INTRODUCTION
Improvements and Betterments coverage protects a tenant’s use of and interest in improvements and
betterments it installs or arranges for in the leased building. This coverage
is available to only named insureds that are tenants. The insured may have made
the improvements and betterments that are eligible for coverage or a previous
tenant may even have made them but only if the insured purchased them from that
tenant. The important point is that the insured has invested in these items but
cannot remove them. This coverage is part of CP 00 10–Building and Personal
Property Coverage Form. Because the insured cannot remove improvements and
betterments from the premises, but has a use interest in them, a special method
for valuing tenants’ improvements and betterments is a part of the coverage
form.
COVERAGE ANALYSIS
Improvements and Betterments coverage may be written as either
separate insurance or as part of the coverage on personal property in CP 00 10–Building
and Personal Property Coverage Form. It covers the insured's use of and
interest in improvements and betterments made or added to a leased building.
Valuation
If a covered cause of
loss damages or destroys improvements and betterments during the policy term,
payment is determined as follows:
- The actual cash value of the lost or damaged property is paid
if the insured makes repairs. These repairs must be made promptly.
- A proportion of the original cost is paid when the insured does
not repair or replace the items in a reasonable time period. This
proportion is calculated as follows:
Step 1: Determine the original cost of
the damaged improvement and betterments.
Step 2: Determine the number of days
from the date of loss to the expiration date of the lease or the expiration of
any lease renewal option.
Step 3: Multiply Step 1 by Step 2.
Step 4: Determine the number of days
from the date that the damaged improvements and betterments were installed to
the expiration date of the lease or the expiration of any lease renewal option.
Step 5: Divide Step 3 by Step 4.
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Example: Clayman Industries leases a building on a 20-year lease
with a 10-year renewal option. Clayman made substantial improvements to the
building at its own expense that cannot be removed. The cost of the
improvements was $200,000 when the lease was signed in January 2004. A
windstorm destroys the building in January 2014 and Clayman decides to
relocate to another state. The loss payment is determined as follows:
Step 1: Cost is $200,000
Step 2: 20 years X 365 days = 7,300
Step 3: $200,000 X 7,300 = $1,460,000,000
Step 4: 30 X 365 = 10,950
Step 5: $1,460,000,000 / 10,950 = $133,333
Clayman receives
$133,333 for its loss of use value of the improvements and betterments.
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Replacement Cost Optional Coverage
Improvements and
betterments may be written on a replacement cost basis instead of on an actual
cash value basis. In that case, if the insured actually repairs or replaces the
improvements and betterments, it recovers on that basis. However, the
proportional method is used to determine the settlement if the insured does not
make the repairs or replace the improvements.
Definition
Improvements and
betterments are defined as fixtures, alterations, installations, or additions that
become a part of the described building that the tenant makes or acquires at
its expense. It does not include rent paid. The tenant cannot legally remove
them from the building.
UNDERWRITING
Coverage on improvements
and betterments may be written for a tenant that occupies a building under a
conventional term lease, on a month-to-month basis, or under another form of
rental agreement. The insured is not required to actually occupy the building
to be eligible for coverage. Coverage may also be written for a lessee that has
installed or acquired improvements and betterments at its expense and subleases
or rents the premises to others.
Improvements and
betterments are not limited to those installed during the term of the current
lease. Coverage also applies to those made to the building or that the insured
acquired at its expense at any time during its tenancy.
RATE AND PREMIUM
The way improvements and
betterments are scheduled determines the rate used. The personal property
rate is used if the improvements and betterments are included in the same limit
as other personal property. The building rate is used if they are listed and
scheduled separately. This difference is logical because the tenant cannot
legally remove the improvements and betterments from the building without
damaging the building. This property usually falls into the category of
building and the insured should benefit from using the building rate.
At times, the insured
might not want to schedule the improvements and betterments separately because
the values are low. The insured is penalized when it makes that decision and
the higher personal property rate is used.
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Example: Pete's
restaurant is in a building that John owns. A previous tenant installed the
cooking equipment, ovens, and booths. Under the terms of the lease, Pete must
pay $10,000 in advance towards the cooking equipment and then $1,000 per
month for the cooking equipment in addition to his lease payment for five
years. Pete has a five-year lease with John with an option for five
additional years. The terms of the lease require Pete to repair the damaged
equipment. Pete includes the value of the improvements and betterments in his
$100,000 personal property limit of insurance because of that requirement.
The personal property
rate is 1.00 and the premium is $1,000. His new insurance agent explains that
the value of the improvements should be broken out and written separately.
Pete revises his limits to reflect $65,000 on improvements and betterments
and $35,000 on personal property. Because the building is masonry
non-combustible construction, its rate of .30
applies to the improvements and betterments. Using the new allocation of
limits, Pete’s premium is reduced to the sum of $195 ($65,000 x.30) plus $350
($35,000 x 1.00) for a total of $545.
