July 23, 2012

Summary: In the early 1900s, blanket property insurance applied almost exclusively to manufacturing and large mercantile businesses. Today, there appears to be no restrictions on the nature of property that can be combined for one limit. The alternative is insurance on a specific (or scheduled) basis. Both have advantages and disadvantages. One problem is that writing insurance on a blanket basis is conducive to certain abuses by policyholders. This article discusses these abuses and how some insurers are dealing with them. The question of whether the coverage as written is, in fact, on a blanket or specific basis is also discussed. As noted, some insurers are able to transform blanket coverage to coverage on a specific basis through the use of special wording couched within their policies, much to the dismay of insureds. How policies are prepared to provide blanket property coverage needs to be pondered carefully or the coverage may result in something less than policyholders commonly expect.

Topics covered:

Blanket versus specific coverage basis
Vertical coverage
Horizontal coverage
Blanket or scheduled—the big issues
The agreed value (or amount) clause
The margin clause
Rationale
A minefield of potential problems
Proceeding with caution
Conclusion

Blanket versus Specific Coverage Basis

A cause of disappointment by some insureds in commercial property loss adjustments is the discovery after loss that the total amount of insurance, even though sufficient to satisfy the applicable coinsurance requirement, is insufficient to fully cover a loss. When this occurs on a policy with two or more items of scheduled coverage, it is especially disturbing to discover that the insurance on other items of the schedule has not been exhausted, yet is not available to apply to the loss.

This situation can be avoided by use of blanket coverage in which different items of property are covered for one amount. Blanket property insurance can be arranged to apply in one of three ways: (1) vertically, where two or more items of property, such as building and the named insured's business personal property, are covered for one amount at one location; (2) horizontally, where a single kind of property is covered at one or more locations, such as business personal property of others; or (3) a combination of (1) and (2), for example, two or more buildings and their contents.

A blanket limit of $1,000,000 for building and business personal property of the named insured and of others has the entire amount of insurance available to apply to the building, business personal property of the named insured, or of personal property others, or all three in the event of a covered loss. For claims adjustment purposes—and particularly for debris removal purposes—there is no distinction between business personal property and building.

Specific, also referred to as scheduled, insurance is another way of covering commercial property. A separate limit of insurance applies to the building, and another limit applies to business personal property. For example, a policy with a total limit amount of $1,000,000 is apportioned with $500,000 applying to the building, $250,000 to business personal property, and $100,000 to business personal property of others in the named insured's care, custody, or control. If a total loss occurs to both building and business personal property of the named insured and that belonging to others, the limits shown on the policy apply separately. These amounts may be sufficient, unless there is a coinsurance deficiency. Debris removal is based on the limit of insurance applicable to the covered property and is limited to 25 percent of the sum of the deductible plus the amount paid for direct physical loss or damage, with an additional amount of $10,000 for each location if necessary. (This amount will increase to $25,000 in 2013.)

Vertical Coverage

The types of property that can be blanketed, according to the Insurance Services Office (ISO) Commercial Lines Manual, are building; personal property of the named insured; personal property of others in the care, custody, or control of the named insured; and tenants improvements and betterments.

Of these types of property, all except building may be written as a single blanket item with a minimum of 80 percent coinsurance at the rates applicable to the coinsurance percentage used. When building is included, the 90 percent coinsurance clause must be used, at a minimum. (As an incentive, the rate reduces with a corresponding increase in the percentage.)

Vertical coverage is usually better than specific (or scheduled) coverage but, depending on the particular circumstances, may not be entirely satisfactory either. Generally, including the building as a single item with machinery and equipment can be beneficial in at least two ways: (1) the question of what items are building and what are machinery and equipment that often arise with such things as machinery foundations and equipment for service of building, is eliminated, and (2) debate is eliminated over which debris removal costs are for building items and which are for business personal property.

With specific machinery and equipment or business personal property coverage, the business personal property limit may be exhausted while there is still unused building insurance. With vertical blanket coverage, the entire amount of insurance is available to pay for damage to either kind of property and for site clearance and removal of all debris, whether from building or business personal property items.

