We’ve just returned from the International Council of Shopping Centers Law Conference in San Diego. The “hot topic” this year seemed to be “insurance,” and the “hot sub-topic” seemed to be “business interruption insurance.” To some, that means “rent insurance.” In May, we wrote: “What Would Rent Insurance Be If There Were Such A Thing?” You can see that blog posting: HERE. Basically, “rent insurance” is a colloquial term for a major “element” of Business Interruption Coverage, which, itself, is a colloquial term for “Business Income” coverage, which is what the appropriate forms are titled.
Today, we’re going to talk “principles,” not details; the “broad” sweep, not the cute little ins and outs. Next week, we’ll dig a little deeper. So, study up. You’ll need the following background for next week’s posting.
Fundamentally, a property insurance policy pays for “direct damage” to property. That is, it pays to repair or replace property damaged by an insured peril. But, what about the financial damage that comes from not having the use of that property while it is being repaired or replaced? Can that be covered? Of course it can.
If a party is worried about its ability to recover, financially, after a fire or similar event (or pay its mortgage or pay its rent), it will want to add coverage using a Business Income form, either the (Insurance Services Organization – “ISO”) Business Income (And Extra Expense) Coverage Form [CP 00 30] or the ISO Business Income (Without Extra Expense) Coverage Form [CP 00 32]. Also available is a pure ISO Extra Expense Coverage Form [CP 00 50].
Before we proceed, let’s talk about terminology. Lease, mortgage, and contract draftspeople like to call for “rent insurance.” You won’t find an insurance policy for “rent insurance” or an Endorsement for “rent insurance.” What you want to cover is either the loss a landlord experiences if its tenant is relieved of the obligation to pay rent when the premises are unusable by reason of a fire or other peril, or you want to cover the “loss” a tenant experiences when its lease requires it to keep paying rent even though the premises are unusable. Either the lease is going to require a tenant to keep paying rent (as is not uncommon in a ground lease) or it will abate rent (as is common in a space lease). Thus, either the landlord will experience a loss of “business income” or the tenant will need to replace the business income that would have paid the rent. So, if rent abates, a landlord can continue its stream of income by procuring Business Income coverage If the rent does not abate, a tenant can cover the rent (for temporarily useless space) by procuring the same kind of coverage coverage. That’s how one gets “rent insurance.” And, as you might expect, each Coverage Form pays for other types of lost income and for other extra expenses, and that’s what keeps the insured party in business while the damaged property is being repaired or replaced.
Of critical importance is that there are three coverage options under a Business Income or Extra Expense Coverage Form: (a) business income including rental income; (b) business income excluding rental income; and (c) rental income only. If a property owner is using its own leasable space, the policy will pay the fair market rent for the space plus whatever “pass-throughs” a tenant would ordinarily pay. On top of that, it will pay certain operating costs, such as payroll related to the damaged premises.
This week, we won’t elaborate about what extra expense coverage might entail. We’ll just tease readers with an example. Suppose a landlord uses a part its property as a leasing office, rent free. If the office is destroyed by a fire, the landlord doesn’t lose “rent income,” but it will have the “extra expense” of renting space from someone else.
For those who haven’t yet made the inference, the insurer’s payment under these Coverage Forms is conditioned on there being a “covered loss” to “covered property.” This means that if the loss of business income or the extra expense didn’t arise out of a physical loss to property that is covered by a property insurance policy (read that, a “direct loss”), there is no recovery for lost business income or for extra expenses.
Supplementing this set of Coverage Forms are various Endorsements. They either affect the scope of “covered property,” the dollar amount of coverage or, most importantly, the length of time payments will cover. The “dollar amount of coverage” is self-explanatory. The other two may not be.
The duration over which payments will be made is related to premium cost. Therefore, negotiators have to assess the risks involved and the needs of the party or parties who will be required to carry the coverage. Not long ago, it was common for lenders to require that their borrowers cover 12 months’ of lost business income (and, for landlords that means “rent loss”) as well as for corresponding extra (operating) expenses, such as the cost to keep critical, on-site personnel employed while repairs are being made. Today, an 18 month requirement seems to be the norm.
There are other available Endorsements. In most cases, their very names are self-explanatory. One will be of particular interest to landlords, that being the ISO Business Income—Landlord as Additional Insured Rental Value Endorsement [CP 15 03]. With it, the named landlord will be treated as an insured for loss of “rental value.” There are also endorsements to cover situations where nearby properties, such as a convention center that draws customer traffic to a retailer, is closed by reason of insurable damage.