3. Property Insurance
Property Policy Introduction
Property insurance provides protection against most
risks to property, such as fire, theft and some weather
damage. This includes specialized forms of insurance such
as fire insurance, flood insurance, earthquake insurance, or
homeowners insurance.
The three primary coverages of either the building or
the contents under a property policy are the building,
contents and the loss of use. You can insure specific
items such as jewelry, or purchase blanket coverage for
property at a particular location.
• Specific Insurance - This is when you insure a specific item.
• Blanket Insurance - This is when you insure several items, such as “all personal property
located at 123 Main Street.”
Perils Insured Against
If you recall from lesson one, the cause of a loss is called a peril. Perils are what we insure against
when we purchase an insurance policy.
With property insurance, policies can be written as named peril (broad form) policies or as open
peril (all risk or special). A named peril policy (broad form) provides lists of all the perils covered
in the policy such as wind, hail, fire or lightning. If a peril is not named or listed in the policy, then it
is not covered. With a named peril policy, it is the insureds responsibility to show that any loss was
the result of a covered peril listed in the policy.
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With an open, special or all-risk peril policy, all perils will be covered unless it is specifically
excluded in the policy. When an insured files a claim, the company must pay the claim unless the
cause of loss is listed as an exclusion under the policy.
Quick Review: Remember that a hazard is a condition or the source that increases the probability
or severity of a peril. Hazards will typically be present before a peril occurs; however, remember that
it is the peril that actually causes a loss.
Property Policy Components
Property insurance provides protection against most risks to property, such as fire, theft, and wind.
Many states have adopted a set of uniform or standardized insurance laws which allow similar forms
to be used in these states. This is not to say that all policies are alike, because that is not the case.
For the states that have standardized form laws, property and casualty insurance contracts are
comprised of the following major components.
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#1 Declarations (Dec Page)
Each Dec Page contains the same type of information, but is customized for each policy, providing
a summary listing as follows:
A. Who is Insured
a. Named Insured - The person or business that is insured.
b. First Named Insured - If there is more than one named insured, this is the person who has the
most responsibility and rights.
c. Additional Named Insured - This may be the bank that has the property financed.
b. What Property Is Covered and Where It Is Located
a. Specific Insurance: - This is when you insure a specific item.
b. Blanket Insurance - This is when you insure several items, such as “all personal property
located at 123 Main Street.”
c. Specifies the policy period by date, when coverage begins and ends, and time—where and
in what time zone.
c. How Much the Property Is Insured For
a. Policy Limits - This is the maximum amount for which an insured is protected under the terms
of the policy.
d. Premium amount
a. What's it going to cost you?
Policy Period and Coverage Territory
The policy period, which is usually 6 months or one year is defined by the contract. Coverage territory
is also defined in contract. For example, personal property is covered by your homeowners
policy anywhere in the world up to a certain limit. A commercial property policy will cover
business personal property on premises or within 100 feet of premises.
#2 Definitions
This is a simple one to remember. The definitions part of an insurance policy defines the meaning
of certain terms used in the policy.
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#3 Insuring Agreement (Clause) The insuring agreement contains the insurer’s promise to pay. It also contains an explanation of what
property is covered and the perils insured against:
• Key policy coverages are described in detail
• Additional coverages, if any, are described and
• Lists the specific perils insured against such as fire, lightning, etc.
#4 Additional Coverages The insuring agreement will list any additional coverages that are a part of the policy. For example,
coverage extensions can provide additional coverages to a policy. Extensions provide separate or
additional limits of insurance and require the insured to meet certain requirements before they are
applicable. Extensions may be helpful in adding back coverage that the basic policy excluded or
limited. One example excluded from coverage as personal property in a homeowners policy would be
credit cards. However, the additional coverages give back a limited amount of this coverage.
Keep in mind that coverage extensions are typically available for a surcharge or extra premium
amount.
#5 Conditions The conditions section of an insurance policy shows the general duties or procedures that the
insurer and insured agree to follow under the terms of the policy. Provisions are used in the
policy that stipulate the conditions or place limitations on the insurer’s promise to pay or perform.
If the policy conditions are not met, the insurer can deny the claim.
