Disasters Raising Questions of Insurance Adequacy



...entire blanket amount overall becomes available to apply to the loss at any one location. If the insurance is based on 90 percent of total property value (as required for blanket insurance with a 90 percent coinsurance or agreed value clause), the insured can recover 100 percent of a loss, (up to the limit of blanket insurance carried), including cost of debris removal, even though the loss substantially exceeds the amount (90 percent of property value at that location) used as the basis to determine the amount of blanket insurance to provide.

If appropriate ordinance or law coverage is also included, the cost of demolition and site clearance, loss of the value of the undamaged portion that must be demolished and increased cost of reconstruction according to current code are also covered.

From the perspective of reinsurance companies, the ability of insureds to purchase blanket agreed amount insurance and obtain the full amount of coverage at any one location—even when the property values are inadequate—is undoubtedly the reason insurers are adding margin clauses to their policies.

Briefly, when a margin clause is added to a commercial property policy, it eliminates the agreed amount provision. The net effect is to provide no more coverage than a certain percentage—ranging from 10 to 20 percent—of the damaged or destroyed property as shown on the statement of values.

If, for example, the blanket limit is $1 million and the building destroyed by fire is shown on the statement of values to have a replacement cost limit of $500,000, the most the insurer has to pay, with a 10 percent margin clause, is $550,000—with the difference between actual cash value and replacement cost paid when reconstruction is completed.

Adequacy of Construction

A common finding after a catastrophic loss is that buildings supposedly built to generally accepted construction standards are deficient in many subtle ways not obvious to the potential buyer. In a competitive construction market, corner-cutting, which can be the difference between the contractor’s profit and loss, becomes obvious only after a major disaster. Following Hurricane Andrew, numerous instances of deficient construction came to light: buildings inadequately anchored to the foundation, roofs not sufficiently tied down, use of inferior wall panels that were highly subject to damage under hurricane conditions, to mention but a few. Comparable deficiencies also frequently come to light in the aftermath of a major earthquake. In major fires, failure to firestop between adjacent portions of buildings can allow rapid spread of fire, engulfing the entire building. Use of inferior materials can contribute to more rapid fire spread or greater structural damage than standard materials.

Moreover, many older buildings —built to the standard at the time of construction—have not been upgraded to meet modern standards. This produces a twofold problem: (1) under loss conditions, greater damage may result than if the building met current standards; and (2) following loss, upgrade to meet current standards may be required, perhaps even requiring demolition of undamaged portions of the building.

This is especially true of earthquake exposures where technology has advanced rapidly and building codes, although commonly allowing “grandfathering” of existing buildings, have become increasingly restrictive, even to the point of requiring demolition of a damaged building.

While it is not always possible to recognize building deficiencies before they are dramatically revealed by a loss, many defects are recognizable and should be...