RISK PROBLEMS/SOLUTIONS

CONTRACTORS' EQUIPMENT PART 2

Employ the used machinery market value when
insuring contractors' equipment.

By LeRoy Utschig, CPCU, CLU, ARM

In the September issue we discussed improved coverage features for larger contractors' equipment schedules. Here we will illustrate other coverage features, some of which would apply only to larger equipment schedules, and other recommendations that can apply to both larger and smaller contractors' equipment schedules. To illustrate the need for the coverages being recommended we will refer to some actual loss situations. You will notice that some of the coverages being recommended are quite commonly used on commercial property insurance contracts but are seldom used on inland marine policies.

One business we'll call Road Paving Contractor (RPC) was having a successful year. Because the weather had been good, RPC had finished their largest job ahead of schedule and had received a bonus for it. They had made so much money that their accountant recommended Road Paving Contractor buy some new equipment to minimize their taxes.

Accordingly, Road Paving Contractor ordered a new design of road paving machinery worth $250,000. RPC sent their best driver with their semitractor and low-boy semitrailer to pick it up on a Saturday. The driver was going down the highway at a moderate rate of speed, and everything was going well. Then it happened! A couple of cars were driving down the same highway at high speeds. Just as they passed the semitruck, one car cut off the other car. The second car swerved and started to skid. To avoid hitting the skidding car, the semitruck driver made a quick maneuver. The sudden sideways move was enough to shift the piece of equipment on the truck. Due to the load shifting, the machine broke the chains and cables holding it to the truck. It fell off of the truck and rolled down a steep, high embankment.

RPC presented a claim to its contractors' equipment insurers. Coverage on RPC's contractors' equipment form was provided for machines with values in the $150,000 to $250,000 range, and several were insured for about $350,000. Prior to the loss, RPC had not called the insurer to add the machine to their schedule. Several days after the loss was reported, the adjuster call Road Paving Contractor to tell them that there was a limit of $50,000 that applied to the newly purchased machine. The clause in American Association of Insurance Services Form IM-810, Contractors' Equipment Coverage, said:

"We cover contractor's equipment acquired during the policy period...the most we will pay for such items...$50,000."

There is no charge for increasing the limit on newly purchased equipment. My recommendation is that the newly acquired equipment limit be high enough to cover the types of machines a client is likely to buy. In the Road Paving Contractor scenario, I would have had a $350,000 limit on newly acquired equipment. The rationale is that if an account is insuring equipment with values of $350,000 each, it is likely to buy equipment with that value or higher. A client whose schedule shows items worth $200,000 is likely to buy equipment worth $200,000 or more. There is no charge for the higher limits on automatically covered newly purchased items. It is also recommended that the policy give automatic coverage for newly leased items. Of course, the limit for leased machinery should be as high as for newly purchased equipment.

In another example, Excavation Contractor (EC) did small jobs with backhoes mounted on tractors, several smaller bulldozers, and related equipment. Each unit was scheduled on EC's Contractor's Equipment Policy. The items were valued at tax value. For tax purposes, most of the items were completely written off in five to seven years. However, all of equipment had value on the used machinery market. Some of the items actually were worth more as a used machine than what Excavation Contractor had paid for them.

A small bulldozer rolled down an embankment when some ground suddenly gave way. The machine was insured for its tax value of $30,000. It had cost $40,000 and would sell for $50,000 on the used machinery market. Knowing the used machinery value, the adjuster was not concerned about the cost of the machine when it was new. All the adjuster saw was a $30,000 policy limit on an item with a used machinery value of $50,000. This loss would be adjusted by deducting betterment from the repair cost and then paying 3/5ths ($30,000 amount of insurance divided by $50,000, the amount of insurance that should have been carried) of the depreciated value of the repairs. Here is the actual clause the adjuster quoted from the American Association of Insurance Services Form IM-810, Contractors' Equipment Coverage:

"You must maintain a minimum coverage amount for each described item. This minimum coverage amount is the full actual cash value of the described item. If the coverage amount at the time of the loss is less than the minimum coverage amount, we will pay only a part of the loss. Our part of the loss will be determined by dividing the coverage amount by the minimum coverage amount."

The reason why many insurers use the used machinery value as the actual cash value is that in the event an item is totally destroyed, the insurer would need to go to the used machinery market to buy a unit to replace the damaged one. The insurer is simply using the same values for adjusting a small loss as it would for a total loss. It is usually impossible to buy used machinery at an accountant's determined tax value.

My recommendation is to employ the used machinery market value when insuring contractors' equipment. The example of used machines appreciating in value has been a very real factor during economic times of high inflation. Whether high inflation is involved or not, the used machinery values are a realistic equivalent to "actual cash value."

Using the used machinery values is one recommendation to minimize the likelihood of a coinsurance penalty, but there is another feature to add to the contractors' equipment policy to guarantee there will be no penalty. Adding American Association of Insurance Services (AAIS) Coinsurance Waiver, Form IM-120 prevents any coinsurance penalty from being applied. It reads:

"The coinsurance provision is deleted."

This does the same thing that an "agreed amount clause" does on Insurance Services Office's (ISO) commercial property forms. There is one important difference between the ISO form and the AAIS form. Unlike the property form, the American Association of Insurance Services form does not contain an expiration date.

