Property Insurance

Property insurance includes coverage on your buildings, the contents of your buildings, and the loss of income that comes from a fire or other insured cause of loss. There can also be coverage for the increased cost of getting back into business quickly.

How is Your Property Valued?

How do you get paid for property you lose? Who comes up with the value?

Valuation can mean several different things:

-real estate value (the price at which you could sell).

-tax assessment value.

-replacement cost.

-book value (purchase price minus accounting depreciation).

-actual cash value (replacement cost minus usage depreciation).

Two forms of valuation are commonly used in property insurance. The traditional (meaning old-fashioned) valuation is “actual cash value.” The term is defined by most policies as replacement cost minus depreciation. In some states, you must also consider market value in the determination of the actual cash value of property.

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Actual Cash Value – Building Example

Suppose that a thirty-year-old building would cost $1.5 million to replace. The structure is well-maintained and in no way obsolete. The roof was replaced last year. Plumbing and electrical have been updated recently. A fire destroys the building.

The insurance company adjuster determines that twenty percent depreciation is called for. She issues a check to the insured for $1.5 million, less twenty percent, minus the deductible.

Actual Cash Value – Personal Property Example

Suppose that a pipe in the ceiling of a bank branch office bursts, damaging a conference table, chairs, audio-visual equipment, and several computers. The cost to replace the items is $35K.

The insurance company adjuster determines that the equipment was obsolete and the furniture was in poor repair. Based on photographs and interviews, it is determined that sixty percent depreciation is in order. You are offered $14K (forty percent of $35K), less your deductible.
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Replacement cost valuation of property uses the actual cost of buying a replacement item or rebuilding the structure. If the building burned to the ground, how much would it cost to rebuild with the current cost of materials and labor?

Generally, you’ll want your insurance to be written on a replacement cost basis. The policy maker agrees to pay the full cost of reconstruction without deduction for depreciation.

Carry actual cash value coverage only when you would not replace a building after a fire — a relatively rare plan.

Personal property can also be valued at replacement cost or based on its actual cash value. Again, in most cases, replacement cost is the most desirable valuation.

Buy the Right Amount of Coverage

Most property policies have severe penalties for underinsurance. The amount of coverage you buy depends on the valuation of the property. Most banks need replacement cost coverage, which is insurance designed to pay for the replacement of your property with new materials and the current cost of labor.

Your agent can help you with estimating the replacement cost of your buildings. Determining the value of contents is tougher. Go through your locations room by room and count thousands of dollars in value (e.g., desk and chair, $1K; three file cabinets, $1K; computer and printer, $2K).

Beware of Coinsurance

Coinsurance is a penalty provision found in most property insurance policies for underinsurance. It never helps you. It can only hurt at the time of a loss.

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Example – Underinsured Building With Coinsurance

Property value: $1 million

Eighty percent coinsurance clause (requires the purchase of $800K of insurance)

Amount of insurance: $750K

Amount of fire loss: $75K

Loss = what you bought, divided by what you should have bought, times the amount of the loss.

Claim payment = $750K divided by $800K = .9375

.9375 multiplied by $75K = $70,313

$75K – $70,313 = $4,687 Coinsurance penalty

Example – Correctly Insured Building with Coinsurance

Property value: $1 million

Eighty percent coinsurance clause (requires the purchase of $800K of insurance)

Amount of insurance: $850K

Amount of fire loss: $75K

Since the amount of insurance is more than the $800K required by coinsurance, the loss payment is the full $75K (less any deductible).
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Most insurers will eliminate the coinsurance clause at your request. Many carriers will add a clause to the policy agreeing that the amount of insurance meets the coinsurance clause — called the agreed amount endorsement. Work with your agent to eliminate any coinsurance clauses from your policies.

Blanket Insurance

Talk with your agent about blanket coverage—one amount of insurance for all your property. Even if your bank is contained in only one building, combining the building and contents insurance into one amount of coverage can help you at the time of a claim.

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Example – Specific Insurance

Main building coverage: $1.7 million

Contents of main building: $750K

Elm Street branch building coverage: $750K

Contents of Elm Street branch: $400K

If the Elm Street location burned, the policy would pay up to $750K for the repair of the building and $400K for the replacement of the contents.

Example – Blanket Insurance

Main building coverage: $1.7 million

Contents of main building: $750K

Elm Street branch building coverage: $750K

Contents of Elm Street branch: $400K

Blanket amount of insurance: $3.6 million ($1.7 million + $750K + $750K + $400K)

If the Elm Street location burned, the policy would pay up to $3.6 million for the repair of the building and for the replacement of the contents.
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Special Perils

Perils are causes of loss—fire, lightning, wind, or hail, for instance. Policies that include coverage for “special perils” provide the broadest coverage—protection for any cause of loss not excluded by the policy. Common exclusions are earthquake, flood, nuclear events, damage by insects or animals, and mold. If the cause of loss is not excluded by the policy, there is coverage for the damage.

