents is too great to be insurable. There are floaters that cover theft, but they require evidence or at least a strong presumption that theft has occurred.




Infidelity (a disloyal act) We like to believe that honesty is a trademark of business. As Enron demonstrated, this is not always the case. Insurers are not interested in duplicating the coverage of fidelity bonds or assuming the moral hazard where there is “misappropriation, secretion, infidelity, or any dishonest act on the part of the insured . . . his employees . . . or others to whom the property may be entrusted (carrier for hire excepted).” Artificially Generated Electricity Those who have a generator or some other devise for generating electricity may find that their policy does not cover loss as a result. Usually, it applies only to electrical apparatus and does not exclude coverage for fire that may ensue. Earthquake and Flood Earthquakes and flood perils are excluded with respect to property at the premises of the insured. There are policies that may be purchased that would cover such loss. Inland marine policies may also offer floaters to provide this coverage. War, acts of war, and nuclear reaction It may seem unlikely that one would be applying for compensation following an act of war. However, in these times of terrorism there is the possibility that an act of war, even in peacetime, can happen. The intent is to avoid the catastrophe hazard. With the changing times, it has been necessary to expand the traditional definition of warlike actions. Underwriting Moral and Morale Hazards The types of property that inland marine policies cover are susceptible to theft because it is mobile, hard to identify, and readily convertible to cash. In addition, the goods often have a high value. The owner, if financially stressed or simply dishonest, can submit a claim for theft and still sell the merchandise. Even an honest policyholder, if careless in protecting the




goods, may end up submitting a claim when the goods are genuinely stolen. This leads to high premiums and selective underwriting. Assignment Insurance companies recognize the importance of the person purchasing the insurance. While the property being insured is certainly a major focus so, too, is the person purchasing it. Because underwriters consider the buyer when issuing a contract, they tend to prohibit assignment of the policy to another without their consent. When their consent is requested for assignment, the company will consider whom the policy is being assigned to before granting permission. The underwriter will be considering the moral hazard that might be present. Who is requesting coverage? Those insured will be presented in the same order found in the Nationwide Marine Definition. Risks vary so greatly depending upon the subject that there is no particular order necessary anyway. Some inland marine contracts will be standardized, whereas others are literally written to meet the specific needs of a particular insured. Imports and exports (categories A and B) As we have previously discussed, this relates to the ocean marine policy. Inland marine policies merely adapted the ocean marine policies for their use with the warehouse-to warehouse clause. Domestic shipments (category C) As the name implies, this relates to domestic shipments. The property transportation begins and ends within the United States. That doesn’t mean that all these policies are the same. Since the interests and goods may be vastly different, the policies governing them may be vastly different as well. The coverage of domestic shipments is separated into two main groups. First there is the exposure to loss by the ones who have an interest in the goods themselves. This is the shipper. Second, there is the exposure of




loss for one carrying the goods of another. That would be the liability of loss of someone else’s goods while in the carrier’s care. This is the carrier. The shipper has several choices:

• He may transport the goods on owned or leased equipment himself. • He may place his goods in the care of a common carrier. • Or, he may place the goods in the care of a contract carrier.

Of the owner (shipper) uses railroad or truck common carriers, then under English common law, the carrier is generally responsible for the safe delivery of the goods. There are exceptions. If the loss results from acts of God, acts of the public enemy, exercise of public authority, fault or neglect on the part of the shipper, or inherent vice or nature of the property then the carrier is not at fault and is not, therefore, liable. This is different than carrier by sea, whether domestic or overseas, where they are not responsible for loss to cargo simply if “free of negligence.” Responsibility of air carriers falls between the land and the sea carriers, being greater than that of the sea carriers and less than that of the land carriers. The liability of a contract carrier depends upon the terms of their contract. When the contract does not address the subject of liability, then the carrier is usually only considered liable if there is negligence. What is a common carrier? A common carrier is one that holds itself out to serve all who want to use their services, provided its equipment is suitable for the goods being shipped. Typically common carriers operate on established routes on an established schedule. Contract carriers reserve the right to choose the shippers they serve and to go where the shipper directs. When there is a loss, how is payment for that loss determined? There is the right of the carrier to limit the dollar amount of recovery. If a “straight bill of lading” is used then the carrier will be liable for the full value of the damaged goods. The tariff, which is the charge for carrying the goods, will be higher than if a “release bill of lading” is used. Under a “release bill of lading” the amount that can be recovered is limited. Since the tariff might be substantially higher under a straight bill of lading, the second type is often used. Even though the common carrier may have liability for the goods being transported, it is often beneficial for the owner of the goods to carry insurance of their own. This is often considered because the loss of goods due to some peril that would not be covered by the shipper must be




recognized. In addition, the shipper may be given the “release bill of lading” which would not cover the true value of the goods. Finally, in the event of loss, the shipper would receive immediate compensation from his or her personal policy and through subrogation gives the insurer the opportunity to seek satisfaction from the carrier. Even though a court may find the carrier liable to the shipper, whether or not the shipper could collect damages is always uncertain. Transportation policies Transportation policies may also be referred to as transit policies. Transit policies are considered vital to shippers since they cover the shipper’s interests only. They are usually of the open or floater type (the word “open” is used in the same sense as it was in connection with ocean marine cargo policies). In other words, it is written on a time basis and automatically covers all shipments of goods of the kind described in the policy. In “open” policies the values of all shipments are reported to the insurer and periodically the premium is determined based on the values of the goods shipped since the last adjustment. There are no rate filings for most transit policies since there are no standard policies. Rates and coverage will depend upon the past loss experience of the insured, the type of cargo being transported, the frequency of the shipments, the value of the shipments, where the goods are going to and coming from, plus anything else that might influence the possibility of loss. This would include how the goods will be stored before and during the delivery and how the goods will be handled (even how many times they will be handled) by the insured. The insurance normally applies in the United States from the time the goods leave the premises of the insured until they reach their destination. Protection is available on either a specified-perils or on an all-risks basis. As we stated, all-risks is more expensive, but also more comprehensive. Under specified perils coverage, protection is typically listed as:

1. While on land against loss or damage by fire, lightning, cyclone, tornado, flood; collision, derailment, and overturning of a vehicle; and other perils inherent in the act of transportation.

2. While waterborne, against loss or damage caused by fire and perils

of the sea, including general average and/or salvage charges and




expenses, but free of particular average unless amounting to 3 percent of the value of each case or package.

3. Against theft of an entire shipping package only, but does not include

pilferage.3 The all-risks (broad form) extends the coverage to include “all risks of loss or damage from any external cause.” Both types of coverage will list exceptions to the protection purchased. Some types of property will not be insured at all, including such things as accounts, bills, currency and goods carried on deck. This stated list is not inclusive. There can be other types of goods not covered besides those listed here. Some types of hazards are not covered, such as acts of war (whether declared or not). Generally loss determined to be caused by neglect will not be covered. Most merchandise being transported via public carriers are written on an “all risk” policy. Policies will have conditions in them. Conditions relate to multiple things including any other insurance that might be primary, misrepresentation when applying for either the insurance or for a covered loss, fraud, notice of loss, damage to labels on insured goods, plus anything else that might apply to the particular types of goods being transported. Some of the conditions will be adaptations from fire and ocean marine policies. Others will be specifically designed for the individual policy based on individual traits of the transaction. Parcel Post and registered mail policies When an agent drops new business into the mail, he or she usually insures the package (we hope). This is done as a protection against loss or theft if it includes any type of monetary document and as a way of tracing the package if it becomes misdirected. Parcel post and registered mail policies cover the shipments by specified transportation companies. Each type of mail is specific so each policy will be specific as well, although there will be similarities. Depending upon the mail piece, carriers will use airlines, railroads, trucks, and other forms of transportation that may be specific to the carrier. This might even include individuals who are contracted to make the final leg of the mail delivery journey. 3 Inland Marine Risks and Coverages, P. 229




Parcel post insurance is available to those who ship often by parcel post and who do not want to deal with insuring each piece of mail individually with the U.S. Postal Service. Coverage is written using an open form that requires the insured to keep a record of shipments and to report them periodically to the insurer. An estimated premium is typically deposited in advance. The premium may be adjusted as necessary to keep up with the mail shipped. The quoted rate per $100 of value shipped is applied to the reported values to arrive at the final premium.4 Packages and mail is insured while in transit by parcel post, whether registered or not, from the time the property passes into the custody of the Postal Service for transmission until arrival at the stipulated address within the limits of the continental United States, Canada, and Alaska. Although there are some exceptions, the coverage is for all risks of loss or damage from any external cause. Goods that easily deteriorate are only protected against fire, theft, pilferage, and non-delivery. There is also an exemption from loss when the package or goods have been wrongly addressed or the address is not complete. This would even include the omission of a suite or apartment number. There is also no coverage against loss if the package is not properly packaged or wrapped. Obviously, there would be no coverage if sufficient postage has not been paid. Coverage may also be excluded if the package is not marked “Return Postage Guaranteed.” In addition, some items are not insured, such as currency, bills or deeds. They may be able to be insured under a separate coverage. Liability for any one package shipped by ordinary parcel post is limited to $100 per package unless additional insurance has specifically been purchased. The limit is $50 for any one package shipped by registered mail or government-insured parcel post. Registered mail policy The Registered Mail policy is typically used to insure transfer of securities, bullion, jewelry, precious stones, coins, currency, checks, money orders, postage, or other types of goods that have a specific value that need specific handling. This type of mail is shipped by “registered mail and/or express (including registered air mail and/or air express) within and between places in North America and/or places in North America to places anywhere in the world and vice versa.” This offers protection that exceeds that offered by most other shippers. Shipments may be reported on a daily, monthly or annual basis.

4 Property and Liability Insurance by Huebner, Black & Webb




All risks are covered under a registered mail policy, except for war and nuclear energy. Coverage is in place while the mail is between the premises of the sender and addressee or until returned if delivery is not possible. Like all policies, there are conditions. Some are adaptations from fire and marine policies. Others are particular to the type of policy this is. Due to the content value of many of these packages, there may be the condition that the contents be verified by two persons. Wrapping may also be required to meet certain criteria. Liability to the insurer is typically limited to certain amounts depending upon the type of property shipped. These limits may be quite high. Securities, for example, may be as high as $5,000,000 or more. First class mail policy Even first class mail can be insured. It is a special form covering shipments handled by the Postal Service. This policy and certified mail coverage were designed to supplement coverage for the insureds holding registered mail policies. This type of coverage is issued to banks, bankers, trust companies, investment firms, security brokers, and others who transfer security issues. The policy covers all risks on shipments of bonds, coupons, stock certificates, and other securities. The only exclusion is war and nuclear energy. It should be noted that no coverage is provided on any U.S. government securities or coupons thereof. Certified mail coverage may be an endorsement on the first class mail policy, which then covers another form of shipment that is handled by the Postal Service. Other forms Armored car and messenger policy Just as postal services find insurance necessary, so does messenger services and armored car services. Their policies are similar to the registered mail policies in that they cover types of merchandise that need special handling. The merchandise would include such things as precious metals, currency, and other items that would be difficult, perhaps even impossible to replace. Coverage is from the time of acceptance to the delivery point. If delivery is not possible, the policy would also cover the return to the shipper. The policy is all-risk with exceptions for war, nuclear energy and theft by the shipper or the consignee.




Motor truck cargo insurance As we know, trucks move large amounts of American goods across the country. Obviously, they would purchase insurance for their own protection. The trucking companies are liable to the shipper if goods are lost or damaged due to any reason that is not excluded in their transportation contract. Not all motor truck cargo insurance policies are the same, but they do share similarities. The Owner’s Form of the motor cargo policy is similar to the transportation policy, except that it is designed to protect the shipper who owns and operates their own fleet. The policy will use wording similar to “merchandise is insured only while in the custody of the insured and actually in transit and only while contained in or on the following described motor truck and/or trucks that are owned and operated by the insured.” Typically, covered perils include:

• Fire, including self-ignition and internal explosion of the conveyance, and lightning

• Flood

• Cyclone and tornado

• Perils of the sea, lakes, rivers, and/or inland waters while on ferries only

• Collapse of bridges, and

• Accidental collision, including overturning of the vehicles.

Theft coverage is often added to this list, although it is usually limited to theft of either an entire shipping package or the entire load. All goods must be valued prior to shipment. The amount of insurance is, therefore, specific to each truck’s goods. Not every type of loss or merchandise is insurable. Motor truck cargo insurance excludes such things as:

• Accounts, bills, currency, deeds, and similar items

• Property located in or on the premises of the insured, or in any garage or other building where the described trucks are usually kept

• Loss due to delay, wet, dampness, spotting, and so forth




• Loss due to strikers, locked-out workers, riot, civil commotion, and so forth

• Loss or damage to livestock, except in the event of death caused or made necessary by the enumerated perils in the policy

• Loss or damage due to war.

Public trucker’s legal liability forms The Interstate Commerce Commission (ICC) that governs motor carriers engaged in interstate commerce requires public truckers to obtain legal liability coverage before certificates of convenience and necessity for engaging in motor trucking will be issued. Many states also require cargo endorsements to be attached to policies of carriers operating within or passing through their borders. As a result, this type of insurance is a necessity for most trucking companies. Each policy issued will have a stated maximum of liability coverage for each truck. Means of communication coverage The Nationwide Marine Definition identifies bridges, tunnels, piers, pipelines, power transmission lines, and radio and TV towers, including the equipment. Although these items are stationary, they are still involved in the moving of goods and people. Since coverage for such items must be so broad, only the inland marine underwriter was equipped to issue the protection. It has only been recently that fire underwriters have started to insure these types of items against the perils that affect them: collapse, flood, ice, earthquake, and collision. Inland marine underwriters had established their place in writing all-risk coverage for bridges and tunnels as well as aids to navigation, transportation, and communication as early as 1935. As time went by, inland marine underwriters added other insured items, such as power lines and communication equipment. This topic could be expanded into a course itself, so much has happened in recent years under the heading of communication. Many of the items covered do not have a standard form. Each policy is written to fit the situation.


Chapter 11: Risks and Protection


Risks & Protection

Personal Property Floater Risks There are special coverages that are designed for special classes of property listed in the Nationwide Marine Definition. These are called “floaters.” The protection provided follows the property wherever it may be located. This would include property at a fixed location and property that is transit. These policies typically cover property that is frequently, or at least has the option of, moving from place to place. These policies are usually of the all-risk variety rather than named perils. The exclusions in these all-risk policies are usually loss or damage from certain named causes such as insects, vermin, inherent vice, wear and tear, gradual deterioration, war and, nuclear energy. It should be noted that under “vermin” there is often some question as to what is covered. For example, while a rat or mouse is definitely considered vermin, a squirrel is questionable. Since insurance is constantly changing as needs or desires change, such policies are only limited by the ingenuity of those involved. It is not unusual for the Nationwide Marine Definition to change in order to accommodate the needs of the consumers of insurance. Scheduled and Unscheduled Floaters Scheduled Floaters are those in which the individual items or groups of similar items are listed along with a specific amount of insurance applying to each item or group of items.1 Unscheduled floaters have one amount of insurance that applies to any of the items within the scope of the policy. Unscheduled floaters are also known as “blanket floaters.” To avoid underinsuring, with resulting rate inequities, limitations on applicable amounts of coverage are written into the contract. The personal property floater is an example of underwriting through the contract.

1 4th Edition of Property and Liability Insurance, P. 238




Standard Provisions Like fire insurance, there are basic forms that are used for personal property floaters and commercial property floaters of inland marine insurance. The Insurance Services (ISO) and the American Association of Insurance Services (AAIS) are the two bureaus that prepare and file these basic forms in several of the states. The wording may vary between the two organizations, but the intent is the same. The two basic forms used are called the Personal Property Floater and the Personal Articles Floater. Both contracts consist of several standard provisions together with a declarations page. The desired floater will be attached to one of these two policies. Either one of these basic policies is more flexible than the rigid 165 lines of the Standard Fire Policy. The provisions of either floater will deal primarily with loss adjustment, cancellation, subrogation, and general conditions. Terminology of the personal property floater Concealment Concealment or misrepresentation of a material fact, before or after a loss, will void the policy. The clause found in the Standard Fire Policy is similar. Valuation The insurer’s liability is limited to actual cash value at the time of loss unless the contract specifically states otherwise. This is true even if the items covered under the policy are scheduled. The insurer may elect to either repair or replace the lost item. Repair is more likely to be used in floaters than in fire policies because items such as furs or jewelry can be purchased at wholesale and often for less than the actual value of the property that was insured. Pair or Set Clause Some types of property exists in pairs. When property that is lost or damaged is part of a pair or set, the financial loss may be greater than the value of the single item. Despite this fact, policies often state that the loss of one of the set or pair cannot be considered a total loss of the set or pair. Rather the loss will be prorated based on a fair proportion of the total value, which requires consideration of the significance of the lost article’s relationship to the value of the set. Some policies may allow the insured to give the insurance company the remaining piece of the set and then collecting the total value. Perhaps the company can obtain the missing piece through another insured.




Other Insurance The other insurance provision in the basic policy states that the inland marine policy is considered to be excess coverage over any other collectible insurance policy that may exist on the same loss. Commonly, there will be specific forms attached to the basic policy, which deal with other insurance. Of course, other insurance may also have provisions dealing with other coverage. It’s not unusual for insurance companies to share the coverage of the loss on a pro rata basis. Loss Clause Inland Marine General Terminology, as formally stated by the American Association of Insurance Services (AAIS) states:

RESTORING THE COVERAGE AMOUNT. The payment of a claim will not reduce the coverage amount. If we pay a loss for items that are separately listed and the coverage amount that applies to these items is reduced at your request, we will return the unearned premium for these items to you.

The ISO form is quite similar. The inland marine insurers have followed the practice of fire insurers in providing continuous policies. Notice of Loss Written notice of a loss is required by most insurance policies. The notice must be given to either the agent or the home office as soon as possible or practical. Of course, proof of loss must also be submitted. Most insurers require proof of loss within 90 days after discovery of the loss. If the loss is due to suspected theft, quick notification is especially important since it may be possible to recover the stolen property. Suit Legal action against an insurance company must be filed within twelve months following discovery of the loss. The clause recognizes that such an abbreviated limitation may be in conflict with the law of some states. Where that is the case, the policy requires the shortest permissible statute of limitations to apply. Protection of Property When there is a loss, the insured is required to protect the property from further damage. This is the “sue and labor clause” that provides for reimbursement of such expenses in proportion to the insurer’s liability for loss to the property involved.




No Benefit to a Bailee Some types of property are routinely entrusted to others who have a primary responsibility for its safekeeping. Because of this, the policy provides that the insurance shall not “benefit those who are paid to assume custody of the covered property.” This clause reinforces the subrogation rights of the insurer. Subrogation The insured must agree to safeguard the insurer’s rights of recovery from a third party responsible for the loss. When there is payment for a loss, the insured must assign any rights to the company and execute a loan receipt. If it is necessary for the insurer to sue a bailee for recovery, it will be done in the name of the insured. If it is successful, the insured then repays the loan to the insurer. If there is no recovery of loss, there is no obligation under the terms of the loan receipt. Settlement of a Loss The insurer promises to pay “or make good” the loss within thirty days after acceptance of satisfactory proof of interest and proof of loss. If the loss was covered or paid by someone else, the clause states that they will not cover it. This relates to subrogation. Examination Under Oath The insurance company reserves the right to examine the damaged and undamaged property, as well as related accounts and records. As often as may be reasonably necessary, “the company may examine under oath” those parties who have an interest in the property. This right would likely only be exercised when a claim was incomplete or there was some reason to question its accuracy. It is hoped that this clause will also discourage fraudulent claims. The policy has already stated that filing fraudulent claims, whether before or after the loss, voids the policy entirely. Appraisal Should the insured disagree with the payment on an insured loss, the policy has an appraisal process that is very much like that found in the Standard Fire Policy. Floaters Personal property floater Inland marine companies use two different approaches in writing the coverage for personal property normally found in a residence. One is the Personal Property Floater and the other is the Personal Effects Floater.




