Cancel Liability Insurance the Day a Property is Sold? Secondary Dependent Properties NY WC Experience Split Point Change Approved as of 10/1/13

The three topics this month are unrelated, but are all important. A perfect example of how diverse the insurance business is.

Don’t Cancel Liability Insurance the Day the Property is Sold.

Often producers, in a mistaken effort to provide outstanding service, cancel all insurance for an insured as soon as they learn that an insured property has been sold; the cancellation is often effective as of the day of the transaction. While that’s appropriate for property insurance, it’s not a good idea for liability insurance. Every two years or so, I see a case where the former owner is sued based on an accident that occurred after title to the property has passed and the policy cancelled. The latest one was decided on May 15, 2013.1

On July 31, 2007, Jericho Atrium Associates sold Jericho Atrium, a 145,000 square foot office building located on the “Gold Coast” of Long Island to AGMB. Jericho Atrium Associates cancelled its liability coverage with Travelers as of the date of sale. Ten days later, Mary Bozzello fell at the entrance to the building. Bozzello and her husband sued the former and the new owners. The theory for suing the former owner is that the condition causing the accident existed prior to the sale and that the new owner wasn’t informed about it and/or didn’t have sufficient time to discover and remedy the condition.

In cases like this, insureds argue that the old policy should provide coverage because the condition existed prior to policy cancellation. Insurance companies reply that occurrence-form policies are clear—there’s no coverage for the former owner if the policy has been cancelled prior to the accident. Typical occurrence policies provide that:

This insurance applies:

(1) To “bodily injury” and “property damage” only if: …

(b) The “bodily injury” or “property damage” occurs during the policy period (emphasis added)… Courts almost always agree with the insurer. My recommendation: Don’t cancel liability coverage as of the day the property is sold.

The next question, of course, is how long should coverage be maintained? That, like what is an adequate liability limit, is a “how high is up?” question. A year is not unreasonable; I had a client whose attorneys recommended five years. But whether it’s 1 month, 6 months, 1 year, 5 years, or more is the insured’s decision. There is another way around the problem. If the insured has a policy covering many locations, the insured’s protection can be continued by leaving the name of the property owner on the policy even though the location itself has been eliminated and the insured has received a return premium. The CGL policy excludes only property damage for property that’s been sold:

2. Exclusions

This insurance does not apply to: … “Property damage” to: … (2) Premises you sell,…if the “proper ty damage” arises out of any part of those premises;… There’s no comparable exclusion for bodily injury. Therefore, as long as the former owners are named insureds, the policy will defend and indemnify for bodily injury claims even though the insured doesn’t own the building any longer. Leaving the insured’s name on the policy won’t work if the policy contains a designated premises endorsement; such an endorsement limits coverage to the named locations.

Secondary Dependent Properties

At one time, the gold standard of American business was vertical integration— the control of the entire process of producing and marketing the product. The prime example was the Ford Motor Company. In the early 1900s, Ford was plagued by raw material shortages and unreliable suppliers. Henry Ford’s answer was to control the entire process from the iron ore mines that supplied the raw material for the cars to the dealers that sold them to the public. At its peak, Ford Motors owned businesses in 33 different countries ranging from rubber plantations to glassworks. Ford was wildly successful. At the height of its success, the overwhelming majority of the cars produced in the world were model T Fords.2

Not every company was as successful with vertical integration and even Ford ran into trouble managing the huge empire that was required to carry out this plan. Businesses abandoned vertical integration; outsourcing, large supply chains, and justin- time inventory replaced it. Today, even the largest firms rely on suppliers for much or all of the production that Henry Ford once controlled on his own.

The risk management problem of outsourced supply chains has long been realized. A serious loss at a key supplier can cripple production just as much as if it had occurred at the firm’s own facilities. We all know that the business income loss flowing from the destruction of key suppliers and manufacturers, customers, and leader properties can be insured using the dependent property (formerly known as contingent business income) forms. Dependent property endorsements cover the business income loss the insured suffers due to damage by an insured peril to property at the location of firms that the insured depends on. But what if the interruption is due not to damage to the firm the insured is dependent on, but to damage to those firms that the supplier depends on? This exposure is referred to as “secondary dependent property.” ISO has now added an option to its dependent properties coverages endorsements to close this gap.3

A secondary contributory location is defined as an entity that: Delivers materials or services to the contributing location identified in the schedule, which in turn are used by that contributing location in providing materials or services to the insured or Accepts materials or services from the recipient location identified in the schedule, which in turn accepts the insureds materials or services.

Locations that provide utility services (power, communications, water supply, and wastewater removal) are not secondary locations. Neither are roads, bridges, tunnels, waterways, airfields, pipelines or similar structures. (Utility Services—Time Element coverage can close some of the first gap for the insured’s premises and Ingress/Egress coverage—not a standard ISO coverage—can provide some protections from the second, but there’s no option to extend these coverage to secondary dependent properties at present). ISO dependent property forms require that the name, occupancy and location of dependent properties be shown. However, there’s no requirement to list secondary locations. Whatever locations serve the dependent properties at the time of the loss.4

When secondary contributory location coverage is provided, ISO rules call for a 50% increase in the dependent property rate. Premiums for dependent property coverage are often quite low, so that’s not as onerous as it sounds.

