Coinsurance Penalty and Business Income on a Fire Caused by Equipment Breakdown
Birmingham Metal Works insures its plant under a commercial property policy (special form, replacement cost) with a $1,800,000 building limit, a 90% coinsurance clause, a $10,000 deductible, and business income coverage of $600,000 with a 72-hour waiting period and a 60-day extended period of indemnity. In April a dust-collector bearing seized, overheated, and ignited ductwork. Building damage is $450,000 at replacement cost and includes the dust collector itself. Repairs will take five months; net income plus continuing expenses run $52,000 per month, and sales return to normal only after a two-month ramp-up. The building's replacement value is now confirmed at $2,400,000. A tenant's $80,000 racking, stored in space the plant leases to the tenant, was destroyed; the lease places no responsibility on the plant.
1. Calculate the building payment, including the coinsurance effect. Then explain how the dust collector's own mechanical damage is treated.
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Coinsurance test: required limit = 90% x $2,400,000 = $2,160,000. The insured carried $1,800,000, so it is underinsured.
Payment = (limit carried / limit required) x loss, not to exceed the limit:
- (1,800,000 / 2,160,000) = 0.8333
- 0.8333 x $450,000 = $375,000
- Less the $10,000 deductible = $365,000
The insured absorbs $75,000 of the loss purely as the coinsurance penalty and cannot cure it by re-appraising after the fire. A blanket or agreed-value form would have avoided the penalty; this policy is specific insurance.
Dust collector: a seized bearing is mechanical breakdown/wear and tear, which the property form excludes. The ensuing fire is a covered peril, so the fire damage to the ductwork and building is payable, but the cost to repair or replace the failed dust collector itself (the excluded item that broke) is not covered unless an equipment breakdown policy was purchased.
2. Compute the business income recovery, addressing the 72-hour waiting period, the ramp-up, and the limit.
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Period of restoration: five months, ending when the building is repaired with reasonable speed.
- Monthly business income loss = $52,000 (net income plus continuing expenses).
- Five months = $260,000.
- The 72-hour waiting period is a time deductible: the first three days of suspension are not covered, so subtract roughly 3/30 of a month, about $5,200, giving about $254,800 for the restoration period.
- Extended period of indemnity adds up to 60 days after repairs are complete to cover the ramp-up. With sales returning gradually, the recoverable amount depends on proof of the actual shortfall, but it is capped at 60 days at the pre-loss rate (up to about $104,000).
Total exposure is roughly $340,000-$360,000, comfortably under the $600,000 limit and within the 12-month limit period. If the policy also has a business income coinsurance percentage, confirm the limit purchased was at least that percentage of annual business income; on these numbers the limit does not appear to be impaired.
3. The tenant demands that the plant's property policy pay for the destroyed $80,000 of racking. Analyze whether the plant's policy responds.
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The plant has no insurable interest in the tenant's racking, so it cannot collect for the tenant's loss in its own right. The question is whether the racking falls within personal property of others in the insured's care, custody, or control.
- If the plant merely leases space to the tenant and the tenant stores its own racking there, the plant does not have care, custody, or control - no coverage, and the tenant's own commercial property policy responds.
- If the lease makes the plant responsible for the space and its contents, or the plant bailed or stored the racking, coverage may extend under the personal property of others provision, subject to any sublimit and to the coinsurance limit for that coverage part.
- The racking is not "Business Personal Property" of the insured and is not a tenant improvement the landlord owns, so it cannot be folded into the building loss.
Because the lease places no responsibility on the plant, the correct answer is no coverage; the plant should refer the tenant to its own policy and confirm the lease language in writing.