Common conditions in a policy include the requirement to file a proof of loss with the company, to
protect property after a loss, and to cooperate during the company’s investigation or defense of a
liability lawsuit.
#6 Exclusions and Limitations This part of the policy eliminates coverage for certain perils. There are 4 broad categories of exclusions:
1. Non-Accidental Losses
These losses are excluded because they are certainties, not risks. Wear and tear, deterioration, rust,
decay, mechanical or electrical breakdown, are all examples of non-accidental losses. The company
will not pay to replace your 20 year old roof just because you think it's time to get a new one.
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2. Losses You Can Control
These are losses that you could control or prevent with extra care or effort, such as scratching,
breaking, or chipping of valuable objects.
3. Extra-Hazardous Perils
An example of an extra-hazardous peril is earthquake or nuclear explosion.
4. Catastrophic Losses
This type of loss could bankrupt the insurance company. Losses resulting from war or nuclear
disasters are examples of catastrophic losses.
Limitations are similar to exclusions, but are not the same thing. Limitations eliminate or reduce
coverage only under certain circumstances.
For example, after a building has been vacant for 60 days, some policies will limit losses by
reducing any claims by 15%.
#7 Endorsements If you need to modify or change the original policy, such as adding or deleting insureds or certain
coverages, you can accomplish this by a procedure known as endorsement. An endorsement is a
written document attached to an insurance policy that modifies the original policy by changing the
coverage offered under the policy.
Loss Settlement Options
Loss settlement or valuation is how losses will be paid. In general, the insured can collect the lesser
of:
1. Insurable interest
2. Policy limits
3. Actual cash value
4. Cost to repair
5. Replacement cost
So what options do you have when buying a property policy?
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Option #1, Actual Cash Value (ACV)
Today’s replacement cost minus the depreciation on the insured item is defined as Actual Cash Value (ACV).
Formula: Replacement cost minus Depreciation equals Actual Cash Value.
For example, Rhonda has a large-screen TV that was destroyed in a fire. The TV depreciated $300
in the first year, $150 the second year, and $150 each of the remaining three years. After the TV was
destroyed, Rhonda located a new TV that would cost $2800. The actual cash value of Rhonda’s old
TV is $1,900.
$2800 - ($300 + $150 + $150+ $150+ $150) = $1,900 ACV
Option #2, Replacement Cost The insurer agrees to automatically pay the replacement cost for covered losses, without subtracting
depreciation. Initially, the insurer will pay only the ACV of the covered item to be replaced. Once the
item has been replaced, the insurer will pay the remaining balance.
Option #3, Functional Replacement Cost The functional replacement cost is when damaged property is repaired or replaced with lower-
cost alternative materials that are functionally equivalent to the damaged materials. This allows
replacement of expensive and outdated items with less expensive, more modern and up-to-date
work. An example would be if you owned an older home with lathe and plaster walls. After a fire, the
insurer replaced the walls using more modern materials such as wallboard or plywood.
Option #4, Agreed Value This is a property policy provision where the insurer and insured agree, at policy inception, as to the
amount of insurance that represents a fair valuation for the property.
These contracts are often used to help determine the value of certain hard-to-value items such
as paintings or antiques.
Option #5, Stated Amount If stated value coverage is selected, the maximum amount paid at the time of loss is the value of the
policy, even if the loss amount is larger than the amount insured. The insurer's obligation is the cost
to repair, replace or cash out their insured, at their discretion, not to exceed the stated amount (or
maximum) of coverage.
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Option #6, Fair Market Value Market value would be what the property could be sold for at the time of the loss.
For example, suppose Joe spends $400,000 to build a fancy house in an open area. Subsequently,
the land around the house becomes zoned for heavy industry and a bad-smelling oil refinery is built
nearby. Joe may now have trouble finding a buyer; therefore, his house may have a market value of
only $250,000, even though it would cost $400,000 to rebuild if it were destroyed.
Policy Provisions and Conditions
Deductible As the insured, you will pay the first part of every loss up to the amount of the deductible. You may
not like this, but the insurer knows that deductibles help reduce the cost of insurance by reducing
the number of small claims.
For example, if Joe has a homeowner policy with a $500 deductible, and a hail storm damages his
roof causing $4,000 in damages, his policy will pay $3,500 ($4,000 - $500).
