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Should You Respond to a Reservation of Rights Letter?

An organization buys insurance to transfer certain types of risks (depending on the policies purchased). If a covered event occurs that results in a loss, you submit a claim and get paid. Simple, right? That’s how it would seem, but many experienced risk managers know it doesn’t always go that smoothly.

A recent RIMS Executive Report discusses one of the most common instances when things don’t go according to plan, and the insurer sends along some unpleasant surprises. In “A Risk Manager’s Guide to Reservation of Rights,” we learn how an insurer protest against paying a claim is commonly initiated and communicated: the dreaded reservation of rights letter.

In case you’ve never had the pleasure of receiving one, a reservation of rights letter is “a notice that the insurer has reserved its rights to either limit or deny coverage for the claim, based on the terms and conditions of the policy or information uncovered in an investigation of the claim itself.” In other words, these legal notices can become hurdles for an organization trying to realize the value of the insurance it has purchased.

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Many risk managers do nothing when they receive this letter—they assume that the insurer will act in good faith and everything will work out.

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The authors of the RIMS Executive Report, however, strongly encourage a more active response. At the very least, the risk manager should compare the wording of the letter to the insurance policy language in question, as well as draft a response to the letter. The authors state: “Generally, there is no requirement that a policyholder respond to an insurer’s reservation of rights letter, disagreeing with the reservation or the bases thereof. However, it is highly recommended that the policyholder do so.”

A response letter might look something like this:
In some cases, a well thought-out response can save an organization a large amount of money. A good example is the common insurer-proposed reservation to recover defense costs spent on defending a policyholder if the insurer determines at a later date that it did not, in fact, have a responsibility to defend. In order to reject this reservation and the big legal bills that could come with it down the road, many jurisdictions in the United States require that the insured respond to the reservation of rights letter and specifically disagree with this detail.

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According to the authors: “Receipt of a reservation of rights notice should prompt a review by risk managers…leading to an informed decision and deliberate action: whether to accept the insurer’s interpretation of the coverage and defense obligations, or respond with a reservation of its own rights. If not, unexpected and unintended consequences may result.”

The report also includes more in-depth information on obligatory communications, the use of tolling agreements and conflicts of interest that arise in these situations. In a reservation of rights situation, there can be some tricky territory to navigate. For example, insureds are almost always contractually obligated to cooperate with the insurer’s investigation and defense of claims. Failure to communicate or cooperate with these efforts can be a breach of contract and result in loss of coverage.
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It is important for the insured (i.e., the risk manager) to “understand its obligations in the claims management and settlement process, and the continuing obliga­tions when a reservation of rights notification is issued.”

The balancing act is that “Insureds need to continue cooperating…regardless of any coverage disputes, to preserve the continuity of claim management as well as meet the policy obligation.”

As the coordinator between functional areas and the in-house risk expert, risk professionals have an important role in all of these stages.

Recovering from Hurricane Matthew

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Many organizations in the southeastern United States recovering from Hurricane Matthew are still dealing with downed power lines, swollen rivers and blocked roads. As soon as they are able to, business owners should start assessing damage to their property and begin their insurance recovery process. They will need to assess not only physical damage to their property but also any income losses that may have occurred as a result of flooded and blocked roads and bridges, interrupted shipping and air transport, evacuations, and closures by civil authority.

They need to gather the information they’ll need for their insurer, and also be familiar with their policy and policy language. “In the runup to a storm, we always hear insurance executives on the news assuring the public that they will take care of things—that policyholders can rest assured,” Marshall Gilinsky, a shareholder in the insurance recovery group at Anderson Kill P.C., said in a statement. “But it’s vital for businesses not to assume everything’s going to be taken care of automatically. Storm-related claims can run into a snarl of unclear policy provisions, sublimits and exclusions, and occasionally obstreperous insurance company adjusters. A false sense of security leads easily to lost insurance proceeds.”

Businesses impacted by the storm that have flood insurance, he said, “should look for coverage not only for physical damage to their premises due to any flooding, but also business interruption and contingent business interruption coverage.” For best results, they should be sure they are up-to-date on how their insurer defines and invokes sublimits for “flood,” “storm surge” and “named storms” and how their insurer deals with claims that include damages from both wind and flood, Gilinsky said.