So-called “named peril” policies provide a laundry list of events for which coverage applies—fire, lightning, hail, vehicles, aircraft, windstorm, explosion, and vandalism, for example. If the damage was caused by a peril not listed, there is no coverage.

Put another way, special perils policies cover any cause of loss except what is excluded. Named peril policies cover only causes of loss listed.

“Special perils” is the preferable way for a bank to insure its property.

Machinery Coverage – The Peril of Mechanical Breakdown

Many property insurance policies are now including a new peril that was previously excluded: mechanical breakdown.

Some banks have a “boiler and machinery” policy that provides equivalent coverage. I include a discussion here, as you may find the protection within your property policy.

Consider the events that will cause you to have to replace a phone system, air-conditioning unit, heating system, or another machine or piece of equipment.

Obviously, fire, theft, vandalism, or a windstorm that destroys your building can damage the equipment. All these perils are covered by your property insurance.

How about a voltage surge that blows out the motor of your air conditioning system? How about loss of water in a heating system, causing a crack in the boiler? How about the failure of the lubrication system in an elevator unit, causing overheating and damage to the travel unit?

All of the above are excluded by standard property insurance.

Machinery coverage (a separate policy or an added peril to the property policy) can add protection for the losses described.

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Machinery Coverage Comment

In general, banks have little need for machinery coverage. The largest loss I have seen in a bank for machinery or mechanical breakdown is $3,500 for the replacement of some components in an alarm system when a voltage surge hit it. Certainly not a catastrophic loss. Inconvenient? Yes. The bank didn’t lose any business though, and the alarm was up and running that afternoon.

I’m not saying banks should ever buy machinery coverage.

If your building is heated with a high-pressure boiler, buy the coverage 100 percent of the time. Otherwise, look at the value of the coverage and your other insurance needs. Is the premium for machinery coverage better spent on additional umbrella liability coverage? Consider using the funds to buy additional limits on your bond or your D&O protection.
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What’s a Building?

The word “building” should be straightforward, right? Not in the world of insurance!

Most property insurance policies define “building” as a structure including:

  • completed additions
  • fixtures, including outdoor fixtures
  • permanently installed machinery and equipment
  • personal property owned by you that is used to maintain or service the building, including fire extinguishing equipment, outdoor furniture, floor coverings, and appliances used for refrigerating, ventilating, cooking, dishwashing, or laundering.

While the policy does not define “fixtures,” the term is generally held to entail items such as light poles and flag poles, parking stops, mailboxes, and in-ground sprinkler systems. Signs attached to your building are also considered fixtures. A drive-through awning is a part of the building. The pneumatic tubes at drive-up windows are covered as part of the building. Most insurers would consider an ATM unit to be a fixture—even as a separate kiosk.

ATMs in a separate building should be separately insured and described in most policies.

Under most insurance policies, freestanding signs are covered to $250 or another small amount. Extra coverage can be purchased.

Building additions under construction are covered if you have not purchased other insurance, such as builder’s risk. Materials used in the construction of an addition are covered when stored within one hundred feet of the premises.

Consider Buying Flood Insurance

Earlier, I said that flood is excluded from most property insurance policies.

As you consider the peril of flood, don’t think of it as water damage. Floodwater is not nice, clean water that happens to be in your lobby. Floods take out septic systems and sewage treatment plants. Dead things will be floating in the basement of your building. Shovels, not mops, are used to clean up the mess. It’s dirty, smelly, and disgusting. You’ll want help cleaning it up, and insurance can offer that help.

Many insurers will offer flood coverage as part of the package policy. You’ll probably have a separate limit. Perhaps the policy will include a limit of $1 million for any location. Is that enough?

Some policies provide flood coverage only to buildings not located in flood zones. Check your policy and talk with your advisor. You may need to buy a separate flood insurance policy.

Consider Buying Earthquake Insurance

As I write this, the earthquake of March, 2011 in Japan is fresh in my mind. Almost sixteen thousand people lost their lives in a country that is recognized for having one of the most sophisticated warning systems and preparedness plans in the world.

The recent earthquakes that hit Washington, DC, and New York in August, 2011 point to the damage that can come from relatively minor shakes.

Intense quakes can hit anywhere. An earthquake hit Boston in 1755 and damaged 1,200 buildings. More than a hundred chimneys were leveled. People on ships in the harbor said they felt like they had run aground because the intensity was so great. Think of what would happen if an earthquake of that same intensity hit Boston now.