The Personal Property Floater provides all risk protection on personal property that has not been specifically excluded from coverage. The Personal Effects Floater provides all risk protection to wearing apparel and some other personal articles when outside of the home. The ability to endorse the Personal Articles Floater onto one’s Homeowner’s policy has greatly reduced the demand for both of these separate policies, but prior to that ability they were widely used. There is still call for them, however, in specific situations. The Personal Property Floater covers all members of the family residing together, including sons and daughters away at school. All personal property that is owned, used, or worn by the insured members is covered. Besides personal clothing, personal property means furniture, appliances, electronic equipment, cameras, sports or hobby items, jewelry, watches, and furs. In fact, this floater covers practically all personal property, which means everything that is not real property. Real property means land and those items that are attached to it. Personal property is everything else. In some cases, there may even be some coverage for real property. If the insured chooses to purchase it, there may even be coverage on the property of other people who are on the insured’s premises. Because this includes such wide coverage, there are three classes of coverage in the Personal Property Floater. The majority of the property is insured on a blanket basis. The declaration page provides for thirteen general classes of personal property, except for personal property floaters issued by some mutual companies, which does not use the same breakdown. The insured states an aggregate value for all goods falling within each category. A separate amount of insurance is assigned to each of the thirteen categories of property. The amount of insurance stated is the maximum that the insurer will pay for any one loss to property within that category. The blanket part of the policy limits recovery in any one loss of jewelry, watches, and furs to a specified amount (usually $500). Some companies may omit the stated limitation if the cause of the loss is due to fire, lightning, or one of the extended coverage perils. The stated dollar amount is the maximum amount that will be paid for any one loss, regardless of the actual value of the items. The limit may be increased by endorsement, but of course there will be additional premium charged. Recovery on cash and securities is also limited. Generally, the limit on cash is $100 and securities are limited to $500. Like jewelry, watches, and furs the limitation may be increased by endorsement for extra premium. Even when an endorsement does increase the amount that may be recovered, there is still a limitation on the maximum recovery. Usually,




these endorsements limit the recovery on jewelry, watches, and furs at $1,000. Money may be raised to $500 and securities to $1,000. Policies do provide for scheduling of personal jewelry, watches, furs, and fine arts, in order to adequately protect these individual items that have a high value. Scheduled coverage is not excess over the blanket policy. Due to this it is important to have adequate coverage on expensive items. Scheduling of high-value items removes them from the valuation of the unscheduled property. If a loss occurs to a newly acquired unscheduled item, there is an extension of coverage. The policy will pay up to 10 percent of the amount of the blanket policy on all unscheduled property, or $2,500 (whichever is less) for loss to newly acquired unscheduled property. This includes $2,500 for real property damage to the residence of the insured resulting from theft, or interior residence damage as a result of vandalism or malicious mischief. Unscheduled property located at a secondary residence must be insured with a specified limit of coverage. Every policy has exclusions. The insuring agreement states that the property covered is personal property owned, used, or worn by the insured and by members of the insured’s family of the same household. The exclusions eliminate coverage for animals, autos, motorcycles, aircraft, and boats. Business property also is excluded although books and equipment owned by the insured will be covered while they are located at the residence. Property that is on exhibition (away from the residence) is also excluded from coverage. There are some perils that are excluded from coverage. These include breakage of fragile articles, mechanical breakdown, wear and tear, deterioration, insects, vermin, inherent vice, war, and nuclear energy. Unscheduled property at the insured’s premises is not covered against flood, damage from animals, or birds belonging to the insured. Also excluded is damage resulting from refinishing, renovating, or repairing. The repairing exclusion does not apply to jewelry, watches, or furs. Personal Effects Floater The Personal Effects Floater gives worldwide protection against nearly every loss or damage to personal effects carried by tourists and travelers (although some companies offer a more limited version which is called the Tourist Floater or Tourists’ Baggage Policy), or belonging to, used by, or worn




by the insured, including the spouse and their unmarried children that reside with them. The policy will specifically list items that are not covered, including motor vehicles, bicycles, boats, accounts, currency, evidence of debts, letters of credit, money, securities, tickets, passports, household furniture, animals, contact lenses, artificial teeth or limbs, professional or business equipment or samples, and any merchandise for sale or exhibition. Personal property that is specifically insured elsewhere or under another policy is also excluded. Specified perils are also excluded, as they are with any all-risk policy. In this type of policy, those perils excluded would be gradual deterioration, inherent vice, moths, vermin, or damage done to the property while being worked on, war, and breakage of fragile articles. The exclusion would not apply to loss by theft or fire, or resulting from an accident to a conveyance transporting the articles. Although this policy gives worldwide protection, it does not apply when the property is on the residence premises of the insured, in storage, or in the custody of students away from school, with the exception of loss by fire. The exclusion of students’ property can be covered for additional premium. One blanket amount of insurance applies to any and all eligible property. The policy does contain dollar limitations, but no coinsurance. Although the deductible amount will vary, it is commonly $25 or $50. There are policy limitations. Jewelry, watches, articles of gold, silver or platinum, and furs are not covered for more than 10 percent of the total insurance amount, nor for more than $100 on any one article. The 10 percent limitation would apply collectively to all items lost in a single occurrence. Because of these limitations other forms of coverage are often bought rather than the Personal Effects Floater. Personal Articles Floater The Personal Articles Floater is used to insure personal items of value, including furs, jewelry, silverware, fine arts, stamp and coin collections, musical instruments, cameras, and athletic or hobby equipment. Each specific item is listed by class with a total amount of insurance for the class, with its own rate and premium.2 Only listed personal property owned by the insured or in his or her custody and members of his or her household would be covered. Coverage is written on an all-risks basis. Each insured article will be specifically stated, described, and scheduled. A specific amount of 2 Inland Marine Risks and Coverages, P 243




insurance equal to full value must be indicated for each item in the schedule. Coverage is automatic for newly acquired jewelry, watches, furs, cameras, and musical instruments for thirty days if there is existing insurance on the same type of property at the time of purchase. Fine arts, silverware, and stamp and coin collections will not be automatically covered. Newly acquired items in this group must be reported and coverage arranged. Newly acquired items must be added to the schedule and a pro rata premium paid from the acquisition date. The Personal Articles Floater has the typical exclusions of wear and tear, gradual deterioration, insects, vermin, inherent vice, war, and nuclear energy. When a claim occurs, recovery is on an actual cash value basis despite the items being scheduled with a specific amount of insurance. In other words, it is not possible to over-insure an item. The policy will typically state that recovery will not exceed what it would cost at the time of loss to repair or replace with material of like kind and quality. Words such as “valued at” may be added to the insuring agreement by endorsement. When this is the case, it changes it from an actual cash value to a valued policy. Fine arts would be the exception to this since the value is scheduled. Although there may be variations in wording, the policy often states that the scheduled amounts on fine arts “are agreed to be the value of said articles for the purpose of this insurance.” Any item can be valued with a specific amount of insurance. Property that is not considered to be highly valued is usually insured with a blanket policy. With the exception of scheduled fine arts, all items are insured at actual cash value, even if scheduled at higher rates. Fine arts will have an agreed value that is listed in the contract. Fine arts that are scheduled have an agreed value basis. Fine arts insured on a blanket basis are insured at actual cash value and are usually limited to no more than 10 percent of total fine arts coverage. The limit may be increased if the underwriter agrees to do so. The insured property is covered “wherever it may be located.” Insurance on fine arts is the only exception to the absence of territorial limits.3 Then limits in this type of coverage are the continental United States, Hawaii, and Canada. A further restriction excludes coverage for fine arts on exhibition at fair grounds or national expositions, unless such premises are specifically added by endorsement. 3 4th edition Property and Liability Insurance, Chapter 17




Government Service Floater The Government Service Floater is designed for the personal property of those on active duty with the Armed Forces. Some policies will be for any person fitting this definition, while others will insure officers only. Those with the Diplomatic Service of the United States may be covered as well. The policies generally cover property located in North America and the United States insular possessions (but not in the permanent residence of the insured), but the contract may be broader by endorsement. Being an all-risk policy, there are the standard exclusions of wear and tear, inherent defect, war, loss to motor vehicles, fragile articles, or loss of securities, money, and other currencies. Snowmobile Floater Policy The snowmobile Floater Policy is now routinely written since it has become a sport that nearly anyone may participate in. Many businesses also use them in off-road transportation in ski resort areas and similar situations. Alaska residents have nearly given up dog sleds in favor of snowmobiles. Although snowmobile prices are not cheap, they are affordable, which is another reason they have gained in popularity. Snowmobiles are often covered with an endorsement on an automobile policy or attached to a Homeowner’s policy, or as a separate Inland Marine Policy. The Inland Marine Policy is not standard. Rather it is an uncontrolled line. Premiums for Snowmobile coverage under Inland Marine Policies vary depending upon the judgment of the underwriter. Premium rates are influenced by the value of the snowmobile, the speed and horsepower, use, age of the drivers, geographical area, deductible amounts, and the breadth of coverage purchased. The policy may be an all-risk or on a named-perils basis. Named-perils policies typically cover fire, lightning, windstorm, sinking, and upset or overturn of conveyances. Broader policies may include collision, theft, vandalism and malicious mischief. It would be unlikely that all of these additional perils would be covered but one or two of them may be. There is usually a deductible listed on the policy of $25 to $100. Of course, any deductible amount is possible. It depends upon the underwriter and the desires of the insured. Like all policies, there are exclusions. Those typically seen in this coverage include loss occurring while the snowmobile is involved in a race, while being used as a public conveyance, or while rented or leased to others. If the




policy is written on an all-risks basis, exclusions would further include marring and scratching, wear and tear, freezing, mechanical breakdown, and inherent vice. Nearly anything is possible Coverage may be purchased for just about anything. For example, it is possible to buy a Wedding Presents Floater. No detailed description would be given in the policy of the items insured since the bride would have no way of knowing what items she would receive as gifts. There are exclusions in the policy on real estate, animals, automobiles, aircraft, bicycles, boats, evidence of debt, letters of credit, passports, money, and securities. The Cold Storage Locker Floater is a special form of the Personal Articles Floater. This type of coverage insures food and articles put in a commercial frozen food locker or cold storage plant. This coverage goes beyond the insurance that would be carried by the owner of the locker. The Snowmobile Floater Policy is a type of Mobile Machinery Coverage. Another type of Mobile Machinery Coverage is the Bicycle Floater Policy. This would cover scheduled bicycles on an all-risks basis if they are owned by individuals and are used for pleasure. This coverage would not apply to mopeds or other types of motorized bicycles. This is often a $5 deductible on the policy. Also under the Mobile Machinery Coverage comes the Mobile Agricultural Equipment Floater. This type of coverage has two forms or bases of coverage: Section A is blanket and Section B is scheduled. Both contain an 80 percent coinsurance clause. Companies prefer that the insured schedule specific equipment if they have significant value. The policy will not apply to equipment held for sale, on consignment, in the process of manufacture, or to self-propelled harvester-threshers or cotton pickers used for hire, or machinery used in logging operations. Commercial Property Floater Risks Business floaters have tended to be written on a named-perils basis rather than on an all-risks basis. Today all-risk policies are more widely used. There are many types of floaters that come under the commercial category including the Physicians’ and Surgeons’ Instruments Floater, Patterns and Dies Floater, Salesmen’s Sample Floater, Exhibition Property Floaters,




Theatrical Floater, Builder’s Installation Floater, Mobile Machinery and Equipment Floater, Property in Custody of Bailee Floater, Installment Sales Floater, plus many more. Livestock Floater A common commercial floater is on livestock. Livestock is considered to be domesticated animals. Livestock, including horses, mules, cattle, swine, sheep, and poultry, are covered while on the described premises under the Farm Property Form, which would be attached to the Standard Fire Policy. Floaters are used to broaden that coverage. There are four forms of inland marine coverage available for domesticated animals: (1) livestock form A, (2) livestock form B, (3) a monthly reporting form used especially by dealers and feed lot operators, and (4) a winter range form that is used primarily for seasonal coverage on range stock in Colorado, Kansas, Nebraska, New Mexico, and Oklahoma. Section A: blanket coverage for livestock by classes subject to a stated limit of liability on any one animal in each class. There is an 80 percent coinsurance clause. Section B: scheduled coverage of individual animals with an agreed amount of insurance or value. Monthly Reporting Livestock Floater: blanket coverage that is similar to Section A. Winter Range Floater: adds the peril of freezing since the stock is on the range. The insurer is not liable for more than the lesser of 75 percent of the actual cash value of the animal, nor for more than the stated limit of liability on any one animal. Usually the insured period is from October first through May first. The insured may not cancel during this time and the company can only cancel by giving seven days notice and returning the entire premium. It would be easy to confuse the Livestock Floater with the Livestock Mortality coverage. The Livestock Floater is more in the nature of an accident policy, whereas the typical mortality policy indemnifies the owners of horses and valuable farm livestock for loss due to death from natural causes, fire and lightning, accidents, acts of God and people, and necessary destruction for humane purposes. Specifically, the Livestock Floater covers the loss or the death or destruction resulting from or made necessary by the perils of fire and lightning, wind, hail, explosion, riot, civil commotion,




aircraft, smoke, earthquake, flood, collapse of bridges, collision or overturn of a vehicle used for transport, stranding or sinking of vessels, general average or salvage charges, and theft (excluding escape and mysterious disappearance). Additional perils can be added for additional premium. Those that may be added, if acceptable by the underwriter, include accidental shooting, drowning, artificial electricity, attack by dogs or wild animals, and collapse of buildings. Exclusions may include conversion, infidelity, loss due to acceptance of counterfeit money or bad checks, loss caused by snow or sleet, or by accident or nuclear war, loss by seizure or destruction under quarantine or customs regulations, confiscation by order of any government or public authority (destruction to prevent spread of disease), or illegal transportation or trade. Accounts receivable insurance Credit insurance covers losses occurring because a customer-debtor of the business cannot or will not pay an outstanding debt. In contrast, Accounts Receivable insurance covers a loss that the insured incurs due to the loss of the records proving debt. This is often referred to “evidence of debt.” The insured is unable to collect the debt owed because they are unable to prove evidence of it. A common reason for this is fire that destroys all records thereby preventing the business owner from knowing who to bill. Coverage is all-risk, but it applies only while the records are on the premises. The policy requires records be kept in a specific manner, such as in a vault or fireproof safe when not in use. Exclusions include fidelity losses, losses due to bookkeeping errors, losses where no evidence existed, and losses due to nuclear destruction and war (it’s hard to imagine Sears sending a bill following nuclear bombing). Also excluded is loss due to electrical or magnetic injury or to disturbance or erasure of electronic recordings, except by lightning. Most business do, therefore, also keep hard copies of debt. Loss adjustment must be based on the preceding year’s receipts since the current records have been destroyed. They are adjusted for the increase or decrease in the volume of business in the current year. The policy may be written on a non-reporting basis if the required limit of insurance is less than $100,000. Reporting will be required on higher amounts.




Valuable papers & records insurance It is common for a business to have papers and records that have value. This may include such things as manuscripts, notebooks detaining results of experiments, maps, mailing lists, drawings, deeds, or mortgages. The loss of these items or records means a financial loss for the business. The loss goes far beyond the actual value of the paper or material the information was on. The value is not the record itself, but rather the value lies in the information or uniqueness of the item. The loss is the cost of reproducing the information found in the records or papers. Sometimes it may be impossible to reproduce the information lost. This might especially be true if the information was based on facts that must also be reproduced, such as experiments. It could also be the case if the lost item was a manuscript. Even the original author may be unable to exactly reproduce the written material. In the case of artwork or a book that is out of print, replacement may be impossible. The policy is designed to reimburse the insured on an all-risks basis for the financial loss. The policy will require that the insured keep the records in a specific manner, such as a fireproof safe. The protection, unlike the Accounts Receivable Policy, covers the items even off the premises, but to a lesser degree. The insurer’s limit of liability will not exceed the actual cash value of the item no matter how much insurance has actually be purchased. Commonly, the policy will state an agreed value for each item. The exclusions tend to be the same as listed for Accounts Receivable Insurance. Floor plan merchandise policy Inventory items of high value are often used as collateral for loans by businesses. As the items are sold, the secured loan is repaid. This is common for businesses that sell cars, motor homes, or mobile homes. The Floor Plan Merchandise Policy is an all-risks policy that is often written to cover the risks of the lender. Coverage ends when the item is sold. The policy amount is determined by the inventory’s value. Signs and street clocks form The United States probably has more signs than any other country. Just the signs used by a motel chain can easily represent an investment of more than $50,000. It would not be unusual for a chain of signs to cost more than $500,000. Obviously, something that represents this much money must be insured. Both liability insurance and direct damage insurance is needed.




Signs that are attached to the building may be covered by a Standard Fire Policy unless excluded specifically by the policy. Signs that are attached to leased property may be insured under an improvements and betterments policy. It is the general rule that detached signs located more than 100 feet away from a building are not covered unless specifically scheduled in the policy.4 The Inland Marine form gives all-risk coverage with the standard exclusions for wear and tear, mechanical breakdown, electrical damage, and war. Lightning is covered. Also excluded is loss from faulty manufacture and breakage during installation or repair. Coverage is not limited to a fixed location so the form qualifies as a floater. Each sign must be scheduled and full insurance to value is provided. There will usually be a deductible. Dealer’s block insurance Dealer’s Block Insurance has been supplied by inland marine underwriters on an all-risks basis for years. Originally only the Jewelers’ Block coverage was specifically permitted by the older marine definition, although the stocks of fine arts dealers and stamp and coin dealers were also underwritten. Today there are many more forms. The Jewelers’ Block Policy is an all-risks policy. To be issued there must be a written application submitted containing information about the prospective insured’s business. Once issued, the application will be part of the policy. The Jewelers’ Block Policy will cover three types of property: (1) pearls, precious and semiprecious stones, jewels, jewelry, watches, gold and silver, and other stock usual to the conduct of the business which is owned by the insured; (2) property as just described, delivered or entrusted to the insured but owned by another person or entity that is not a dealer; (3) property as just described, delivered or entrusted to the insured by others who are dealers in such property or engaged in the jewelry trade in some manner. Merchandise that is owned by someone other than the insured is covered by the policy only to the extent of the insured’s interest in it. The Jewelers’ Block Policy insures against all risks of loss, but there are several exceptions. Not covered are losses due to theft or other dishonest acts of the insured and his or her employees. Also not covered are losses under the following situations: 4 Property and liability Insurance, P. 254




• Damage or loss occurring while the property is being worked on or on display at any public exhibition.

• Damage or loss caused by such events as wars, strikes, riots, storms, earthquakes, and other land disturbances.

• Damage or loss resulting from an unattended automobile.

• Damage or loss from breakage if it occurs under specific circumstances.

• Unexplained shortages, including those discovered while taking inventory.

• Dishonesty on the part of the insured.

The basic policy also excludes losses from smashing windows or showcases, although this can be covered by adding an endorsement to the policy. When a claim does arise, the policy contains limits of liability. The insurer is not liable for more than the actual cash value of the property destroyed or the cost to repair or replace the property with material of like kind and quality. Typically, there is also a deductible of $1,000 or more. The policy is actually intended to cover the business premises of the insured. Transportation coverage is incidental to the main intent of the policy. While in transit, liability is limited to a stated amount for any loss of property. Even if the property is not actually in transit, but merely at a different location than stated in the policy, coverage will be limited. The limitations are known as travel and outside limitations. The insured must agree to keep an inventory and other records so that a loss can accurately be determined by the insurance company. The policy may also require a watchman or security devices. The Jewelers’ Business-owner’s Policy was established because so many retail jewelers had not purchased the Jewelers’ Block Policy. This newer approach to insurance is a combination of the CMP with a Difference-in-Conditions endorsement for the “on-premises” crime exposure. There is usually a smaller deductible than seen in the Jeweler’s Block Policy, which may be more advantageous for the smaller companies with smaller inventories (under $100,000). Because it is a package policy, the Business-owner’s Policy includes Storekeeper’s Legal Liability along with coverage for the jeweler’s building and contents, and of course the crime coverage.