According to Galinsky, the following coverages (and coverage limits) will apply in a storm’s aftermath:

Business interruption or BI covers businesses for losses stemming from unavoidable interruptions in their daily operations.  BI coverage may be triggered by circumstances including a forced shut-down, a downturn in business due to damage to premises, or a substantial impairment in access to a business’s plant or premises.

Businesses that are not themselves forced to close may be able to tap contingent business interruption coverage, triggered when policyholders do not themselves suffer physical damage but still lose revenue after a property loss sidelines a major supplier or customer base.  Contingent BI is a standard provision in many property insurance policies, though many small businesses are not aware of it.

Also in play will be coverage for evacuation by order of civil authority, triggered when authorities close off access to a damaged area – and ingress egress coverage, which insures lost profits due to difficulties in accessing the insured premises due to the storm. Again, damage to the insured’s own property is not required to trigger coverage — though typically, the losses must result from property damage of a type covered by the insurance policy.

“Too many businesses do not think about insurance unless their premises are damaged—or if they do, they fail to calculate the full range of loss,” Gilinsky said. “Small businesses in particular may not even be aware of their civil authority, ingress egress and business interruption coverage, let alone their contingent business interruption coverage.”

He also noted that many commercial property insurance policies provide different sublimits for losses caused by “flood,” “storm surge” and “named storms.” How the policy defines these key terms can be critical in determining the amount recoverable for the policyholder’s loss.

The Property Casualty Insurers Association of America offered the following tips to help businesses through their recovery process.

Business Recovery Information

  • In the aftermath of natural disasters, businesses should take immediate steps to minimize damage, speed up the claims process and accelerate business recovery. Assess the damage and report all damage to your insurance company agent as soon as possible.
  • Take pictures of your building and contents to document the damage.
  • Check for safety hazards, such as downed trees, branches, downed power wires and leaking gas.
  • Keep all receipts for anything purchased for that purpose so they can be submitted to your insurance company.
  • Be prepared to list the “replacement cost” of each item and its actual cash value.
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    Replacement cost is what it would cost today to replace an item with another one just like it. Actual cash value is what the item is really worth after deducting for depreciation and wear.

  • Restore your utilities, phone service, gas lines and other important links as soon as possible.
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  • Business interruption coverage is complex and will vary by insurers. It is important to read your policy and understand what is and is not covered.
  • As you seek contractors to make repairs, deal only with reliable, licensed professionals.
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    Get written bids from the contractor, but don’t sign any contracts or give a deposit until you have seen your insurance adjuster.

  • If you or your employees get involved in clean-up efforts, use safety items like proper eyewear, gloves, hardhats, dust masks and respirators.
  • Keep detailed records of business activity and extra expenses during the interruption period, and prepare records to show the income from the business both before and after the loss.

Making the Most out of a Crisis

CALGARY, ALBERTA, CANADA—Suppose your company experiences a major hurricane, tornado or fire: Property is destroyed and your business is stalled, meaning customers are left waiting.

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But there are buildings to be rebuilt and equipment to be replaced, and the claims process hasn’t even started. This is when the risk manager’s skills at placing the company’s insurance coverage and negotiating for the best payout can not only demonstrate their true value, but can put the company back on course, according to experts here at RIMS Canada’s annual conference.

“When there’s a serious property loss, this is the time for the risk manager to shine, because up until then it’s about premium, premium, premium,” Tom Parsons, manager of risk management at Fairmont Raffles Hotels International in Toronto said during a RIMS Canada Conference session. “Up until a serious loss occurs, I don’t think you feel the impact that you can give back to the company. Because what we do is buy insurance, so it has to work.

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It is what you helped craft and build into your policy through the years. You have created a policy that is robust, and that is going to cover everything—you hope.”

Among the examples cited was a soft drink bottling plant flooded with eight feet of water following a hurricane. While the company’s high-speed bottling equipment was damaged and would need to be replaced, explained Jeffrey Phillips, managing director in PwC’s U.S. forensic advisory practice, the issue was that floodwaters were highly contaminated due to a number of chicken and hog farms in the area. As a result, the company determined that the building could not be used for any type of food processing and would need to be demolished. The insurer, however, argued that the walls could be sealed, containing any contaminants. The company had found a competitor to do some of the bottling, but it wasn’t enough to fill their orders, Phillips said.