Not long ago, I experienced my first earthquake at my home in Maine. My first thought was that the house would collapse. Then I wondered why a train was coming down my street. All the neighbors met in the street within two minutes. One guy thought his furnace had exploded. I guess we are wimps in the Northeast when compared to the residents of California. Ours was a 2.7 quake, and people talked about it for weeks.

Earthquake is excluded under most property insurance policies. Consider adding coverage for this peril.

If you live in quake-prone areas, your agent has undoubtedly discussed the coverage with you. Most agents on the East Coast don’t even talk about earthquake with their clients. That might be a mistake.

Talk with your agent. You may be surprised at how inexpensive the coverage is.

Business Interruption and Extra Expense

I am regularly asked to explain business income insurance. First, let’s get past semantics. The following terms mean the same thing: business interruption coverage, loss of business income, time element, use, and occupancy. They all describe protection from the loss of income that occurs when a business is shut down due to a fire or other insured loss.

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Silly Story to Explain Loss of Business Income Insurance

For many years, I’ve used the same story to help business owners understand what exactly business income coverage does. It’s a silly story, but it makes my point.

Pretend you own a goose (a building). Your goose lays golden eggs (cash flow). If your goose is run over by a truck, it’s going to take you nine months to get a new goose (get back into operation). You have insurance that will pay for the cost of the new goose (property insurance), but what about the value of the eggs you won’t get in the nine months you’re without a goose? Business income coverage pays you the value of the eggs while you’re waiting for your new goose.
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Part two of business interruption coverage is extra expense—coverage that pays the increased cost of getting your goose in five months instead of waiting nine. It is the most pressing need for business interruption coverage for banks. If a branch is down due to fire or windstorm, the priority is to reopen quickly through a temporary location or bank trailer. Extra expense coverage will pay for the rental.

Insurers will generally provide a blanket limit of extra expense coverage over all locations.

Work with your advisor to determine the correct business income protection for you.

Another point: eliminate coinsurance penalties from business income coverage, if possible.

Extra Expense Worksheet

Determining the correct amount of extra expense coverage can be a challenge. Here is a calculation I came up with that can help determine the minimum coverage limit for a specific location. This is alchemy, not science.

Enter The Number of Employees (Full & Part Time) In Box A—> A
Multiply A by $5K. Enter in Box B —> B
If Computer Center, Put $50K In Box C—> C
Per Location Constant D $100K
Recommended Minimum Coverage: Total of B+C+D=E —> E

The minimum limit of coverage for this location is the value in box E. Consider other issues as well, such as difficulty in getting temporary office space. When in doubt, buy more.

For blanket coverage, buy at least the highest recommended limit multiplied by one-half the total number of locations you have.

Another approach is to have a minimum of $500K on major locations and $250K on minor ones.

If you have an extra expense form that includes coinsurance, buy at least the coinsurance percentage times the total of the recommended minimum coverage. Better yet, get your agent to delete the coinsurance clause.

Deductibles

In my review of bank insurance programs, I find that most banks have relatively low property deductibles. Think of it this way: your home insurance probably has a $500 or $1K deductible, and a few hundred thousand in insurance. Your bank has millions of dollars of insurance. Does a $1K deductible really make sense?

Things happen in our daily lives. Don’t use your insurance to pay for the bumps in the road. Look to insurance to help you through catastrophes.

Did vandals damage a sign outside the main office? Why look to insurance to pay for it? Did a windstorm damage a few shingles on the roof of a branch office? Fix them and move on. Insurance should be for when your roof is destroyed, or for a loss that would have a devastating effect on your bank’s financial health.

Use high deductibles on your property insurance to reduce your premiums. Consider $5K, $10K, or higher. Small losses are a cost of business. Budget for them.

Note: Never pay liability claims yourself. Report damage to other people’s property or injuries to people as soon as possible. Even if it seems that the injury is minor, report the claim to your insurer quickly.

Storage Locations

Review other locations where you may have property, such as warehouses and mini-storage companies. Consider equipment belonging to the bank that is at employees’ homes. Telecommuters and executives with bank computers at home may need to be listed on your property insurance policies.

Computer Coverage

Some property insurers segregate computers into a separate limit of coverage. Are your computers properly covered? Is the limit of insurance adequate? Is a computer virus a covered cause of loss? Does the policy include coverage for laptops and other computer equipment that is away from a bank premises? Is there coverage for PDAs and hand-held computers?

Builder’s Risk Insurance

The construction of a new building usually requires specific insurance to address the hazards encountered in construction. Talk with your insurance advisor and contractor about your need for builder’s risk insurance.

