RISK PROBLEMS/SOLUTIONS

IMPROVEMENTS AND BETTERMENTS

By LeRoy Utschig, CPCU, CLU, ARM

This article will address some of the problems that can be associated with improvements and betterments. An improvement and betterment is anything installed by tenants that cannot be taken with them when they leave, such as light fixtures, wallpaper, floor covering, and interior walls. Since determining what is considered an improvement and betterment can be difficult, adjusters commonly use three tests to determine whether a given item will be considered as contents or improvements and betterments: annexation, adaptation, and intention.

To illustrate, consider the following fictitious examples ... Jan and Brian's Jewelry, LLC (JBJ), a small jewelry shop, moved into a 25 by 70 foot space in a small strip shopping center that had only a few other tenants. Brian was a true craftsman whose specialty was custom-made gold jewelry. To make the store more appealing to customers, Jan and Brian's Jewelry, LLC spent about $50,000 on items such as light fixtures, carpeting glued to the cement floor and walls covered with expensive wallpaper.

In the early morning hours, JBJ's crucible, where Brian melted gold into a liquid, short circuited. It smoldered for a while and finally burst into a small flame. The flame was just starting to spread from the table on which it was sitting when Jan and Brian arrived to open the shop. Seeing the fire, Brian ran to grab the large ABC-rated fire extinguisher while Jan dialed 911. Brian was having a difficult time extinguishing the fire because as soon as he'd put it out, the fire would reignite itself. Insulation on the electrical wiring leading to the crucible had been burnt off. Without the insulation, the wiring would short out, get very hot and cause another fire to start. The volunteer fire department arrived in less than five minutes from the time they got the fire alarm call, just as Brian's extinguisher became nearly empty.

They recognized what was happening, turned off the electricity and then checked the entire premises. The fire department stayed at the scene for several more hours in case the fire reignited.

Jan and Brian had a great deal of work to do. The smoke damage was significant. Thousands of pieces of jewelry needed to be cleaned. The gold melting setup had to be reinstalled. Carpeting and wallpaper had been damaged and would need to be replaced. As the carpeting and wallpaper were attached to the building, they checked with their landlord, Reyer Realty, LTD, to have the landlord pay to replace the carpeting and wallpaper.

Reyer told them that JBJ was on its own for replacing the carpeting and the wallpaper. There was nothing in the premises lease addressing the issue of who was to replace damaged improvements and betterments.

Jan and Brian's Jewelry, LLC then talked with their insurance agent about the damaged building items. The agent looked at their policy and saw the following clause on Insurance Services Office's Form CP0010 0695, Building and Personal Property Coverage Form:

"We will pay for direct physical loss or damage to ... Your use interest as tenant in improvements and betterments. Improvements and betterments are fixtures, alterations, installations or additions: (a) Made a part of the building or structure you occupy but do not own; and (b) You acquired at your expense but cannot legally remove."

Adjusting the loss

Another section of the contract stated how the insurer would pay for an improvements and betterments loss:

"We will determine the value of Covered Property in the event of loss or damage as follows ... Tenant's Improvements and Betterments at: Actual cash value of the loss or damaged property if you make repairs promptly."

There was coverage for the damaged carpeting and wallpaper. As part of the adjusting process, the adjuster asked for receipts for the improvements and betterments and also asked for verification of the value of the display cases and furniture. The only furniture was located in the rear of the premises where Brian did his goldsmithing. A relative of a friend of Brian's had died leaving behind a farmhouse filled with old furniture. It was from this house that Brian had gotten all of his furniture. There were some old heavy tables and some old chairs. JBJ had paid nothing for the furniture. A jeweler who was retiring gave them the display cases at no charge.

A jeweler's block policy was used to insure the stock held for sale by Jan and Brian's Jewelry, LLC. Their furniture, equipment and display cases were insured on a regular property insurance contract. As they had not paid for the furniture and display cases, it had been difficult to determine the proper amount of insurance to cover them. A used office furniture store had given them some guidelines on how to establish values. JBJ insured the furniture and fixtures for $20,000.

The adjuster agreed to the value of the damage. Then she said that she would be applying a coinsurance penalty. Adding the furniture, fixtures and improvements together, the total value was $70,000 ($20,000 + $50,000). As an 80% coinsurance clause had been used, Jan and Brian's Jewelry, LLC should have carried an amount of insurance of a least $56,000 (80% X $70,000). Since they had an insurance limit of $20,000 and should have had $56,000, they would be paid for 36% ($20,000/$56,000) of their loss. In this case, neither the insured nor the insurance agent considered the amount of the improvements and betterments when establishing the amount of insurance.

Another costly coinsurance problem

Hair Creations, Inc., was the name of a beauty shop located in the same shopping center. Recently, it had doubled its size and had done some extensive remodeling. Several new tanning booths had been installed and more chairs had been added to double the capacity of the beauty salon along with adding new flooring, all new built-in lights (they used special recessed lights to give a softer look to everything), a new ceiling and, of course, some very expensive wall coverings. While all new hair drying equipment had been ordered, it had not yet arrived, so they were still using several of the old dryers that had been in service for more than 15 years.