Restoration/Nonreduction of Limits Each property policy has a limit that reflects the total amount that the insurer will pay for a loss.
Most claims that are filed by insureds are for partial losses rather than total losses. When a partial
loss claim is filed, if covered by the policy, the insurer will pay for only the amount of the partial
loss. In paying for a partial loss, the total limit of the policy is reduced by the partial loss amount;
however, after the repairs are made to the property, the insurer restores the total limit of the
policy back to the original amount.
Coinsurance Remember that coinsurance helps persuade policyholders to insure their property to value. It shows
the minimum amount you should have the property insured for. It is expressed as a percentage of
the property’s value, usually a minimum of 80%. If you carry the amount of insurance required by
the coinsurance condition at the time of a loss, the insurer will pay losses up to the policy limits. If
not, the insurer will pay only a percentage of what the full reimbursement would have been. This is
called the coinsurance penalty.
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The coinsurance formula is calculated as follows:
Insurance carried ÷ Insurance required x loss amount = loss payment
For example, Joe purchased a new house. Shortly after moving in, he had a $5,000 loss. Joe's house
is valued at $100,000; however, he insured the house for only $60,000 to save a few dollars on
premium. Remember Tightwad Hardware Store? So how much will the insurance company pay on
this loss?
Using the coinsurance formula, let’s find out.
$60,000 ÷ ($100,000 x 80%) x $5,000 = $3,750 is the amount the company will pay for the loss
The coinsurance penalty in this situation was $1,250 ($5,000 -$3,720). Costly penalty for Joe being
cheap!
Policy Period and Coverage Territory
The policy period, coverage territory condition, states that a loss must occur during the policy period
and in the coverage territory to be covered. The coverage territory means the United States of
America (including its territories and possessions), Puerto Rico and Canada.
Mortgage Clause
This clause specifies the rights and duties of the mortgagee,
or loss payee, under the policy. The mortgagee is generally
named in the declarations since the mortgagee has an
insurable interest in the property.
If a covered property suffers a loss and the insured fails
to file a proof of loss, the insurer notifies the mortgagee,
and the mortgagee must file the proof of loss to protect
its rights under the policy. Also, the mortgagee may be
required to pay the premium if the insured fails to pay it.
If for some reason the insurer denies a claim made by the
insured because of some condition caused by the insured, and the loss would have otherwise been
covered, the denial may not apply to the mortgagee.
The insurance company generally has the option of paying off the mortgage and receives full
assignment and transfers all rights to the property. The mortgagee will then have no interest in the
property.
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Other Insurance
What happens when you have two insurance policies that cover the same risk, do you get to collect
twice for the same loss? The answer is: maybe. It depends on how the Other Insurance provision
in your policy is worded. This provision helps to comply with the Principle of Indemnity we
discussed in an earlier lesson which states that an insured should not profit from an insured loss.
Five important definitions you should learn:
1. Concurrency and Nonconcurrency
Concurrency is when two or more policies cover the same risk with identical coverages.
Conversely, nonconcurrency is when two or more policies cover the same risk, but the coverages
are not identical as to the extent of coverage provided. This situation could result in coverage gaps
or other problems and should be avoided.
Let's take a closer look at a few methods the Other Insurance clause uses to pay losses.
2. Escape Clause
Other insurance clauses may have an "escape" clause, which is the most basic type. It simply denies
any coverage for a claim if other insurance is available.
3. Pro Rata
Many policies will have an Other Insurance provision using the pro rata method to pay the loss.
This provision may read something like this:
- If a loss covered by this policy is also covered by other insurance, we will pay only the proportion
of the loss that the Limit of Liability applies under this policy bears to the total amount of
insurance covering the loss.
This wording limits the amount the policy will pay to a proportion (pro rata) of total coverage
in place for all policies covering the same risk. The amount each company pays is determined by
adding up the limits of all policies that cover the loss, and then dividing the limit of each policy by
the total amount of insurance available to arrive at the percentage each policy will pay toward the
loss. Each policy's percentage is then multiplied by the amount of the loss to determine the loss
payment amount.
As an example, assume you have two homeowners policies that specifically cover fire losses. Policy
A has a limit of $100,000, and Policy B has a limit of $300,000. If you suffer a fire loss in the amount of
$100,000, Policy A will pay ¼ of the loss ($25,000) and Policy B will pay ¾ of the loss ($75,000).