Discuss dependent property coverage with clients and prospects. If they are dependent on properties outside the US and Canada—I hear reports that some firms even have suppliers in China—there is worldwide coverage available. ISO has a limited form international endorsement, but you’ll want to check non-ISO insurers to compare their coverage. Interestingly, some companies that pride themselves on offering coverage that’s superior to market- standard, have let ISO get the jump on them on this one.

Hot off the Press: NY WC Experience Split Point Change Approved as of 10/1/13

It’s official: New York will join all the other states that have adopted the new  workers compensation experience modification split point5 . It’s good news/bad news for insureds. Rating bureaus estimate that total US workers compensation premiums will not change, but some insureds’ modifications, and therefore premiums, will go up while others will go down. It’s estimated that 7% of insured will receive modifications that are 11 or more points higher than they would have been had the split point not changed. Another 7% will see increases of between 5% and 10%. Counterbalancing that, it’s estimated that 38% of insureds will have modifications that are between 2% and 5% lower under the new split point and that 8% will be between 5% and 10% lower than they would have been.6

For producers and those who work with workers compensation insureds, it’s just bad news. I’ve never had an insured tell me that he or she isn’t being charged enough for insurance and I doubt that you have either. We won’t hear from those whose ratings improve. We will hear from those whose ratings and premiums increase.

It’s good news for insureds in another way: they’ll have more control over their experience modification. To understand that, let’s look at what’s happening. The split point is increasing from $5,000 to $10,000. The split point is the dividing point between “primary” loss (the smaller losses and the first portion of larger losses) and excess loss (the rest of an insured’s losses).

Experience modification is basically a comparison of the insureds adjusted  actual losses with the losses that an average insured is expected to incur. If the adjusted total is higher than average, the insured receives an experience modification higher that 1.00; if it’s lower, the insured’s modification is lower than 1.00.

The key word is adjusted. Only the primary loss total is used in full. The excess losses are composed in part of the insured’s actual excess losses and in part of excess losses expected by an average insured with the same payrolls and classifications. As little as 5% of the insured’s actual excess losses go into the calculation for the smallest insureds; even for midsize insureds the percentage is under 25%. The rest of the insured’s adjusted loss is calculated by taking the remaining percentage (95% for smallest insureds, up to 75% for midsize account) of the excess losses that an identical average insured is expected to have and adding that to the insured’s actual losses. Thus, even if an insured has had no losses at all, a charge for excess losses will be added in calculating it’s experience modification. Why is that good news? Because an insured can have much more success in controlling the frequency of losses than in controlling severity and it’s the frequency of claims that drives up primary losses.

Consider two identical insureds, each having $100,000 in workers compensation claims. The only difference: Firm A had 8 claims of $12,500 each whereas firm B had just 1 claim of $100,000. Firm B is a much better risk and will have a lower modification than firm A. In fact, firm B may have a credit rating (less than l.00) while firm A may have a debit rating (more than 1.00). If their loss totals remain the same, Firm B’s rating will be lower and Firm A’s higher under the new $10,000 split point than they would have been if the split point hadn’t changed. Tell your insureds about the upcoming change. Point out that controlling claim frequency will lower their experience modifications. It may help you soften the blow for those whose ratings increase and it may get you some credit from those whose ratings go down. You won’t have done anything to earn the credit, but you get blamed for things you didn’t do so take credit wherever you can.

Furthermore, the split point will change every year from here on out. It’s scheduled to increase to $12,500 as of 10/1/14 and $15,000 as of 10/1/15. However, starting with 10/1/15, it will be adjusted for claim inflation. It’s estimated that the 10/1/15 figure will actually be $17,500, with increases each year thereafter if claim inflation continues. The annual change will give you a reason to contact insureds each year to point out that claim frequency is becoming ever more important.

1 Jericho Atrium Assoc. v Travelers Property Casualty Co. 2013 NY Slip Op 03461

2 “Vertical integration Moving on up” The Economist Mar 27th 2009 http://www.economist.com/node/13173671. In “what-goes-around comes-around” fashion the article points out that vertical integration is making a comeback.

3 The “2013” commercial property insurance changes have been approved in NY, NJ, CT and most other states. (The forms bear October 2012 edition dates, even though they were filed to be effective in 2013.) I discussed the items I thought were major in the 344-page ISO circular describing the changes in the January 7, 2013 issue of the Insurance Advocate (“2013 Commercial Property Changes—Major or Minor?” Insurance Advocate CINN Group Inc., Mt. Vernon, NY January 7, 2013 pages 10, 12, 14, and 16). However, I omitted Secondary Dependent Properties, mea culpa.

4 Some company forms provide dependent property coverage blanket without the requiring the listing of locations. ISO forms do provide coverage for miscellaneous unnamed locations of up to .03% of the limit of insurance per day—but that’s just $3,000 per day if the amount of insurance is $1,000,000.

5 For a more detailed discussion of experience modification, see Jerome Trupin “What is The Workers’ Compensation Split Point, How is it Changing, and Why Should You Care” Insurance Advocate CINN Group Inc., Mt. Vernon, October 15, 2012 pages 8, 10. 12, 14, 16

6 Kory Wells “How Will Mods Change Under New NCCI Plan Recommendations?” Work- CompEdge Blog Zywave http://www.zywave. com/blogs/2011/08/02/how-will-modschange- ncci-rule-recommendations/