In a worst case scenario, however, since all the property is usually at risk in a single occurrence, even 90 percent insurance to value may be inadequate to pay the entire loss, which, with site clearance and debris removal, may well run to 110 percent or more of the property value on which the 90 percent amount of insurance was chosen. This is especially true if inflation or property additions, or both, have increased the insurable value, and the amount of insurance has not increased.

Horizontal Coverage

If an entity has stock stored at different locations and the values at each location vary, while the total value is relatively constant, horizontal blanket coverage may appropriate. For example, a furniture store has three locations in a city. One of the locations is a warehouse where furniture is received and held until delivered to one of the two stores. Though the inventory at any one location may vary, the annual stock value remains constant. The anticipated average may then be used as the basis of the blanket rate. Provided policy conditions are met, the full blanket amount can be applied to a loss at any location. One policy can provide coverage for the named insured's buildings and personal property at all locations, with a minimum of paper work on the part of the named insured.

Consider, for example, a named insured with business personal property at two locations, valued at $200,000 and $150,000. The property is insured on a specific basis for $160,000 and $128,000 respectively, with an 80 percent coinsurance clause. Imagine a total fire loss to the personal property at the first location. Although the named insured is in compliance with the coinsurance clause, there is still an uninsured loss of $40,000. (The value is $200,000 but the amount of insurance is $160,000.) Now consider the same two locations covered under one blanket policy, with a limit of $280,000 ($350,000 x 80%) and an 80 percent coinsurance clause. Personal property at the first location is destroyed. Under the blanket policy, the entire loss would be payable because the amount of insurance is adequate to satisfy the coinsurance requirement, and the loss is less than the amount of insurance.

Even when personal property fluctuates in value, it may still be feasible to rely on a blanket basis, rather than having to resort to the cumbersome reporting form that requires period reports on a timely basis. Generally, the anticipated average, rather than peak, values can be used in establishing the average rate and the blanket amount of insurance, and as long as the maximum values subject to a single loss do not exceed the blanket limit, full coverage can be provided at the minimum cost. While some paperwork is involved in the initial blanket rate filing each year, no monthly or quarterly reports of values are required, and the danger of invoking the “honesty clause” commonly found in reporting forms when values are underreported is avoided.

Combined vertical and horizontal blanket coverage is the optimum basis. This is where buildings and business personal property, or several kinds of property or building improvement and betterments, are involved in various combinations at more than one location.

Blanket or Scheduled—the Big Issues

Some insureds have found blanket insurance to be a way to save a lot of money, at the expense of insurers, by ignoring the inflationary values of property, obtaining agreed amount endorsements that suspend coinsurance requirements, and purchasing enough insurance to cover the maximum loss at any one location.

For example, a business has five buildings at different locations, where the replacement cost is $1,000,000 each. At 90 percent coinsurance, the required insurance would be $900,000 at each location. The business ignores the increase in inflationary values of the buildings and lists each building on the statement of values (SOV)—a required document with blanket insurance to determine average rates—for $500,000. The total amount of blanket insurance, therefore, is $3,000,000, when, instead, it should be $4,500,000. The amount of insurance deficiency is $1,500,000, not to speak of the average rates charged. To avoid any coinsurance penalty, the business is able to obtain an agreed amount endorsement, which has the effect of suspending the application of the 90 percent coinsurance provision. If the business sustains a loss of $1,000,000, it will be fully covered. In fact, it will be fully covered for a loss up to $3,000,000.

This kind of practice among insureds has become so rampant that insurers have taken a variety of steps to curb this practice. From an underwriting standpoint, this practice has been controlled through the (1) refusal to grant an agreed value (or amount), or (2) issuance of blanket coverage, subject to a margin clause.

The Agreed Value (or Amount) Clause

Purchasers of commercial property insurance have come to learn that the agreed value provision is a good thing to have, particularly in relation to blanket property coverage, so as to maximize the amount of insurance payable in the event of loss. It also avoids having to understand the coinsurance clause, which remains an enigma to many people. Nothing could encourage more policyholders to take advantage of the agreed value provision than the approach taken by ISO with its Building and Personal Property Coverage Form CP 00 10, where agreed value is a “coverage option.” All that is necessary to activate this provision—free of charge—is to designate it in the commercial property declarations.

