Coinsurance, Code Upgrades, and a Vacancy Permit
Riverside Holdings owns a 12-unit apartment building with a replacement cost of $1,000,000. Its commercial property policy has a $600,000 building limit, an 80% coinsurance clause, a $5,000 deductible, and actual cash value (ACV) settlement unless a replacement cost endorsement applies. A kitchen fire causes $200,000 in damage; the ACV of the damaged property is $140,000. The local building code now requires a $30,000 sprinkler upgrade before the damaged units can be reoccupied. The policy excludes ordinance or law unless endorsed; no such endorsement was purchased. Riverside also had a 30-day vacancy in two units before the fire, and the policy has a vacancy permit endorsement that requires the building to be at least 70% occupied. The building was 83% occupied at the time of loss. Riverside's agent had recommended a $1,000,000 limit and replacement cost endorsement, but Riverside declined to save $4,200 in annual premium.
1. Calculate the coinsurance penalty and the amount payable for the fire loss, showing each step. State any assumptions about ACV and deductible order.
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Step 1: required insurance = 80% × $1,000,000 replacement cost = $800,000. Step 2: coinsurance ratio = carried limit ÷ required limit = $600,000 ÷ $800,000 = 0.75. Step 3: because no replacement cost endorsement applies, the loss is measured on an ACV basis. The ACV loss is $140,000, not the $200,000 repair cost. Step 4: apply the ratio: $140,000 × 0.75 = $105,000. Step 5: subtract the $5,000 deductible: $105,000 − $5,000 = $100,000 payable. The $600,000 limit is not exceeded. Assumption: the deductible is applied after the coinsurance calculation, which is the usual approach; if the policy applies the deductible first, the result would be slightly different. The insured bears the remaining $40,000 of ACV loss plus the difference between ACV and replacement cost. If a replacement cost endorsement had applied, the starting loss would be $200,000, producing $150,000 after coinsurance and $145,000 after the deductible, subject to repair completion.
2. Is the $30,000 sprinkler upgrade covered? Explain the ordinance-or-law exclusion and the effect of the agent's prior recommendation.
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The $30,000 sprinkler upgrade is not covered. The policy excludes ordinance or law unless endorsement is purchased, and no endorsement was purchased. The upgrade is required by the local building code before the damaged units can be reoccupied, so it is an ordinance-or-law loss, not direct fire damage. The insured cannot add the $30,000 to the ACV loss or treat it as part of the fire damage. The agent's prior recommendation for a $1,000,000 limit and replacement cost endorsement is helpful evidence of good advice, but it does not create coverage. The insured declined the coverage and saved $4,200 in premium, so the code upgrade is a self-insured cost. Going forward, Riverside should add ordinance-or-law coverage with adequate limits and consider replacement cost coverage. The agent should document the prior recommendation and obtain a signed rejection for any declined coverage.
3. Does the vacancy permit bar coverage? What risk-management and coverage advice should the agent give Riverside now?
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The vacancy permit requires at least 70% occupancy, and the building was 83% occupied at the time of loss. On those facts, the permit is satisfied, so the vacancy condition should not bar the fire claim. The two vacant units may still affect business income and liability, and the agent should document how occupancy was calculated. For risk management, Riverside should not rely on a $600,000 limit when the replacement cost is $1,000,000; the coinsurance penalty turned a $140,000 ACV loss into a $100,000 payment. The agent should recommend increasing the limit to $1,000,000, adding replacement cost and ordinance-or-law coverage, and considering a higher deductible to manage premium. The $4,200 savings was outweighed by the uncovered coinsurance and code-upgrade costs. The agent should present a written coverage comparison, document the client's choices, and follow up before the next renewal.