Actuarial Notes

BPP Loss Conditions and Additional Conditions

Study guide: Exam DISC-IA

The loss conditions and additional conditions of the BPP are the rules that decide how a covered loss is reported, valued, settled and shared. The seven loss conditions are abandonment, appraisal, duties in the event of loss or damage, loss payment, recovered property, vacancy and valuation; the two additional conditions are coinsurance and mortgageholders. Both sets apply alongside the Common Policy Conditions and the Commercial Property Conditions. The provisions below are sections E and F of ISO CP 00 10 10 12.

\text{Paid} = \min\left(\frac{C}{p\,V} \times L - D,\ C\right)

\text{Paid}_{\text{vacant}} = 0.85 \times \text{Paid}

\text{TIB} = K \times \frac{n_{\text{remaining}}}{n_{\text{total}}}

  • Symbols: C is the limit of insurance, p the coinsurance percentage, V the value of the covered property at the time of loss, L the loss before the deductible and D the deductible. The first block applies when pV > C; otherwise the loss less the deductible is paid, up to the limit. The vacancy factor applies to covered causes of loss other than the six the vacancy condition removes. In the last block, K is the original cost of a tenant's improvements and betterments, n_{\text{remaining}} the days from the loss to the lease's expiration and n_{\text{total}} the days from installation to expiration.
  • Abandonment: The insured cannot abandon damaged property to the insurer.
  • Appraisal: If the parties disagree on the value of the property or the amount of loss, either may demand an appraisal in writing. Each picks a competent and impartial appraiser, the two pick an umpire (or a judge does if they cannot agree), and a decision agreed by any two is binding. Each party pays its own appraiser and they share the umpire's and other costs equally. Appraisal settles the amount only: the insurer keeps its right to deny the claim.
  • Duties in the event of loss or damage: The insured must notify the police if a law may have been broken; give prompt notice and a description of the property; describe how, when and where the loss happened; take reasonable steps to protect the property from further damage and keep a record of the expense; give inventories of damaged and undamaged property on request; allow inspection, sampling and examination of books and records; send a signed, sworn proof of loss within 60 days after the insurer's request; and cooperate. The insurer may examine any insured under oath, separately from other insureds.
  • Loss payment: The insurer may pay the value of the property, pay the cost to repair or replace it, take all or part of it at an agreed or appraised value, or repair, rebuild or replace it with property of like kind and quality. The cost to repair does not include the increased cost of complying with an ordinance or law. The insurer gives notice of its intentions within 30 days after receiving the sworn proof of loss, pays within 30 days after receiving it once the amount is agreed or appraised, never pays more than the insured's financial interest, may adjust losses directly with the owners of others' property, and pays a share of a damaged party wall in proportion to the insured's interest.
  • Recovered property: Whichever party recovers property after settlement must tell the other. At the insured's option the property is returned to it and it repays what the insurer paid for it; the insurer pays the cost to recover and repair the property, subject to the limit.
  • Vacancy: A tenant's unit is vacant when it does not contain enough business personal property to conduct customary operations. An owner's or general lessee's building is vacant unless at least 31% of its total square footage is rented and used by tenants for their customary operations or used by the owner for its own. Buildings under construction or renovation are not vacant. Once the building has been vacant for more than 60 consecutive days before the loss, the insurer pays nothing for vandalism, sprinkler leakage (unless the system was protected against freezing), building glass breakage, water damage, theft or attempted theft, and reduces payment for any other covered loss by 15%.
  • Valuation: Property is valued at actual cash value at the time of loss, except that building repairs costing $2,500 or less are paid at replacement cost if the building limit satisfies coinsurance (awnings, floor coverings, appliances and outdoor equipment stay at actual cash value); stock sold but not delivered is valued at the selling price less discounts and unincurred expenses; glass at the cost of safety glazing where the law requires it; and a tenant's improvements and betterments at actual cash value if repaired promptly, at a proportion of original cost if not, and at nothing if others pay for the repair. The replacement cost optional coverage substitutes replacement cost for actual cash value (Actual Cash Value, Replacement Cost).
  • Coinsurance: If the value of covered property at the time of loss times the coinsurance percentage exceeds the limit, the insurer divides the limit by that product, multiplies the loss before the deductible by the result, subtracts the deductible and pays that or the limit, whichever is less. When one limit covers several items, the test uses the total value of all of them (Blanket Insurance). The reasoning behind the clause is on Insurance to Value.
  • Mortgageholders: The insurer pays covered building losses to each mortgageholder in the declarations, in order of precedence, as interests may appear, even if the mortgageholder has started foreclosure. If the owner's claim is denied for its own acts or noncompliance, the mortgageholder is still paid if it pays any premium due at the insurer's request, submits a sworn proof of loss within 60 days after notice of the owner's failure, and has told the insurer of changes in ownership, occupancy or substantial changes in risk it knew of. The insurer then takes over the mortgageholder's rights against the owner to the extent of its payment, or may pay off the whole mortgage and take an assignment of it. The mortgageholder gets 10 days' notice of cancellation for nonpayment, 30 days for any other reason, and 10 days' notice of nonrenewal.