10 3 Property Insurance
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Step 1: The amount each insurer will pay is determined by adding the total limits of all policies that
cover the loss. This sum is the total amount of insurance available.
Do the math: Policy A $100,000 + Policy B $300,000 = $400,000 total coverage on your home
Step 2: The next step is to divide the limit of the first policy by the total amount of insurance
available, which is shown in Step 1.
Do the math: ($100,000 ÷ $400,000) = .25 x $100,000 = $25,000 Policy A
Step 3: The amount from Step 2 is then multiplied by the amount of the loss to establish that
policy’s payment amount.
Do the math: ($300,000 ÷ $400,000) = .75 x $100,000 = $75,000 Policy B
4. Contribution by Equal Shares But what happens if you have the other Insurance condition in multiple policies covering the same
property? Then all insurers contribute equally up to the policy with the lowest limit. After the policy
with the lowest limit has been reached, the remaining policies with higher limits continue to pay
until all limits are exhausted or the loss is paid, whichever comes first.
5. Primary and Excess Your policy may stipulate that when other insurance exists, they will pay only the excess above what
the other insurance pays for a loss. So if Policy A would pay $100,000 of a $150,000 loss, Policy B would
pay no more than $50,000 of the loss. In this example, Policy A is considered primary insurance and
Policy B is excess insurance.
Assignment This condition specifies that a policy cannot be transferred to another person without the written
permission of the insurer, with the only exception being the death of the insured.
Abandonment This condition states that the insured may not abandon his or her property to the insurer and then
ask to be reimbursed for the property’s full value.
For example, Joseph wrecks his 7-year-old pick-up, causing significant body damage. The
abandonment condition protects the insurer from having to accept the truck if Joseph decides to
abandon it.
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Salvage
This condition allows the insurer to settle with the insured by taking possession of the car and
reimbursing the insured for the loss of the auto. When the insurer sells the salvaged goods, the
proceeds can reduce the cost of the claim to the insurance company.
For example, Joe wrecks his car and his insurance company considers it a total loss. After the insurer
pays the claim, they sell the car to a salvage dealer. The proceeds from the sale will help offset the
claim paid.
Legal Action against the Insurer
The insurance company may not be sued unless the insured has fully complied with the terms of the
policy and the suit is brought within 2 years of the date of loss.
Vacancy and Unoccupancy
This provision allows the insurance company to limit or restrict
coverage if the insured property is unoccupied or vacant. There
may be a greater chance for loss to occur when a property becomes
vacant or unoccupied.
There is a difference between the two terms: Vacancy means the
absence of both people and property, while unoccupied means
that there are no people present.
Liberalization
In some cases, your insurance company will decide to add or enhance coverage at no cost. When
this happens, your policy's liberalization clause gives you immediate access to the new or enhanced
coverage.
For example, the Insurance Commissioner starts receiving numerous complaints about homeowner
policies with XYZ Insurance Company. The complaints center on XYZ’s refusal to pay for seepage
and leaking on these homes. The Commissioner gets XYZ to change or broaden their coverage to
include the seepage and leaking on this policy. This change affects all existing similar policies issued
by XYZ.
12 3 Property Insurance
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Subrogation Most policies come with a subrogation clause. If another party is legally responsible for damages,
the insurer will pay you and then sue the negligent party to recover damages. The insurance company
will not pay you and also allow you to recover damages from the negligent party for the same loss.
For example, Joe is injured in an auto accident caused by another driver. The other driver refuses to
pay for the damages, so Joe’s insurance company intervenes and pays for the damages. His insurer
then sues the other driver and/or the driver’s insurance company to recover the amounts paid on his
behalf.
No Benefit to Bailee A bailee is someone to whom personal property is temporarily entrusted to for cleaning, storing, or
repairing. The bailee is not covered under the insured’s policies while they have the possession of
the insured’s property. Examples of bailees would be dry cleaners, jewelry repair shops, and storage
facilities.
Insured's Duties Following a Loss The insured's duties following a loss include:
• giving prompt notice of claim to the insurance company or agent;
• protecting the property from further damage;
• completing a detailed proof of loss (inventory of the damages);
• making the property available for inspection by the company;
• submitting to examination under oath if required; and
• assisting the insurer as required during the claim investigation procedure.
