For owners of commercial real estate, and their lenders, property and casualty insurance coverage is one of the key requirements. It is likely also one of the least understood.
We are joined today by Brian Scott, President of Smith Petrie Carr & Scott . SPCS is one of Eastern Ontario’s largest independent insurance brokerages. He is well placed to help us understand some of the basics. Thank you for joining us today Brian.
What type of coverage do Lenders typically require?
YPLP: Building owners typically obtain financing, and consequently their lenders are often instrumental in directing the type and amount of insurance coverage an owner obtains. Has this been your experience?
Brian Scott: Yes, Lenders drive the type and amount of insurance but increasingly they are using Risk Managers prior to closing. Risk Managers assist the Lender by recommending types and amount of Insurance.
YPLP: In grossly simplified terms, Lenders typically require that a property owner obtain property insurance as well as liability coverage. Is there a difference between what type of coverage is appropriate for a property owner whose business resides in the premises vs. a property owner who leases out the premises to arm’s length tenants?
Brian Scott: While a building that has an owner on premises is desirable from an Insurer’s perspective, what really influences the insurance rates for a building owner are construction and the occupancy on site. I.E. High risk vs Low Risk – Fireworks manufacturer vs. offices for example.
Business Interruption Insurance is a must have!
YPLP: Lenders also typically require Business Interruption Insurance. Is this generally required only in cases where the property owner has rented out the premises?
Brian Scott: Business Interruption Insurance should be maintained in all cases. E.g. a building owner might create a holdco and then rent part or all of the building out to his operating company.
YPLP: Lenders typically require Replacement Cost coverage. Is this the industry standard for commercial property owners?
Brian Scott: Replacement Cost should always be added. Insurers may not wish to provide it on older buildings that have not been updated (e.g. roof, electrical, plumbing) but it is the industry standard. The Broker should also ensure that the “Same site rebuilding clause” be deleted from the replacement cost endorsement. If a total loss occurs the building owner is then free to build elsewhere.
Make sure you understand your Co-Insurance clause!
Pay particular attention to the Co-Insurance Penalty Clause. Unless you have had a replacement cost estimate completed by a professional appraiser, your policy is likely to contain a Co-Insurance Clause. Essentially this clause will make you a co-insurer of a partial loss unless you insure to some predetermined number – usually 90%. E.g. If your building is worth $1,000,000 and your policy contains a 90% co-Insurance penalty you must insure the building to a minimum of $900,000. Otherwise, in the event of a partial loss you will be a co-insured in the loss. Call your Insurance Broker for a more detailed explanation of this clause and make sure you understand it.
YPLP: A commercial property may have a high market value primarily due to its strategic location. The mortgage amount may well exceed the replacement cost of the building. Yet, there is a commonly held belief that property insurance coverage should meet or exceed the mortgage amount registered against the property. What would your recommendation be in such a circumstance?
Brian Scott: Call your Insurance Broker. Likely s(he) has had this conversation with Lenders many times over the years. A property can only be insured for the cost to rebuild, which likely will not equate with market value.
YPLP: Lenders commitment letters often call for Borrower to obtain coverage in which the Lender is named as a Mortgagee. In addition the Mortgagee is typically to be named as an Additional Insured party. Why?
Brian Scott: The Lender should be added as Additional Insured with respect to liability. For example, when a slip and fall occurs a typical statement of claim will not only name the Building Owner and the Tenant but also the Mortgagee – in an attempt to reach the “deep pockets”.
What coverage should your tenant have in place?
YPLP: Landlords typically require that their Tenants have insurance in place as well. Generally speaking, should a landlord insist that the Tenant have the same type of insurance in place, i.e. replacement cost coverage, business interruption, and liability coverage?
Brian Scott: Take the time and spend the money to have a good real estate lawyer draw up a standard lease to be used with the tenants. The tenant should have all of the above coverage’s as a minimum, and the Landlord should be named as additional Insured.
How can your Insurance Broker help?
YPLP: When seeking to place coverage on a newly acquired commercial property, how can a Broker assist a property owner with their requirements?
Brian Scott: Give your Insurance Broker as much lead time as possible when you know you are closing. We have checklists in place to ensure that the proper coverage is in place including but not limited to:
Replacement Cost endorsement with same site rebuilding clause deleted; Arrange for Co-Insurance penalty to be deleted if you have a replacement cost appraisal; Equipment Breakdown Insurance (Boiler and Machinery); By-Laws, Flood, Earthquake, Sewer-Back up, Standard mortgage Clause, Business Interruption, Liability Insurance, etc.
Prior to finalizing insurance coverage please advise your Insurance Broker of anything you become aware of as the result of the building condition report or environmental audit.
YPLP: Do you see common or perhaps re-occurring property insurance coverage issues in practice? How can clients help you to help them?
Brian Scott: Consult your Insurance Broker prior to purchasing a building with knob and tube wiring, galvanized steel plumbing, or a property with a history of water damage losses. Don’t forget to ask about previous occupancies. Environmental exposures are increasingly a significant concern to both building owners and their lenders.
Thank you for your insights Brian. They have been very valuable.