By LeRoy H. Utschig, CPCU, ARM
Restaurants seem to be everywhere. Some are parts of large chains. Others are individually owned. There are huge nightclubs as well as small one- or two-worker diners. The basic insurance program for a restaurant consists of property insurance for the building and business personal property, liability, workers compensation and, sometimes, auto exposures. We will take a closer look at several of these coverages to determine if there are coverages--using examples of fictitious restaurants.
Tenants' property
Local Restaurant, Inc., which rented its location from Landlord, LLC, was insured on a businessowners-type of insurance contract. The policy required that the business personal property coverage be written for an amount equal to 100% of the replacement cost of the business personal property. Because the restaurant bought all used equipment when starting its operation, the contents insurance was issued for the amount of the cost of the used equipment plus the cost of the stock kept at the location.
A fire destroyed all of Local Restaurant's equipment and stock. These items were covered subject to the limit of insurance. At the time the loss occurred, used restaurant equipment was not available. Since the policy clearly covered the replacement cost of the equipment, the restaurant purchased new equipment.
When the adjuster offered a settlement, there was only enough insurance to cover a fraction of the value of the new equipment and stock. The adjuster explained that the equipment was covered on a replacement cost basis, that is, new equipment for the old equipment. However, the amount of insurance was not large enough to pay all of the value of new equipment. The amount of insurance had been based on the lower cost of used equipment. Had the amount of insurance been large enough to reflect the replacement cost value of the equipment and fixtures, the insurance company would have paid for the entire cost of the new equipment.
The amount of insurance should always reflect the replacement cost value of machinery, equipment and fixtures.
Improvements and betterments
Pizza, Ltd., put $750,000 of improvements and betterments into the newest location that it leased. The restaurant owners' lawyer reviewed their lease and had no criticism. The subject of insurance didn't come up.
A short time after the grand opening, a faulty electrical connection started a fire. The fire department did a good job and saved the building. However, the furniture, fixtures, food, and improvements and betterments were severely damaged.
Because the improvements and betterments became a part of the landlord's real property, the owners of Pizza, Ltd., presumed that the landlord would replace them. They were very surprised when the landlord refused. Replacing the improvements and betterments was Pizza, Ltd.'s, responsibility.
Improvements and betterments are automatically covered whenever a tenant purchases business personal property coverage. Whether an insured has a businessowners policy or a commercial property policy, there is automatic coverage for improvements and betterments. Pizza, Ltd., had coverage for the damaged improvements and betterments, but their values were insufficient.
Not all leases are clear in regard to improvements and betterments. Some leases will state that the landlord will replace them when they are damaged. Other leases are silent. A few leases will state that the tenant is responsible for repairing them. My experience is that the tenant is always responsible for damaged improvements and betterments unless the lease clearly states that the landlord will fix them.
Landlord's improvements and betterments
Real Estate Rentals, LLC, had many restaurant buildings that they rented out. In one building that was leasing at the highest price in the area, each tenant had put in as much as $1 million worth of improvements and betterments.
This high-priced property suffered a major loss when several of its heat exchangers blew up at the same time. As part of the adjusting process, the adjuster looked at a typical lease for the building. Then she asked for the values of the improvements and betterments that had been put in by each tenant.
The amount of insurance was based upon the construction cost of the building when new. Adding the value of the improvements and betterments raised the value of the property to almost double the construction costs. The combined value of the construction costs and the improvements and betterments was what would be used for purposes of applying a coinsurance penalty.
Improvements and betterments always create a value owned by the landlord. The basic nature of improvements and betterments is that items are permanently attached to the real estate. A landlord's property insurance always needs to reflect the value of the improvements and betterments installed by the tenant(s). This means that the landlord will need to increase the amount of building insurance by the value of the improvements and betterments.
Note, however, that a landlord will not need to increase the amount of building insurance to reflect the value of the improvements and betterments if an endorsement excluding them is attached to the building coverage.
Utilities
An ice storm knocked down power lines in a strip about 50 miles wide and 200 miles long. It was a week before Eats, Ltd., could reopen its restaurant for business. Eats, Ltd., presented a time element claim on its businessowners policy. A short while later, the adjuster contacted them to tell them that there was no coverage for a time element loss caused by a loss of electricity.
Shortly after being told that she had no time element coverage due to the loss of electric power, the owner was talking about this with a friend of hers who owned a restaurant about two blocks away. Her friend had coverage for a time element loss due to the loss of electricity.
When the owner asked her agent about this, the agent replied that it could not be provided on a businessowners contract. Eats' owner then learned that her friend had his insurance on a commercial property contract rather than a businessowners policy.
Time element coverage for losses due to the loss of electricity is available on a standard endorsement promulgated by the Insurance Services Office (ISO). Any insurer who is using ISO forms is filed to write this coverage. Be sure that the endorsement shows that the loss of electricity can be caused by damage to the power plant or transmission lines.
Consequential loss
Several young men and women were having fun driving around an empty shopping center parking lot in pickup trucks with oversized tires and mufflers that made loud noises. Their fun stopped abruptly when one of them drove into the cooling units for the refrigerators and freezers used by a restaurant in the shopping center. All of the vehicles quickly left the area.
The next morning, the restaurant owner noticed that the cooling units had been damaged. Repair people were called. From the time the damage occurred until the freezers and refrigerators were again cooling items took about 10 hours. The storeowner was about ready to commence selling the refrigerated and frozen items when the state food authorities arrived. The state simply condemned all of the food that was in the refrigerators and freezers. Food worth about $100,000 had to be thrown away.
The restaurant submitted a claim for both the damaged equipment and the spoiled food. The insurer responded that the damage from the vehicle was covered, but that there was no coverage for the loss of the food. The insurer described the food loss as a consequential loss and, therefore, not covered by the property coverage forms.
Coverage for consequential loss damage can be provided. One way of covering this exposure is to use a consequential loss form written by a boiler and machinery damage insurer. Another way is to endorse consequential loss onto a regular property policy. Many insurers have a special form to do this. My recommendation is that consequential loss coverage needs to be reviewed with any client that deals in refrigerated or frozen foods.
Water main
While doing some road repair, construction workers broke a water main close to a restaurant, which forced the restaurant to close its doors for the four weeks that it took to do the repair work. The restaurant submitted a business income claim for the business that it lost during those four weeks. The restaurant's insurer denied the claim because there was no off-premises coverage on the restaurant's policy.
Time element coverage for losses due to the interruption of utility services can be written. This coverage is found as a standard endorsement for any insurer using ISO forms. When using this form, be sure that the insurer is covering loss to both the utility facilities and the transmission lines or pipes.
Conclusion
These are the key points we have covered:
1) If the tenant is responsible for damaged improvements and betterments, be sure to include the value of the improvements and betterments in the amount of business personal property insurance.
2) The values of improvements and betterments always increase the value of the real estate. When writing the building insurance for a landlord, be sure either to:
* raise the amount of building insurance to reflect the value of the improvements and betterments that have been added to the building, or
* specifically endorse the building insurance to eliminate any coverage for the improvements and betterments.
3) Coverage for loss of electricity due a damaged power plant or transmission lines can be added to time element coverages.
4) Coverage for business income losses due to damaged utilities such as water mains or sewage lines can be endorsed to the contract. *