Co-authored by Brian Cromly
We continue where we left off in our previous feature in the SBO Quarterly dealing with insurance fluency. Risk is a simple concept: exposure to some hazard capable of causing a loss. The resulting loss can be a simple slip and fall causing a minor injury to a single person or a major disruption to the entire student body like the loss of an entire building due to fire or weather. The money and effort required to fully recover from these losses can come from many sources. The most common source is through the purchase of insurance to provide the resources necessary for the district to be made whole. We concluded our last feature by mentioning the main coverage lines: Property, Liability, and Ancillary coverage. We will continue with Property coverage.
Property Insurance
Of all the types of insurance, property is probably the most easily identifiable. Owning a tangible item and insuring it for loss is property insurance. Within property insurance terminology are many different aspects which we will touch on throughout this article. We will begin with several of the most basic coverages that fall under the property category.
The first and most recognizable coverage term is your building. This covers the buildings and structures owned by the district. When we think of covering a building, the most common loss example is that of a fire that damages a large portion, if not all, of the structure. Fire loss is not common due to excellent building codes and fire prevention efforts. Losses from other forces of nature such as wind, water, and unfortunately human forces like vandalism, are far more common, and all covered under most property insurance offerings.
The second insurance term under property coverage is contents. Contents are the items in your building that are typically stationary and used and/or stored within the building and do not typically leave; including tems like desks, furniture, electronics, cabinets, shelving, and curtains.
A third less-obvious term used is inland marine. Inland marine are those items that are more mobile than contents. Inland marine includes items such as sports equipment and musical instruments. Depending on the values of different types of inland marine items, some insurance providers will ask that you schedule items valued over a certain dollar amount. As an example, if your provider requires that you schedule any item valued over $5,000, you will need to provide a listing of all items valued over $5,000. This is typically done for items such as trailers, expensive musical instruments, and high-value sports equipment. For all items valued under $5,000, you can provide a total value without breaking down exactly what is being covered. Items such as tools, some musical and sports equipment, and audio-visual equipment fall into this category.
From these three terms, a total property value can be derived. That value (building + contents + inland marine) is what the insurance company is promising the district should a total loss occur. The insurance company is going to use its internal resources to evaluate how much premium they will need to collect to offset the cost of a total loss. That premium is based on actuary studies of the likelihood of total loss events and expectations of loss control efforts in place by the district. The insurance premium paid by the district can be lessened should different risk-sharing efforts be chosen.
No two premiums are the same. All start with the total property value but how much risk the district wants to share with the insurance company can greatly impact the overall cost. Some key terms in regard to property coverage can impact the premium.
The first and most likely understood term is deductible. Almost all property insurance policies have a deductible which means that you as the consumer are responsible for the deductible before the insurance coverage would provide any reimbursement. For example, if your school had several windows broken by vandals and the cost to repair those windows was $2,000, but your policy has a $500 deductible, you would receive $1,500 from the insurance company and be responsible for the other $500. Conversely, if only one window was broken and the cost to replace it was $500, you would not receive any reimbursement from your insurance provider as the amount must exceed your deductible in order to trigger a potential payment.
Deductibles vary in size and can impact your premium. Typically, the larger the deductible you choose, the larger premium credit that is offered. However, it is important to note that many providers also have minimum deductibles that are required, often based on the amount of coverage you are requesting. Thus, it is something you will want to discuss with your insurance agent. Making decisions on deductibles could help save you premium dollars, but in years where you have a significant number of losses, the deductible payments you make for each loss could cost you more in the end. Conversely, if you choose a lower deductible and don’t have any losses, you may have paid more. Understanding your loss history and balancing the risk versus reward is an important distinction and conversation to have with your insurance agent.
Co-insurance is another risk-sharing term that can have an impact on your premium. For policies with a coinsurance clause, eighty percent is a common coinsurance percentage. What that means is if your building is worth $1,000,000 and you have an 80% coinsurance clause, you must have your building insured for at least $800,000 or you could be responsible for a proportionate share of the loss. An easy way to understand the coinsurance clause is to walk through an example.