Valuation Condition The valuation or how losses will be paid condition determines what an insurance company will pay
when a covered loss occurs. Generally, the insured can collect the lesser of:
• insurable interest;
• policy limits;
• actual cash value.
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Appraisal If the insurance company and the insured disagree on the value of the property or the amount of
loss, either may make written demand for an appraisal of the loss. In this event, each party will select
a competent and impartial appraiser. The two appraisers will select an umpire. If they cannot agree,
either may take the matter to court. The appraisers will state separately the value of the property
and amount of loss. If they fail to agree, they will submit their differences to the umpire. A decision
agreed to by any two will be binding.
Each party will:
1. Pay its chosen appraiser; and
2. Bear the other expenses of the appraisal and umpire equally.
If there is an appraisal, the insurance company will still retain their right to deny the claim.
Arbitration If the insurance company and the insured disagree on whether the insured is legally entitled to
recover damages or to the amount of damages which are recoverable by the insured, then the
matter may be arbitrated.
Both parties must agree to arbitration. If so agreed, each party will select an arbitrator. The two
arbitrators will select a third. If they cannot agree within 30 days, either may take the matter to court.
Each party will:
1. Pay the expenses it incurs; and
2. Bear the expenses of the third arbitrator equally.
Recovered Property If property is recovered after loss settlement, the insured may choose between the recovered
property and the insurer's loss payment. If the insured chooses the recovered property, the insurer's
loss payment must be returned, but the insurer will pay for any necessary repairs to the recovered
property plus the recovery expenses.
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Pair or Set Clause
A Pair or Set condition is a loss settlement condition that appears in many
property contracts dealing with losses involving part of a set or one of a pair. In
this case, the insurer can either:
1. Repair or replace any part to restore the pair or set to its value prior to the loss, or
2. Pay the difference between the actual cash value of the property before and after the loss.
Suppose that Joe's wife, Jane, has a pair of diamond earrings valued at $2,000. If one of them is
damaged, destroyed, or stolen, the remaining earring might only be worth $650. You might think
that the loss is $1,000 because one out of two items was lost. But to Jane, the loss is $1,350—the
difference in value before and after the loss.
Cancellation and Nonrenewal An insurer may start a cancellation on a property or casualty policy by mailing or delivering a notice
of cancellation to the named insured—usually at least 30 days before the policy cancellation date.
If the cancellation is due to nonpayment of premium, the cancellation notice must be mailed or
delivered at least 10 days before the policy cancellation date.
Cancellation Cancellation is the termination of an insurance policy before its expiration date by either the insured
or the insurer. State laws govern when and why an insurance company can cancel a contract but
you as the policyowner have the right to cancel your policy at any time for any reason. Insurance
policy cancellation provisions require insurers to notify insureds in advance of canceling a policy and
stipulate the manner in which any unearned premium will be returned.
For example, if you pay in advance for an auto policy with a term of 6 months, your insurance
company could cancel you after 3 months if you were using your personal auto in your limo business
(livery services are excluded). The company would refund your unused premium (3 months) on a
prorata (proportional) basis…50% of your money back.
A short-rate cancellation means you will receive a pro-rated refund minus a penalty. The penalty
is usually for administrative costs incurred by the company. We commonly see short-rate refunds
when you cancel your existing policy midterm to replace it with a new policy from a different
company.
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Then there is the flat rate cancellation in which you will receive your entire premium back. For
example, life insurance comes with a free-look period. If you decide that you do not want to
keep the policy for any reason during the free-look period, the company will process a flat rate
cancellation.
Non-Renewal A non-renewal is simply the decision to not renew your policy at your renewal date. Either you or
your insurance company can decide not to renew the policy when it expires. State law requires your
insurance company to give you a certain number of days’ notice and explain the reason for non-
renewal before it drops your policy.
Lesson Wrap-Up
You should see by now that there is no secret to this—no magic formula. Take notes, review this
lesson several times, and then proceed to your lesson Driller-open book end of chapter quiz. Learn
the information, don't memorize Driller questions. Think through your Driller questions. Not all of
the question answers are obvious.