Cedar Ridge: Coinsurance, Code Upgrades, and the Swing Lease
Cedar Ridge LLC owns a 24,000-square-foot warehouse/office insured on a commercial property special form written on a replacement-cost basis: $1,600,000 building limit, 80% coinsurance, $10,000 deductible, business income with a 12-month period of indemnity, and the ordinance-or-law endorsement with a 10% sublimit. The building's actual replacement cost is $2,400,000. A mezzanine fire causes $600,000 of covered building damage and $25,000 of debris removal. The city will not allow reoccupancy until $90,000 of sprinkler and egress upgrades are installed; those upgrades were not part of the damaged work. Repairs take four months. In month two Cedar Ridge leases swing space and resumes 70% of normal output; the additional lease and moving costs are $40,000, and its actual lost net income plus continuing expenses over the four months come to $96,000 rather than the $180,000 it would have lost at full operation.
1. Calculate the building payment, including the coinsurance penalty and debris removal.
Read the worked answer
Step 1 - coinsurance requirement: 80% × $2,400,000 replacement cost = $1,920,000.
Step 2 - ratio actually carried: $1,600,000 ÷ $1,920,000 = 0.8333. The insured is a coinsurer for the shortfall.
Step 3 - apply to the covered loss: $600,000 × 0.8333 = $500,000 (a $100,000 penalty).
Step 4 - debris removal: $25,000 is additional coverage under the form. It does not reduce the building limit and is not subject to coinsurance, so it is not multiplied by 0.8333. It is also not a separate "loss" for deductible purposes.
Step 5 - deductible once per occurrence: $500,000 + $25,000 − $10,000 = $515,000 payable.
Two cautions worth stating in the file:
- Read the form's loss-payment condition before promising the figure. Some forms apply the deductible to the loss before the ratio ($600,000 − $10,000 = $590,000 × 0.8333 = $491,667 plus $25,000), which is a few thousand dollars different.
- Because the building was underinsured by $320,000, the coinsurance penalty is not a claims decision - it is contractual. Explain the arithmetic to the insured in writing and recommend a replacement-cost review before renewal; a total loss today would leave a $800,000 gap plus the penalty.
2. Is the $90,000 of sprinkler and egress work covered, and what would the answer be without the endorsement?
Read the worked answer
Covered, but only because the ordinance-or-law endorsement is on the policy - and only within its sublimit.
- The base commercial property form excludes the cost of complying with ordinances or laws regulating construction or repair. Without the endorsement, the $90,000 would be uninsured even though the city required it as a condition of reoccupancy.
- The endorsement typically provides three pieces: coverage for the undamaged portion of the building that must be torn down, demolition costs, and the increased cost of construction to comply. Here the upgrade is increased cost of construction.
- The sublimit is 10% of the $1,600,000 building limit = $160,000, so $90,000 fits comfortably.
Does the coinsurance penalty apply? Ordinarily yes: the increase in the cost of construction is payable on the same basis as the building loss, so $90,000 × 0.8333 ≈ $75,000, inside the sublimit, with no second deductible. Confirm against the endorsement's loss-payment wording before committing.
One drafting point to raise at renewal: the sublimit is a percentage of a limit that is itself 33% below replacement cost. The real ceiling is $160,000, not 10% of what the building would actually cost to rebuild - so the endorsement's practical protection shrinks along with the limit.
3. How much business income and extra expense is owed, and what governs the length of the payout?
Read the worked answer
Business income - $96,000, not $180,000. The measure is the actual loss sustained: net income plus continuing normal operating expenses during the period of restoration. By relocating in month two and recovering 70% of output, Cedar Ridge genuinely reduced its loss to $96,000, and that is what it can prove. The $180,000 figure is a hypothetical it did not suffer. Insurers do not pay a loss the insured avoided - but neither may the insured claim the full hypothetical.
Extra expense - $40,000. The swing lease and moving costs are extra expense, a separate coverage. It is not offset against the business income payment and does not reduce it; rather, extra expense exists precisely so an insured will spend money to shorten the business income loss. Both share the business income limit, which with a 12-month period of indemnity is more than adequate.
Period of restoration. It runs from the date of loss until the property should be repaired, rebuilt or replaced with reasonable speed and similar quality - roughly the four months the contractor projected. It does not run to the end of the swing lease, and it is not extended because the insured chose to relocate or because approvals dragged. If Cedar Ridge delays repairs to keep operating cheaply in the swing space, the carrier should shorten the period. Verify the business income form's own deductible; many packages apply the property deductible to the building payment only, but that must be confirmed before the settlement letter goes out.
Check for a 72-hour waiting period: it applies to civil-authority and (on some forms) utility-service interruption, not to the base business income coverage triggered by fire damage at the insured premises.