See chapter three for details on builder’s risk insurance.

Property Insurance Exclusions

Most bank property insurance is written on a “special perils” basis. In short, the policy says that every cause of loss is covered except for what is excluded. If the cause of your loss is not excluded, the insurance policy pays.

Here’s the normal list of excluded perils:

  • ordinance or law
  • earth movement
  • governmental action
  • nuclear hazards
  • utility service
  • war and military action
  • water
  • artificially generated electrical currents
  • delay, loss of use, and loss of market
  • wear and tear, or mechanical breakdown
  • changes in temperature or humidity
  • explosion of steam boiler or pressure vessel
  • continuous or repeated leakage of water
  • loss by freezing (unless you take precautions)
  • dishonest or criminal acts by you or employees (except for acts of destruction)
  • voluntary parting
  • rain, snow, ice, or sleet to personal property in the open
  • pollution
  • acts or decisions
  • faulty, inadequate, or defective planning, design, repair, materials, or maintenance

The policy also describes property that is not covered. The excluded items relevant to banks are:

  • accounts, bills, currency, money, and notes
  • cost of excavations
  • foundations, land, and retaining walls
  • property covered by another policy
  • underground pipes
  • fences, radio antennas, and satellite dishes

Vacant Property Issues

A vacant building has coverage restrictions. Most policies say that after a building has been vacant for sixty consecutive days, coverage for the following perils is excluded:

vandalism

sprinkler leakage/water damage

glass breakage

theft or attempted theft

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Perhaps the Most Common Bank Property Loss?

Banks don’t have a great many property losses. In my career, though, I have seen four banks encounter the same kind of incident. It’s a silly event, and the cause of much embarrassment for all concerned: a truck getting stuck in the drive-through teller roof overhang.

Loss prevention is simple for this type of accident. Put up a sign or a hanging tube for the unwary to hit before they hit your building.
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Valuable Papers Insurance

Valuable papers insurance pays for the cost of recreating documents destroyed by an insured peril. It pays for the cost of researching and copying the documents you need to run your business after a fire or other insured cause of loss.

Example: A fire destroys part of your office space that contains important loan records. The information is vital both to your operation and to your regulators. The data must be recreated. Valuable papers insurance will pay the restoration costs.

Sidenote: Buying valuable papers insurance alone is a lousy way to protect your bank’s records. Physically protect documents or records that are important to your operation. Put your vital documents in fireproof filing cabinets or a vault. Better yet, scan paper records and store them digitally—with proper backup, of course!

Debris Removal

After a fire or other insured damage to your building, there will likely be debris that need to be removed. Coverage is usually limited to 25 percent of the loss. The amounts paid for debris removal do not increase the total limit of coverage for the whole claim. It is, therefore, possible that you can run out of coverage.

To help, insurers provide an additional amount of coverage (usually $10K) to pay for the cleanup. Some insurance companies increase the additional amount to $25K or $50K.

Review your buildings. Will special disposal of rubble and debris increase the cost of reconstruction? Asbestos or other hazardous substances (found in older buildings) may point to the need for additional insurance.

Ordinance or Law

After a loss to your building, you may find that local laws and building ordinances increase the cost of reconstruction. Perhaps you will have to add a sprinkler system or handicap access. Recall from our discussion of perils that actions of a government are excluded.

Ordinance or law coverage provides additional insurance to pay for the higher cost of reconstruction due to building codes, laws, or regulations.

The coverage actually has three parts:

Coverage A – Loss to the Undamaged Portion of the Building: Coverage is provided for the value of the part of the building that is undamaged but that must be demolished by order of a governmental authority due to a building code.

Coverage B – Demolition Cost to the Undamaged Portion of the Building: Pays the cost of demolishing and removing the undamaged portion of the building.

Coverage C – Increased Cost of Construction: Pays the increased cost of construction due to law or building codes.

Fine Arts

If your bank owns artwork, antiques, or other items of unusual value, consider having the items appraised and insured under a fine arts policy.

Fine arts insurance provides additional perils (breakage, for example) and alternative valuation methods (cost of restoration) to what is offered by standard insurance policies.

Highly valued windows, murals, and other ornamentation can be specifically insured as well.

Don’t forget to insure artwork loaned to museums and galleries. Check the loan agreement; you may find that the receiving institution is responsible for coverage.

Signs

Signs attached to your buildings are covered by most standard building insurance. Freestanding signs need to be insured specifically or with a special policy endorsement.

Mail Insurance

Mail insurance protects property in the custody of a government postal service. Review the policy for specific descriptions of property covered and parties responsible for transporting the property. Some policies will extend coverage to include organizations like FedEx and UPS.