Chapter 19 Exercises

Work these the way a property underwriter works a submission: never trust a value you have not verified, always ask over how long before you set a business-income limit, and read the form and the SOV before you read the big number on the front. Items marked with a dagger (†) have worked solutions in Appendix: Answers to Selected Exercises; the rest are for discussion or self-test. Section references like (§19.3) point you back to the relevant part of the chapter. Every dollar figure here is a constructed teaching example — illustrative, not a real account.

A. Recall and definitions

  1. † Name the three coverages bundled in the ISO Building and Personal Property Coverage Form, and say in a phrase what each insures. (§19.1)
  2. Distinguish the Basic, Broad, and Special Causes of Loss forms. Which one is "all-risk," and what does that phrase actually mean about the burden of proof? (§19.1)
  3. Define business income (BI) coverage and state precisely what two things it pays. How does extra expense differ from it? (§19.3)
  4. † Define the period of indemnity in one sentence, and explain why it is governed by the longest critical-path element of the recovery rather than by the building rebuild. (§19.4)
  5. State the four building-valuation methods (replacement cost, ACV, agreed value, functional replacement cost) and give a one-line reason each exists. (§19.2)
  6. What is a highly protected risk (HPR), and what four things (roughly) does a property need to qualify as one? Is Harbor Steel an HPR? (§19.5)
  7. Define a statement of values (SOV) and list three things on an account that are built off it. (§19.7)
  8. † What does equipment breakdown coverage insure that the commercial property Special form excludes? Why is that exposure easy to miss on inspection? (§19.6)

B. Building valuation

  1. † A building has a full replacement cost of \$20,000,000 today. Its roof and several major components are old; an appraiser estimates accumulated depreciation at roughly 30% of the building's value. (a) Very roughly, what would an ACV policy pay on a total loss? (b) Why might an insured prefer replacement cost anyway, and what is the insurer's offsetting concern? (§19.2)
  2. Explain the difference between replacement cost and agreed value when both are set at the same dollar figure (\$20M). They pay the same amount on a total loss — so what is the practical difference at claim time? (§19.2, §19.4)
  3. † For each property, choose the most appropriate valuation basis and justify it in one sentence: (a) a brand-new distribution warehouse the owner intends to rebuild as-is; (b) a 1920s building with ornate masonry that would be absurdly expensive to reproduce exactly; (c) a 30-year-old roof at the end of its life on an otherwise sound plant. (§19.2)
  4. A broker submits a building value that has not changed in six years, during which regional construction costs have risen sharply. Why should you distrust this value on sight, and what specifically would you require before quoting? (§19.2)

C. Business income and the period of indemnity

  1. † A single-plant manufacturer requests a \$2,000,000 business-income limit. Annual revenue is about \$28M and gross earnings run roughly \$9–10M a year; a total loss would idle the plant for about twelve months, driven by a specialized production line with a 9–12 month replacement lead time. Is the \$2M limit adequate? Estimate a defensible limit and explain how you got there. (§19.3, §19.4)
  2. Explain why business income has no fixed relationship to the building value, and give one example of a cheap building with a huge BI exposure and one of an expensive building with a modest BI exposure. (§19.3)
  3. † Draw (in words or a simple list) the critical path of a plant's recovery from a total fire loss, and identify which single element most often makes the period of indemnity longer than the building rebuild would suggest. (§19.4)
  4. What does the extended period of indemnity endorsement add, and why is it needed even after the physical property is fully restored? (§19.4)
  5. A new underwriter sets every account's BI limit at "50% of the building limit" as a rule of thumb. Explain, with the chapter's reasoning, why this rule will be wrong in both directions, and which direction is the dangerous one. (§19.3)

D. Coinsurance — price this risk

  1. † An insured carries a \$12,000,000 limit on a building whose full insurable value is \$20,000,000, under an 80% coinsurance clause. A partial fire loss of \$4,000,000 occurs; the deductible is \$50,000. (a) What is the required limit? (b) What is the coinsurance ratio? (c) What does the policy pay? (d) How much does the insured absorb beyond the deductible — and is the \$12M limit exhausted? (§19.4)
  2. Rework Exercise 18 assuming the insured had instead carried the full required limit (\$16,000,000). What does the policy now pay on the same \$4M loss, and what does this show about the purpose of the coinsurance clause? (§19.4)
  3. † Explain, to a frustrated insured who just took a coinsurance penalty on a partial loss with their limit nowhere near exhausted, why the clause did that — and what you, the underwriter, could have structured at binding to prevent it. (§19.4)
  4. Under what conditions is agreed value the right structure, and what responsibility does choosing it transfer from the insured to the underwriter? When would you refuse agreed value? (§19.2, §19.4)