A Coinsurance Penalty A building worth $600,000 at the time of loss is insured for $450,000 with a 90% coinsurance percentage and a $2,500 deductible. A fire causes a $120,000 loss. Find the payment using the form's four steps.

Answer

\begin{align*}
\text{Step 1:}\ \ 0.90 \times 600{,}000 &= 540{,}000 \\
\text{Step 2:}\ \ \frac{450{,}000}{540{,}000} &= \frac{5}{6} \\
\text{Step 3:}\ \ \frac{5}{6} \times 120{,}000 &= 100{,}000 \\
\text{Step 4:}\ \ 100{,}000 - 2{,}500 &= 97{,}500
\end{align*}

The insurer pays $97,500, which is less than the limit. With a limit of at least $540,000 it would have paid $117,500, so the penalty costs the owner $20,000 on top of the deductible.

Unrepaired Tenant Improvements A tenant spent $90,000 on improvements and betterments when it moved in. The lease runs 1,825 days from the installation, with no renewal option. A fire destroys the improvements with 730 days left on the lease, and the tenant decides not to repair them. How are they valued? What if the landlord pays to restore them?

Answer Because the tenant does not repair promptly, the improvements are valued at the proportion of original cost that matches the remaining lease term.

\begin{align*}
\text{TIB} &= 90{,}000 \times \frac{730}{1{,}825} \\
&= 36{,}000
\end{align*}

If the tenant repaired promptly, they would be valued at actual cash value instead. If the landlord pays for the repairs, the tenant has lost nothing and the valuation is zero.

Vacancy and a Mortgageholder An owner's building has had only 20% of its floor area in use for 75 days when it is damaged. (a) A fire causes $200,000 of damage and the deductible is $1,000. What is paid? (b) Separately, suppose the owner set a fire that caused $260,000 of damage to an occupied building insured for $300,000, with no coinsurance penalty, a $2,500 deductible and a $150,000 mortgage, and the mortgageholder meets its conditions. What happens?

Answer (a) With less than 31% of the floor area in use, the building is vacant, and it has been for more than 60 days. Fire is not one of the six perils the condition removes, so the payment is reduced by 15%.

\begin{align*}
\text{Paid} &= 0.85 \times (200{,}000 - 1{,}000) \\
&= 169{,}150
\end{align*}

(b) The owner's claim is denied for its own act. The mortgageholder is still paid its interest of $150,000, within the $257,500 the loss would otherwise have paid. The insurer then holds the mortgageholder's rights against the owner for the $150,000 it paid.

How it appears on the exam

  • DISC-IA: The objective is applying the BPP loss conditions and additional conditions. Questions give a claim situation and ask which condition governs it: a dispute over the amount (appraisal), a delay in filing proof of loss (duties), stolen goods found after settlement (recovered property), a building half empty (vacancy), or a lender after the owner's claim is denied (mortgageholders).
  • Calculations: The coinsurance calculation is the core numeric item, often combined with vacancy, valuation or the deductible (BPP Limits of Insurance and Deductible).

Exam traps

  • Value at the time of loss: Coinsurance tests the limit against the value when the loss happens, not the value when the policy was written.
  • Vacancy is two rules: Six perils are not paid at all; every other covered cause is paid at 85%. The 31% test applies to an owner, and the "customary operations" test to a tenant.
  • Appraisal does not decide coverage: An appraisal award fixes the amount of loss, but the insurer can still deny the claim.
  • Mortgageholders are paid despite the owner: The owner's arson or breach does not defeat the mortgageholder's claim if it meets its own three conditions.
  • Abandonment: The insured cannot hand damaged property to the insurer and demand full value; the insurer only has the option to take property at an agreed or appraised value.