Agreed Value is listed on the declarations page of the commercial property policy under the section titled optional coverages. When this optional coverage is desired, and the underwriter is willing to provide it, the information required needs to be completed. This information consists of identifying the coverage, its location(s), amount(s), and the expiration date of the agreed amount clause.

To make this optional coverage operational, it is necessary to complete the ISO Statement of Values (SOV) form, CP 16 15. It consists of three pages and requires the agent or broker to complete the first two pages where designated. The following items must be completed; (1) the designation of what items of coverage are to apply on an actual cash value and/or replacement cost basis; (2) the form numbers to apply to these values; (3) the applicable coinsurance percentage; and (4) the causes of loss for which rates are requested. The SOV states that it is optional with the insurer whether the insured must sign this document attesting that all values submitted are correct to the best of the insured's knowledge and belief. The insurer, however, may still require the insured's signature when it is considered necessary.

It is important that the 100 percent values, as listed on the SOV, are accurate, because if they are not, it can distort the rates to the disadvantage of the insurer. The best way to make sure that values are in line with inflationary trends is to retain the services of a professional appraiser every three to five years. Use of the inflation guard may not be of adequate help unless a professional appraisal is done first. Many property owners, however, are reluctant to spend the money to obtain professional appraisal services, so property values can be way out of line despite the use of an inflationary guard, which increases the values periodically. If the actual value of property is a guess, the amount of insurance is likely to be distorted, despite any inflationary guard precautions.

When the agreed value provision is selected, as reflected on the declarations page, it is necessary to also insert the coverage—building and/or business personal property—by location and building number, the expiration date of the agreed value provision, and the agreed value (amount) on the covered property. When the agreed value provision applies, a provision in the Building and Personal Property Coverage form, CP 00 10, states that the additional condition dealing with coinsurance does not apply to covered property to which this optional coverage applies. As long as the amount of insurance is equal to the agreed value, the loss will be paid in full up to the amount of insurance. If the amount of insurance represents values of 90 percent, and a loss is total, it is still possible for the limit to be deficient. What would be necessary here to avoid some deficiency in payment, even though an agreed value provision applies, is valuation at 100 percent. (Another advantage of calculating coinsurance valuation at 100 percent, rather than 90 percent, is a rate reduction.)

The Margin Clause

One of the ways some insurers are dealing with the abuses of blanket property insurance is to include a built-in provision or endorsement that is referred to as a “margin clause.” This clause transforms coverage from a blanket to a specific coverage basis, but with the added provision that the maximum amount payable is a certain percentage or margin above the property's value as listed on the statement of values.

As a point of clarification, use of the margin clause is not limited to abuses by policyholders. One underwriter stated, for example, that the margin clause also is relied on when a risk is subject to a high blanket limits and some certainty is desired with regard to the maximum possible loss at one location, and to provide a fixed target for the amount of reinsurance to be purchased.

For about five years or so, there were no typical margin clauses. Then in 2007 ISO introduced Limitation on Loss Settlement—Blanket Insurance (Margin Clause) CP 12 32. According to ISO Commercial Lines Manual, Rule 34B.6, this endorsement may be used on property written on a blanket basis with or without a coinsurance requirement or agreed value requirement.

When the standard ISO margin clause endorsement is issued, the maximum loss payable is determined by applying the applicable margin clause percentage, indicated in the endorsement schedule, to the value of the property shown in the latest statement of values. According to the previously mentioned rule, the margin clause percentage can range from a low of 105 percent, subject to a rating factor of 0.93, to a maximum of 130 percent, subject to a rating factor of 0.96.

Endorsement CP 12 32 provides examples that should be helpful for a better understanding of the mechanics, such as the following, which explains the mechanics of the margin clause and involves three buildings written on a blanket basis subject to a limit of $4,500,000. The combined value of these three buildings is $5,000,000. With a 90 percent coinsurance requirement, there is no penalty. For Building 1, with a value of $1,000,000 listed on the SOV, and the margin percentage being 120 percent, the maximum loss payable would be $1,200,000 less the applicable deducible. If, in this same example, the named insured were to maintain a $4,000,000 blanket limit instead of $4,500,000, subject to a 90 percent coinsurance provision, any loss payable would be subject to a coinsurance penalty of .889 ($4,000.000 ÷ $4,500,000 required at 90%). The adjusted amount of loss would be $1,200,000 x .889 or $1,066,800 less the applicable deductible. If the applicable deductible were $10,000, the maximum payable would be $1,056,800, with the remainder of the loss, $143,200, to be assumed by the named insured due to the coinsurance penalty and deductible.

