Commercial property adjuster John Rankin got the call at 8:15 Monday morning. During the night, a pipe in a commercial building's fire suppression system had burst, flooding the premises and damaging 80 percent of the company's inventory.

This was peak selling season for the insured, a wholesale paper supply company. Delivery deadlines were backed up and cash was needed quickly in order to replenish inventory and get back in business.

With 300 open files in his caseload, John was eager to close the file quickly. His decision to sell the damaged inventory back to the insured for 20 percent of its replacement cost seemed a wise decision. He saved the insurer close to $150,000 by not having to remove and dispose of the damaged paper. The insured was comfortable with the final settlement.

What John did not know is that there is a strong secondary market for commercial pulp and paper. Because no competitive forces were present in the one-on-one negotiation with the insured, only approximately 10 percent of the fair market retail value was realized. The issue came to a head when the insurer subrogated against the building owner and the contractor who recently had installed the new fire suppression system. They successfully challenged the claim by arguing that the insurer failed to get fair market value for the damaged paper. The case dragged on for months, generating substantial fees along the way, and the final settlement was well above the carrier's reserve.

Every day, insurers leave money on the table when it comes to salvage recovery. Looking at standard industry practices on an historical basis, it is easy to understand why. Until recently, insurers have had few viable alternatives for selling salvage and, often, negotiated with the insured to retain the goods or sold them locally. Traditionally, the insurance salvage marketplace has been managed by thousands of adjusters and surveyors working through local independent salvors and buyers. The localized approach is characterized by a general lack of consistent standards, limited prospective buyers, and varying depths of expertise handling sales.

Online Marketplaces

New Internet-based auctions have changed the salvage market. Online services such as eBay, SalvageSale, and BlueCycle.com have transformed the marketplace for salvage from local to global, making it fast and easy for adjusters to find market specialists and determine fair market value for damaged goods. The new resources are altering standard industry practices as insurers discover the untapped asset that they have in salvaged goods.

Use of a global marketplace dramatically changes the number of bidders at the table. A traditional auction run by a local salvor might attract three to five bidders and, usually, is conducted via sealed bids. The environment does little to stimulate competition. In an online marketplace, damaged goods are marketed to thousands of potential buyers with interests in purchasing that particular type of merchandise. Given the expanded buyer base, it is common to have 100 or more bids from geographical locations worldwide.

Not only is the participation greater, the process is different. In a typical online auction, participants submit sealed and anonymous bids through the Internet. They can watch the auction on the online marketplace's web site. Prospective buyers are blind to the value of the highest bid and the names of the other bidders, but can monitor the order of the bidding and see exactly where they stand in the process. This heightens the level of competition, as the buyers have opportunities to increase their bids, unlike the traditional method, which allows for only one opportunity.

Statistics show that insurers using global online auctions are increasing their recoveries, anywhere from 50 to 100 percent or more, depending on the line of business and the goods being sold. Results are strongest on higher value salvage and when buyers have access to accurate information.

Despite new opportunities for increased returns, only an estimated 10 to 20 percent of salvage that could be sold on the open market actually makes it there. One factor is the industry practice of negotiating with insureds to purchase damaged materials. This costs insurers money. Without competition, insureds can make low offers, believing that the damaged material is of little or no value to the insurer and capitalizing on their own superior knowledge about the product. When insureds are asked to participate in open, competitive auctions, it is not unusual to see them increase their bids by 50 percent or more from their original offers in one-on-one negotiations with insurers.

Insurers that are serious about maximizing recovery are requiring policyholders who want to retain damaged goods to compete for the goods in open auctions, and it is in the insured's best interest to cooperate. From a contractual standpoint, the policyholder has an obligation not to erode the value of damaged goods. Generating higher salvage proceeds reduces the claim total paid and improves the insured's loss history. This helps keep insurance premiums in check, if not lower them. Clients who understand the role losses play in the price they pay for insurance are quickly convinced of the benefits.

The second factor that prevents salvage from making it to the open market is the “brands and labels” and “control of damaged goods” clauses written into many commercial insurance policies. Although these clauses exist for legitimate reasons, they are costly to insurers and, thus, are reflected in premium rates. Insureds and insurers seeking to better manage premiums should take a second look at policy wordings and explore creative solutions for addressing insureds' concerns. The technology and resources available today provide viable solutions for disposing of salvage while still protecting insureds' brands and distribution channels, and minimizing product liability concerns.

Higher returns on salvaged goods are only the beginning of the story. Insurers that can prove they have received fair market value for damaged goods and have disposed of property in a responsible manner significantly improve their positions in any subrogation proceedings.

A competitive auction in which goods are marketed to a global community of potential buyers provides clear, unassailable proof of the fair market value of the damaged property. When an insurer has this proof of value, the chances that the claim will be challenged on the basis of the salvage value are greatly reduced. It also speeds processing and reduces the expense of subrogating the claim.

Avoiding Unnecessary Risk

As insurers seek to maximize returns on salvage through these relatively new, online marketplaces, they can take a number of steps to protect themselves:

oWhen choosing an auction, make sure that it operates under clearly stated rules and that the process is transparent. Require that the auction provide documentation of every step of the sale process. The fairer the salvage disposition process is perceived to be, the less it will be challenged.

oMake sure that the terms of sale on salvage goods are spelled out clearly. This should include details such as “as is” condition, location of the goods, storage fees and shipping costs, responsibilities of the buyers and sellers, and deadlines for the removal of goods. Include appropriate legal contract clauses such as the waiving of warranties and guarantees. Be clear about when and where title will be transferred, as this can have significant legal implications, including tax liabilities. The more precisely the terms are defined, the less likely it is that post-auction disputes will arise.

oProvide fair and accurate disclosure about the goods. Buyers tend to bid more aggressively when they have good information. Disclose the circumstances that led to the salvaging of the goods, but avoid descriptive adjectives that might be considered matters of judgment rather than fact, and avoid details which may be difficult to guarantee or verify. Providing information about the goods is generally the responsibility of the seller (or the insurer, adjuster, or any other agent acting on its behalf), not the marketplace operator. In addition to enhancing the auction process and improving returns, fair and accurate disclosures improve the finality of the auction process and reduce the risk of dissatisfied buyers.

oClarify any special requirements known to the seller, such as brands and label requirements, geographic resell restrictions, import/export restrictions, and duties.

oHave funds deposited into escrow accounts with reputable stakeholders. This ensures that funds are received and cleared before goods are released. Before accepting transfer of funds, make sure the goods are in the same condition as when auctioned, and that there has been no further damage, theft, or shortage of salvage.

As the pressure to control loss costs continues, salvage offers insurers new opportunities. An effective salvage disposition process offers significant saving potential, while providing insurers with additional protection in subrogation claims they had not enjoyed previously. Equally important, taking advantage of this process requires minimal investment in personnel or training. Given that most adjusters and surveyors have Internet access, no additional investment in technology is necessary. Capitalizing on the opportunity hinges on an organizational commitment to manage salvage as a company asset and to identify processes that maximize return.

Jess Millikan is an attorney with Bullivant Houser Bailey and the managing shareholder in the firm's San Francisco office. Daniel S. Parsley is chairman and CEO of SalvageSale, with headquarters in Houston.