The Camera Dealers’ Floater and Musical Instrument Dealers’ Floater are identical except for the stock description. The coverage is all-risks on the insured’s stock in trade. It does include theft. Where the dealer would be liable, it also covers similar property of others. Once the property has been sold by the dealer it is no longer covered under the insurance. This is true even if the dealer still has a financial interest in it. Policies written on a specified amount basis typically has an 80 percent coinsurance clause that applies to the total value of all insured property, except when in transit. If the policy is written under a reporting form, the insured must report all values monthly. Electronic data processing A new area for insurance is Electronic Data Processing. It is still a nonstandard segment of the insurance market. Although large companies have been using large computer installations for a long time, smaller and mid-sized companies have not. The introduction of mini computers has changed the insurance problems involved. There are three areas involved:

1. the computer itself and the related equipment (such as printers), 2. the software used, and 3. the consequential loss exposure.

At one time there was a fourth element: loss resulting from the termination of an insured lease agreement, which was insured under a Computer Equipment Lease Indemnity Policy. That element is seldom used today. Insuring the equipment is insured either by treating the equipment as one would any other type of business property or by the use of the inland marine Electronic Data-Processing Policy, called an EDP. Both methods cover loss from fire and lightning along with the extended-coverage perils. The perils may be extended to include earthquake, interior water damage, and vandalism. Both methods leave gaps of coverage for damage from mechanical breakdown, damage from artificially generated electricity, and malfunctioning of the computer. Insuring the software will require computer insurance, which is essentially a special form of valuable papers insurance. It covers the cost of




reproducing what has been lost. It may be bought as a separate inland marine coverage or alternately it may be added by endorsement. The consequential loss exposure is often the biggest loss of the three. With today’s technology, many businesses exist because of their ties to the computer and the internet. For those firms whose existence tie closely to their computer use, some form of consequential loss coverage is essential. The exact type of coverage will depend upon the needs of the business and the underwriter’s willingness to provide it.


Chapter 12: Consequential Loss Insurance


Consequential Loss Insurance

Loss of business It is common to insure against loss of material items or buildings housing a business. However, the greater loss is often due to the interruption of the business itself. This is referred to as consequential loss. There are some startling statistics: on average it takes up to six months after a major fire for a retail store to resume sales. It takes up to a year for a manufacturing firm to resume business.1 Given these facts, no wonder that 40 percent of businesses that experience a major fire or direct damage loss are forced out of business permanently even though they carried adequate insurance for damage of physical property. Consequential loss can be insured by attaching the appropriate forms to the Standard Fire Policy or other basic policies. When insuring consequential losses the policy may be classified as those involving a time element and those that have no relationship to time. The time element coverages include business interruption insurance, extra-expense insurance, and rent insurance. In each of these policies, the amount of benefit will be based on the period of time that is required to restore the damaged property to its normal operational condition. When the amount of indemnity has no relationship to time, the policies would include leasehold interest insurance, profits insurance, those covering the loss of perishables due to temperature change, and those covering losses resulting from the interruption in supply of power, light or water. Business interruption insurance No matter how much insurance is carried for physical damage, the greatest damage to a company is often the loss of the ability to conduct business. The company loses the cash flow and they also lose customers. They lose customers because, during their inability to conduct business, their competitors get the opportunity to lure in and maintain their client base. Even when the company is back in business, part of those lost clients will

1 Consequential Loss Insurance, P. 259




remain lost to their competitors. There is probably no way to effectively measure the true loss of a business interruption. Most manufacturing, mercantile, or similar businesses carry insurance to cover fire and other perils. What may not be carried is business interruption insurance. This may be known by other names, including use and occupancy insurance, earnings insurance, business income coverage, and prospective earnings insurance. A loss of earnings happens because there was an interruption in the day-to-day activities of the business itself. There are a couple of elements to loss of earnings: the net profit that would have been realized if the company were conducting business and some fixed charges and expenses that must continue in part or whole even though the business is not actually functioning. Some expenses that might have to continue include payments on loans, salaries of those necessary to get the business open again (executives and those on contractual salaries), costs of utilities unless the building is a complete and total loss, professional services (accountants and lawyers), costs of advertising so that the public knows the business plans to rebuild, taxes, rent if the building is not a total loss, trade association dues, and insurance premiums. This is not necessarily a complete list. Many companies may have continued costs that are particular to the industry.

Most business interruption policies are a contract of indemnity that covers only the “actual loss sustained”. That means the policy would cover loss of business only “to the extent to which it would have been earned.” This limitation has resulted in the use of the term “prospective earnings insurance.” Valued business interruption policies pay a fixed amount per each day of business interruption without regard to the actual loss that might be incurring.

A separate and specific policy In most cases, insurance covering the interruption of business and the resulting monetary losses are covered through a separately written contract. This makes sense because in many cases the one insuring the building against fire and other perils is not the same person owning or operating the business within that building. While some business owners do also own the




building, many more rent the space. When there is a common owner, the insurers may take the position that there is less danger of confusion if the direct and consequential coverages are written separately against the potential losses. Exceptions will be in the endorsements to the multi-peril policy and other package policies. Business Interruption policies are made by attaching to a blank fire, windstorm, and other direct-damage insurance policy one of the interruption insurance forms that describes the nature of the interest covered. The contract will clearly state that only consequential losses will be covered. The loss does not have to be total for consequential losses to be covered. The loss may be partial as well as total. Of course, in order to be covered, the loss must be the result of an insured peril. Those perils would typically include fire and lightning, but there can be endorsements adding other perils. The important point is not which perils are covered, but rather the fact that the loss must be the result of an insured peril occurring on the insured’s premises. An exception to this is found in mist business interruption forms by a Civil Authority Clause, which extends coverage up to two weeks to those situations where the insured is denied access to his premises by civil authorities due to a fire or other peril insured against that damages other property in the vicinity.2 Therefore, if there were riots in Chicago that caused extensive burning of property near the insured, since fire is covered by his or her consequential loss property, if the civil authorities require the business owner to close until the riot and fires are controlled, the loss may be covered. Describing the Property Any insurance policy will be specific on some details. Since the business interruption risk depends upon the nature of the property and how the loss of earnings would affect it, underwriters require that it be specifically and adequately described. The application for coverage will require accurate and detailed descriptions of buildings, equipment, stock, and the type of situations that would interrupt earnings. Most business interruption policies are designed for either manufacturing or mercantile risks, although there are forms that are used for mining companies, schools (against loss of tuition), and seasonal crops and seasonal foodstuffs. This usually applies to the processing, canning, or freezing of food items. Not every aspect of the business would affect income. In a manufacturing business, only items that contribute to future production can cause a loss of

2 Property & Liability Insurance, P 279




earnings. If the finished goods were damaged, that would not be considered a consequential loss or loss of income. Damaged goods would be covered under a different policy (not under a business interruption contract). Only when a loss affects the production of future sales would it be covered under a business interruption policy. Separate forms are used for manufacturing and mercantile risks because what would cause a loss of earnings is different for each. Even so, the description of the building and of the equipment in it would be generally the same. It is the term “stock” that must be handled differently. In forms covering manufacturing risks, the term that applies is “raw stock.” Raw stock is raw materials that have been purchased, but not yet worked on. “Stock in progress” means raw stock that has undergone aging, seasoning, mechanical, or other process of manufacturing at the specific location. Stock in progress is not finished stock; it is still in the process of becoming finished stock. If finished stock were lost, it would not affect production. In manufacturing companies, there is always a distinction between the inability to continue business and the loss of goods ready for sale. Generally speaking, insuring the continued business of manufacturing firms is more complicated than insuring the continued business of mercantile firms. Some items of manufacture present risks particular to the business and the insurance underwriters must use creativity to effectively insure the company. This is usually the case when the manufacturing process requires years for the product’s maturity rather than days or weeks. Mercantile treats “stock” differently. In forms covering mercantile risks, the term “stock” is used without qualifications because finished stock is what continues their ability to do business. If the store cannot sell their stock, they cannot continue doing business. Therefore, future earnings would be affected. Indemnity Period The Period of Indemnity is the period over which an interruption loss extends. The period of indemnity is affected by the term “stock” that was previously discussed. The business is interrupted until repairs and restocking is possible. The policy will state: “Due consideration shall be given to the continuation of normal charges and expenses, including payroll expense to the extent necessary to resume operations of the insured with the same quality of service that existed immediately preceding the loss.” The insured does not have the requirement to rebuild or restore the property as a prerequisite for recovery of the business income. This type of insurance must only restore the business to an operational level.




The measure of recovery is based on the restoration of business operations with “due diligence and dispatch.” The newer policies have added a clause regarding damage to media for electronic data processing by a covered peril. The maximum length of interruption covered by the policy is limited to the greater of (1) sixty days, or (b) the length of time required to rebuild other property damaged by the same loss. For additional premium, the policy may extend the sixty day requirement to ninety or even 180 days. The insured is not necessarily forced to replace speedily nor even required to repair, but the amount of indemnity collectible is based on the length of time that would be required to do so with diligence and dispatch. In the case of mercantile, it would be the time required to replace the stock in the store. For manufacturing firms, it would be the time to restock raw materials and goods in process. The face amount of insurance places the upper limit on the period during which the insured can be indemnified for a shutdown of income. The amount of indemnity purchased will depend upon the business type. For those that have seasonal fluctuations, more coverage may be required than if the business has a stable amount of income throughout the year. It would be foolish to base the amount on a low period when a shutdown during the peak season would eliminate most of the year’s income. We think of seasonal businesses in relation to crops, but many types are actually seasonal. For example, a business that relies on tourism, such as gas stations in some areas, motels and even some restaurants, make nearly their entire year’s income from only three months business. A shutdown during this peak season could mean the loss of the entire year’s income. This means that seasonal companies must insure for a higher loss since they must be able to recoup an entire year’s income in a short period of time. For companies whose income is spread out over twelve months, the policy may be smaller since they would not be trying to recoup an entire year’s income in a short period of time. There are special exclusions that restrict the insurer’s liability for any increase in loss of earnings because the period of indemnity is extended due to:

• Any ordinance of law,

• Delays caused by such things as cancellation of leases or licenses, or

• Delays caused by strikers or other persons that interfere with rebuilding, repairing, replacing the property, or continuation of business.




It should be noted that there is no exclusion for strikes that delay a materials supplier from delivering merchandise or supplies. Most policies require the insured to utilize other available options, such as other buildings or locations of the company that could be used temporarily to keep the business operational. This might be required even if it would mean additional cost to the insured to move the business operation to the new site. Remember that the policy requires the insured to act with due diligence and dispatch to rebuild, repair or replace the damaged property. If this means simply moving the operations, that is what is expected of them. Whatever the company is able to earn by moving operations would be credited against the loss that results from the suspension of business at the regular location. The insured would be compensated for any additional expenses that incurred as long as these were not greater than the avoided loss would have been. Where moving a business or replacing an item temporarily means great additional expense for the company, there may be some compensation possible under the policy. As with all contracts, the insured must be aware of his or her policy and the conditions that it contains. Forms There have been two primary forms for business-interruption insurance: (1) the gross-earnings form and the (2) earnings form. At one time, there were actually five forms for all but unique types of risk. These included:

1. gross earnings form for mercantile and non-manufacturing operations, 2. gross earnings form for manufacturing risks, 3. earnings form with no coinsurance for mercantile and non-

manufacturing firms, 4. earnings form for manufacturing risks, and 5. business interruption form with extra expense.

These five forms have been replaced by a single form containing an election for selected optional clauses.




Gross earnings form Most business interruption insurance is written under the gross earnings form, which has a coinsurance clause. For the most part, all coinsurance forms are similar in that they pay actual loss sustained, subject to the coinsurance requirement. An exception to this is the valued outage coverage attached to a Boiler and Machinery Policy. Therefore, assuming the face amount meets the coinsurance requirement, the insured will be fully covered. The Gross Earnings Form contains a single item in its insuring clause, which covers the reduction in gross earnings less charges and expenses that do not necessarily continue during the period of interruption. Each aspect is defined in the policy. Ordinary payroll and all other charges and expenses are covered by the single insuring clause as necessary to resume operations with the same quality of service as existed immediately prior to the loss. It is important make the distinction between the amount of recovery provided for in the insuring agreement and the amount of insurance required to meet the coinsurance requirement. To calculate the coinsurance, it is necessary to determine the annual gross earnings anticipated in the policy period. In manufacturing gross earnings are defined as the sum of (1) total net sales value of production, (2) total net sales of merchandise, and (3) other earnings derived from the operation of the business, less the cost of (a) the raw stock from which such production value is derived, (b) supplies consisting of materials consumed directly in the conversion of such raw stock into finished stock or in supplying the services sold by the insured, (c) merchandise sold, including packaging material, and (d) services, purchased from outsiders for resale, which do not continue under contract. Gross earnings in mercantile coverage are less elaborately defined as the sum of (1) total net sales and (2) other earnings derived from the operation of the business, less the cost of (a) merchandise sold, including packaging materials, (b) materials and supplies consumed directly in services sold, and (c) services, purchased from outsiders for resale, which do not continue under contract.3 The gross earnings form covers the actual loss of business income. The measure of loss is the reduction of gross earnings less charges and expenses that probably do not continue if the business is not in operation. Some items may or may not continue depending upon the amount loss. Heat, light and

3 Principles of Insurance by Robert Mehr & Emerson Cammack, P. 286




power are examples of costs that may continue or may not depending upon the damage to the building and what might still be operational. Consideration is given to the continuation of normal charges and expenses, including payroll, if such continuance is necessary for the business to resume without lowering the quality of service. As stated, the gross earnings form has a coinsurance amount. Obviously, if losses are to be paid in full, the amount of insurance carried must equal or exceed the amount determined by application of the coinsurance clause to future earnings. This is a difficult thing to determine in some cases. For one thing, agents and business owners must adequately project future earnings. This can especially be difficult for small business owners who may see tremendous growth in the years to come. It is also difficult for seasonal companies whose income is primarily earned in three to four months out of the year. In these cases, there is always the possibility of being either under-insured or over-insured. Agents may try to compensate by using multiple endorsements as time goes by. There are two endorsements that tend to be used to eliminate or reduce the problems related to fixing, in advance, face values of insurance. They are called (1) the agreed amount endorsement, and (2) the premium adjustment endorsement. In addition, there are two other endorsements that deal with time and form of payment rather than the amount of coverage. The agreed amount endorsement This may not be available to all who would like it, but for those in some territories, fire-resistive or sprinklered risks of the mercantile or non-manufacturing type could qualify for this endorsement. If eligible, the insured files a statement of values with anticipated gross earnings provided. The policy is written for the anticipated values agreed upon. This is a substitution of a dollar amount for the percentage requirement of the coinsurance clause. The endorsement contains a Full Amount or Honesty Clause, meaning the insured must accurately report past earnings. Failure to fully disclose earnings would result in losses being paid in proportion that reported values bear to actual earnings. Underinsuring consequential losses has been a big problem in America. Studies have shown that, on average, there is at least 20 percent underinsurance. Considering this fact, it is understandable that the Agreed Amount Endorsement is not casually written or accepted by the underwriters.




Premium adjustment endorsement Although the Agreed Amount Endorsement is important, it is not the total answer to the problem of estimating future income. Companies that have large fluctuations in earnings or sharply angled trend lines needed something more. The Premium Adjustment Endorsement allows the insured to have the benefit of the full amount of insurance that may be needed during the year while paying only for the amount actually used. The insured overestimates a face amount that is considered adequate in most cases. A premium amount based on these inflated figures is deposited with the insurer. At the end of the year there is an audit by the insurer to determine the final premium based on the actual amount of company earnings. When using the Premium Adjustment Endorsement, the agent for the business must encourage the owner to highly estimate income, even if he or she feels the amount estimated will not be reached. In the event of a loss, over estimating will not be a problem, but estimating too little certainly could be. The insurer will never pay more in losses than the provisional face amount. Some policies do carry a penalty if the insured goes overboard and sets the provisional amount substantially too high because the provisional premium is based on the face amount. This means that even though the insured will recover the overpayment at the end of the policy period, funds have been unnecessarily tied up during the interim. Some professionals feel this is an unwise use of premium dollars.

WARNING: Some policies do carry a penalty

when the insured estimates income unnecessarily high. The Premium Adjustment Endorsement, like the Agreed Amount Endorsement, has an Honesty Clause. The basic Gross Earnings Policy does not impose a specific time limit on recovery, but the endorsement does. Perhaps the most confusing aspect of the endorsement is the clause that radically alters the operation of the coinsurance clause. It states: “liability under this policy shall in no event exceed the policy’s proportion of said percentage (the elected coinsurance percentage) of Gross Earnings that would have been earned during the 12 months immediately following the date of damage. . .” As we previously stated, the basic Gross Earnings Policy does not impose a specific time limit on recovery, but the endorsement does. Therefore, if a loss takes longer than 12 months to recover from, the policy will only cover up to that 12-month period if this endorsement is attached.




Extended period of indemnity Many companies that are closed temporarily due to a loss from fire or other covered peril lose much of their customer base during that period of closure. The fact that the business reopens does not ensure that their original customer base will return any time thereafter. Even if the customers do eventually return, there will be a loss of revenue immediately following their reopening. This amounts to an uninsured loss. To meet this need, an endorsement extending the period of indemnity is available. The Extended Period of Indemnity may be purchased in units of thirty days. It continues to cover actual loss of income, but only for such additional length of time as would be required to restore the insured’s business back to its original income. The endorsement does contain an other insurance clause, which means that if there is more than one business interruption policy, the endorsement should be attached to all of the existing policies. Deferred loss payment endorsement The Deferred Loss Payment Endorsement changes none of the basic contract provision or limitations, but it does require the insurer to settle losses on an installment basis rather than wait until the firm is operating again. This is advantageous where the loss may involve an interruption of business that is unusually long or when the amount of the loss may fluctuate widely. Payroll endorsements When a business is interrupted, some employees are essential to getting the company reopened while others are not. Which employees remain will depend upon several factors, including local labor markets, employee skill levels, cost of training new employees, and management’s loyalty to some or all of the people employed. Both Gross Earnings Forms 3 and 4 cover continuing expenses, including insurance adequate to cover the payroll. There are two endorsements that provide the insured flexibility with regard to “ordinary payroll”. These are (1) ordinary payroll exclusion endorsement, and (2) ordinary payroll limited coverage endorsement. (1) Ordinary Payroll Exclusion Endorsements are used to exclude ordinary payroll and thereby reduce the amount of insurance required.




Under the definition used in this endorsement, ordinary payroll is the entire payroll expenses of all employees, except for officers, executives, department managers, employees under contract, and other important employees. The terminology is considered loose enough to allow the insured to define ordinary payroll in whatever way best suits his or her needs. Even so, there is a limitation that should not be overlooked. If the insured elects the Ordinary Payroll Exclusion Endorsement, the 80 percent coinsurance clause must be used. Otherwise, there could be serious adverse selection against the insurer. (2) Limited Ordinary Payroll Coverage Endorsements are used when the firm elects not to completely eliminate ordinary payroll. This endorsement allows the firm to add back ordinary payroll coverage for a limited period of time, usually 90, 120, 150, or 180 days. This particular endorsement allows a company to keep all their employees when it is believed the business will be closed for only a short time. Keeping the employees allows the firm to eliminate the need to retrain new people once they reopen. The eighty percent coinsurance would still apply. Simplified earnings forms While the Simplified Earnings Forms have some basic provisions that are identical to the Gross Earnings Form, there are some differences that must be recognized by the agent and the insured. First of all, the definition itself of the term “earnings” is broader under Simplified Earnings Forms. This form identifies earnings as the sum of total net profit, payroll expense, taxes, rents, and all other operating expenses earned by the business. Like the Gross Earnings Form, the coverage is on an actual loss-sustained basis, which means that payment will be made only for income actually lost and expenses actually incurred. The most notable thing about these forms is the lack of required coinsurance. Rather, this form uses a monthly limit, which requires that not more than a certain proportion (16 2/3%, 25%, or 33%) of the total amount of insurance carried may be claimed in any one month of interruption. This limitation is not cumulative. There is no penalty if the insured underestimates the gross earnings, although recovery would be inadequate. If the business interruption happens to occur during a peak period, being underinsured could be quite serious for the company. In comparison, the regular Gross Earnings Form has no monthly or other limitation. The entire amount of insurance is available to cover an interruption of any duration if coinsurance requirements have been met.