Assume we have a building valued at $1,000,000 with an 80% coinsurance clause. As noted above, you as the district would be expected to insure to at least 80% of this value, or $800,000. If you chose to insure the building for $500,000 and suffered a $300,000 loss, you would not have met the coinsurance requirement and accordingly would not be fully indemnified for your loss. The insurance provider would take the amount you insured your building for and divide it by the minimum required under the coinsurance clause. In this case, $500,000/$800,000 which is 62.5%. Accordingly, the insurance provider would only pay 62.5% of the $300,000 loss or $187,500. This leaves your district responsible for the other $112,500. Had the building been insured for $800,000, the entire $300,000 loss would have been paid. While a coinsurance clause can help save you money, it is important to understand your building values, and have your buildings appraised is a highly recommended practice so that you do not find yourself in a situation like the one above.
The third term to review is the valuation of your buildings. This is one of the items a claims adjuster will review when determining the value of your loss. The two most common valuation techniques are replacement cost and actual cash value. When reviewing your policy, many people believe the value listed on their policy is what they will be paid should the building experience a total loss. It is important to denote that those values are the maximum in most cases and the valuation chosen plays an important role in that determination.
Replacement cost valuation pays in an amount to replace damaged property today with property of like kind and quality without deduction for depreciation. In its simplest form, if your property damage loss is valued at $1,000,000 and you have $1,000,000 of coverage for that building, replacement coat would pay you the $1,000,000 to rebuild or repair the building. It is designed to get you back to where you were before the loss.
Actual cash value works differently as it is the cost to repair or replace the damaged property with materials of like kind and quality, less the depreciation of the damaged property. This means that a building that is 30 years old will have depreciated in value over the life of the building. In the case above if the cost to replace your building was $1,000,000, but you had chosen actual cash value, the depreciation would be calculated, and you would receive a settlement of significantly less than the $1,000,000 you would have received with replacement cost, depending on the calculation for depreciation.
If your intent would be to rebuild, actual cash value could leave you short of the required funds to rebuild your building. If the building in question was a building you would have rebuilt, but possibly to a lesser degree, actual cash value may be a valuation option to be considered in your insurance discussions.
While replacement cost and actual cash value are the most common examples of insurance valuations, there are other less common terms you may come across depending on your district’s needs.
Functional replacement cost is the cost to replace damaged property or destroyed property with property that serves the same function. It is used when replacement of damaged property with substantially identical property is either impossible or unnecessary. This type of valuation is most common with older buildings that had unique features that cannot be replicated or are not necessary and would not be needed in the same fashion they are currently in should they sustain damage.
Agreed Value is a property coverage provision that suspends the coinsurance clause. Insurers usually require a statement of property values signed by the insured as a condition of activating or including an agreed value provision in a commercial property policy. This is much less common for a school district and is typically used for items such as classic cars and unique items of that nature. Should your district have an item like this as an asset, agreed value may be an option for consideration.
In short, the type of valuation you have chosen on your insurance policy can have a significant impact on your insurance. While replacement cost coverage is the most common and preferred valuation, there are numerous reasons why actual cash value or functional replacement cost may be the appropriate choice for your district. It is also important to note that most insurance providers do not require you to choose just one valuation for all of your property exposures. For example, if you have one location that actual cash value makes the most sense, you can select that valuation for that individual location and the remainder of your property (buildings, contents, inland marine) can remain on replacement cost.
Blanket limit is the final risk-sharing term to discuss. While not all insurance providers offer this coverage, it means the entire limit of property (and in some cases inland marine values) are listed as one value. As an example, assume you have three school buildings, each valued at $3,000,000. In the event you have blanket coverage, your limit of insurance for anyone loss at a location would be $9,000,000 rather than each building having a maximum replacement cost of $3,000,000. This allows some room for error if one location is actually misstated at $3,000,000 and should have actually been valued at $4,000,000. Because you have a blanket limit, the building could be replaced at the $4,000,000 value (subject to any coinsurance clauses or valuation restrictions as noted earlier).
Many blanket limits allow for building, contents and inland marine to be included as one value, allowing for a greater potential limit in the event of a loss to one location.
We will conclude our article on the property line and take up discussion on the other lines in future articles dealing with insurance fluency.