One of the old dryers had an electric short that started a fire about midnight and caused a bright light before it burned through a wall or ceiling. The shopping center was close to the road, and someone driving by saw the fire and called the fire department. While the fire department responded with its usual promptness, the fire had been burning for some time prior to their arrival. By the time the firefighters had arrived, the fire had burned through the ceiling in the beauty shop area and was quickly spreading through the attic from one end of the shopping center to the other. The firefighters were lucky that it was not windy that night. They were able to extinguish the fire and contained the damage to the ceiling of the hair salon and about 25% of the roof.

The landlord, Reyer's Realty, LTD., submitted the fire loss claim to its insurer. As part of the adjusting process, the adjuster requested values of the improvements and betterments installed by each tenant. The shopping center was insured for $600,000, the cost of constructing the building less than a year prior to the fire loss. Adding the cost of the improvements and betterments installed by all of the tenants showed that $300,000 in value had been added to the structure. The total value of the building was $900,000, not its original value of $600,000. As the original construction cost of the building ($600,000) was used in establishing the amount of insurance and the current value was $900,000, a coinsurance penalty of nearly one-third applied to the building loss.

You may recall that the lease used by Reyer's Realty, LTD, did not specifically address the issue of who would pay for damaged improvements and betterments. Because of this, Reyer's Realty, LTD, could tell the tenants that they were responsible for fixing damaged improvements and betterments. However, even though Reyer's Realty, LTD, could tell the tenants to fix their own improvements, this did not alter the fact that the improvements and betterments were permanently attached to the building and were, therefore, a part of Reyer's Realty, LTD's, building value. With an unendorsed property form, the value of the improvements and betterments should be insured because the property insurance description of a covered structure includes the improvements and betterments.

Reyer's Realty, LTD, asked their insurance agent if there was some way to avoid insuring the tenant's improvements and betterments. The owner of Reyer's Realty, LTD, reasoned that the tenant's improvements and betterments were of no value to him. Whenever a tenant moved in, the new tenant would tear out the existing improvements and betterments and install their own. The current agent stated that there was no way to write the property insurance without including the value of the improvements and betterments.

Another insurance agent approached the owner of Reyer's Realty, LTD, to ask if she could quote on the insurance for the shopping center. During the conversation, the owner of Reyer's Realty, LTD, complained that he did not understand why he had to insure for an amount to recognize the value of the improvements and betterments installed by all of the tenants. In response to the statement, the new agent said, "If I can insure your shopping center without needing to include the value of the improvements and betterments, will I have the order for the insurance?" The owner of Reyer's Realty, LTD, responded by saying, "I have been with my current agent for 30 years and he knows what he is talking about. You obviously don't know much about insurance." But, after discussing the issue for some time, Reyer's Realty, LTD, finally agreed to give the new agent the shopping center insurance if she did not need to insure the improvements and betterments.

The new agent prepared a quote and included Insurance Services Office's (ISO) Form CP1420 0695, Additional Property Not Covered. This form can be attached to any ISO form that covers property. The form reads: "The following is added to property not covered."

The form has space into which can be typed the description of property that is to be excluded from coverage. Using Form CP1420 0788 to declare "any item attached to the structure by a tenant" would negate the landlord's need to increase the amount of insurance on the building to include values installed by the tenant(s).

Lease does not change coverage

Premises leases are usually silent regarding the issue of who is responsible for damage to improvements and betterments. Leases can state that a tenant is responsible for damage to improvements and betterments. Sometimes, a lease will state that the landlord is responsible for damage to improvements and betterments. Regardless of what the lease says or does not say in regard to improvements and betterments, unless endorsed off of the policy, the landlord's building insurance will always cover and include the value of improvements and betterments. Only by adding Form CP1420 0788, "Additional Property Not Covered," will the landlord's amount of insurance not need to include the value of the improvements and betterments.

A different shopping center, Hillside, Inc., stated in its lease that Hillside, Inc., would respond for damage to improvements and betterments. Local Hardware Store, LLC's (LHS) insurance agent noticed this while reviewing LHS's lease. The hardware store had put in $200,000 of improvements and betterments. Had the lease not stated that Hillside, Inc., would cover damage to the improvements and betterments, the $200,000 would have been added to the amount of business personal property insurance that Local Hardware Store, LLC purchased. As LHS did not need to insure the $200,000, its amount of insurance was reduced by that amount. To avoid having the improvements and betterments value become a part of any loss settlement calculation, Form CP1420 0788, "Additional Property Not Covered" was added to Local Hardware Store, LLC's business personal property insurance. The $200,000 of improvements and betterments was excluded from the tenant's insurance policy by using Form CP1420 0788.

Hillside, Inc.'s, building insurance values had to reflect the total value of all of the improvements and betterments installed by all of its tenants.

Summary

Improvements and betterments values should be included in the amount of insurance purchased by a tenant.

* A tenant's improvements and betterments are included in the values used as part of the coinsurance calculations for a tenant's loss.

* Landlords also need to increase the amount of their building insurance to reflect the total values of improvements and betterments installed by all of their tenants.

* Coinsurance calculations for a landlord include the value of the improvements and betterments installed by all of the tenants.

* Form CP1420 0788, Additional Property Not Covered, can be attached to exclude improvements and betterments coverage from either a landlord's or tenant's insurance contract. *

The author

LeRoy H. Utschig, CPCU, ARM, is a Wisconsin-based insurance educator, consultant and expert witness.