Usually the amount of insurance carried is determined by first estimating the number of months the business might be interrupted. This may be done by considering how long it would take to restock a mercantile or repair a manufacturer’s operation. Next the earnings would be projected for the best earnings month of the year. The length of time estimated to reopen would be multiplied by the earnings for the best month. The rate per $100 of insurance is always higher for this non-coinsurance form than for the gross earnings business interruption forms. Therefore, it tends to be used only for smaller risks where total amounts of insurance are smaller.4 For those who do not fully understand how the coinsurance clause works, a limitation consisting of a percentage of the face amount may be easier to work with. Contingent business-interruption insurance It is not unusual for some companies to exist solely because another company exists. In Seattle, many small companies cater solely to Boeing, for example. If Boeing were to close or relocate, those small companies could not survive. Contingent Business-Interruption Insurance provides protection if there is an interruption to the insured’s business due to an insured peril occurring at another’s premises that is not owned or operated by the insured. In some territories, two forms are used: one for contributing properties and one for recipient properties. A separate (but related) form is used if the individual’s earning is based on commissions. It is important to note “due to an insured peril”. If Boeing relocated, causing the dependent business to close, the policy would pay no benefits. Relocation is not a covered peril. If Boeing suffered a fire, temporarily affecting the related business owner, the loss would be covered. There is also a contingent business-interruption exposure when the insured depends on another business in the same area to attract customers to his place of business. This might be the case with a motel or restaurant that is located outside of Disneyland, for example. The small business relies on the traffic attracted to Disneyland for their income. In this case, Disneyland would be referred to as a leader property. Contingent Business Interruption insurance is usually written under a policy that is separate from that covering the direct business interruption loss. This

4 Consequential Loss Insurance




eases the possibility of misunderstandings related to coverage and it is also necessary because rates are entirely different. Contingent Business Interruption insurance must name and give the location of the supplier or customer on the application. The policy will pay benefits only if that specified supplier or customer has a covered interruption that affects the insured at the location that was listed. The premium rate is based on the rates at the contributing locations, without regard to exposure at the insured’s location. If exact locations are not used in the policy, recovery is limited to one-half of one percent of the amount of insurance for any one month. The policy does require the insured to seek means to continue business. If their supplier suffers a fire, for example, they are required to seek out a new supplier. If doing so incurs additional expenses for the insured, there will be compensation if the net result is a reduction in the total amount of the loss. An earnings form of Business interruption insurance An earnings form of business interruption insurance is available to the operator of a small business. It is a simplified edition of the mercantile gross earnings form and usually is available only to mercantile and other non-manufacturing businesses. Instead of a coinsurance clause (as seen in the gross earnings form) it has a stipulation that no more than a stated percentage of the face amount of the policy can be used in any 30 consecutive calendar days. This percentage is selected by the insured. It can be as high as 33½ percent. The cost of coverage under the earnings form is usually related to the fire insurance rates for the building and may be considerably higher than other types of business-interruption policies. The earnings form of business interruption insurance is normally bought by small companies. Even though the cost is higher, since the amount of insurance purchased is also usually smaller the higher price does not necessarily hinder sales. This is probably because there is no coinsurance clause. A major decision in whether or not to purchase this type of coverage hangs on whether or not payroll must continue. Small companies may find it less expensive to




cover payroll than to purchase business interruption insurance. Even so, consequential loss insurance may still be prudent. Extra expense insurance Business interruption means loss of business As we have discussed, an interruption in business may mean a permanent loss of future revenue as customers begin to use competitors during the time the company is not operational. Some businesses will go to any length and any expense to avoid the loss of their customer base. Extra-expense insurance covers the types of costs associated with staying operational when that means extraordinary expenses are involved in this effort. Therefore, this insurance is not business interruption insurance. Rather it is “additional expense” insurance. It covers the extra costs (thus, the name extra expense insurance) over and above the normal cost of doing business if necessitated by a fire or other insured peril. The policy will cover costs (to specified limits) of doing business at a temporary location and for the cost of any equipment necessary to “continue as nearly as practicable” the routine duties of the company. It would be easy to consider this coverage all inclusive, but that is not the case. As was seen in the case of Travelers Indemnity Company v Pollard Friendly Ford Company, the policy does not cover fees for outside professional consultants, advertising costs, and legal or CPA expenses. Like the business-interruption policy, the Period of Indemnity covers only the period necessary to rebuild, repair, or replace the premises or contents. The policy does not have coinsurance requirements, but there are limitations on the amount of benefits that will be paid. The limit is generally accumulative. Therefore, if less than the full limit is used the first month, the unused portion is added to the limit for the second month and so on. While there can be variances, usually no more than 40 percent of the policy amount may be applied in a period of one month or less. The standard formula is 40-80-100, which means not more than 40 percent of the policy amount may be applied in a period of one month or less, not more than 80 percent in a period of two months or less, and 100 percent for a recovery period of more than two months. The minimum period of emergency operation that will be written is typically three months. There is always the possibility that this is different in some territory, so it is always important that the agent read every policy personally. The premium cost for extra-expense insurance is based on a percentage of the 80 percent building rate and will vary depending on the combination of monthly limits chosen by the insured. Since requirements may vary by




territory, it is important for the agent to investigate any specifics for the location issued. It should again be noted that business interruption insurance is intended to get a business back into production or ready for business in some capacity. It does not cover, nor does it intend to cover, loss of business to competitors due to the interruption. Nor would business interruption insurance cover the extraordinary expense incurred by a company who continues conducting business (to avoid losing their customers) regardless of the expense caused by doing so. That is precisely why a company might also want to purchase Extra-Expense Insurance. It can be more expensive to stay open following a fire than it would be to close temporarily. In many cases both business interruption insurance and extra-expense insurance is needed. For those agents who write homeowner’s insurance, the Extra Expense policy is comparable to the coverage known as “additional living expense insurance.” Additional living expense insurance is written for individuals who wish to be insured against the cost of having to live outside of their home during repairs following damage from an insured peril. Business income coverage form The ISO (Insurance Services Office) form with the Business Income Coverage title may or may not include all of the business-interruption and extra-expense coverage provided by the five historical standard forms previously stated. Because the title is so long, Business Income Coverage Form is often stated as BICF. Without modification, the BICF provides basically the same coverage formerly provided by the gross earnings form of business interruption insurance. However, the term “gross earnings” is not used in this form. The BICF may be written to cover:

1. Business Income including “rental value” 2. Business income excluding “rental value” 3. Only “rental value”

Rental value is placed in quotation marks to indicate that it is defined in the form. Business income is defined as: the sum of (1) the insured’s net profit or loss before income taxes that would have been earning if the interruption of




business had not occurred, and (2) continuing normal operating expenses incurred, including payroll. Rental value is defined as: the sum of (1) total anticipated rental income from the insured premises; (2) the total amount of all other charges that the tenant would have been required to pay, and which would otherwise be the insured’s obligations; and (3) the fair rental value of any portion of the premises occupied by the insured. This definition means that rental value is covered whether or not any part of the property is actually rented out to others. The BICF covers only Business Income lost during the time of restoration (called Period of Restoration) due to the interruption of the insured’s business operation resulting from property damage by an insured peril. Policy Definitions: “Period of Restoration” means the period of time that:

a. Begins with the date of direct physical loss or damage caused by or resulting from any Covered Cause of Loss at the described premises; and

b. Ends on the date when the property at the described premises should be repaired, rebuilt, or replaced with reasonable speed and similar quality.

“Period of Restoration” does not include any increased period required due to the enforcement of any ordinance or law that:

1) Regulates the construction, use or repair, or requires the tearing down of any property; or

2) Requires any insured or others to test for, monitor, clean up, remove, contain, treat, detoxify or neutralize or in any way respond to, or assess the effects of “pollutants.”

The expiration date of this policy will not cut short the “period of restoration.”

“Operations” is defined as:

(1) the insured’s business activities at the insured premises, and (2) if “rental value” is covered, the tenantability of the premises.

There are several standard endorsements that are used with the BICF. The most notable are:

1. An endorsement to exclude ordinary payroll;




2. An endorsement to limit ordinary payrolls to thirty, sixty, ninety, or

one hundred-twenty days; 3. Two endorsements to provide coverage for Business Income From

Dependent Properties, which provide the coverage previously called Contingent Business Interruption; and

4. Business Income Premium Adjustment endorsement, which is

functionally equivalent to the Premium Adjustment Endorsement used with the older business interruption forms.

Individual consequential loss insurance Agents and consumers understand the need for business interruption insurance, but they are less likely to recognize the need for such coverage for individuals. There are two types of individuals who may need this coverage. The first group includes those whose income directly relates to sales and the second group are the franchise dealers. A large part of the franchise dealer’s income is dependent on the output of a particular manufacturer or supplier. This coverage was designed to cover those individuals who were not owners of a business, but whose income would be reduced or eliminated if the business was interrupted. In order for the policy to cover, of course, the interruption must be from an insured peril, usually fire. The income covered was defined as “salary, commissions or other earnings accruing to the insured from operation of the business. . . less any income guaranteed to the insured”. Coverage for income loss is no longer a standard form. Also discontinued is the Commissions of Selling Agents Form. While in use, it allowed the insured to name one or more factories, plants, or warehouses, the direct damage of which would mean a reduction or loss of income. The measure of loss used was the “reduction in gross selling commissions of the insured under contract for the sale of products less charges and expenses which do not necessarily5 continue.” The form most widely used today is the Business Income From Dependent Properties form. The term “personal business interruption insurance” may also be used to identify a form of health insurance used by

5 Property & Liability Insurance, P. 281




doctors and dentists. A similar term is also used for small sole-proprietorship businesses, so it is necessary to be sure which insurance form is being referred to. Rent Insurance Although there can be variances, usually rent insurance protects the insured against either loss of income from property or loss of use of the property. The loss might be the result of the insured property being rendered untenantable by fire or by any other peril that is covered under the contract. There must be an insurable interest before rent insurance will be issued. This is done by simply determining who would suffer a loss of the type covered by the insurance. The answer to that question would depend upon the nature or terms of the tenancy. If the owner occupies the property, he or she would be the one to lose the use of the property (suffer a loss) due to a fire or other covered peril. The owner should, therefore, carry rent insurance. The amount of coverage should be equal to the rent that would normally have been received if the property had been rented to someone else. This is called the rental value of the property, and the insurable interest is referred to as a rental value interest. When property is occupied by a tenant (not the owner), the loss could affect both the owner and the tenant. It would depend upon the terms of the lease and the state laws. If the tenant must continue to pay rent even though the property is unfit for occupancy after the damage, the loss would fall on them, so they need to have rent insurance. In such a situation, full rental value coverage is needed. If the rental value goes up, even though the tenant may be unable to utilize the property due to the damage, their rent would still increase. In most contracts, the tenant is relieved from liability for the rent if the building is not usable through no fault of the tenant. Even if it is not in the contract, many states have specific statutes that address this issue and relieve the tenant of any financial liability. This leaves the loss on the owner rather than the tenant. Whether the loss is with the tenant or the property owner, both types of loss are covered under the same insurance forms, called rental value forms. There are two rental value forms available. The main difference between them is that one contains a coinsurance clause while the other does




not. The form without coinsurance includes a monthly limit on the amount of recovery in lieu of a coinsurance clause. When a loss occurs, benefits are paid less charges and expenses that do not necessarily continue following the loss. If coinsurance applies, it is based on the gross amount of rental value without any adjustment for charges and expenses that may not necessarily continue following the loss. Forms Residential property has several dwelling forms, including the Homeowners, which provide coverage for rent and rental value losses. There is similar protection in the Business-owners Policy. The Commercial Multi-Peril Policy (CMP) has a specific endorsement called the Rental Value Insurance. Special situations also have forms available for use. Forms that cover ordinary risks cover the rental value of all portions of the property whether the property is actually rented out or not. This means that no distinction is made where property is divisible into separate occupancies, other than remaining a contract of indemnity. As a result, it must be demonstrated that the insured sustained a financial loss by reason of fire damaging unoccupied premises. Coinsurance As we have stated, some contracts contain coinsurance provisions. When a coinsurance clause is included, the minimum requirement must be met before the insured may fully collect any benefits. The required amount of insurance is found by determining the rent that will be lost in the year following the damage. The expected duration of interruption will dictate the coinsurance percentage. The rate decreases as the coinsurance percentage increases. Premium is higher for higher coinsurance because more coverage is then required. An alternative to a contribution form is the Monthly Limitation Form. This form limits the insured’s recovery to a specified fraction of the face amount of insurance each month that the rent is lost due to the building’s damage. Selection of the monthly fraction will depend on the extent of any monthly fluctuations in rental values and the anticipated time of the income interruption.




Period of Indemnity Rent insurance losses use the principle of indemnity exactly like other property forms do. The rental insurance coverage provides that the company will be liable for the rental value of untenantable portions of the property less charges and expenses that may not continue following the damage. The loss will be computed from the date of damage until the building is again rentable, with the exercise of reasonable diligence and dispatch. Once the building is again rentable, the benefits stop even if no renters actually come forward. Rates It is always difficult in a course that is used across the United States to discuss premium rates. There are too many variables. However, we can state that rent insurance rates will be based on the fire insurance rates for the building property under consideration. The chance of fire determines the chance of a rent insurance loss, but the severity of fire does not determine the severity of loss. This means that the fire insurance rate must be modified before being applied to a rent insurance risk. The rate will likely be higher if the insurance required is equal to the rental value for the time required to rebuild than if it is equal to the rental value for a full year. In the latter case, a larger amount of insurance is generally required. Additional living expense Additional living expense is part of the dwelling forms. It is actually a form of extra-expense insurance applied to an unlivable dwelling. The form recognizes that the insured who suffers a fire or other covered loss to the insured dwelling usually faces additional costs to continue living in the same manner as before. Short-term rental of an apartment or hotel room, extra transportation, restaurant costs, laundry bills, and other costs related to being forced out of one’s home generally result when one’s home is damaged. These costs are an indirect or consequential loss to the interruption of the use of their home. The policy will pay only for expenses that are actually the result of the temporary loss of the dwelling and only for expenses actually incurred by the named insured. Payment will be made only for the actual amount and is limited to (1) the time necessary to repair or replace the damaged property, or (2) the time required for the household to become settled in permanent quarters. The maximum dollar amount recoverable under the combined




rental value and additional living expense is typically limited to 20 percent of the dwelling coverage amount in the Homeowners policy. Leasehold insurance When a building is damaged, it may affect the businesses in another way: it may adversely affect the location of their business. That might be because a new lease site is more expensive or because the new lease site is not as favorably located. Leasehold insurance is designed to protect a lessee against the loss resulting from the cancellation of a favorable lease from a covered peril. This is most likely to happen when it involves long-term leases, or anything that deprives the lessee of the right to use or sublet the premises. As we have stated, usually, the lessee may cancel the lease if there is damage that makes the location unusable. If rental rates have greatly increased, the lessee may be glad to cancel and relocate. The lessor may also be glad to cancel the lease if it means that he or she will be able to raise the rent once the property is again rentable. The loss of the difference between the present rental value and the rent that was specified by the lease agreement is the amount of value at risk for the duration of the lease. This amount is known as the leasehold value interest. If the lessee had sublet the premises to another person or company at a higher rate, the cancellation of the lease would cause a loss equal to the difference between the rent that the original lessee was receiving and that which the same party was paying for the premises. This is called a leasehold profit interest.6 The loss is would continue for the duration of the lease. Therefore, the loss is not limited to just the amount of time it takes to repair or rebuild the building to a rentable state. There may be an additional loss. In some instances those who are renting have paid a cash bonus to acquire a particular lease (often due to its location). If no provision were made for a refund in the event of a fire or other damage due to a covered peril, the tenant would lose the amount paid for this bonus. The same situation exists when the tenant has paid their rent in advance, with no provision for a refund in their lease in the event of fire or other loss due to a covered peril. If the tenant has improved the property for the benefit of their business, unless their lease specifically repays them for these improvements, that investment is lost.

6 Consequential Loss Insurance, P. 286




Since the person with the leasehold interest cannot also be the owner of the property, separate policies generally would be written to cover leasehold interests.

The leasehold interest cannot also be the owner of the property.

The insured must purchase insurance equal to the discounted value of the leasehold interest, using a rate of interest specified in the policy. This usually ranges from 5 percent to 15 percent compounded annually. Discount tables covering different time periods are printed as part of the leasehold forms, so the determination of the amount of insurance is not a complicated matter. At one time, some forms required the lessee to over-insure because they were required to insure an interest to the full undiscounted amount. This is no longer the case. Whatever form was used, the loss payment was always the same since all forms provided payment at the discounted or present value of the leasehold interest. It is possible to purchase special forms that provide coverage for bonuses, prepaid rent, and improvements made to the premises. The leasehold forms contain some important provisions. The insurer’s risk depends a great deal on how easy it is to cancel the specific lease. Another important provision relates to the right of the insured to cancel a policy before a loss and to the liability of the company in the event of covered property damage that might or might not bring about a lease cancellation. Recovering profit losses It is certainly true that a manufacturer or a mercantile wants to recover the cost of reopening or continued manufacturing. However, there are also lost profits to consider. Since business interruption policies cover only the cost of getting back to business (and not the profits that would have been made), there are policies available that do cover the loss of profits under specific conditions. The addition to the coverage is called a Selling Price Clause. It is for certain types of stock of either a manufacturing or mercantile business. The coverage substitutes the price for which the goods would have been sold over the actual cost of resupplying them. In the case of manufacturing, the coverage is on all finished stock. For mercantile companies, the coverage applies only to items sold, but not delivered. The intent is to cover losses that fall between the direct-damage coverage and the earnings forms of business interruption insurance.




Although there are no specific charges made for adding the Selling Price Clause, one must be aware of the effects it has on the applications of the basic coinsurance. The coinsurance percentage will apply to a greater property value, which could result in a penalty if the amount of insurance proves to be inadequate.