Because delivery of the new bottling equipment was slated to take months, there was also a large business interruption period being covered, he said. This is when innovation came into play. The bottling company was able to show the insurer that buying another plant rather than rebuilding would put them back in business sooner, cutting back on their losses. The insurer agreed and sent them a check. As a result, the company purchased a larger facility in a better location.

“They were up and running in six months—the business interruption had stopped,” he said. The better location also meant reduced shipping costs and the company gained market share. Because the company was able to make the case to its insurer, both came out ahead in the long run.

Phillips recommended that companies negotiating after a crisis “communicate, communicate, communicate” with their insurers.

They should also get their insurers to sign off on major contracts such as scope of work, rates and overhead and discuss changes to operations or facilities with the adjustment team and agree on scope of property damage repair or replacement whenever possible.

Insurers will typically push to return the facility to pre-loss condition, “unless you can prove the changes will save them money,” he added. “Insurers will not be creative for you, they don’t know your business or your goals.”

Time for Post-Storm Claims Filing

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Record-breaking Storm Jonas, which struck a large portion of the East Coast last weekend, was yet another reminder to have property insurance policies up to date and be familiar with claims procedures. To get the claims process moving, risk professionals whose business suffered damage should contact their insurer and broker as soon as possible.

According to the Insurance Information Institute, business owners need to:

▪ Fill out claims forms as soon as possible—including a “proof of loss” form, which must be completed within 60 days.

▪ Make a list of damaged property; the more detailed the better. Take photos or video to back up the claim.

▪ Be prepared to show the adjuster the damaged property as well as financial records or other documents.

▪ Get at least two bids for repairs or replacements.

▪ Keep copies of all correspondence regarding the claim and note the name, title and phone number of everyone you speak with. For more details, see Filing a Business Insurance Claim.

 What Is, and Is Not, Covered 

Business property owners also need to understand what is and is not covered by insurance, and the various coverage options available to protect their business. Property damage is typically covered under a business owners policy (BOP) or through a commercial multi-peril (CMP) policy.

Most commercial property policies provide either:

Replacement cost coverage – pays to rebuild or repair the property, based on current construction costs.

Actual cash value coverage – pays to rebuild or replace the property minus depreciation

Depreciation is a decrease in value due to wear and tear or age so with actual cash value coverage a business that is destroyed may not be in a position to completely rebuild. Business owners can also opt for a combination of both types of coverage.

Business income insurance, also known as business interruption, is typically included in a BOP or CMP and provides coverage for:

▪ Revenue lost due to the closure.

▪ Fixed expenses, such as rent and utility costs.

▪ Expenses of operating from a temporary location.

To receive appropriate reimbursement from business interruption coverage, there must be direct physical damage to the property resulting from an insured event. Also, there is generally a 24- to 48-hour waiting period before business income coverage kicks in.

Determining a business interruption loss involves establishing what the business would have earned had there been no loss. Insurers will consider past tax returns, profit and loss statements, projected sales and non-continuing expenses.

If basic business interruption insurance and property insurance coverage was expanded to include utility interruption, you may be covered if either electrical or water service was discontinued as a result of the storm.

Businesses that rent or lease a building can purchase tenant coverage, which insures your on-premises property, including machinery, furniture and merchandise. The building owner’s policy will not cover contents, however.

At Risk for Flood Damage?

Location is the most important factor for weighing your risk for flood damage. Is your business located in or near a flood zone? (Flood map search tools can be found online.) In what part of the building is your businesses equipment and inventory located? Anything housed on a lower floor, for instance, will be at greater risk.

Standard commercial insurance policies exclude flooding from melting snow or tidal surge. Commercial flood coverage is available from the National Flood Insurance Program (NFIP) and from a few private insurers. The NFIP provides up to $500,000 in building coverage and $500,000 for contents. Excess flood insurance is also available for businesses.

For more information on coverage options and disaster preparedness, see the Business Insurance section of the III website.

Related Links

▪ Facts and Statistics: Catastrophes

▪ Articles: When Disaster Strikes: Preparation, Response and RecoveryDoes My Business Need Flood Insurance?Does My Business Need Earthquake Insurance?Does My Business Need Terrorism Insurance?;