The Rough Notes Company, Inc., is not legal counsel and we cannot give legal advice. What we can do is offer some things to think about with regard to the question presented and one possible interpretation of some of the coverage forms.
Q Our client recently suffered a fire loss to their property in California, an apartment complex that was over 90% occupied at the time of the loss. The forms used are standard ISO forms: CP 10 30 10 91, CP 00 10 10 91, and Business Income without Extra Expense, CP 00 32 10 91. The Declarations page shows there is blanket coverage for Business Income. The policyholder leases furnished units with all utilities included.
The Business Income form states under A. COVERAGE, "Coverage is provided as described below for one or more of the following options for which a Limit of Insurance is shown in the Declarations: (I) Business Income including 'Rental Value,' (II) Business Income other than 'Rental Value,' (III) 'Rental Value'."
Unfortunately, the Declarations does not specify, as the form indicates it should. Which one applies?
The original application for insurance of 12 years ago indicates "Loss of Rents" or "Rental Value" was applied for, desired. It is our understanding that "Rental Value" is all-inclusive, including utilities and continuing monthly expenses. Is this understanding correct, or is it necessary to calculate these expenses and separate them from the claim, taking into consideration discontinuing expenses?
The insureds bore these expenses before the loss and included these in the rent, even when expenses for electric and gas drastically rose or fell due to the weather. It is the carrier's position that even though these are technically continuing expenses, since the building is not being occupied, these are not owed. Is this the case?
A We will look at your first question regarding which coverage applies--Business Income including Rental Value, Business Income other than Rental Value, or Rental Value. You mentioned that the original application 12 years ago requested Loss of Rents or Rental Value only. Has the insurance for this coverage been with the same carrier-- uninterrupted--for the last 12 years? If so, the next step would be to see if there have been any changes in the named insured, the operation of the insured or any other factor (other than increases in coverage limits) that would affect the nature of the account. If there have not been, the insurer may wish to correct the error on the existing policy by amending the current policy to fit the original intent.
On the other hand, if there have been changes in the carrier, the entity covered, the nature of the risk or any other major intervening factor, the lines are not quite so clear. Changes in the entity or nature of the account with the same carrier would require a full review of the changes made and the information provided the insurer. Likewise, changes in carrier would require review of the material or information provided the new carrier and the rating and underwriting attached to the account.
Any such review (change in carrier or change in major account factors) would require a full evaluation of the named insured and all operations that the named insured is involved in under the entity designated, at the location designated. In other words, does this specific named insured have any other operations at the location specified as covered under the Business Income coverage such as a retail or office operations?
Is there any income earned other than rents at the location designated for the named insured(s) that is listed? If the answer is no, the only business income exposure is rents and the situation is simplified some. If there are other exposures, operations or sources of business income, the situation is not simple and the application and subsequent information that has been provided the carrier that is providing coverage at the time of loss becomes the determining factor.
Going on to the question of rents themselves and what they do and do not cover, look to CP 00 32 10 91--Business Income without Extra Expense. Under A. Coverage, it states:
We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your "operations" during the "period of restoration." The suspension must be caused by direct physical loss of or damage to property at the premises described in the Declarations, including personal property in the open (or in a vehicle) within 100 feet, caused by or resulting from any Covered Cause of Loss.
1. Business Income
Business Income means the:
a. Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred; and
b. Continuing normal operating expenses incurred, including payroll.
The two components of this coverage are:
1.The net profit or loss that the insured would have earned if there had been no loss. This is not the amount of rents the insured would have collected but the amount of profit earned based upon the legitimate, projected occupancy of the property covered.
A very basic illustration of this concept would be the following: The insured owns a 20-unit apartment. The insured earns a net profit of $100 per unit per month (based upon a minimum of 50% occupancy) after all expenses, payroll and other adjustments have been made. Just prior to the loss, the insured had 18 of the units rented with no known changes to occur in the next six months. A fire totally destroyed the property. It would take six months to rebuild. The insured would be entitled to $100 (net profit per unit) multiplied by 18 (number of units rented) multiplied by 6 months plus continuing expenses.
If the number of renters is not to remain consistent because tenants have given notice or new leases have been signed, the formula is adjusted accordingly. However, proper documentation would be necessary. Without such, net profit would be determined based upon the experience of prior years, adjusted for the current year.
2. The actual amount of normal, continuing operating expenses that the insured incurred. This does not mean that if the insured usually spends around $1,000 per month on electricity, the insured will receive that amount. What it means is that if the insured has to maintain a utility, service or other continuing expense, it will be covered but only for the amount that the insured actually incurred as long as it is a normal operating expense.
Let's use a total fire as an example. The entire building is destroyed. Look at some of the expenses that may or may not be incurred:
Electrical hookups most likely will have to be maintained at the site and the electric company may charge a flat minimum fee per month to maintain this necessary service. The minimum fee as an actual incurred expense should be covered--but only for the amount incurred--irrespective of how much the insured included in the rent charged each tenant.
However, there are exceptions. If electricity is necessary for construction purposes and the electrical usage for the construction operation is in excess of the normal expenses of the insured's operation, it would not be covered.
Cable TV service would not have to be maintained; so even if cable were part of the rent charged a tenant, it is a non-continuing expense and is not covered.
Telephone may or may not be kept in service, depending on the needs of the insured. However, if it is kept in service, only the actual amount of the insured's potentially reduced service (one or two lines and maintenance charges) would be covered--only what is actually incurred. Again, increased costs because of construction are not covered.
Water and sewer may need to be maintained and would be handled in the same way as the electrical and telephone services. What the insured incurs to maintain hookups and reduced usage is covered. Increased costs due to construction are not.
Payroll is covered if employees are actually kept and their payroll expenses are incurred.
Remember, net profit--not the amount of rents--plus the actual, normal, continuing expenses that have in fact been incurred, are the factors used to determine the amount of loss payment. *
©COPYRIGHT: The Rough Notes Magazine, 1999