Chapter 13: Boiler and Machinery Insurance/Glass Insurance


Boiler and Machinery Insurance Glass Insurance

Boiler and Machinery Insurance There are many types of “pressure vessels” and machinery that may cause a loss due to accidents. Primarily due to the excellent inspection services provided by insurers, boilers have a low rate of loss, but when a loss does happen, they can be very serious. Accidents involving boilers, other pressure vessels, piping, and machinery can result in heavy financial losses, including business interruption, extra expense, and consequential damage. Such accidents may also cause severe injuries and even loss of life. One such accident (a boiler explosion) at a branch office of the New York Telephone Company killed 24 people and injured 94 others. Besides the human loss, the financial toll can be enormous in a boiler accident. For example, when a paper mill roller was involved, it took nearly two years before a replacement roll could be built and production resumed. The direct property damage was $300,000 at that time, measures taken to reduce further loss added up to $700,000, and indemnity for lost production amounted to $2,900,000. The total loss to the insurance companies involved added up to over $3,900,000.1 Realize that this was a single accident. With this in mind, it is easy to see why insurers have developed such an excellent inspection service. Losses involving equipment other than the boiler occur more often, although the results are less severe. Virtually every type of equipment that contains pressure, or generates or transmits power, needs to be insured. This would include piping to air conditioning compressors and deep-well pumps that may be covered by boiler and machinery insurance. Premium Considering the potential of claims, premiums are surprisingly low. The premium represents approximately one-third of one percent of the industry’s total premium volume.2 When this information was originally printed in 1994 1 Property & Liability Insurance, 4th Edition, P. 294 2 Best’s Aggregate & Averages P/C, 1994 edition, P. 319




that represented around $700 million. That figure is probably low today. The loss ratio is generally in the range of 40 to 50 percent. Why aren’t premiums higher? Perhaps the main reason is the tendency to underinsure (limiting the insurance company’s liability). Why would they underinsure? Often, the business is more interested in obtaining the insurer’s inspection service than they are in obtaining the insurance. Obviously, if a loss could put a company out of operation for as much as two years, they do not want to experience a loss at all. It is well known that the inspection services have greatly reduced loss and that is what the company is often seeking. As inspections reduce losses, that allows the insurers to reduce premiums. Although this is an ever-changing industry, relatively few companies write Boiler and Machinery coverage. This is probably due to the need for highly specialized underwriting, engineering service, and loss-adjustment facilities. Only a handful of companies write enough volume to even make it notable. Inspection Services The inspection service performed by boiler and machinery insurers predates indemnity for loss.3 In fact, the actual writing of policies was merely an out-growth of the inspection service. This can be seen in the insurer’s name: the Hartford Steam Boiler Inspection and Insurance Company. Although inspection is certainly an important aspect, there are other functions that also help reduce the incident of loss. They range from assisting in the revisions of the American Society of Mechanical Engineers (A.S.M.E.) boiler code that deals with manufacturing standards for power plants, to inspection of nearly all boilers and pressure vessels during manufacture, inspection of equipment when installed, establishment of safe operating practices, periodic inspection of the object, supervision of repairs after a loss, gathering and analyzing facts after a serious loss, and promoting basic research in Boiler and Machinery loss prevention. Even though inspection is an important part of the insurance, the companies make a great effort, through the terms of the contract, and through their agents, not to promise any frequency or standard of inspection. Such liability would be foolish. Any misunderstanding on the part of the insured regarding the protection of inspection could place the insurance company in a responsible position. In fact, recent cases in the field of

3 Boiler and Machinery and Glass Insurance, P 29




workers’ compensation insurance have stressed the potential exposure of an insurer with regard to implied loss-prevention services. The insurer does reserve the right to inspect the insured’s premises and the items insured at all reasonable times. Boilers are usually checked no less than once each year, with some companies inspecting more often. If a dangerous situation is noted, the insurer may, with written notice, immediately suspend insurance coverage on the particular object. Coverage on non-defective items would continue. Coverage may be resumed only by endorsement to the policy. Any unearned premium would be returned. Due to the inspection services, much of the premium collected is used for service activity. It has been estimated that more than 22 cents of every premium dollar is spent for inspection service. Fifty cents or less of every dollar collected is paid to the policyholder for losses. Application for Coverage There is no standard form for Boiler and Machinery insurance. Of course, the agent must collect the necessary information. Few agents have enough education in this very narrow field to do more than gather information. The underwriter will dictate which information is needed, and then make policy determination, including the premium amount. Even though there is no standard form, standard information will be needed. That would include:

1. The complete name of the company applying for coverage and their business address.

2. The policy term being applied for, typically one year beginning at 12:01 a.m. standard time “at the place where the accident occurs”.

3. The kinds of equipment being insured. 4. The limit per accident, constituting the property damage limit for any

one occurrence, even though more than one object may be involved. 5. Whether or not business interruption and/or consequential loss

coverage is being requested as well. 6. If the agent has access to the information, the premium amount.

Otherwise, it will be listed on the declaration page or provided by the company’s underwriter.

7. Sometimes, the underwriter will add the identification of all schedules attached to the policy.




Direct-Damage Policy Schedules will be attached to the basic policy. The introductory paragraph of the insuring agreement will emphasize their importance. Because this type of machinery has maintenance costs, which the insurer has no intention of covering, the insurer has not replaced the term “accident” with the word “occurrence” as has been done in many other types of insurance contracts. Some terms that will be seen in these policies include: Accident, as defined by the Broad Form: “Accident” means a sudden and accidental breakdown of the “object” or a part of the “object.” At the time the breakdown occurs, it must manifest itself by physical damage to the “object” that necessitates repair or replacement. None of the following is an “accident.”

• Depletion, deterioration, corrosion, or erosion. • Wear and tear. • Leakage at any valve, fitting, shaft seal, gland packing, joint, or connection. • Breakdown of any vacuum tube, gas tube or brush. • The functioning of any safety or protective device.

Turbine Units may have a separate definition of “accident.” If so, refer to the Declarations for the appropriate accident definition. If a strike, riot, civil commotion, act of sabotage or vandalism results in an “accident”, this insurance applies. However, the War and Military Actions Exclusion and the conditions of this Coverage Part still apply. Under the Limited Form, “accident” is defined as follows: “Accident” means a sudden and accidental tearing asunder of the “object or a part of the object.” This tearing asunder must be caused by pressure of water or steam in the “object.” None of the following is an “accident”:

1. Cracking; 2. Depletion, deterioration, corrosion, or erosion; 3. Wear and tear; 4. Leakage at any valve, fitting, joint, or connection; or 5. The functioning of any safety or protective device.




The key words in the Limited Form are sudden and accidental tearing asunder, which means explosion. The Broad Form covers loss from accidental bulging, burning, or cracking, but in the Limited Form, the boiler must actually explode to trigger coverage. The Limited Form is often the plan of choice because of the lower premium rate. More often, the underwriter is willing to write only the narrower coverage when the object to be insured is old or has been poorly maintained. Object, as found in the Boiler and Machinery Coverage form: “Object” means the equipment shown in the Declarations. Full description of specific “object” categories are found in the Object Definitions endorsement attached to this Coverage Form. The “object” definition shown in the Comprehensive Coverage endorsement is much more specific. It states:

A. “Object” means any: 1.Boiler, fired vessel, unfired vessel normally subject to vacuum or internal

pressure other than weight of its contents, refrigerating and air conditioning vessels, and any metal piping and its accessory equipment;

2. Mechanical or electrical machine or apparatus used for the generation, transmission or utilization of mechanical ore electrical power.

3. Any of the following vessels listed below are included within the provisions of this section when used with an “object”: a. Condensate return tank; b.Cushion or expansion tank used with a hot water heating boiler.

B. “Object” does not mean any: 1.Part of a boiler, fired vessel or electric steam generator that does not contain

steam or water; 2.Insulating or refractory material; 3.Non-metallic vessel, unless it is constructed and used in accordance with the

American Society of Mechanical Engineers Code (A.S.M.E.); 4.Catalyst; 5.Buried vessel piping; 6.Sewer piping, piping forming a part of a fire protection system or water piping

other than: a. Feed water piping between any boiler and its feed pump or injector; or b. Boiler condensate return piping; or c. Water piping forming a part of refrigerating and air conditioning vessels

and piping used for cooling, humidifying or space heating purposes; 7. Part of a vessel that is not under:

a. Pressure of the contents of the vessel; or b. Internal vacuum;




8. Oven stove, furnace, incinerator, pot or kiln; 9. Structure, foundation, cabinet or compartment containing the object; 10. Power shovel, dragline, excavator, vehicle, aircraft, floating vessel or

structure, penstock, draft tube or well-casing; 11. Conveyor, crane, elevator, escalator or hoist, but not excluding any

electrical machine or electrical apparatus mounted on or used with this equipment;

12. Electronic computer or electronic data processing equipment, unless used to operate one or more insured objects;

13. Media used with any electronic computer or electronic data processing equipment;

14. Machine or apparatus that is used for research, medical, diagnostic, surgical, dental, or pathological purposes;

15. Felt, wire, screen, die, extrusion, plate, swing, hammer, grinding disc, cutting blade, cable, chain, belt, rope, clutch plate, brake pad, non-metallic part or any pat or tool subject to frequent, periodic replacement;

16. “Object” manufactured by you for sale. C. For any boiler or fired vessel, the furnace of the “object” and the gas passages

from there to the atmosphere will be considered as outside the “object.” D. When a vessel uses a heat transfer medium other than water or steam we will

consider the medium or its vapor as substitutes for the words – water or steam. E. We will consider that the—connected ready for use—requirement of the

Coverage Form and its endorsements has been met by an “object” in this section if that “object” is:

1. Periodically filled, moved, emptied and refilled in the course of its normal service; and

2. Used for storage of gas or liquid. F. For any gas turbine “Accident” does not include the cracking of any part of the

object exposed to the products of combustion. G. We will not pay for loss or damage to any catalyst. H. We will not pay for: 1. Damage to media used with any electronic computer or electronic data

processing equipment; or 2. Any indirect loss resulting from damage to that media. I. For any “object” covered by this endorsement, Paragraph F.1.e of the definition of

“accident” in the BOILER AND MACHINERY COVERAGE FORM is replaced by the following: Breakdown of any electronic computer or electronic data processing equipment, unless used to operate one or more insured objects;

There is a further restriction in the insuring agreement that the object is only insured while it is in use or connected and ready for use at the location




stated in the schedule. The policy does not intend to cover the machine or boiler while it is in storage, because this would be a form of personal property, which can be insured under a commercial property contract. The policy is intended to be a fixed-location contract. Portable objects may be insured at various locations if the wording so specifies in the contract. This type of equipment (portable) is often mounted on trailers or flat cars and would, therefore, obviously be used at different locations. Even though it is possible to insure objects individually, with each itemized in the contract, most policies are written as blanket group coverage. A general description of the group is stated. All objects of the same class would be insured. There is usually automatic coverage on objects existing at any newly acquired property of the insured. It will be subject to some limitations:

1. the object must be included by one of the object group descriptions on the policy, and

2. the insured must notify the company within 90 days of acquisition.

Automatic coverage does not apply to any indirect coverage. Primarily Property Coverage Boiler and Machinery Coverage is primarily a property coverage. However, some property damage liability coverage is also provided. The coverage protects against damage to an insured “object” or other property of the insured at a designated location as long as the damage results from an accident, which must meet the definition in the policy, to an insured “object.” The form will also cover the insured’s liability for damage to property of others in the care of the insured as long as the damage results from an “accident”, as defined in the policy. As previously stated, using quote marks around a word, such as “accident”, indicates that the definition is stated in the policy. Coverage would be for damage to property, as well as the cost of investigation and defense of claims. Payments made for investigation and defense are made in addition to the policy limits. Also covered are expenses incurred to expedite repairs. This could include such things as air shipment of needed parts and overtime payments for workers to install the part.




Exclusions There are three exclusions that apply to all losses under the policy:

1. war damage and military action; 2. nuclear hazard; and 3. increased cost due to any ordinance or law regulating or restricting

repair, alteration, use, operation, construction, or installation. There may be additional exclusions applying to specified types of losses:

1. Loss caused by an explosion is excluded, but the exclusion does not apply to the explosion of a covered “object” of the following types: (a) steam boilers, (b) electric steam generators, (c) steam piping, (d) steam turbines, (e) steam engines, (f) gas turbines, and (g) moving or rotting machinery caused by centrifugal force or mechanical breakdown;

2. Loss caused by fire or explosion that occurs at the same time as an accident. However, with respect to electrical equipment forming a part of an “object”, this exclusion applies only to fire or explosion outside of the “object” that occurs at the same time as or ensures from an “accident.”

3. Loss caused by explosion of gas or unconsumed fuel within the furnace of any boiler or fired vessel or within the passages from the furnace to the atmosphere, whether or not such explosion was caused by or contributed to by a covered “accident.”

4. Loss caused by an “accident” that is the direct or indirect result of an explosion or fire;

5. Loss caused by water used to extinguish a fire, whether or not the attempt is successful;

6. Loss caused by lightning, provided the loss is covered by other insurance; 7. Loss by flood, unless an “accident” results from the flood, in which case the

damaged caused by the “accident” is covered; 8. Loss resulting from an “accident” to any “object” while being tested; 9. Loss caused directly or indirectly by earthquake, landslide, mudslide, volcanic

eruption, subsidence or any other earth movement; 10. Loss caused by lack of power, light, heat, steam, or refrigeration; 11. Loss caused by a delay in, or interruption of, any business, manufacturing, or

processing activity; or 12. Loss caused by any other indirect result of an “accident” to an “object.”4

Some losses normally not covered may be by adding an endorsement.

4 4th Edition of Property & Liability Insurance, P. 300




Endorsements There are several endorsements that may be added to the basic Boiler and Machinery policy. These include:

1. Business Interruption on either a valued or on an actual loss sustained basis.

2. Extra Expense on an actual loss-sustained basis. This was formerly called Outage Insurance.

3. Combined Business Interruption and Extra Expense on a valued basis.

4. Consequential Damage for actual loss sustained.

5. Utility Interruption on actual loss-sustained form.

It is just as important to buy appropriate coverage for indirect-damage endorsements as it is to purchase the basic Boiler and Machinery policy. Business interruption endorsement As the name implies, Business Interruption Endorsements protect the insured from an interruption to his or her business activities when it is caused by an “accident” to an insured object. Remember, the accident must meet the definition in the policy, which is why “accident” is in quotes. In addition to meeting the policy definition of “accident”, it must occur to the “object” on the insured’s premises. The “object” must be the one described in the policy. There are two Boiler and Machinery Business-Interruption forms. The first is valued and the second is loss sustained. Under the valued form, the insurer agrees to pay the insured a specified daily indemnity for a total interruption of their business or a reduced amount for a partial interruption as the result of a covered accident. Coverage is extended to pay reasonable expenses to reduce the duration of the interruption. Any payments made to speed up the process will cause a reduction in the insurer’s limit of liability. The valued form has a loss adjustment advantage in that the insured is not required to prove the actual amount of loss. There is only the need to show that the business is completely interrupted and will, as a result, be entitled to the stated daily indemnity until the limit of their policy has been reached. The limit of loss is fixed by the insured with the selection of the amount of daily indemnity,




along with the estimated time period that the business could be interrupted. The insured may select 90, 180, 270, or 360 days. In the case of partial interruption of business, the insured may receive that part of the specified daily indemnity that the business loss bears to the business that would have been conducted had no interruption existed. Loss-sustained forms are more popular than valued forms. Loss-sustained forms provide payment for the actual loss sustained as the result of a business interruption. The insured must, of course, prove the amount of the loss, which is defined as the loss of net profit, fixed charges, and continuing expenses. This may be modified to include ordinary payroll expenses. Any coinsurance clauses would apply. Coinsurance requirements can range from 25 percent to 100 percent of the annual value. While there may be some variances, a typical coinsurance clause states:

We will not pay the full amount of any loss if the Business Interruption “annual value” at the time of loss is greater than the “estimated annual value” shown in your latest report or if your report was received by us more than 3 months after the due date, or if your report is overdue. Instead we will determine the most we will pay by the following steps: a. Divide the “estimated annual value” last reported to us by the “annual

value” at the time of the “accident”; b. Multiply the total amount of the covered loss by the figure determined in

paragraph a. above; c. Subtract the applicable Deductible from the amount determined in b. above.

Payment cannot exceed the Business-Interruption Policy limit. The coinsurance clause applies separately to each location insured for business interruption. Two policy definitions are important in the interpretation of the above coinsurance clause. They are: “Annual Value” means the sum of net profits and “fixed charges and expenses” that would have been earned had the “accident” not occurred. “Estimated Annual Value” means the sum of net profits and “fixed charges and expenses” as estimated by you in the most recent annual report. Premiums may be reduced by the use of a dollar deductible or an extended waiting period. This is accomplished by stating that recovery will not commence for a specified number of hours (in multiples of twelve but not less than twelve) following the accident. This has the same effect as a deductible waiting period. Alternatively, the deductible may be stated as a




dollar amount. This is found by taking the number of days to be deducted and multiplying them by an amount of daily indemnity. There is no way to say one form is better than the other since each form has instances in which they apply. The form selected is usually determined by two factors: does the business have fluctuations in earnings and how much the interruption in business will represent an accurate measure of lost earnings. If there are wide fluctuations, the actual loss sustained form may be best. For businesses that have specific seasons in which most of the earnings are obtained, whether or not the interruption would affect earnings would depend upon when it happened. In low season, the loss of earnings may be minimal, but in high season it could mean the loss of nearly the entire year’s earnings. Using an actual loss-sustained form would probably be wisest, even though the valued form is easier to understand. Business interruption rates are based on $1,000 of daily indemnity. Consequently, it is necessary to determine:

1. When the time indemnity is to begin following the loss;

2. The desired dollar deductible; 3. The amount of daily indemnity; 4. the limit of the loss.

Extra expense insurance There are nearly always extra expenses following an accident. For example, firms that are dependent upon steam power produced by a boiler may go to considerable extra expense to rent a portable one until the original boiler may be repaired. The purpose of the Extra Expense Form is to pay those extras that must be covered following an accident to an insured “object.” There is no loss of earnings coverage, so there should be no real duplication, other than the $1,000 of expediting expense, with the Business Interruption Form. Combined business interruption and extra expense There are forms that combine business interruption and extra expense protection. The combination form is designed for the situation where part of the business can be continued at significant extra expense, but in spite of the continuation, there will be a decrease in sales or production that will cause a




loss of income. Both a valued form and an actual loss-sustained form are available. Consequential damage insurance Consequential Damage Insurance, as endorsed on the Boiler and Machinery Policy, is written on an actual cash value basis and applies only to the property while at the location described in the policy. The limit of liability applies to each accident, and there is no limitation on the number of covered accidents. When the standard Consequential Damage Endorsement is attached to the basic Boiler and Machinery Policy, the insured is protected against loss caused by spoilage of specified property resulting from the lack of power, light, heat, steam, or refrigeration due to a covered accident. Depending upon the policy, it can cover any amount that the insured is obligated to pay to others (such as rented meat lockers), as well as the insured’s own property. Rates will be based on each $1,000 of coverage for a one-year policy term. The actual rates will vary depending upon several factors, including the type of object being insured, whether the property is insured only while in storage or at all times, and the coinsurance percentage selected. Utility interruption The Utility Interruption Endorsement is for interruptions of utility services that are off-premises. The source is typically a public utility providing electricity, steam, water, or gas. However, it could be any type of energy. The accident must cause actual physical damage to the utility’s equipment. The endorsement pays for actual loss and is, of course, subject to any policy limitations, deductibles and waiting periods. Glass Insurance Today’s office buildings have more glass than ever before. More glass windows and more glass displays. Glass insurance is actually one of the oldest casualty lines around. The cost of such glass is dramatic. Considering the increased use of glass in buildings and displays, premium volumes actually show a surprising decline in the purchase of glass insurance. There




may actually be a valid reason for this: considering the amount of glass in buildings, relatively little of it is actually covered by the policy and more of the glass premium is being put into the indivisible premiums of the multiple-peril policies. It is also possible that those purchasing the insurance do not realize some of the policy limitations that they are buying. For example, Vandalism and Malicious Mischief coverage typically excludes most glass breakage. The Glass Form insures against breakage of the glass or damage caused by chemicals accidentally or maliciously applied. Breakage is considered to have occurred when the break penetrates through the entire thickness of the glass. How much of the pane is broken does not matter. This type of coverage is written to cover nearly any type of glass, including mirrors. Stained glass in lead sections are usually excluded, however. Policies may cover the cost to repair or replace the damaged glass, lettering, or ornamentation, or their value at the time of loss; whichever is less. The insurance companies usually exercise their contractual options to replace the broken glass and take over the salvage. Only when prompt replacement is not possible do they pay the cash value to the insured. Since the insurers cover many companies, they are in a position to get the best prices themselves as well as the quickest service. It is important for the insured to realize that lettering and ornamentation are only covered if the policy specifically stated so.

It is important for the insured to realize that lettering and ornamentation are only covered if specifically insured.