Rationale

The apparent impetus for using these clauses was reinsurance requirements following hurricanes and other catastrophic events. An underwriter, in explaining his company's rationale for adding a margin clause to even its better package policies, stated that after large losses involving hurricane, and even following the damage resulting from the September 11, 2001, terrorist attacks, insurers found that many of the properties were underinsured. However, many insureds were still able to capitalize on their recoveries without being penalized. An example is when a policy was written for $2,000,000 on two buildings, with no coinsurance penalty, and with the SOV showing the replacement cost of each building was $1,000,000. If one of the buildings was destroyed, and it cost $2,000,000 to replace it, the named insured could still collect $2,000,000 even though the named insured only purchased $1,000,000 on that building. Another reason for use of the margin clause, as explained earlier, is to give the underwriter some certainty regarding the maximum possible loss and the amount of reinsurance to purchase.

A fallacy of this argument for implementing a margin clause is that $2,000,000 of insurance was actually purchased by the named insured in the example given. So why not give the named insured the coverage it purchased? The answer, as has been explained, is that some insurers may need to know with more certainty the maximum possible loss in those cases where high blanket insurance limits are needed. Some insurers, however, appear to be adding the margin clause on all of its policies without discretion. About the only control against its use will be competition, which is cyclical.

A point to consider here is that underwriters could avoid this problem of insureds capitalizing on blanket insurance by requiring appraisals of real property from certified professionals every five years or so, instead of permitting insurance agents/brokers to calculate estimates based on square footage or other measures, and being more discretionary with issuing the agreed value provision. Chances are, however, that such suggestions will likely be ignored in place of margin clauses, which will most likely become increasingly popular unless insurers continue to use the traditional method of blanket and agreed value coverage as a competitive tool.

Although mention of the margin clause brings to mind a clause where the maximum loss payable is determined by applying the applicable margin clause percentage to the value of the property shown in the latest statement of values, there appear to be other margin clauses that are entirely different than what applies under standard ISO provisions. In Rainbow USA, Inc. v. Crum & Forster Specialty Ins. Co., 711 F. Supp.2d 655 ( E.D. La. 2010), the margin clause applied to a change in premium rates in the event of large changes to the values shown on the statement of values. Specifically, the margin clause stated:

Total values as of the inception of the policy, being September 1, 2004 are $531,475,000. An additional premium or return premium will apply if the total increase or decrease in value during the policy term exceeds 10 percent of the values reported at inception. This clause does not apply to newly acquired locations for the peril of Wind I Florida and Puerto Rico and the peril of Earthquake in California, which are subject to the underwriters rating and additional premium charge.

Since this provision is considerably different from the mechanics of the margin clause, as introduced by ISO, a caveat here is that one should keep in mind that it is not the title of the provision that is important but, instead, what the provision says.

A Minefield of Potential Problems

Some people may view the use of the margin clause to be somewhat harsh, since it, in effect, eliminates the advantage of blanket coverage. Others may view the implementation of a margin clause as being better than covering property on a specific basis. Still others may view the margin clause as not being as bad as initially perceived, particularly when its use is compared to those practices of some insurers that have built-in provisions making the amount payable subject to the statement of values.

Technically speaking, the statement of values is a separate document that is not considered part of the property policy. This, however, does not mean that the statement of values cannot form an integral part of the property policy, because it can. Many insureds, however, do not realize this until after a loss occurs. A case that comes to mind here is Anderson Mattress Co., Inc. v. First State Ins. Co., 617 N.E.2d 932 (Ind. App. 1993), where the named insured sought a declaratory judgment establishing that its property policy provided blanket coverage. In the sums insured section, the policy stated, “At Named Location(s) $2,702,000 per occurrence.” The policy definition of “occurrence” is, “As used herein, Occurrence shall mean any one loss, disaster, or casualty, or series of losses, disasters, or casualties arising out of one event.”

