Coinsurance, Deductible and a Lease Waiver on an Apartment Fire
Harborview Holdings LLC owns a four-unit apartment building in Lowell. Replacement cost is $1,600,000, but the LLC, squeezed by a refinance, insured the building for $1,000,000 on a commercial property form with an 80% coinsurance clause, replacement cost valuation, and a $5,000 deductible. The form carries the standard Loss Payment, Coinsurance, and Transfer of Rights of Recovery conditions. In March a tenant's remodeling contractor started a fire with a torch near exposed framing. Building damage is $320,000 at replacement cost, and the LLC intends to rebuild, so depreciation is not in dispute. The LLC's lease with its tenants contains a mutual waiver of subrogation between landlord and tenant. The property manager calls for answers before signing the proof of loss.
1. How much will the insurer pay for the $320,000 building loss? Show the arithmetic and explain what the coinsurance clause is actually doing.
Read the worked answer
Step 1 - required limit. 80% x $1,600,000 replacement cost = $1,280,000.
Step 2 - ratio. Did ÷ should have carried = $1,000,000 ÷ $1,280,000 = 0.78125.
The ratio is below 1.00, so the LLC is a coinsurer for the balance.
Step 3 - apply the ratio to the loss. 0.78125 x $320,000 = $250,000.
Step 4 - deductible. $250,000 - $5,000 = $245,000, comfortably inside the $1,000,000 limit.
What it cost them. With no penalty the payment would have been $320,000 - $5,000 = $315,000. The coinsurance clause therefore shifted $70,000 of this single loss onto the insured. That is the point of coinsurance: it is an incentive to insure to value, not a limit cap. Because the LLC bought $280,000 less than required, it effectively self-insures 21.875% of every loss.
One caveat worth flagging: if the Loss Payment condition applies the deductible to the loss before the ratio, the payment is 0.78125 x $315,000 = $246,094, about $1,094 more. Read the form's order of operations before promising a number.
2. The lease contains a mutual waiver of subrogation between landlord and tenant. Does that block the insurer from pursuing the remodeling contractor? What should the LLC and the insurer each examine?
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Subrogation is derivative - the insurer steps into the LLC's shoes and takes only the rights the LLC actually had. So the question is the scope of the waiver, not whether the contractor was negligent.
- Who is released? A waiver running to 'tenant' alone does not release the tenant's independent contractor. If the lease releases 'tenant and its agents, employees, contractors and invitees,' the LLC has already given away the claim it would otherwise have assigned to its insurer.
- Was it written and pre-loss? Most commercial property forms permit the insured to waive recovery rights in writing before a loss (typically to parties with whom the insured has a written contract), but not after. A post-loss waiver is an impairment.
- Impairment consequence. If the LLC impaired the insurer's recovery after the loss, the insurer may reduce or deny the payment to the extent of the lost recovery - here potentially most of the $70,000+ exposure.
What to do: pull the actual lease language before answering. If the waiver does not reach the contractor, the insurer subrogates against the contractor and its CGL carrier and the LLC's claim is paid in full. If it does reach the contractor, tell the adjuster now rather than after the check clears.
3. The agent proposes raising the limit to $1,280,000 to 'buy out' the penalty. Evaluate that advice and identify the risk that remains even at $1,280,000.
Read the worked answer
The advice is directionally right but incomplete.
The benefit. At $1,280,000 the ratio is 1.00 and the $70,000 penalty on a loss of this size disappears. On a total loss the difference is $280,000 of unprotected value, so the premium increase is usually easy to justify.
What it does not fix. The coinsurance test is measured against replacement cost at the time of loss, not at policy inception. Construction costs in eastern Massachusetts have moved sharply. If the same building is worth $1,700,000 when the next fire happens, the required limit becomes $1,360,000 and, at a $1,280,000 limit, the penalty is back (ratio 0.941). A margin clause or a stale valuation defeats the purpose of the increase.
Practical recommendations:
- Raise the limit to at least $1,280,000 and re-run the valuation annually.
- Ask the carrier whether an agreed value option is available - it suspends the coinsurance test for the policy term.
- Or keep coinsurance and fund the retained exposure deliberately, which is what the LLC is doing now whether it realizes it or not.
Sell the trade-off in dollars of expected retained loss against premium, not as a slogan about being 'fully covered.'