The insuring agreement covers, where necessary, the cost of repairing or replacing damage to frames, boarding up or installing temporary plates in openings, removing and replacing any fixtures or other obstructions, and removal of the debris of covered property resulting from a covered loss. Payment will be made in addition to the policy limits. As in all policies, there are exclusions. In the Glass Form, those limits include loss by fire, war, and nuclear energy. There is no specific exclusion for scratching, defacing, and so forth since the policy clearly states that only breakage and chemical damage to the glass are covered. Covered glass will be specifically described in the policy. Some types of glass will have a value stated as well. Some policies will insure all glass of described types rather than scheduling each piece individually.




The policy will not be reduced due to payment of a broken glass. Nor will additional premium be necessary following a loss. Provisions for such things as subrogation and other insurance follow the usual pattern. Some types of glass will require special endorsement. This is typically the case for neon and fluorescent signs. The all risks protection is extended, but loss caused by wear and tear, mechanical breakdown, or loss or damage to electrical apparatus caused by electricity, other than lightning, is excluded.


Chapter 14: Insurance Ethics


Insurance Ethics

Principles of honor and morality It is probably safe to say that everyone would consider themselves moral. Of course, it depends upon whose definition of moral is being used whether or not that is true. Perhaps the first lesson in ethics is that there is no right or wrong, merely opinions. Ethics are defined by the New American Webster Dictionary as:

(1) the principles of honor and morality; (2) accepted rules of conduct; (3) the moral principle of an individual.

Sometimes other words, such as moral, may be used in place of ethical, but ultimately the meaning points in the same direction: what we as individuals or a society considers to be right or wrong. The topic of ethics is a complex matter. While it may be simplified into a single statement (Ethics means being honorable and moral), defining what is meant by honorable and moral becomes a complex issue. For example, our society says that it is illegal to defy our laws. Does that mean, then, that it is also unethical to do so? No, it is not unethical to defy society’s laws if the individual believes them to be immoral. Such was the case when individuals helped slaves escape to Canada to obtain freedom. They believed so strongly that slavery was wrong that they were willing to risk not only their own freedom, but also their very lives, for that belief. Obviously these individuals were moral people even though they were breaking the law. Although we now believe, as a society, that slavery is wrong, that was not the thought of the day when slavery was legal. What would apply today? One example under today’s laws might be abortion. It is legal in many states, but that does not mean that everyone feels it is moral. The next question must follow: if a person feels abortion is wrong should they break the law in an attempt to stop it? Does morality mean simply following what one feels is ethical personally or are they obligated by morality to try to force their opinion on society? There are no easy answers. Obviously, the slaves were glad that some people were willing to help them escape slavery, but that is not really the issue. The real issue is whether or not it is right for one person to attempt to force their opinion on another.




There are several ways to examine this question:

1. Does the moral issue affect others adversely? Obviously slavery did. Does abortion? Again, it becomes a complex issue since there are different opinions as to when a fetus is actually considered a person. Is it at conception or when the fetus could survive outside of the mother’s body? When the mother is murdered, the viability of the fetus becomes a legal question (was the baby also murdered?)

2. Are we responsible only for our own actions? In most cases,

society tends to feel each of us can only answer for ourselves. However, there have been some cases that made parents responsible for the actions of their children. In Puyallup, WA parents were held legally and financially liable when their children burned down a school.

3. Can we morally rationalize the forcing of our opinions on

others? Many ethicists state that it cannot be ethical to force an opinion on another. Persuasion must be the road traveled. Perhaps the real question is whether or not it is ever effective to force an opinion on another. Anyone who has children has seen the natural resistance in people to anything forced on them. Do you want another to pretend to agree or actually agree to a moral issue? Some people, out of politeness, may listen to another but that seldom signifies agreement.

State insurance departments have learned long ago that they cannot mandate morality with laws. Certainly consumer laws must be on the books, but that does not mean that unethical agents will follow them. That is exactly why the states have punishments also on the books for those who violate consumer and insurance laws. The hope, of course, is that agents who would otherwise not follow the requirements will do so merely to avoid the accompanying punishments. We know that society’s “morals” change with the times. Women are now allowed to wear pants in public and own property, in most towns it is legal to drink alcohol on Sundays, and every person of legal age can vote (except under some specific circumstances). Philosophers say that ethics is no more than evolved knowledge and, as the previous examples show, this is mostly true. It was in the fifth century B.C. in Greece that the philosopher Socrates gave ethics its formal beginning. The word “ethics” comes from the Greek word “ethos”, which means character. The subject was further developed by Socrates’ student, Plato and later by Plato’s student, Aristotle. Some say that these three so completely explored the subject of ethics that nothing new has been said since (although the subject has certainly been discussed).




Every time we think ethics, as a subject, is no longer necessary something happens to remind us how very important it is. A few years ago, society was looking hard at our government, particularly the Internal Revenue Service. Following that, during Bill Clinton’s administration, morality was the topic. In the new century it was accounting practices of corporations that affects the finances of Americans. When Enron went bankrupt it was discovered that those running the company were acting solely for their own best interest without regard for the financial loss that others would suffer. If it had only been operating without regard for others, the results would have been less unnerving, but the company was also engaging in fraudulent accounting practices. It will probably be years before the public is aware of everything that went on, but those investigating the company are saying it was a jumble of errors that allowed stockholders and employees to lose nearly everything while a few within the company became rich. There will be plenty of blame to go around, but casting that blame (however deserved) is not likely to help those who lost their entire savings and retirement funds. We are only sales people. As agents, we are not expected to know the answers to the universe. We are expected to know our products and our ethical expectations. Unfortunately, when it comes to commissioned sales, ethical conduct can be

in short supply. The insurance company issues contractual agreements to agencies which then hire agents to produce sales. The producers may be expected to produce regardless of how they “make it happen.” When an agency stresses SALES, SALES, SALES without regard to other elements, it is not surprising that the sales force may lose sight of their ethical responsibilities. When there is no ethical leadership, problems may develop that bring in state regulating authorities. More often, however, consumers suffer without realizing the full extent of the problem until years later when it is too late

to do much about it. The selling agent is often out of the business by then, so resolving the issue often falls on the insurance company that issued the policy. People (not just commissioned salespeople) are likely to consider their job and their personal life separately when it comes to ethical conduct. An agent




may “bend the law” or fail to tell the complete truth in order to obtain a sale, while expecting their child to be honest in school. An agent may cheat on their taxes (or on their required continuing education) while expecting their spouse to remain loyal. Can our conduct be divided between “okay for me” and “not okay for you”? Or is ethical conduct something that exists 24/7 for each of us? It might be said that ethics are a recipe for living – day in and day out. Our code of ethics gives us our personal rules and values that determine how we think of ourselves and how others perceive us as well. Our choices will affect everyone we know and love. If we cheat on our taxes we may be financially penalized, which affects those we love. If we cheat on our education, we may make mistakes that affect us financially, which (again) affects those we love. These kinds of mistakes can be measured in dollars, but how do we measure other types of mistakes? If we are not loyal to our spouse, what will the emotional toll be on our mate and on our children? Can that toll be measured? Some results may not be seen for years. How is loss of respect measured? Can it be measured at all? Moral conduct is never a separate part of our lives. It is present during an insurance presentation and it is present when we hug our children. It has been said that touching a rock is contact with our past, touching a flower is contact with our present, and touching a child is contact with our future. What we do today impacts our future. Our ethical conduct is part of everything we do and say. There is no separation possible. In today’s lawsuit prone society, the wise agent will certainly make a point of following state and federal regulations. Some agents will consider that enough. For others, their personal pride in who and what they are will require more. How did I become a moral person? I didn’t plan to be moral. How did it happen? Most people develop their moral code during childhood and adolescence. It is fine-tuned in their adult lives. We may not realize why we dislike cats or why broccoli doesn’t appeal to us, but those characteristics came from somewhere. Unfortunately, parents give their children more of their traits than they realize. The child who hears ethnic jokes will adopt the attitude heard. Children are much more adept at picking up emotions and attitudes than most parents realize. One does not have to actually state they dislike a culture for the child to realize the emotion is there and to accept it as their own.




Moral or ethical conduct is continually learned. Susan Neiburg Terkel reported in her book, Ethics, when Mahatma Gandhi, India’s leader in the struggle for independence from England, was asked why he had changed his views over the course of a week, he replied, “Because I have learned something since last week.” As individuals accept as truth new ideas or new ways of viewing a subject, their attitude will change with their perceptions. That is why ethics is so affected by acquired knowledge. No person is either all good or all bad; we are made up of many elements. Any person can make a bad judgment without becoming a bad person. In the same way, any person can do a kind act without necessarily affecting their future personality. Some individuals choose to be moral by following a specific way of living. This is often the case with those who practice a religion. Their church advocates ways of behavior that follow the teachings their organization perceives to be right. Many churches study the Bible for direction in their daily lives. It is not necessary to “prove” their faith right or wrong. Since ethics is all about perceptions, it is only necessary to “believe” in their way of living. Since mainstream religions all advocate treating others well, it would be hard to believe that their teachings are wrong. Is it necessary to be religious in order to be moral? Certainly not. Any person can be moral. In fact, any person who is acting according to his or her own perceived beliefs of what is right is, in fact, behaving morally. Agreement is not necessary for ethical behavior to exit. Different conclusions may be reached to the same moral question. That does not mean that someone is right and someone is wrong. It means that each person has their own personal view. It is always important to remember that ethics are not about laws or society’s view. Ethics are a personal matter that is individual to each person. Is it really necessary to be ethical? Apparently not everyone believes that it is necessary to be ethical. Certainly not some of those connected with Enron. Few people will have such wealth even available to them, but it does bring up a question: Does money corrupt? Money is neither bad nor good. It is merely a function of our society that enables us to trade goods and services. It is how money is used that changes how we measure the results. Wealthy people who give to charities are not said to be unethical.




Why does one person choose one path while another goes a different direction? There are mountains of books exploring that question, but the simple answer is not complicated. We make our own decisions. While some of what we base those decisions on came from our parent’s teachings, ultimately each of us must take responsibility for the choices we make. When we ask the question “Is it really necessary to be ethical?” we must then assume that people choose to be one way or the other. This addresses four basic issues:

1. Is it possible to teach ethical behavior?

2. Whose ethics would we teach?

3. What does it take to practice morality?

4. Are we responsible for the morality of others?

There is no doubt that each of us affects others, often when we do not even realize it. How we treat the clerk at the store or the driver beside us on the freeway will have a domino effect. The emotions that we spread to others are then spread to those they come in contact with. Each of us has experienced rudeness that affected the rest of our day, yet we continue to treat others in ways we ourselves would find offensive. The golden rule applies to everyone: treat others as you would like to be treated. Is it possible to teach ethical behavior? It is possible to teach children ethical conduct because their personality is being molded. By the time we are old enough to hold an insurance license, there is some debate on the matter. Ideally, each agent would desire to display ethical conduct and a commitment to each client. In reality, that is not always the case. State regulating authorities can mandate behavior and hope that agents will follow what is required of them. Most agents will because they do not want to cause themselves legal problems. Those few who refuse to are unlikely to remain in the profession very long. That’s not to say that they won’t do lots of damage before they depart. It will be the career agent who follows them that will have to clean up their financial messes. Agents who wish to remain in the profession will follow what is legally required, but they may also pick up some ethical direction as well. Usually that is the result of management that expects ethical conduct. Each of us faces ethical questions that we determine as individuals, but our past training as children, our adult experiences, and the schooling we have received will give us direction. We may not realize why we make the decisions we do, but instinctively we seem to know what is right.




When an individual wants to make the right decision but is unsure of what that is, we look to others for guidance. That guidance may come from family, friends, or our church. In the insurance industry, agents turn to the management or the insurance company for direction. Every type of profession has an informal code of ethics (although it may be referred to by many different names). Often conduct is more understood than written. Ethics create standards within any given profession to upgrade it and give it honor. It is a means of measuring individual performance and acknowledging outstanding people. Ethics provide priorities and builds tradition based on integrity. It would be hard to imagine doing business with anyone we knew was unethical or immoral. What client would allow an agent to handle their finances if they knew the person was not trustworthy? Who would take their car to a mechanic that was known for cheating people? Would you allow a doctor to operate on someone you love when he had a reputation of not caring about the quality of his work? Each of us wants a professional regardless of what the job relates to. It doesn’t matter if the professional is our accountant, our doctor, our attorney, or our waitress. We want professional service. Do we think our clients want anything less than that? Egoism: Acting in our own self-interest. Plato argued that immorality is ultimately self-defeating. However, one does not necessarily have to be immoral to act in their own self-interest. Webster’s dictionary defines egoism as the doctrine that self-interest is the basis of all behavior. It should not be confused with egotism, which is the habit of being too self absorbed or conceit. Psychological egoism maintains that people are always motivated to act in their own perceived best interest. Psychological egoism is not an ethical theory since it does not tell people specifically how to behave. Rather it attempts to explain why people behave in certain ways. Ethical theorists may still treat it as a theory, however, since it does have a bearing on their own theories that they wish to introduce as fact (Is this acting in their own self interest?). There is a version of egoism that is a genuine ethical theory because it states how people ought to act. It is called “ethical egoism.” An ethical egoist (again, not to be confused with egotist) argues that people should act in their own best interest at all times because it is good for the general economy, providing industry and jobs, for example. Ethical egoism and psychological egoism are separate and distinct, but they tend to be meshed




together by writers and speakers. We will not, therefore, dwell on the differences either. Just be aware that psychological egoism is an explanation of behavior whereas ethical egoism is a theory of behavior. Many philosophers agree with ethical egoism. The English philosopher, Thomas Hobbes is one who feels the theory can be substantiated with fact. He points out that it is because of ethical egoism that America has become a world leader. Our business men and women worked for their own self interest in building companies that employ millions of people enabling our citizens to maintain one of the highest standards of living. In the marketplace we all try to buy low and sell high. It is unlikely the buyer worries about the seller or vice versa. Each person wishes the best price for themselves. It works well because the practice is both orderly and productive. This is the positive side to egoism. What happens when a person’s self interest is in conflict with the self-interest of another? That actually happens quite often without necessarily hurting the theory. For example, when an insurance agent replaces the business of another, each agent’s self-interest is in conflict. The replacing agent will earn a commission and the one being replaced will lose a commission. The hope is, of course, that the consumer benefits by either receiving more for their premium dollar, or saving the amount of premium dollars being spent. If the consumer saves money, he or she is likely to spend it another way, which benefits our economy. The agent who earns the commission will also spend what they earn. The agent that loses the commission will have to work to re-earn it through another sold policy. Each transaction benefits society in some way. The theory of egoism does not fit well to some acts of heroism where the person is obviously not acting in their own self-interest. We read often of someone who lost their own life or endangered their own life for another. While there are many such examples, perhaps one of the most obvious pertains to the passengers on United Airlines Flight 93. Surely, none of the passengers who left Newark, NJ on September 11th, 2001 intended to be heroes that day. Even so, a united act of many, including Jeremy Glick, Tom Burnett Jr., Mark Bingham, and CeeCee Lyles, saved the lives of others in one of the most dramatic events ever seen in the United States. We may never know what the plane’s target was, but we do know that the willingness of the passengers to act in the interest of others saved the lives of those who were the intended victims. It is doubtful that the passengers of Flight 93 gave any thought to the morality of their actions; they merely came together for the good of people they didn’t even know.




Each of us may be a hero in ways that go unnoticed by others. The child who shares his lunch with another who doesn’t have one, the woman who gives her last dollars to the homeless man, the teenager who volunteers at the local cancer ward are all heroes. They just aren’t acknowledged as such. When anyone gives time or money to a cause or person that has no personal fulfillment, the theory of ethical egoism does not seem to fit. Is it possible for a person to both fulfill their own needs and the needs of others? Apparently it is. How else could we explain the agent who is ruthless when it comes to replacement business, yet gives their time and money to charity on a regular basis? Perception is everything Ethics are totally about perception. Each person perceives what they believe to be right and wrong. There is no “right” or “wrong” to these perceptions. Perceptions of what is right and wrong are taught to us from childhood. Of course, children often receive very mixed messages. Johnny is punished by his father for lying, then overhears him tell his boss he is sick so he can go play golf. Perceptions of ethical or moral conduct depend upon many factors, including society’s views, religious views, and personal views. No person or society can state ethics for universal use. As we said, perception determines ethics. If Johnny decides that it is not ethical to lie, except to the boss, that is then his code of ethics. As long as he only lies under what he perceives to be acceptable conditions, he is maintaining his ethical code. How do we view lying? A study conducted some years ago found that 90 percent of Americans admit to lying occasionally. We legally allow police officers to lie to those they have arrested in the interest of justice. We apparently allow our politicians to lie routinely (since we continue to reelect those that have been caught doing so). Do Americans consider lying an offense? Not according to studies that have been done by the University of California. Americans consider it to be only a minor flaw. Although Americans may not view lying adversely, some organizations certainly do, among those the state insurance departments. While we may not care if our politicians lie to us, we fully expect our insurance agents to be truthful. Insurance departments will follow up complaints against agents suspected of lying to consumers. Penalties will be levied if the agent is found to be guilty.




Exactly what penalties are levied on an agent who is found guilty of misconduct depends upon the state. Misconduct includes many things and will have some variance, also depending upon the state. Promoting ethics is a full time job. While our history shows disagreement from time to time on what is ethical, everyone seems to agree on one point: lack of ethics promotes disorganization, financial turmoil, and sometimes even the demise of governments. While we may believe that could never happen in America, we do have a history that says otherwise. The Southern Confederation was a government that did fall due to a dispute over whether or not slavery was ethical (and therefore legal). As individuals, we may feel that we have little control or even say in our government. In fact, this attitude probably explains why we have such low voter turnout. In other countries that often have no voting rights, their citizens are amazed at our apparent apathy. Perhaps the only real say we do have is in the voting booth. Those that actively seek change have found that their greatest strength lies in a united voting front. This has also been true for those who have sought change in companies and company policy. Some investors want to do more than just invest their money for their future security. Some investors want to invest in companies they can be proud to be a part of. While it is possible to merely seek out such companies and avoid those that do not meet the individual’s standards, some investors have chosen the “activist” role. This is called the activist approach. These investors seek out basically good companies and then become involved in their business practices. The activist investor starts with one basic fact: shareholders own the company.

The activist investor starts with one basic fact: Shareholders own the company.