Despite the connotation of the occurrence definition that one amount was available in the event of one loss, the court held that the policy provided specific, rather than blanket, coverage based, in part, on the section of the property policy addressing the limits, which stated:

The Limit of Liability or Amount of Insurance shown on the face of this policy is a limit of amount per occurrence. Notwithstanding anything to the contrary contained herein, in no event shall the liability of the Company exceed this limit or amount in one occurrence as defined on Page . . . of this form.

The premium for this policy is based upon the Statement of Values on file with the Company, or attached to this policy. In the event of loss hereunder, liability of the Company shall be limited to the least of the following:

The actual adjusted amount of loss, less applicable deductible(s).

The total stated value of the property involved, as shown on the latest Statement of Values on the [sic] with the Company, less applicable deductible(s).

The Limit of Liability or Amount of Insurance shown on the fact of this policy or endorsed onto this Policy.

One cannot assume anything about the application of a policy until the entire document is read. This case, incidentally, is not unique. A number of cases exist where named insureds have found coverage to be adjusted on a specific coverage basis in light of the provision as previously noted. Another case containing that identical provision making adjustment subject to the latest SOV is Honda Trading America Corp. v. Lexington Ins. Co., 2006 WL 547990 (E.D. Cal. March 6, 2006).

In Axis Specialty Ins. Corp. v. Simborg Development, Inc., 2009 WL 765298 (N.D. IL March 20, 2009), the policy had an endorsement that limited application of coverage to two provisions, instead of three, as found in other policies. The endorsement stated that in the event of a loss, liability of the company would be limited to the least of the following:

The actual adjusted amount of loss, less applicable deductible(s) or self-insured retention.

100% of the individually stated value for each scheduled item of property, time element, or other coverages shown on the latest Application of Statement of Values on file with the Company, less applicable deductible(s) or self-insured retention(s).

The court also agreed with the insurer's citing of other cases holding that the provision was not ambiguous. One of these cases is Knowlton Specialty Papers, Inc. v. Royal Surplus Lines Ins. Co., No. 03 Civ. 705 slip op. at 4-5 (N.D. N.Y. October 14, 2003), where it was held that “the plain and unambiguous effect of the endorsement, which limited liability to 100 percent of the individually stated value of each scheduled item of property insured as shown on the latest statement of values on file with the company,” was to establish scheduled [specific] coverage. See also Core-Mark International Corp. v. Commonwealth Ins. Co., 2006 WL 2501884 (S.D. N.Y. August 30, 2006).

Interestingly, in Lynd Co. v. RSUI Indem. Co., 2012 WL 1030342 (Tex. App.—San Antonio, March 28, 2012), the property policy contained a Scheduled Limit of Liability endorsement, which read similar to part B. of the policy in the Axis case, except that it also included a margin clause under provision b., which reads as follows:

115% of the individually stated value for each scheduled item of property insured at the location which had the loss as shown on the latest Statement of Values on file with this Company, less applicable deductibles and primary and underlying excess limits. If no value is shown for a scheduled item then there is no coverage for that item…..

If there is any caveat here, it is that no one can take for granted that a property policy written on a blanket coverage basis will actually apply as has traditionally been the case. Or, to say it another way, one should not assume that policy reference to one limit applying to one kind of property at two or more locations or two or more kinds of property at one location, or a policy written on an agreed value means what both of these have come to be in custom and practice.

When the named insured tries to collect on a loss that is substantially higher than the value listed on the statement of values or schedule of locations, a disagreement can occur. In fact, it is not unheard of for a policyholder to demand the entire policy limit for loss of one building on a policy covering a number of other buildings. Even though the statement of values is not part of the policy, the insurer will likely use that document in its defense to show that it does not owe what the policyholder is demanding.

A case on point is Bratton v. St. Paul Surplus Lines Ins. Co., 706 S.W.2d 189 (Ark. App. 1986). The named insured purchased a property policy to cover its buildings and contents at four different locations. The single premium payment was $7,392. A Schedule of Locations attached to the policy set forth the value of each building and its contents with the combined insurance limit of $528,000. During the policy period, the building, its machinery, and contents at location number two were destroyed by fire. Since the schedule valued the building at $80,000 and the contents at $140,000, the insurer paid the named insured the total of $220,000. The named insured, however, felt that since the total blanket amount of coverage was $528,000, the insurer owed it the difference between that amount and the $220,000 that was paid. The named insured maintained that since it made a single payment for the insurance, it was entitled to recover the amount of the loss at the one location up to the total policy limit. Both the trial court and court of appeals found the named insured's arguments, including ambiguity, to be unpersuasive.