A problem that was part of the loss adjusting process for Excavation Contractor (EC) was that the adjuster could not find the bulldozer listed on the policy. EC had made a number of changes to the schedule, but the insurer's underwriting services unit had not yet issued the change endorsements to add the bulldozer to the schedule. Frequent changes to the list of the equipment, adjusters needing to verify that a unit is on a policy, and underwriters not getting endorsements out in timely fashion can be addressed in a very efficient way. American Association of Insurance Services Form IM-5, Large Schedule Endorsement, can be added to any contractors' equipment form. Here is the direct quotation from
IM-5:

"We cover only those items that are listed on the schedule dated xx/xx/xx. This schedule is on file at our office...The coverage amount shown for each item is the most that we will pay for a loss to that item."

When Form IM-5 is added to the contractor's equipment policy, there is no schedule of items shown and there is no need to endorse a policy whenever an insured adds or deletes a piece of equipment. This form is only a partial solution. IM-5 eliminates the need for frequent endorsements when an insured buys and sells equipment. However, this form does not automatically cover new equipment, and the equipment is covered only for the amount shown.

Part of the problem can be minimized by having the insured maintain a list of the equipment in its computer. As the business changes equipment, it simply updates the equipment list in its computer and sends a copy of the list to the insurer. Under a true blanket coverage endorsement, coverage is not limited to the amount shown on a schedule. Several insurers will attach a large schedule endorsement without a limit per item or without restricting coverage to those items on the list provided to the insurer. This is the preferred way to provide coverage.

For example, a Northwestern Wisconsin small bridge builder (SBB) had been building highway overpass bridges for many years. During that time, all of its equipment either sat on the ground or on bridges. Small Bridge Builder won a contract to build a bridge over a small river. Because the bridge span was too long for its cranes to reach the middle of the new bridge from either riverbank, SBB rented a barge on which it could sit one of its cranes. The barge could be moved to the middle of the stream and sit there, with the crane on it, all during the time the bridge was being built. Things went along okay until a large thunderstorm stalled over the area and six inches of rain fell in six hours. The river rose rapidly. Opposite ends of the barge were securely fastened so that the barge could not move from the spot. However, the moorings did not have enough slack for the barge to rise as the water level rose. Instead, due to the tight moorings, one side of the barge rose as the other side stayed down until the barge became so slanted that the crane fell off into the river.

As soon as the waters receded, Small Bridge Builder reported this loss to its insurer. The adjuster called to report that there was no coverage. Here is the actual wording from Form IM- 810, Contractors' Equipment:

"We do not cover property that is waterborne."

Most contractors never have equipment with a waterborne exposure. However, there are some contractors that do. Many times, unless an agent is diligent about asking, the agent or insurer will not be aware of a water exposure until after the loss has occurred. With a minor water exposure, a regular insurance company might be willing to cover the waterborne risk. Should there be more than a minor exposure, waterborne exposures will probably need to be insured with insurers who have expertise in wet-river marine exposures.

A firm we will call Local Plumbing Contractor (LPC) did normal plumbing work inside residences and small commercial buildings. They also installed laterals. A lateral is the name for the pipe that connects a property's water system to the water main that goes by the property. Many times this means that a small trench will be dug from the side of or in the middle of the road to the property's water connection by the building. Local Plumbing Contractor had a medium-sized backhoe to dig these trenches. It was a tractor with a front-end loader at the front of the tractor and a backhoe at the rear of the tractor. The backhoe dug the trenches and the front-end loader was used to push the ground back into the trenches.

While LPC was doing work in the street, an uninsured drunk driver hit the backhoe and severely damaged it. Needing to finish the job quickly, Local Plumbing Contractor rented another backhoe so that they could continue working while their own machine was being repaired. LPC reported the loss to the insurer, but there was no discussion regarding the cost of renting the backhoe. Local Plumbing Contractor presumed that their contractors' equipment form covered the cost of renting temporary equipment just as they had rental reimbursement coverage on their own personal auto policy. It was not until the adjuster and Local Plumbing Contractor were discussing the final settlement that they talked about rental reimbursement. LPC learned that there was no coverage for the cost of renting a substitute piece of equipment.

The owner of Local Plumbing Contractor was told by his agent that rental reimbursement was not available as his underwriter would not give this coverage. However, he later learned, while getting several bids on his insurance program, that rental reimbursement coverage was available since two of the quoting agents included the coverage. Here is the pertinent wording from American Association of Insurance Services Form IM-810-13, Rental Reimbursement Coverage:

"In the event of a covered loss, we also cover your cost to rent machinery and equipment to replace covered property. This applies only if...you do not have other equipment for similar use and it is necessary for you to rent equipment to continue the normal operation on work in progress."

Form IM-810-13 has two provisions that are typical of this type of coverage. There is a three-day deductible, and coverage is for 80% of the rental costs after applying the deductible. Here is actual wording from the Rental Reimbursement Coverage Endorsement:

"Coverage begins 72 hours after you report a loss to us...the most that we will pay for a loss...80% of the actual rental costs..."

Summary

These are the coverage points I recommend on contractors' equipment policies:

Used machinery prices are a close approximation to actual cash value. Verify this with your insurer(s) and show used machinery prices on the schedules rather than tax depreciated value(s).

* Waive the coinsurance clause.

* Increase the limit on the automatic coverage for newly acquired equipment to reflect the types of values already insured.

* Be sure there is automatic coverage for newly leased equipment.

* Rental reimbursement coverage should be added, particularly for those smaller contractors who have few pieces of key equipment.

* Consider replacement cost as an option.

While not many contractors will have the exposure, double-check with your contractors regarding water exposures. You don't want your first notice of no coverage to be after your machine has been dumped in the water.*

©COPYRIGHT: The Rough Notes Magazine, 1997