By Donald S. Malecki, CPCU

Few people would dispute that making a career of insurance is difficult these days. A combination of factors, not the least of which is the hard market, is making business life tough. Simply trying to keep pace with developments, such as keeping track of the solvency of insurers, and determining who writes what and under what conditions are jobs unto themselves.

What is especially disconcerting today is when some insurers add one or more restrictive endorsements to a policy with the idea of reducing coverage and do so without informing their most trusted producers or the policyholder. Of the many situations that can be pointed out within this category today is a practice still in its infancy, but not for long. It concerns blanket property insurance and involves the practice of nullifying the advantages of blanket coverage written on an agreed amount basis.

Characteristics of blanket insurance

The general qualifications of blanket insurance are that a policyholder has one type of property contained in more than one building, or two or more types of property contained in one or more buildings.

Although coinsurance compliance is an important criterion in avoiding the assumption of a penalty following loss, it is almost an automatic step in setting up this coverage to designate the application of the agreed amount (or agreed value) provision. In fact, the ISO forms make this selection easy, since "agreed value" is a coverage option.

When the agreed value option is selected, it suspends application of the coinsurance clause, which otherwise requires a policyholder to purchase insurance on its property to a certain percentage of its full value, ranging from 80% to 100%. When blanket coverage applies, 90% is mandatory. The policyholder, however, must apply for this agreed value option on an annual basis.

Producers can assist their commercial clients by explaining how this suspension of the coinsurance clause benefits them and how detrimental it could be if, at the time of loss, the amount of insurance carried were to be less than the amount necessary to comply with this clause. A rate credit also is available when the insurance is at or above the required coinsurance percent of value. This also might be pleasing to policyholders, so producers need to explain the mechanics and rules of blanket insurance to policyholders.

A Statement of Values is another condition precedent to coverage on a blanket basis. One of these statements must be completed each year listing the type of property to covered, i.e., building, business personal property, or personal property of others, its location, and its total replacement value. The underwriter needs this document in order to promulgate the blanket rate, which is based on an average of the values.

Assuming a policyholder is otherwise in compliance with coinsurance requirements, or an agreed amount provision applies, a policyholder could still collect the full amount of its loss even when the value of the covered property destroyed is more than the value declared on the Statement of Values.

For purposes of illustration, assume a policyholder maintains a blanket policy on its business personal property in four different building locations for a limit of $1 million. The Statement of Values reflects that the amounts at each of the four locations are $250,000. It is determined, after a destructive fire, that the loss of business personal property at that location was $500,000. The policyholder here should be made whole, because it maintained an adequate overall limit of $1 million.

Most policyholders who are candidates for blanket insurance have come to learn the advantages of this type of coverage and, as many producers know, specifically request it. Most policyholders do not know that blanket insurance costs more than when insurance is written on a specific insurance basis, where a specific amount of insurance applies to the covered property. They do not really care about that point. What really counts is having sufficient insurance when loss strikes.

Potentially bad news

What is happening with some regularity is that some insurers are nullifying the advantage of blanket insurance by placing a limit on what a policyholder can recover. (Some insurers have maintained that the most one can collect under a blanket property policy is the amount shown in the Statement of Values. This is nothing new and not the subject being addressed here.)

Instead of limiting the recoverable amount at any location to what is shown on the Statement of Values, the insurers "generously" are applying a certain percentage of the amount shown on the Statement of Values, such as 110%, 115%, 120%, or 150%. This relatively new technique is referred to as the "margin clause," presumably because the amount payable is a margin of the declared value.

Referring to the earlier illustration of the four locations containing business personal property with values of $250,000 each and a loss at one location for an amount of $500,000, a margin clause of 150% would net the policyholder not its total loss of $500,000, but a payment of $375,000. The effect of this type of provision (margin clause) is to almost transform the concept of blanket coverage to insurance on a specific value basis, where, incidentally, the cost of insurance is cheaper!

The apparent rationale for these margin clauses is that some insurers have found, at the time of loss, that the amount of insurance purchased has turned out to be far less than the amount of insurance required, but policyholders have still been able to recoup their full loss. Whose fault is that, given that many underwriters do not require property appraisals from qualified professionals, and offer the agreed value option without any conditions?

Actually, if a policyholder maintains enough insurance to cover a loss, isn't that all that the adjuster should be concerned with? Why involve an underwriter? Realistically, when there is a sufficient spread of property values so as to avoid a catastrophic loss, the policyholder of blanket insurance is likely paying more for insurance than will actually be needed in any one loss.

This is one of the reasons so-called "first loss" coverage was coined many years ago. It was first used in connection with chain stores where there are many locations with sufficient spread of risk where loss is not likely to be catastrophic.

Take an example where a chain store has 20 locations throughout the United States and with the value of stock, business personal property, and improvements and betterments at each of the locations amounting to, for simplicity of mathematics, $100,000. Let's say this means that the chain store would have to purchase blanket insurance in the amount of $2 million at a rate of $1 per $100. The result is a premium of $1,000 for $100,000 of coverage or a $20,000 premium for $2 million of insurance.

Looking at the maximum probable and possible loss, and the store's history, the store decides, for purposes of reducing insurance costs, to purchase a policy with a limit of $100,000 or $150,000 over a deductible and the contingency that if that amount is wiped out in a loss, the underwriter will sell another set of limits at a pre-agreed rate.

Underwriters never liked this concept of "first loss" coverage, because it was a "win-win" result for policyholders and much too practical. Blanket property coverage with an agreed value option is a compromise, giving the underwriter the opportunity for a "win-win" result, because he or she is writing more insurance and charging more premium than will ever be paid out in a one-year period.

The tide has turned, however, and some insurers are slipping in provisions that producers need to be aware of. With that in mind, everyone needs to be on their toes looking for underwriters who are adding these margin clauses to their policies, almost as freely as agreed value options. No one can take for granted that a policy written on a blanket basis, subject to an agreed value option, will actually apply as it once did. To be on the safe side, precautionary policy checking should be part of every renewal.

One other point of interest--perhaps chagrin is a better word--is that with respect to recent bid specifications for a pubic entity, one of the bidders, a producer, went so far as to put into writing that the margin clause was an advantage to the prospective account.

It is uncertain what this producer's rationale was for saying so. The producer either does not understand what a margin clause is all about, or the producer is mistakenly convinced that it is the greatest insurance innovation in recent times. As it turned out, the producer lost the chance to write the account. Make no mistake about it, margin clauses, which usually appear in endorsements addressing the application of limits, have no place with blanket property insurance and are capable of causing more problems than one wants to encounter. *

The author

Donald S. Malecki, CPCU, is chairman and CEO of Donald S. Malecki & Associates, Inc. He is an active member of the CPCU Society, serves on the Examination Committee of the American Institute for CPCU, and is an active member of the Society of Risk Management Consultants.