The average investor does not own enough stock in a company to be able to change how they conduct business or what the business invests in. Without a large voting block, the opportunities to bring about change will be limited. Influence can be increased if an individual is willing to put in a lot of time campaigning for their views, but most people are unwilling to put in the amount of time and energy that would be necessary. The activist investor usually selects companies that influence national policy on issues they care about. Often it is a company that already agrees to




some degree with the investor’s views, but does not routinely follow the path that would promote them. Since the investor understands that each share equals one vote, they work to bring the votes together in one powerful statement. In other words, corporations operate on a one-share, one-vote system. If an investor can influence a majority of the voters, the company will follow the path desired by the investor. Companies often issue thousands or even millions of shares. Therefore, a block of even 25,000 votes may not influence the policies or structure of the company. Even so, it is possible for only a handful of people to sway company policy to a large degree IF they operate effectively to do so. Some small groups have been extremely effective in swaying very large portions of the voting shareholders. Sometimes this is done by attending shareholder meetings and sharing education that sways votes. Sometimes it is done by obtaining proxy rights to voting shares. When small shareholders actively pursue change, they are referred to as gadflies. The dictionary defines gadflies as insects that bite and annoy livestock. It is a fitting description for the shareholders that pursue change. They politically bite those in charge and annoy them by sharing information with the shareholders that often force those in charge to make changes. Gadfly shareholders have been amazingly effective and they have certainly annoyed those in charge of company policy. Gadfly shareholders are not new. They have been effectively influencing company policies for over twenty years. Ralph Nader was among the first (and best known) gadflies. Initially, gadflies were not taken seriously. They first aimed the strategy at the more powerful investors, who were referred to as institutions. This would include banks, trust companies, union and corporate pension funds, mutual funds, money market mutual funds, college endowment funds, and any other organization that had poolings of money to invest. Because of their large amounts of contributors, these institutions had great power when it came to influencing the companies they invested in. Pension funds, for example, hold billions of dollars in investments. Anytime a large institution, such as a pension fund, wants to know a corporations policy regarding a specific topic (such as equal opportunity employment for example) the corporation is quick to comply in a favorable manner. Simply put, gadflies are often able to make favorable social changes that would take decades to achieve otherwise. The changes gadfly investors wish to make may vary, but usually they direct their energies toward social issues. Prior to their involvement,




institutions tended to automatically vote with existing management. Companies now realize that such support can no longer be taken for granted. Gadflies are simply too active these days. A surprising number of individual investors now require their investments to meet their personal code of ethics. While no company is all black or white in their structure, most do meet basic fundamental policies. When investors take the time to investigate companies, even if they are not totally in agreement with their management, there will be many similarities with the desires of the investor. For example, an investor that is opposed to animal experimentation will look for companies that develop products without the use of lab animals. An investor that is concerned with human rights will look for companies that fairly treat all their employees without regard to religion, race, gender, or sexual orientation. What does the investor need to consider to invest according to their own ethical standards? While there may be many factors one wishes to consider, some assumptions must also be made:

1. Every investment has some sort of ethical dimension. 2. Investors can, if they choose to, apply their ethical standards to their

own investment strategies. 3. Investors who do decide to apply their personal ethical criteria may be

more successful than those who do not. Investors are often surprised to find #3 is true. It is not really surprising since the investor must investigate the companies prior to investing. When a company is investigated not only will their ethical approach be learned; the strength or weakness of their production will also be revealed. The reason so many ethical investors do better is simply a matter of financial education. The investor learns much more than they would otherwise know. The most widely used investing approach is called the positive investment approach. It might be referred to as the “invest in what you know and understand approach.” Anytime an investor looks closely at a company more time will initially be required. This is true in ethical investing and positive investing. Either way, the investor must take the time to learn about the company. It may be possible to ask an investment counselor to do the work, but the more successful investors will put their own time and energy into it. Some investment counselors, having received numerous requests, have put together specific investment strategies for specific interests (environment, animal rights, and human rights are the most




common). Investment professionals say the problem they often encounter when trying to put together specific types of investments, such as environmentally sound companies, is obtaining specific information relating to the subject. In past years, companies did not think about such things and consequently did not try to hide adverse elements of the company. Today companies are much more aware of the public’s concerns so they may hide some adverse elements. Some companies are already investing ethically according to their own philosophy. If the company’s philosophy corresponds to the investor’s then it can be easy to decide where to put those investment dollars. However, few companies are totally in line with each investor. In addition, it would be foolish to put all one’s eggs in the same basket. The key to this type of investing is finding companies whose views match that of the investor. If he or she is willing to invest in companies that “mostly fit” their views, it may not be so difficult to find what one is looking for. Investment professionals have discovered another factor when they encourage ethical investing. People are both more likely to invest and also more likely to stay with the advisor when the investing matches their ethical views. Obviously this is good for the professional who makes their living from individual investors. Since money is a deeply personal subject, finances are something that people may not share the details of, even with a money manager. If the topic is first about ethics and those areas the individual finds incompatible with their views, the details of their finances are more likely to come out. This will, in turn, allow the money manager to be more effective. Even with a money manager, however, the investor must become personally involved. It is important for the financial manager to make this point if the investments are to last long-term. Some investors may simply want to avoid some companies based on their business practices. This is called the investment avoidance approach and it is, in some ways, the easiest to follow. Under the investment avoidance approach, the investor merely avoids investing in companies that engage in disagreeable practices. Environmentalists may avoid investing in all logging companies, for example. Animal rights activists would avoid investing in most chemical companies. Basically, the investor is saying “Not with my money!” The Investment avoidance approach is easiest because the disagreeable activity is usually fairly easy to recognize. Obviously logging companies log trees. Beauty products tend to experiment on animals. While a company may be overlooked that would fit the favorable profile, companies that are




disagreeable will also be avoided. The investor simply tells the money manager which industries are not acceptable and the funds invested avoid them. The avoidance technique is seldom used to call attention to disagreeable activities, as some of the other methods are. Rather, these investors merely desire to not personally support any activity they dislike. There is no intent to make a public statement or to bring forth social change. The investor is not interested in provoking public awareness. He or she simply wants to invest in companies and products that do no harm. In addition, it is easier to find companies that do no harm than it is to find companies that promote good. The investor, no matter which method is preferred, must realize that no technique is fail-proof. The avoidance technique is especially not fail-proof since little research is required. The company that appears to use no animal research may actually do so in a sub-company that they own. Combining investment methods for a satisfying result Most investors do not totally use any one method. Most investors use some of each. The two methods most often combined are the positive and avoidance investment techniques. This allows the investor to avoid companies that are obviously at odds with their beliefs while investigating companies that appear to agree with their views. In other words, some companies and products are actively avoided, while others are actively sought out. Positive investing usually tends to go with companies and products that enhance the quality of life in some way. It may be something as simple as a food that is enjoyable or something as dramatic as a medical breakthrough. Companies are often preferred when they participate in the surrounding neighborhood, promote good work relations, and produce a favorable service or product. The National Council of Churches put together the following investment criteria:

1. Do the products meet government standards for quality and safety? 2. Is their labeling adequate and easily understood? 3. Will the products last for a reasonable amount of time? 4. Does the company actively recruit women and minorities?




5. Is the company pioneering safe alternative energy sources or studying

ways to reduce the demand for natural resources? 6. Is the company researching the development of new products or

means of production that will enhance the quality of life? This list may not satisfy the needs of everyone, but it is a good starting point. Again, it is important to realize that companies and products change, especially if management or company ownership changes. What was right for the investing individual this year may not meet the same standards next year. The investor’s criteria may also change. For example, Joe was against the use of animals in research until his daughter was diagnosed with a severe disease. He learns of promising research for a cure using monkeys as subjects. Now he has a personal stake in the outcome of the research. He may have to reconsider his position on the use of animals. How his views change may be determined by how the animals are used. Do the monkeys suffer physically, emotionally, or mentally? Are they sedated to keep their suffering at a minimum? Do the researchers seem to understand the correct criteria for using animals in their research or do they seem cold to the animal’s living standards? All of these factors may impact how Joe changes his views. Few companies will come out of the research as all good or all bad. It just isn’t that simple. Companies want to make a profit and their shareholders want them to make a profit. That is, after all, the point of investing. Most major companies are well diversified which means that an individual may agree with one of their subsidiaries, but not with another. Each investor must make personal decisions regarding which of their views are concrete and which are fluid. Where the investor is firm (absolutely no animal experimentation) investments will require extensive investigation into the companies, but where the investor holds views that simply mirror preferences (I have concerns about the environment), he or she may be flexible in the companies selected. Where do I start? There are multiple avenues for investment. Some have been used for decades and have proven themselves while others are pure speculation. When an agent suggests an investment, he or she should never assume that the consumer understands what is being discussed. “Have you considered




an annuity?” gives the consumer no opening. It would be far wiser to ask, “Do you understand how an annuity works for you?” Because investments tools are so numerous and diverse, investors tend to refer to them as vehicles. A vehicle is simply an avenue for producing the possibility of financial gain. Please note the word “possibility”. Few, if any, guarantee financial gain. Some investments will automatically be eliminated on the basis of ethical views. For example, an investor who was concerned about the environment might automatically be opposed to oil investments. There are two basic categories of investments: debt and equity. Either a loan is made to a company or a division of government (debt) or the investor buys part of a company (equity). If a debt vehicle is purchased, such as bonds, commercial paper or bank notes, a loan is made. If an equity is bought, such as common stock, part ownership in a corporation is made. The value of the interest depends upon the company’s success. If the company is successful, the investor has a right to share in the profits, but only after debt holders receive their interest and principal payments. Unlike debt, the investor’s ownership interest entitles them to a voice in the company’s affairs (the one share-one vote system). The terms, capital gains and income, describe how one makes money on the investments. If the investor sells for a profit, the difference between what is paid and what is received at the time of sale (after deducting brokers’ commissions) is a capital gain. The formula for calculating a capital gain or loss is:

Sale price minus purchase price, minus commissions on both the purchase and the sale

equals either a capital gain or a loss (depending upon the final figure).

Any interest or dividends received are ordinary income. It is possible to get both income and capital gains from some investments. Growth describes investments held for their appreciation in value rather than the income, which might be produced. Investors do not expect to profit from some types of investments until they are sold. A growth investment is a long-term commitment in most cases.




An investment intended for income is generally something that produces income on a regular basis, perhaps even monthly. It may also produce a profit when sold, but that is not necessarily the primary goal. Income investments tend to produce smaller profits when sold than would a growth investment. Most investors tend to seek one or more of each type of investment rather than limit themselves to just one or the other. Balance tends to be the key to successful investing. Investment portfolios A portfolio is a term used regarding liquid assets. A portfolio holds all the investors assets that may easily be turned into cash, thus the term liquid. Liquid assets often include such things as cash, stocks, bonds, money market funds, and mutual fund shares. Non-liquid assets include anything that is not necessarily transferred quickly to cash. That would include an investor’s home, pension plan, antiques, or fine art. Obviously, other items would also fall into this category, although not listed here. A portfolio is strongly influenced by the investor’s age. A person who is still in their younger years, when earnings will continue for some time, will invest differently (or should be) than would a person who was nearing retirement age. Unfortunately, how a person invests is often more likely to be influenced by who rings their doorbell than by deliberate thought. Planning one’s financial future requires time and thought. Many elements need to be considered:

• How many earning years are left? • Can additional income be obtained and shifted towards retirement

planning? • Will college planning be necessary for children or for the adults in the

household? • Should the wage earners consider the possibility of job interruptions? • If retirement is near, where will the investor live after retirement? • What additional costs (such as long term nursing care) should be

considered in retirement?




• If retirement is far away, would it be wise to consider occupation changes to maximize earnings?

This list is certainly not exclusive. Many future costs will depend upon the individual and their lifestyle. One thing is certain: planning for the future is absolutely necessary. This is true whether the individual is 20 years old or 60 years old (and every age in between). Simply planning will not work, of course, unless the plan is followed to some degree. There will always be times or situations that may change the course of the plan, but one must always exist. Financial planning must be flexible, but it must also be precise. General statements (“I plan to retire at 50.”) are useless unless there are measures in place that ensure success. A surprising number of Americans have never even set up a budget, let alone a financial plan. Few financial plans are effective unless a budget is first in place. This is not surprising. How can an individual save for the future if he has no idea where his money is even spent? Where does a person who wants to invest start? He or she first starts with the budget. Map out every expense. From there, look for cash that may be diverted to savings. Once savings have been built up, transfer a portion to an investment. Initially, the savings may go to something essential, such as the first home. As time goes by, the home becomes established and other goals materialize (college savings for the new baby, for example). At some point, retirement will be the goal. When people first begin to save, there is often no real plan in place. As long as a plan is eventually developed, that’s fine. The first step is to learn to save anyway. That first step can be the most difficult one. Our culture does not emphasize saving money; it emphasizes spending it. We receive numerous offers for credit cards, equity home loans, and sales pitches. The simple act of saving part of what we earn can be the most difficult habit to develop. Agents often use the phrase “No one plans to fail; they simply fail to plan.” Part of the reason so many people fail at saving is because no goals have been determined along the way. It is easier to save for something specific than it is to just save for the sake of saving. More than one goal typically exists simultaneously. It is not unusual to be saving for college educations for children and retirement at the same time, for example. Usually the first goal is a down payment on a house.




Along with the big savings goals there should also be some smaller ones. A family vacation is often one of the smaller goals. Most of us need some smaller goals that give rewards along the way in order to stay with the larger long-term goals. Planning for the future is an ethical pursuit. Why? Because it means we are not leaving our future in the hands of the taxpayers or our children. An ethical person cannot expect either to support them financially. Certainly, our children may feel no regret in doing so, but it is never ethical to willingly expect it of them. The taxpayers have no moral obligation to support an individual (although this is often the case as we age and enter a nursing home). Part of planning for our future is the ethical responsibility to plan financially for the costs of aging. How do I know what is ethical? Ethics are entirely about perception. It is not possible to be ethical if an individual is only following someone else’s lead. Ethics must be beliefs that a person feels strongly about. That’s not to say that some people ever establish a moral code intentionally. Many people simply go day-by-day without ever choosing any specific path. However, that in itself is a choice. Moral standards relate to the society the person lives in. Because much of our ethical standards are developed as children, it is expected that each person will take on as their standards those of their parents and friends. Most people also reflect part of their ethical standards on what society deems appropriate. Who doesn’t want to fit in? Scientific discoveries have occasionally changed our perceptions of the world. We no longer believe the world is flat, for example. Science changed our perception of our world. Probably nothing is absolute, so society changes as our knowledge changes. To be absolute one must be fixed and unchangeable. We have all known people who seemed to be absolute, but seldom are they successful as business people or as humans. Some elements may benefit by being absolute. Absolute honesty is certainly a plus. Perhaps it could be summed up best by saying that ethical conduct must be absolute, but the basis of ethics must be flexible to allow for additional knowledge. Some ethical topics have no easy answer. A few years ago, President Clinton wanted to allow equal opportunities for gay and lesbian citizens in the armed forces. There were strong feelings on both sides. Past legal opinions did not seem to offer appropriate answers. In the end, no real change was




made in how the services view gays and lesbians. Some questions simply have no easy answers. How individuals view moral questions nearly always involve their upbringing and education. Both sides of an issue will feel strongly that they are right and the opposing side wrong. From an ethical standpoint, both sides are right if they truly believe so. Being ethically true to oneself never means that society must agree with their views. The variability of moral valuation depends upon each person’s perceptions. Some ethical views seem to be universal and have lasted through the generations. For example, even the very early cultures viewed homicide as wrong and prohibited it within their own community. However, the term, homicide, was not universal. It was both permitted and even encouraged when the victim was an outsider or stranger. The culture of that time considered this to be self-preservation. In some cases, it was permitted to kill the elderly, based on what was perceived as good for the majority of the people. Life was hard and many in the society did not survive the harshness, so some killing served a practical purpose. It is not unusual for society to base their ethical standards on practicality. That may explain the resistance to ending slavery. It was practical for plantations to use slave labor from a financial standpoint. If the North had needed similar labor they may not have been so noble. Of course, there is no argument that slavery served the element of human greed. It is not surprising that greed often leads to rationalization. Past cultures gave little rights to a stranger or outsider. In Greece, the stranger had no legal rights. He would be protected only if he were an acknowledged guest of a citizen. The intentional killing of a citizen was punishable by death whereas the intentional killing of a non-citizen merely resulted in exile. Not all ancient societies were discriminatory to outsiders. The Chinese Moralists pressed for benevolence making no national distinctions. Mih-tsze, who lived in the interval between Confucius and Mencius, taught that we ought to love all people equally. Buddhism commands the duty of universal love. It was the Stoic philosophy that first gave the idea of world citizenship positive meaning and raised these ethical thoughts to historical importance. Today we give voice to freedom and equality for all, but our actions often say something different. America has many lifestyles and it is not surprising that everyone does not agree on moral issues. Moral valuation depends upon personal views. Personal views come from the standpoint of “How will this affect me?” Unfortunately, few people ask:




“How will this affect my community?” In addition, no matter how much we would like to deny it, we still have a tribe mentality. Our definition of tribe has changed, but it still exists. Today we refer to our family, our neighborhood, or our coworkers, but how we react to situations is no different than how past cultures reacted to those outside of their tribe. This perception affects how we view possible threats. What threatens us today? Fear of job loss, social status, or simply a change in our expected routine. Some of us fear for our safety if we live in areas of high crime. Fear affects behavior. Even if not rational, fear will make us treat others differently. Sociologists have felt that fear has been responsible for many of the racial attitudes we have seen in America. People tend to fear what they do not know and understand. People who grew up with mixed races may still have prejudices, but they are less likely when exposure has brought about knowledge. Many prejudices, whether racial, religious, or orientation, are learned from parents, family, and friends. Knowledge is the only way to understanding. Nearly every authority on prejudice has said that education is the best solution for bigotry. Laws may be passed to prevent the most outrageous forms of bigotry, but laws do not change attitudes. When children are exposed to various cultures, ethnic backgrounds, religions, and lifestyles they will understand them and understanding leads to tolerance. It is never necessary to agree with a lifestyle or culture, but understanding is necessary. Once understanding exists, fear subsides. When fear subsides, tolerance is possible. Once tolerance exists, people get to know each other. Knowledge is not necessarily the result of formal education. Many extraordinary people were self-taught. In fact, formally educated people may still be prejudiced. There is the saying: “It is not so much what he knows, but what he understands.” Mores Customs that are enforced by social pressure are called Mores. Mores are relative to individual cultures. They are established by patterns of action to which the individual is expected to conform. Deviation may bring disapproval and perhaps even punishment. While ethical behavior may be dictated by law, laws cannot enforce belief. Since mores are ethical standards that are enforced by social pressure, individuals may not necessary agree with the social standards. Professional groups create standards for their members. Conformity is required in order




to remain in the group. Insurance agents and professional designations must adhere to required standards. Such standards are often a foundation to improve the group’s social standing within the community. Many professionals deal with knowledge that the average person does not possess. Therefore, it is important that the professionals follow a specified code of conduct. Those who seek out the professionals must rely upon their honesty and integrity. It was the potential for abuse of knowledge that provided sets of rules or what is often called ethical standards. Ethical standards may be either written or merely understood. Often what begins as unwritten (but understood) standards become law when too many people do not follow the desired codes of conduct. Mores are not the same for every culture. They will depend upon what the culture considers important for the good of the majority. Many laws develop as the realization develops that there is a need to restrict or direct actions. We often see this in insurance. In the senior market, Medigap policies were originally unrestricted. As problems became apparent, laws were developed. Mores always relate to customs, but not necessarily law (although laws may apply). Customs do often develop into law. Exactly what the mores are will depend upon the culture. The United States is a melting pot, so each culture may have different mores that they follow within their immediate group. Because of the different beliefs, the United States has sometimes been at odds with some groups of new citizens. Governments always expect their citizens to follow the laws, even when those laws go against their culture’s mores. An agent’s ethical requirements Each insurance agent is expected to follow specific laws relating to their profession. While there may be variances from state to state, the basic requirements are similar everywhere. Education Although agents may feel the state is trying to bankrupt them with requirements, it is actually important for the agent to be financially stable. Otherwise, the pressure of being financially insecure may tempt the agent to become




unethical with the consumer’s money. That is one of the reasons states require pre-licensing and continuing education. Of course, they also want the consumers to receive the type of advice that will benefit them. If the agent becomes skilled at their job, the consumer will benefit from their advice and the state will not receive complaints. The agent will benefit from the commissions they earn and be able to remain in business. Any way you look at it, a knowledgeable agent is worthwhile for everyone. Exactly what an agent is required to earn in education will depend upon the state of residency. Agents with a nonresident status must meet the educational requirements of their nonresident state unless that state accepts the requirement of their resident state. If special types of education are required (such as ethics), it is likely that the nonresident agent will need to meet that requirement even if resident education is otherwise accepted. Each state imposes time requirements on the agent’s continuing education. It is not the responsibility of the schooling organizations (often referred to as education sponsors), the agent’s secretary, spouse, or state to keep track of completed education. Each agent is solely responsible for keeping track of completed hours (avoiding duplication of course numbers). Each agent is solely responsible for completing education in a timely manner. Some states require a monitor or proctor to be present during completion of the test. Agents are required to follow state procedures in the manner prescribed. Schooling agencies may not issue certificates of completion if testing is not completed in the manner required. Whether or not the agent agrees with the state’s requirements has no bearing. If an individual wishes to sell insurance or engage in an activity requiring state mandated education, they must comply with the law. There is little point in lecturing the schooling organization. Agents may contact their state insurance department if they wish to input their views. Schooling organizations have no power to change or alter laws. Nor may they change or alter reporting procedures for the convenience of the agent. Meeting the people As every agent knows, no matter how knowledgeable the agent is, if there is no one to sell to, no commissions will be earned. Therefore, one of the most time consuming jobs for an agent is finding a place to be. The method used varies, but whatever method the agent uses, he or she must be sure they do not violate his or her state’s laws.