This case did not make mention of the statement of values. Whether the schedule of locations was considered to be one in the same as the statement of values appears to be unclear, although it was not a problem to the courts addressing this matter.

Proceeding with Caution

With so many cases involving the question of whether a property policy applies on a specific or blanket basis, what begs a question here is how should the policy be prepared so as to avoid this kind of question (and dispute) after a loss happens? Listing different kinds of property at one or more location on the policy declarations subject to one amount does not appear to be sufficient. Some insurance people may likely know that the intent is blanket coverage, but those who purchase insurance, along with the courts, are likely to need more information to make an informed decision.

One underwriter mentioned that when the policy is prepared for blanket coverage, the policy declarations contain such phrases as “blanket buildings,” “blanket business personal property,” and “blanket business income, with extra expense,” and “blanket limits.” This may be acceptable as long as the policy has no margin clause or other provisions, couched within the policy, where adjustment can also take into consideration the statement of values.

Another insurer attaches an endorsement, depending on the circumstances, to clarify the nature of the blanket coverage to apply. Four endorsements available from this insurer are Blanket Limit at a Single Location, Blanket Limitation (Margin Clause), Blanket Limit for Business Personal Property, and Blanket Building and Business Personal Property at All Locations. When one of these endorsements is issued, the intent appears much clearer than when such endorsements were not issued. The Blanket Building and Business Personal Property at All Locations endorsement states that when there is a loss to the buildings and/or business personal property, the limit of insurance is considered to be equal to the sum of all the limits of insurance for buildings and business personal property at the designated premises.

Named insureds also must understand that when a property policy is written on a blanket basis, it is only the property shown on the SOV that is covered. If a certain property that is damaged or destroyed is not shown on the SOV, the named insured is likely to be required to retain that loss. Whether an unintentional errors or omissions provision could be of any assistance in these kinds of cases is open to question. Much would depend on the facts, including what the E&O provision says. In RSUI Indem. Co. v. Benderson Development Co., 2011 WL 32318 (M.D. Fla. 2011), the unintentional errors or omissions provision was held not to be applicable to an excess property policy that did not follow form with a primary property policy that included that provision.

Not discussed in this case, but nonetheless very important, is when blanket insurance is to apply in a tower of coverage or, in other words, when policies are to be layered. The same caution that applies to layering of liability excess policies should apply here with property policies because some insurers simply are reluctant to provide pure follow form coverage. To have pure follow form coverage, each successive excess policy is to apply on the same terms and conditions as the primary policy. What often happens is that instead of an insurer providing excess blanket coverage, it changes the terms and conditions so that coverage applies on a specific coverage basis instead. This can be very troublesome. The RSUI case is an example.

Conclusion

Blanket property insurance can offer some advantages compared to coverage written on a specific or scheduled basis. Over the years, with the use of an agreed value provision, which suspends the coinsurance clause, insureds have been able to abuse the application of blanket property insurance to the disadvantage of insurers.

The introduction of the margin clause is a way to reduce these abuses. Another way to reduce abuse is for an underwriter not to offer the agreed value option on a discretionary basis.

On a more positive note, the margin clause is also used by some insurers where the policy is subject to high blanket limits, and the insurers desire some certainty with the maximum possible loss to enable them to determine how much reinsurance is necessary.

The way some blanket property policies are prepared, it is not known with any certainty if blanket coverage, in fact, applies. A question often before the courts is whether the coverage is on a blanket or specific coverage basis.

Some insurers, particularly those involved in writing excess property policies, contain provisions commonly found within the limits of insurance section that make loss adjustments subject to the statement of values.

The statement of values is a necessary document to determine the blanket average rates based on the values of the property to be covered. It is not customarily part of the policy, but there are exceptions: Let the buyer beware.

Blanket property insurance written on a primary/excess basis for high limits is subject to the same caveats as when primary/excess layers are necessary with liability insurance. Nonconcurrencies of coverage between the excess layers and the primary policy can exist.