AT THE MARGIN
Blanket insurance and the impact of margin clause endorsements
When insured on a blanket basis, if a building is destroyed in a covered
claim, the limit would allow for the complete
reconstruction of that building, even if its initial replacement cost estimate was too low.
Risk Managers’ Forum
By Paul Martin, CPCU, and Cat Ferris, CIC, CRM, CPCU, CLCS, AU
Mastering commercial property insurance is one of the most challenging things for an insurance professional to accomplish. Professional insurance educators notice this struggle frequently. This is because commercial property insurance contracts are long and complicated, and the number of ways a policy can be endorsed to change coverage seems endless.
Additionally, the agent also bears a responsibility for ensuring that the limits provided by the policy will adequately protect their client in the event of a catastrophic loss. This often entails calculating the replacement cost of buildings, inspecting the policyholder’s locations, and auditing records of their inventory. The more property that is to be insured under a commercial account, the more daunting this task can become for the client, the agent, and the underwriter.
One of the methods of writing a commercial property insurance policy is to “blanket” the coverage. A blanket policy provides coverage under a single limit for the total values of the insured’s buildings, business personal property, or a combination of both. This helps the insured if there is uncertainty as to whether they have purchased enough insurance on any single building, or any business personal property across buildings or locations.
How blanket insurance works
Let’s look at an example of how blanket insurance works: ABC Inc., owns multiple buildings across the state. They have estimated the replacement cost of each building as follows:
Location 1: $950,000 Location 6: $400,000
Location 2: $1,200,000 Location 7: $1,600,000
Location 3: $1,850,000 Location 8: $800,000
Location 4: $700,000 Location 9: $725,000
Location 5: $1,300,000 Location 10: $1,475,000
Due to various economic factors and an unknown rate of inflation, ABC Inc., isn’t entirely confident that their estimates to rebuild any one building would remain accurate. So, ABC blankets the coverage for all their buildings—adding together the limits for all of them into one combined limit of $11 million. When insured on a blanket basis, if a building is destroyed in a covered claim, the limit would allow for the complete reconstruction of that building, even if its initial replacement cost estimate was too low.
Blanket insurance for business personal property
Blanket insurance also works for business personal property (where the benefits can be seen very quickly). For example, if a retail business has several locations around town, and inventories are moved from store to store as needed, there may be ongoing uncertainty that any one location has enough limit of insurance for business personal property should a loss strike any one store. Of course, the most obvious solution would be to carry sufficient limits at each location to cover the maximum possible loss.
But this option may seem like overkill to many clients, as it’s likely that most of their stores would have limits that are far higher than the amount of inventory that they’ll actually carry at any one time. This is when blanket limits become an ideal solution. The retailer could determine the maximum amount of business personal property they typically have across all locations and insure it all on a blanket basis with a single limit applying to all their stores.
Blanket insurance can also be used to add together the value of the building and the value of the business personal property into one limit for both. This is particularly helpful when it is difficult to determine what elements of the property should be considered “building,” and which elements are business personal property. This situation can arise within many industries—manufacturers with installed or bulky machinery, restaurants with cooking equipment, or even churches with built-in features like pews or organs.
What about the rate? Since building rates are significantly lower than the rates for personal property, this type of blanket policy will use an “averaged”rate to apply to the combined limit. When using blanket insurance, the insured is expected to provide a Statement of Values for the buildings and/or personal property at each location. These values are used to build the blanket limit. Each year, this statement of values is revised for the renewal’s new blanket limit.
Advantages and disadvantages for the insured and insurer
Blanketing property insurance limits has several advantages and disadvantages for both the insured and the insurance company. While the standard coinsurance percentage defaults to 80%, the Commercial Lines Manual dictates that blanket policies be written with coinsurance percentages of either 90% or 100%. This gives the insured less “wiggle room” in making sure limits are adequate to reflect the actual value of the blanketed property at loss time, meaning that a coinsurance penalty may still be possible in the event of a partial loss. That said, if the insured blankets coverage, they can rest easier knowing that any particular total loss would have ample limits. That’s a big advantage.
For the insurance carrier, obtaining enough information about the true values of buildings or contents on a blanket basis, particularly across locations, can be a time consuming (and expensive) process. Savvy business owners understand this and may hedge their bets that the insurance company isn’t going to go through the trouble of surveying every location.
This aspect of determining blanket values across locations may also tempt an insured to “low ball” their statement of values knowing that by carrying less limit on a blanket basis, they are saving on their premium, much to the disadvantage of the company.
Note: Without getting too deep into the actuarial science of insurance ratemaking, it helps to understand that one of the factors that goes into rate development is the building’s probability of total loss. Let’s say that a building is insured for $1 million. The actuaries assume that the majority of policyholders will suffer only partial losses, so the property rates are developed accordingly.
Similarly, most business owners understand the unlikelihood that their building would face total destruction, which is why there exists the temptation to intentionally underinsure their properties.
This tendency to undervalue their buildings is why coinsurance provisions were introduced in the first place—because ensuring that policies are written with adequate limits gives the insurance company better rate accuracy over time.
Margin clause endorsement
The above scenario is the reason for the introduction of the Margin Clause endorsement: Limitation on Loss Settlement – Blanket Insurance (Margin Clause) Endorsement CP 12 32. Insurance companies didn’t want to run the risk of “getting played” by an insured who low-balled their statement of values, nor have to frequently go through an expensive appraisal process after a partial loss to the blanketed property in order to apply any coinsurance penalty.
A margin clause endorsement is fairly straight-forward. It applies a percentage to property at any particular location, and is the maximum that would be paid for a loss based upon the statement of values submitted to the insurance company before the policy year began. These percentages could be 110%, 115%, 125%, or even higher. It is up to the company, and it’s negotiable.
Consider the example of ABC, Inc. The statement of values lists 10 buildings, with the intent to insure all properties under a blanket limit. Location one suffers a total loss during the policy term. The statement provided to the insurance company values the lost building at $950,000. The margin clause endorsement uses a percentage of 110. In this case, the insurance company would owe no more than $1,045,000 for the total loss. If the insured had closely valued the building, this loss payment limit should be enough to properly indemnify the insured. However, if ABC Inc., had undervalued the building, they could receive less than enough payment to replace it.
What agents need to keep in mind
Margin clause endorsements can surprise even a seasoned insurance agent. Their existence is another reason to closely review newly issued or renewed policies. Agents should recognize that some insurers may have internal policies that place margin clause endorsements on any policy that is carrying a blanket limit.
If the agent has negotiated with underwriting to not place a margin clause endorsement on the policy, or to carry a higher percentage, that word may not have gotten to those processing the issuance of the policy.
Commercial property insurance has many twists and turns that can trip up an insurance agent. Getting educated on the details and staying up to date are the only ways to master the subject. Learn more about commercial property insurance in the CISR Insuring Property or CIC Commercial Casualty courses.
Paul Martin, CPCU, is director of academic content at The National Alliance for Insurance Education & Research headquartered in Austin, Texas. Paul works to develop, maintain, and deliver quality educational programs for the organization. Paul has over three decades in the insurance and risk management industry.
Cat Ferris, CIC, CRM, CPCU, CLCS, AU, is the commercial lines academic director with the National Alliance. In her twenty years of experience within the industry, Cat has focused most of her career in commercial underwriting and independent agency training. She is based in Gainesville, Florida, and can be reached at firstname.lastname@example.org.