Real Estate - Aon · An Ris lutins anuar 201 Risk. Reinsurance. uman Resources. Real Estate Bulletin Earthquake Deductibles: Danger in the Details for Commercial and Residential

Aon Risk Solutions

January 2016

Risk. Reinsurance. Human Resources.

Real Estate Bulletin

Earthquake Deductibles: Danger in the Details for Commercial and Residential LandlordsWith increasing attention being made to the earthquake risks in Canada, there has been considerable discussion recently over earthquake insurance and the earthquake deductible clause contained within a typical commercial property insurance policy. The purpose of this bulletin is to explain how an earthquake deductible clause operates and the various issues you need to consider for this exposure, no matter what type of commercial real estate assets you own.

Property insurance policy earthquake deductiblesTo begin, the following deductible clause, as it pertains to earthquake losses, taken from a typical commercial property insurance policy, reads in part as follows:

Deductible

Each occurrence resulting in a claim for loss or damage shall be adjusted separately and the Insurer (‘s) liability shall be limited to that amount by which the total loss or damage arising from any one occurrence exceeds the following:

Earthquake

British Columbia 10%, subject to minimum $250,000

Quebec & Ottawa Valley 5%, subject to minimum $250,000

All other locations 3%, subject to minimum $100,000

If loss or damage is subject to a percentage deductible, that percentage shall be applied to the total declared value at all locations for which indemnity is being claimed.

In this Issue01 Earthquake Deductibles:

Danger in the Details for Commercial and Residential Landlords

Property insurance policy earthquake deductibles

02 Considerations

03 Contacts

It is important to note several things in the foregoing earthquake (EQ for short) deductible clause. First, the percentage deductible for EQ applies to the “total declared value” of all locations damaged by the EQ for which coverage is sought - it is not applied to just the actual amount of the claim. Total declared value would equal the building’s replacement costs, common furnishing, fixtures and owner’s equipment, and rental income as reported to the insurer. For simplicity sake, if a building’s reported replacement cost values and reported rental income value totaled $50 million, and it suffered damage due to an earthquake, the EQ deductible payable by the owner would be $5 million (assuming 10% EQ deductible) or $2.5 million (assuming 5% EQ deductible), no matter how big or small the actual loss suffered. Thus, in small EQ claims situations, this could mean there is no recovery of any part of an EQ claim from the insurance company.

Second, the EQ deductible clause is applied to the total value “of all locations” for which a claim is being made. In other words, you must add up the total declared value of all locations suffering damage under the policy, and apply the EQ percentage deductible to that amount. As such, insurers take a portfolio-wide view in settling losses caused by a single EQ event under the policy. Thus, if a very large building is part of that portfolio, but it suffers only some very minor damage, it can increase the EQ deductible for the entire claim on all buildings affected and insured under the same policy, small and large; however, you will note this particular wording does give the owner the flexibility, if desired, to not claim any building as part of the loss, if it makes overall financial sense to not do so.

Lastly, such EQ deductible clauses mean when only a small location is affected, it will be subject to an EQ deductible in much higher proportion than larger ones, due to the “minimum deductible levels”. For example, under the above, a $1 million declared total location value situated in British Columbia would have a 10% EQ deductible (or $100,000 in this case), with $250,000 as a minimum deductible; that minimum is far in excess of 10% of the building replacement cost/ rental income value, and thus in this case the EQ deductible would be equivalent to 25%.

ConsiderationsAs seen above, EQ deductibles can result in significant costs to an owner that it must finance in the event of a loss. Even where insurance does apply to a loss, EQ repair costs within the deductible need to be made by the owner, in some cases even before the insurer will contribute to the claim. This is an important point for owners to realize, as there must be a financing source already in place, or at least access to capital quickly, so that repairs can begin immediately.

When you consider that large residential and commercial buildings can range anywhere between $50 million and $500 million (or even more) in combined replacement values and rental incomes, EQ deductibles can be quite substantial. This is especially true in the higher risk earthquake zones, which generally have higher percentage EQ deductibles and larger minimum deductibles apply.

For commercial property owners, of course, the general preferred way to deal with the issue of large EQ insurance deductibles is to minimize

the EQ deductible under the property policy as much as possible. This is preferable since the building’s insurance costs are passed back to the tenants, as would be the case for amounts paid out due to any small deductible paid out within the operating budget. It would be safe to assume that room for any such large expenditure would not be found within the existing building operating budget for a commercial building.

For residential real estate owners, there is generally no direct insurance premium cost recovery from tenants, so premiums and deductibles are borne by the landlord. In both cases of commercial and residential risks there can be options to buy-down EQ deductibles, but they must be specifically asked for, sought out and carefully analyzed.

The foregoing outlines a few of the issues surrounding earthquake deductibles facing property insurance policyholders of commercial and residential properties. It is highly recommended that whatever your situation, landlords be prepared, discuss and investigate all options with your trusted Aon insurance and risk advisor.

Real Estate Bulletin | Aon Risk Solutions | January 2016 2

Earthquake Deductibles: Danger in the Details for Commercial and Residential Landlords

Peter Kennedy Senior Vice President and National Director Real Estate Practice +1.416.868.5685 [email protected]

Contacts

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