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BUILDING OWNER'S INTEREST
The building owner has an
interest in the improvements and betterments because they revert to it when the
lease ends. As a result, the building owner’s coverage should include the value
of all tenants’ improvement and betterments in its building values. The
tenant's policy should not include the building owner as an additional insured
with respect to these improvements and betterments because the interests of
both parties in the property are not the same. The only time the building owner
could be added is when the tenant is contractually required to compensate the
building owner for damage to its improvements and betterments.
COVERAGE UNDER CONDOMINIUM PROPERTY COVERAGE FORMS
CP 00 17–Condominium
Association Coverage Form covers all fixtures, improvements, and alterations
within a unit. However, this is only if the by-laws state that the condominium
association owns such property. If the unit owner owns them, that unit owner
must cover them.
Similarly, with CP 00
18–Condominium Commercial Unit-Owners Coverage Form, a business that occupies a
unit of a commercial condominium may insure
fixtures, improvements, and alterations that make up part of the building that
the unit-owner owns as a separate item of
insurance.
EXPLAINING IMPROVEMENTS AND BETTERMENTS INSURANCE
Improvements and
betterments are actually improvements to the real
estate or to the building that the tenant or lessee installs or pays for
or that it acquires at its expense, exclusive of rent paid. They are permanent
in nature. Some examples are a new storefront, decorations, partitions,
acoustical insulation, and elevators. They usually represent significant value
but they are not personal property because the tenant cannot remove them.
Improvements and
betterments eventually become part of the building and the building owner's
property. The building owner should insure them as part of its building
coverage. However, the tenant also has an interest in them and can insure them
as such because it installed or acquired them at its expense for its own
benefit while it occupies the premises. This is described as the use interest
in the improvements and betterments. Courts and others use it to attempt to
more accurately describe the type of insurable interest a tenant has in the
improvements and betterments as opposed to an outright ownership interest.
When arranging loss
recovery on an unamortized basis, the recovery is based on a proportion of the
original cost of installing the improvements and betterments. For example, the
insured tenant makes alterations or improvements and must spend $5,000 to
remove a portion of the existing building to make the changes. It then installs
the improvements valued at $10,000. This coverage enables the tenant to recover
an insured loss based on the entire $15,000 installation investment. Recovery
on this basis makes the insured whole and also enables it to properly amortize
the entire investment, including the $5,000 wrecking or tearing-out expense. However, if the insured tenant actually
replaces the damaged improvements, the form properly limits it to the actual
cash value of the damaged improvements. This is because it would then be
necessary to restore the improvements themselves and not again incur the
expense of tearing out any portion of the building. In some cases, and for
these reasons, the original cost may exceed the actual cash value.
Improvements and
betterments coverage is subject to coinsurance. Whether listed separately or
included with other personal property, a coinsurance penalty is applied if not
insured to current actual cash value.
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Example: A tenant installs improvements and betterments valued at
$15,000 at the beginning of a five-year lease from 01/01/17 to 01/01/23. A
fire on 01/01/21 destroys them and the tenant replaces them.
Recovery is based on
the full actual cash value as of 01/01/21. As a result, the valuation starts
with replacement cost new as of 01/01/21. Depreciation must then be
calculated and subtracted from that replacement cost. A coinsurance penalty
could be applied if the items are underinsured.
Recovery is based on
the unamortized basis of the years that remain on the lease if the
improvements and betterments are not replaced. That basis is $3,000,
one-fifth of the $15,000 original cost.
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Example: Use the same situation above but add a five-year lease
renewal option. The fire occurs on 01/01/27 instead of on 01/01/21. The
actual cash value now is even less because of depreciation. If the property
is not replaced, the unamortized value is only of $1,500, one-tenth of the
original cost of $15,000.
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LEASES
Leases must be reviewed
carefully to determine exactly who owns the improvements and betterments.
Standard wording usually states that all improvements and betterments become the
building owner's property but there may be exceptions. This is particularly important
if extensive improvements and betterments are made at a specific property. The
lease should list the property that can be removed when the lease ends and the
property that must remain. The property that remains is the improvements and
betterments. In most cases, the permanently
installed property becomes the building owner's property at the end of the
lease and property easily removed belongs to the tenant. An important exception
to this rule involves any property that specifically refers to the tenant by
name or trademark. The lease should identify and address these situations.
DUPLICATE COVERAGE
Duplicate coverage may
apply in cases where neither the building owner nor the tenant repair the
damage or replace the property. In such cases, the tenant could collect based
on the proportion of its use interest in the improvements and betterments and
the building owner could receive the actual cash value of the improvements and
betterments because the building coverage limit should include them. However,
if the building is repaired and improvements and betterments replaced, coverage
applies to only the party that actually
made the repairs or replaced the improvements and betterments.