E. COPE, HPR, and find-the-red-flag

  1. † Run COPE on Harbor Steel — one sentence per factor (Construction, Occupancy, Protection, Exposure) — and use it to justify the non-HPR classification. (§19.5)
  2. A broker markets a 1994 joisted-masonry plant with its original sprinkler system and a welding occupancy as an "HPR-quality risk" to win an HPR rate. Find the red flag(s): name at least three reasons this is not an HPR account and explain what writing it at an HPR rate would do to your loss experience. (§19.5)
  3. Find the red flag. A property submission shows: building value unchanged for 7 years; BI limit equal to exactly 25% of the building limit; Special form requested but the SOV lists no sprinkler data; a single-location manufacturer with one product line and one major customer. Identify the four distinct underwriting red flags and what you would do about each. (§19.2, §19.3, §19.5, §19.7)
  4. Which single COPE factor can an underwriter most readily improve through a subjectivity, and what requirement on Harbor Steel does exactly that? (§19.5)

F. Inland marine, equipment breakdown, and large programs

  1. † A bakery's refrigeration compressor burns out from an internal electrical fault, spoiling the inventory and closing the bakery for a week. For each of the three losses — the compressor, the spoiled stock, the lost income — state whether the commercial property Special form responds and, if not, which coverage does. (§19.6)
  2. Harbor Steel loads \$300,000 of fabricated steel onto its own flatbed for delivery and the load is damaged in a highway accident. Which line responds — commercial property, inland marine, or commercial auto — and why does the building policy not? (§19.6)
  3. Explain the difference between a shared program and a layered program. In a \$50M layered tower ( \$10M primary / \$15M xs \$10M / \$25M xs \$25M ), which layer pays a \$4M fire, and which layers pay a \$40M hurricane? (§19.7)
  4. † Why is high-excess catastrophe capacity cheap per dollar of limit while primary capacity is expensive per dollar of limit? Tie your answer to frequency and severity (Chapter 6). (§19.7; Ch. 6)

G. Memo, ethics, and the Underwriting File

  1. Write the memo. In 150–200 words, write the property-structuring recommendation for Harbor Steel to your underwriting manager: the valuation basis you chose and why, the roof treatment, the business-income limit and period of indemnity, the HPR classification, and the one exposure you are flagging for reinsurance. (The Underwriting File; §19.2–§19.7)
  2. † Ethics dilemma. A long-standing broker who brings you good business asks you to write a \$24M agreed value on a building you have independently estimated at \$19M replacement cost, arguing the client "wants to be safe" and that "values always go up." Walk through the indemnity-principle and moral-hazard problems with insuring a building for materially more than its worth, and state what you will and will not do — and how you keep the relationship. (§19.7; Ch. 4)
  3. Ethics / disclosure. You decide to leave a coinsurance clause in (rather than agreed value) on a competitive account to keep the premium down, knowing the insured's SOV looks stale. What is your professional obligation to the broker and insured here, and why does silence expose you when the penalty surprises everyone at claim time? (§19.4)
  4. Underwriting-File extension. Suppose, after binding, Harbor Steel's specialized fabrication line is upgraded to a newer model with a shorter (6-month) replacement lead time. Explain how this single change affects the period of indemnity and therefore the business-income limit and premium at the next renewal — and whether it changes the building valuation at all. (§19.3, §19.4, The Underwriting File)
  5. Underwriting-File extension / price this risk. Using only the chapter's illustrative methods, sketch how Harbor Steel's \$20M agreed-value building, the ACV roof carve-out, and the \$10M / 12-month BI line together change the premium base relative to a naive \$14M building / \$2M BI submission — and explain why the larger, verified base is the more defensible (not the more expensive mistake). (§19.2–§19.4, The Underwriting File)