Your homework assignments have addressed training your staff in a number of areas, including spill control and countermeasures as well as fire alarm and notification procedures. You also should have designated a group of employees to serve as your response team by now. Last month, I talked about coordinating an environmental cleanup or closure site and I began the important lesson regarding insurance.

In this final installment of my "Plan for the Unexpected" series, I highlight the last of Sobey's suggested homework.

More on Assignment #3: Insurance

Last month, I covered establishing insurable values and asset descriptions. This month, I begin with claim documentation.

Documenting a Claim. In a distressed situation, with your assets reduced to rubble, are you prepared to compile a credible inventory, research the costs to replace assets, and judge fair depreciation for the individual items? For the adjuster to "purchase" your assets for their "actual cash value," you -- the insured -- must prove your loss. Your first task is to create an inventory of the damaged, partially damaged and undamaged property. During this time, you also are trying to preserve and protect your property from further damage.

A credible inventory will be very detailed in the data presented and the documentation supporting it. You can sift through the rubble and old asset purchase files for data and clues. But, if you do this, you may overlook many expensed assets that your depreciation schedule does not track. Your expensed assets, including supplies, tooling, installation and delivery costs, parts, and hand and power tools can add up to a significant amount of money.

Actual Cash Value. The insurance company will pay the insured the actual cash value or depreciated value once the claimed loss is agreed to. When proof that the assets have been repaired or replaced is submitted to the insurance company, the adjuster will pay the withheld depreciation. This term refers to the difference between the adjusted actual cash value and replacement cost value. If repair or replacement cost exceeds the property insurance coverage limit, the insurance company only will pay the policy limit.

Insurance policies do not define the term "actual cash value." Many adjusters and courts interpret the actual cash value as the market value or the sum of money the assets would have brought for cash at the time and place they were destroyed. This measure is a major concern when valuing the actual cash value of real property and older machinery and equipment destroyed in a loss.

The actual cash value policy is a pure indemnity contract. Its purpose is to make the insured whole but never to benefit the insured because a covered loss occurred.

Co-insurance. Many property insurance policies are written with a co-insurance clause. Co-insurance is an agreement that allows the insurance company to offer a business lower property insurance premiums based on an agreement that the insured accepts a portion of the risk of loss. In this agreement, the insured purchases property insurance to an agreed percentage of the replacement value of property.

If you have property damaged by a covered peril, you likely will be tested on the adequacy of your limits of coverage. If your building costs $1 million to replace and your replacement-cost insurance policy has an 80 percent co-insurance agreement, your building insurance coverage limit needs to be at least $800,000. In the event that your limits of insurance at the time of the loss are less than the agreed minimum, the insured becomes a co-insurer of the partial loss. The loss is paid by dividing the insurance carried by the amount of insurance required times the loss or damages. Co-insurance has the effect of preventing one policyholder who has insured for a small percentage of value and paid a correspondingly small premium from collecting as much in the event of a loss as the policyholder who has insured for a larger percentage of value and has a correspondingly larger premium.

The idea of co-insurance is to prevent a policyholder who has "underpaid" premiums relative to the risk accepted by the insurance company from collecting a claim settlement that is not discounted. The policyholder that has insured in compliance with the agreement will not be penalized.

According to Sobey, Curran and Cornelius, there are many misunderstandings among insurance purchasers about the application of a co-insurance agreement. Some interpret the agreement to mean the insurance company will only pay the percentage of the loss that is contained in the clause.

In a total loss, co-insurance is not applicable. In a partial loss, co-insurance applies the penalty for underinsurance.

Business Interruption and Extra Expense Insurance. When a disaster interrupts normal business functions, many expenses continue. Insurance can be purchased to replace the loss of income caused by a covered property loss. Further, a business may incur expenses above normal operating costs to restore business operations. For the purpose of determining your exposure to business income and extra expense loss, Sobey, Curran and Cornelius recommend that you have your CPA, controller or accountant complete the Business Income Report/Worksheet (CP15 15 06 95) on an annual basis. Making an accurate measure of the risk exposure or potential loss allows you to purchase adequate insurance. They recommend an agreed value endorsement for your business income and extra expense coverage form.

Consider forms that include an extended time period, temporary location, ordinance or law increased period of restoration. They also recommend an agreed value endorsement for your business income, extra expense and loss of rents coverage form. Again, making an accurate measure of the risk exposure or potential loss allows you to purchase adequate insurance.

Contingency Planning

Further, the plan should include ongoing communication with the fire department and sewer district related to fighting a fire in your facility and your specific risks or hazard areas. Continually monitor your operation for risk areas and locations where hazardous material could become part of the fire-fighting water runoff and loss debris. Modify your facility to contain potential pollution hazards to your property should a loss occur. Work with knowledgeable consultants to identify your risk and act on their recommendations for improvement.

It is my hope that you will not have to put your homework assignments to use once they are complete. But if you are a good student who has learned from Sobey's experience -- and you complete your assignments -- at least your company will be prepared to pass the test. Class dismissed.

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Appraisal Terms