Each state will have specific laws regarding consumer contact, but a few things seem to be universal. First of all, the agent may not state or indicate in any way that they are representing any state or federal agency. Each agent must clearly state the company they are representing. For example:

“Good morning, Mrs. Jacobs. My name is Brenda West. I am calling you as a representative of American Insurance Company.”

It is always prudent to announce what company or product is being represented. There is no point in using valuable time with a consumer who has absolutely no interest in the product. Agents often feel that consumers will automatically say ‘no’ if they are aware that insurance will be presented. It is true that consumers generally say they are not interested in buying insurance. Of course, they say this before they even know what products are being presented. Despite this fact, it is still important to state who we are and what we represent. First of all, it is required by law, but even if it were not it would be important to do so. A person who feels they have been deceived will not trust the agent enough to buy from them. Trust is very important when it comes to money transactions and insurance certainly falls into this category. It is possible to maintain trust through honesty. Example:

Mrs. Jacobs: “I am not interested in buying insurance. We have plenty.” Brenda West: “It certainly would not be prudent to over-insure. In fact, I find that situation more often than you might imagine. I’ve been in the business a long time, so I can afford to sit back and enjoy my job whether there is a need for additional insurance or not. I don’t just work for a living. I work because I know my trade and I can spot problems that others might miss. I think you’ll benefit from our conversation. You will only be donating some time and I promise not to take too much of it. I’m busy, too.”

Mrs. Jacobs may still turn Brenda down, but if she does listen she will not feel that there was any deceit. Trust will be possible. When trust is established, not only will Brenda possibly get a sale, she will keep the business on the books. Long-term business relationships are often the most rewarding. Agents may also be the target of sales pitches. Their managers try to sell them the art of manipulating sales, even when the agent feels it is not totally




honest. Each person must decide for themselves the sales practices that fall within their ethical comfort zone. The problems develop when agents begin to feel comfortable being less than honest with consumers. There is no replacement for good communication skills. Communication is not only talking, but also listening. A salesperson that listens well always has an advantage over one who tries to do all the talking. It would impossible to know and understand what the consumer is interested in without listening.

Instead of spending one’s time learning the “tricks of the trade”, it would be better to simply learn the trade itself.

What is covered and for how long? Consumers usually prefer simple information that is important to them: what is covered and for how long? Of course, agents must also cover items the consumer may not ask about, especially limitations of coverage. An agent’s greatest area of legal liability is negligence, according to Cheryl Toman-Cubbage in her book titled Professional Liability Pitfalls for Financial Planners. One does not have to be a financial planner to be sued. One of the fastest growing areas of law is lawsuits against agents and their affiliates. Most presentations involve some “set” items. The presentation itself should always follow a specific format, even if consumer questions push it in a different direction. Why? Because using a set format helps agents to prove what they say in each and every situation. Although consumers may not agree, the premium rate is actually the least important part of a presentation. No one has ever been sued because of the cost of the insurance. Negligence, the number one reason agents are sued, center on such things as limitations of coverage, dates of coverage, and failure to properly handle claims. There have also been complaints when an agent fails to cancel a policy as requested. Approximately 95 percent of the E&O claims filed relate to the benefits of the program and how those benefits were explained by the agent. An insurance contract is complex. Because it is a legal contract, it must be written in legal terms or legalese, as it is often called. The contract is technical and hard for many consumers to comprehend, even if they do take the time to read it. It has been said that the insurance policy is the number one unread best seller. As far as our clients are concerned, the only part that matters is that which begins with the words: “We promise to pay. . .”




The type of policy will have much to do with its complexity. It is generally felt that life insurance policies are easier to understand than health policies, for example. While life policies do have many other aspects to them, basically the person insured is either dead or alive. Consumers can understand this concept with little trouble. Medical policies, on the other hand, have numerous conditions, limitations, and clauses. Medical policies have such things as co-payments, stop-loss clauses, elimination periods, and preferred providers. Of course, any policy can cause confusion for the consumer. Even when the selling agent has been very careful, covering every aspect of the contract, the consumer may still end up confused or angry over a non-covered item. There is no way to guarantee that one cannot happen, but communication is always the agent’s best avenue to prevent this. There are some steps the agent can follow to minimize misunderstandings:

1. Full disclosure is always necessary in any type of policy being suggested to a client. Where different interpretations are possible between a brochure and the actual policy, the policy is always the final authority. A brochure is printed for the convenience of the client and agent, but it is never a legal document.

2. Agents often rely on the telephone when they need answers to their

questions. While this is a quick and easy way to understand a product if it would involve any legal aspect, be sure to get something in writing. The company is not compelled to honor misinformation obtained by telephone.

3. An agent should always be slow to replace an existing contract of any

type. This is not to say that some policies should not be replaced. Many in-force policies are old and outdated. The newer mortality tables and newer health plans often offer much more for the consumer. However, it is never prudent to replace a policy without fully examining what is currently in place along with any health conditions that may have developed since it was issued. Health conditions of any dependents should also be considered.

4. Owners and employers of companies may not be enrolled and paying

premiums into worker’s compensation coverage. This could apply to a person of any age who relies on company benefits.

5. Health questions must always be truthfully answered. Wrong

information could cause the policy to be rescinded (taken back) by the company. Misinformation or omitted information is a serious matter to




insurers. Agents who routinely are found to have problems in this area are often terminated by the insurers because they are felt to be untrustworthy. When agents attempt to present an application that is free of health issues, it is called “clean sheeting” the application.

6. Eligibility of applicants is always a concern when replacing an existing

coverage. Any dependents must also be considered. 7. When one coverage is being replaced by another, continuity must be

given prime importance. The old plan should never be canceled until the new plan is firmly in place (issued and delivered for acceptance). The policy should always be viewed for accuracy by the insured.

When filling out the application, the agent must be diligent in answering all health questions and lifestyle questions. Applicants may not necessarily intend to omit information or mislead the insurer. Miscommunication is a constant possibility. For example:

Mrs. Jacobs has high blood pressure that is controlled with medication. Because it is controlled (giving normal readings) she states on the application that her blood pressure is normal. Her medication will alert them, but it should also have alerted the agent.

Many agents like to go through the health and lifestyle questions with their applicants rather than simply handing over the application and waiting for the individuals to fill them out. Insurers typically also have a form for the agent to fill out. It may ask specific questions regarding the apparent health condition of the applicants, such as “Did you observe any oxygen equipment in the home?” Body language should be observed during presentations of insurance. Many people feel awkward saying they do not understanding an issue. Agents who are observant may be able to realize when the consumer does not understand what the agent is explaining. While insurance is technical in nature, it is a mistake being too technical during the presentation, unless the applicant has the background to understand what is being said. Most consumers will not have the technical knowledge of insurance that the agent has. Therefore, an agent who talks above their understanding is not performing his or her job correctly. The role of the agent is not to impress people with their knowledge. The role of the agent is to educate consumers on the purchases they are making.




Policy replacement The insurance field is one of replacement. While many state insurance departments would like to minimize that, it is a fact of life. From the time an agent acquires their license to sell insurance; they are taught how to replace the business of another agent. This is not necessarily bad since many outdated policies need replacement. Unfortunately, many policies that do not need to be replaced are. Some sections of the industry have seen legislation due to inappropriate replacement. This has especially been true of the insurance market that deals with Medicare aged consumers. State departments have liked to say that agents were also stacking Medicare supplemental policies, but that has not been proven by research. Rather, it appears that stacking of Medicare supplements has been the exception, not the rule. However, there is no doubt that supplements were replaced very inappropriately as often as possible. In fact, agents were replacing their own business, often on a yearly basis. The legislature has no way to ban replacement of business. After all, if a consumer wishes to change companies that is their choice. What the states can do is limit the commissions, and that is precisely what they have begun doing. Many types of insurance, such as life products, require replacement comparisons be made for the client and turned in with the completed application. The specific forms used will depend upon the state and their requirements. Does the applicant understand what was said? It is not unusual for a policy to be sold on the basis of assumed facts or information. An agent can imply that which is not totally correct and the applicant may never question it. For example: “Of course you only want to purchase products from A rated companies.” Such a statement would make the consumer assume that the company being represented was an A rated company. If it actually was less, the consumer is unlikely to realize it. If a consumer did question the rating, obviously the agent would then lose all creditability and the sale.




It is never, under any circumstances, permissible for an agent to knowingly allow an applicant to assume false facts. Any seasoned agent has stories of misunderstandings of the facts, but to knowingly allow a misunderstanding to continue is inexcusable. Sometimes it is very difficult to clear up such a situation, especially when the consumer is convinced that they are right in their thinking. Some consumer misconceptions may simply be amusing, while others may cause serious legal problems. When a consumer misconception is not the result of intentional actions on the part of the agent, it may be tempting to let the misunderstanding go by. This is never wise because at some point the consumer will feel the agent is at fault. This could especially be true if the information is corrected by a replacing agent. Career agents say they hate coming in behind an agent that allowed false or inaccurate beliefs to continue. These experienced agents spend most of their time cleaning up after the previous salesperson. While this does tend to cement the sale, it is also time consuming and not always productive. Some consumers, at this point, refuse to believe anything said by anyone. Validating premium cost Most people think everything costs too much these days. Gasoline costs too much; housing costs too much; and insurance costs too much. Agents might even agree with the consumer on this. That still doesn’t change the fact that it costs what it costs. We still drive our cars; we still live somewhere; and we still need to purchase insurance to protect our lives and the financial future of those we love. While there may be no way to really explain why a policy costs what it does it is possible to explain why the coverage is necessary. Agents are often afraid to state policy costs for fear they will lose the sale. Sometimes the agent is correct: they will lose the sale. However, there is no way to soften the cost of any item, whether it is the house one lives in, the car they drive, or the life insurance that will protect their wife and children. Agents may be tempted to incorrectly state the amount of premium. Their hope is apparently to get the insurance in place and hope it sticks. While it is never ethical to mislead a person as to cost, it is also a foolish thing to do. Obviously, the insured will eventually learn the truth and is likely to cancel at that point. If the agent has been paid in advance, he or she will be required to return the unearned commissions.




Applicant signatures Every contract requires original signatures. This is also true for insurance contracts. When an agent is selling a policy, there typically are multiple forms that must be signed. Even an experienced agent has the potential of overlooking one of them. Professionals recommend that agents put the products in packets, each containing every required form. Some forms may not be necessary, but each potentially required form should be included. The agent should then purchase signature tabs. These are tabs of various colors that may be attached to the outer edge of the form, indicating the need for a signature. Doing so will prevent a missed signature, which would require a return trip for the agent. Obviously, it is illegal to forge a person’s signature. That doesn’t mean it never happens. In fact, forging of signatures is one of the most pervasive problems experienced by insurance companies. There are several reasons why signatures are forged by agents. Often agents do not even consider it to be unethical, merely convenient. The agent may have overlooked the required signature on a form. The agent may have been worried about explaining a form (this tends to happen with replacement forms). The agent may be so inexperienced or disorganized that he or she did not realize a form was even needed until they returned to their office. If an insurer suspects a signature is false, they may require every document be resigned. This should come as no surprise, since insurance companies are named along with the agent in lawsuits. Keeping in touch with your clients Perhaps one of the most ethical aspects of insurance has to do with keeping in touch with the applicant following the sale. The hardest policies to replace are those belonging to the agent that has kept in touch. Time is precious to those in commissioned sales since it must be divided between searching for new business, claim work, sales meetings, and family life. What many agents may not realize is that keeping in touch is as simple as dropping a birthday card in the mail at the appropriate time. With today’s computer software, it is easy to know when birthdays, wedding anniversaries, and policy anniversaries arrive. Even a Christmas newsletter is a means of keeping in touch. Ideally, agents should try to maintain some measure of face-to-face contact with their clients. This is not always easy, especially if their clients are in multiple towns or even states. The most common time to re-contact a client




personally is around the policy anniversary date. In fact, some insurance companies actually require anniversary contact. Some lines of insurance are more likely to have contact than others. For some agents, their clients are local and come to their office when they need help with some element of their policies. These agents may hire office staff that does the support work for them. Commingling Funds As every agent knows (or should) company funds are not necessarily their funds. Even when an agent holds a trust agreement with their companies, funds must be kept separate, as required by law. These requirements are discussed in every pre-licensing class. Even so, every year agents are fined or lose their licenses because they have misused the clients or the insurer’s money. Professionals will have a company account used only for consumer funds. Their own accounts will be separate, perhaps even at a different bank. If the agent has a trust agreement, they will maintain two company accounts:

• An operating account, and • A trust account.

The trust account is used for funds that do not belong to the insurance agent. It holds funds “in trust” for either the insurance company or the policyholder. The agent may deposit a check made out to the insurance company into their trust account because they have a trust agreement with the insurer. Any agent who is uncertain how their trust agreement pertains to consumer funds should contact their insurer’s legal department for instructions. Making personal choices Whether or not we choose to be ethical will impact not only our own lives but also the lives of those we come in contact with. This certainly applies to our family and friends, but also to strangers and clients. Much has been written on ethics. All professions require ethical conduct, although some seem to need it more than others. Most of us will never face the really tough issues. We are not doctors who must determine when it is ethical to allow a person to die or perhaps even assist a patient in dying. We are not attorneys who must decide whether or not we can fully back a person accused of




murdering their spouse. We merely have to do our duty as insurance agents. That should not be hard. For most of us, our days move from one to the next without any great moral dilemmas. Our ethical decisions will involve what television shows are appropriate for our children, if we should lie to prevent hurting another’s feelings, or whether we can work for a boss we feel is immoral. For most of us, our lives are not complicated. Why, then, does it seem so difficult to maintain ethics in the insurance profession? It has been said that money is the root of all evil. Money actually has the ability to help others if it is used well. Perhaps it could be more accurately said that greed is the root of all evil. In commissioned sales, greed can certainly play a role in whether or not one acts ethically. An excellent example is that of Michael Milken who, during the 1980’s, earned over half a billion dollars trading in junk bonds. Whether it was greed or a lack of judgment, he used illegal means to increase his wealth using inside information, which was unavailable to the general public. As a result of greed, thousands of stockholders lost substantial sums of money. A current example of such greed may be seen in the Enron Corporation’s management. When Enron went bankrupt it was discovered that those running the company were acting almost solely in their own best interest with little regard for others and how their actions would impact everything from stockholders to retirees. Not until the media became involved were many of the actions even acknowledged by the company. For example, in one transaction Andrew Fastow, Enron’s chief financial officer, took in $4.5 million profit in just two months from an initial $25,000 partnership investment. Many of the partnership transactions were designed to hide huge Enron losses from the investing public while overstating profits to investors. This has been primarily blamed on “accounting errors” by Enron. A German philosopher who lived during the eighteenth century, Immanuel Kant, believed that ethical conduct could be reduced to one universal law governing all morality. He called this law a categorical imperative. He stated one should act in a manner that would be accepted by anyone universally. This would eliminate any bias towards any person since how he treated others would mean he accepted and welcomed the same treatment in return. Viktor Frankl, author of Man’s Search for Meaning, said this of success: “The more you aim at success and make it a target, the more you are going to miss it. For success, like happiness, cannot be pursued; it must ensue and it only does so as the unintended side effect of one’s personal dedication




to a cause greater than oneself or as the byproduct of one’s surrender to a person other than oneself.” All things are relevant to ethics, whether it is how we treat others or obtaining success. Martin Luther King, Jr. said: “Any law that uplifts human personality is just. Any law that degrades human personality is unjust.” Morality is about how we affect people and other living things. A person living alone lying daily to oneself will do no harm. Morality also involves other life forms. It is just as morally wrong to needlessly harm an animal as it is to harm a person. Even when raising livestock for food, there is a moral element to how they are raised and killed. A moral dilemma is a struggle to determine what is right, while a moral conflict occurs when one knows the right path to take but finds taking that path to be undesirable or difficult. It is likely that those who broke the law to help slaves escape were initially in a moral dilemma, which then evolved into a moral conflict. It can be very difficult to take a moral stand that is not socially popular. Simply realizing what moral path should be followed is not enough. Since ethics is entirely about perception, once an individual concludes the direction that is right, he or she is not acting morally unless they also follow that path.

Ethics is the perception of right and wrong. Most of us try to avoid anything that would cause embarrassment or criticism. Even when we feel the moral thing to do is step forward, we may not do so if there are others around. In the 1960’s, following the stabbing death of Kitty Genovese while 38 witnesses did nothing to help her, a study was conducted. The results were surprising. A person is more likely to receive help if only a few people are witnesses. The larger the group, the less likely a person will receive help. It seems people are more likely to wait for a “leader” to step forward if there is a crowd. The smaller the group, the more likely a person is to help another. Fear and moral conflict can be paralyzing. Few people like to perform any activity in front of a crowd (including helping another in trouble). Even when we want to step out of the crowd, we may not do so for fear of looking inappropriate or wrong. Those who are able, despite the circumstances, to step out of the crowd and think and act for themselves possess moral certainty. They know what they must do and they do it. This is not an easy thing. Perhaps that is why there are so few of those types of leaders. Martin Luther King, Jr. was certainly a person who had moral certainty. His job was




very difficult and dangerous, life threatening, in fact. Still, he stepped forward. Why is one person able to perform under extreme duress while the multitude is not able to? Two separate studies have shown that a strict religious upbringing substantially contributes to a person’s moral certainty. There is no ambiguity about what is right and wrong. There are straight-forward definitions of good and bad. Additionally, those who grew up with religion were taught about a person who was able to stand out from the crowd against extreme danger: Jesus. Because this concept is clearly understood, those who grew up with (and believe in) religion have thought out the possibility of standing alone. Because it has been thought out, they are able to respond. Having previously considered the necessity of standing alone seems to make the individual more likely to do so. Another study revealed that when a person is presented with multiple choices, where ideas of right and wrong may not appear concrete, it may have paralyzing effects. The more choices presented, the more likely the person is to be indecisive. The issue of morality could be studied for years, although it has been said that nothing new has been added since Plato. The Golden Rule will always be the universally accepted standard of ethics: “Do unto others as you would have them do unto you.” Obviously our forefathers did not want to be slaves, yet they kept them. Obviously Enron executives did not wish to be robbed of their pensions and savings, yet that is precisely what they did to others. It would be nice to believe that people follow the Golden Rule, but in reality many do not. Because many do not, state insurance departments and other government agencies pass laws to mandate ethical behavior. Why bother with ethical behavior? Why should an individual bother being ethical, especially if those around him do not seem to care? Some years ago, the environment was being discussed in the news. A twelve year old from Ohio wrote: “ If everyone did




their share, no one would have to save the world.” This simple statement makes an amazing amount of sense, yet no one paid much mind to it. Most adults know that everyone is not likely to do their share. That is why organizations always have the same handful of people doing everything (the rest of the membership is too busy). That is why a small group of people can control our government process even to the detriment of the majority. Most people simply do not care enough to get involved in anything, even voting. Unfortunately, this is not likely to change. If one is to be ethical, they must disregard what others are doing (or not doing, as is often the case). No one is ethical by accident. Each person must make a choice to be ethical, because it is the right path for them personally. Most of us make these choices because of those we love. We want our spouse and children to be proud of who we are and what we stand for. We want the respect of those we love and admire. It is easy to be moral when it makes us look good. It is difficult to be moral when it is against popular opinion. Martin Luther King, Jr. said a person’s worth is “not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy.” Perhaps the greatest challenge is not philosophical knowledge but rather moral understanding. Those among us who understand their moral role in life and believe in it will see success that others may not. Success will not always be measured in dollars and cents. Often it will be measured in other ways: a happy marriage, successful children, and loyal friends. Perhaps the best measurement of moral success is a sense of happiness and personal fulfillment.

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Insuring Property and Liability Risks