Quick Reference: Property and Liability Insurance in Commercial Real Estate Transactions

Insurance is used in real estate documents such as mortgages, leases, licenses, etc., to help protect parties from loss due to property damage (real and personal) and liability to injured third parties. Two types of insurance (other than title insurance) used in real estate contracts for the allocation of risk between the parties are "property insurance" and "liability insurance." The COVID-19 pandemic has underscored the importance of maintaining robust property and liability insurance, as well as understanding the coverage they provide.

Parties attempt to minimize their risk of loss by assigning one (or both) of the parties the obligation to obtain adequate property or liability insurance. The party or parties with that obligation should be required to provide proof that they actually obtained the insurance.

Parties in a real estate transaction also attempt to minimize their risk of loss by the use of "waiver of claims" and "indemnification" provisions—this contract language may help parties avoid liability or loss, particularly in situations where the other party is at fault. These provisions, however, do not provide complete protection depending upon the financial capacity of the other party. Therefore, backing up contractual obligations with adequate insurance is essential.

The below quick reference is provided to help clarify key distinctions between commercial property and general liability insurance and what they cover.

	Commercial Property Insurance	Commercial General Liability Insurance*
1st Party or 3rd Party?	1st Party insurance that pays directly to the insured in the event of loss, whether caused by the insured or someone else.	3rd Party insurance that pays to injured 3rd parties – for personal injury or damage to their property.
Insuring Agreement	Covers "all risks of direct physical loss or damage to Insured Property at Insured Location(s), provided such physical loss or damage occurs during the Policy Period."	Covers "sums that the Insured becomes legally obligated to pay as damages because of 'bodily injury' or 'property damage.'" The Insurer has the right and duty to defend the Insured in any "suit" seeking those damages.
Occurrence-Based or Claims Made	Occurrence-Based: Triggered by an "occurrence" (i.e., an accident) during the policy period, even if a claim is subsequently made outside of the policy period.	Commercial general liability coverage is generally Occurrence-Based (triggered when the occurrence took place); however, some liability insurance is "Claims Made" (triggered by a claim made against the insured during the policy period).
Scope of Coverage	Covers "all risks" unless specifically excluded.	Covers defense and indemnity for third party injury and property damage claims arising from the negligence of the insured.
Special Endorsements	Rental Insurance Endorsement protecting building owner against loss of rental income if building is not usable due to an insured loss. Business Interruption Insurance for lessee should property damage interrupt business of lessee. Contingent Business Interruption coverage for loss of income due to damaged suppliers or customers.	Additional Insured coverage, Broad Form Named Insured endorsement to cover corporate affiliates and subsidiaries, pollution or professional liability endorsement.
*Most liability insurance is written on standardized ISO forms. The ISO commercial liability form is called Commercial General Liability insurance, or "CGL." (Note that "Comprehensive General Liability" insurance has not been issued since 1986.)

Glossary

ACORD Form: A type of Certificate of Insurance form (see below), which is published by the ACORD Corporation and is most commonly used by the U.S. insurance industry. Because ACORD Forms are not available to all brokers, it is recommended that insurance provisions require the provision of an ACORD Form "or other form of evidence of insurance reasonably acceptable to [the other party]." The "ACORD 25" is the most frequently issued Certificate of Insurance form for liability insurance. The "ACORD 27" "Evidence of Property Insurance" Certificate form is used for property insurance.

Actual Cash Value ("ACV"): ACV is one method for calculating an Insured’s loss under property insurance policies. ACV is usually not defined, but it is understood to mean replacement cost less depreciation, accounting for such factors as the useful life of building components, physical wear, and obsolescence. ACV is often calculated using insurance trade publications and computer estimating systems.

Additional Insured: An Additional Insured is added to the Named Insured’s policy, typically via endorsement. The Additional Insured may be given the same scope of coverage as the Named Insured or may be insured in some limited way (for example, a party who is insured as to just one coverage, at a single location, for a single activity, or only for vicarious liability for the Named Insured’s conduct). Additional Insureds under a property insurance policy must have insurable interest in the property. The principal virtue of Additional Insured status is that it affords easy and direct access to the Named Insured’s policy, and the Additional Insured may be able to avoid seeking coverage under its own policy and depleting such limits. Named Insureds have obligations under the policy that do not apply to Additional Insureds, and there are also exclusions that apply only to Named Insureds. Subrogation is not typically allowed against an Insurer’s own Insured whether "named" or "additional."

Additional Named Insured: An Additional Named Insured is usually related to the First Named Insured (such as subsidiary or affiliate) and may be liable for the payment of premiums. In addition, some policy exclusions affect Additional Named Insureds, but not persons or entities who are solely "Additional Insureds."

All-Risk Insurance: A colloquial term for coverage wherein the insurance covers all risks of physical loss unless the peril or risk is specifically excluded.

Best’s Rating A++ to F: Not all insurance companies are of equal financial strength. For that reason, it is common for Additional Insureds or interest holders (e.g., mortgagees) to require that the Insured’s policies be written by companies of a certain minimum quality. While there are a number of agencies who rate the financial character of insurance companies, AM Best, with its Best’s rating system, is most commonly utilized. AM Best classifies Best’s Ratings of A++ through B+ as "secure," and lower ratings as vulnerable. Consequently, it is common to see minimum ratings requirements within contracts, leases, and mortgages of A or stronger. An "A" rating is described by AM Best as "Excellent."

Business Interruption Insurance: Also known as "business income insurance," business interruption insurance provides for recovery in the event of loss of income from loss of use of property following a covered loss. In a lease setting, it reimburses the tenant for its inability to use the premises and loss of business resulting from a peril insured against by the underlying policy. Continuing normal operating expenses, including payroll if elected for inclusion by the Insured, are factored into the Insured’s determination of the amount of Business Interruption coverage to maintain, as is the Insured’s projection of the amount of time it will take to repair, rebuild or replace the property that sustained the direct physical loss or damage. Coverage may also be extended to cover "Contingent Business Interruption," i.e. loss of business resulting from damage occurring at the premises of a supplier or vendor that causes loss of income.

Casualty Insurance: Casualty insurance is a term used to describe insurance that mainly protects a person or business against legal liability for losses caused by injury to other people or damage to the property of others. The term "casualty insurance" has been replaced by the more commonly used term "liability insurance" or "commercial general liability" insurance.

Certificate of Insurance ("COI"): Parties seeking status as an “Additional Insured” under another’s liability insurance policy often ask for a “Certificate of Insurance” as proof of that status. COIs are generally prepared and then sent to the Certificate Holder by the Insured’s insurance producer or broker, not the insurance company itself. A COI is not the policy itself nor is it even a part of the policy – it isn’t a contract between the Insurer and the holder of the certificate itself. It only provides evidence that a particular insurance policy or policies existed at the time the certificate was issued. To ensure Additional Insured status, the party should require a copy of the policy itself, including the Additional Insured endorsement.

Claims-Made Coverage: Liability coverage can be written on a "claims-made" basis, meaning that the policy that is triggered is the one in effect when the claim (i.e., a lawsuit or money demand) is made against the Insured, regardless of when the injury actually happened. The claims-made version of CGL coverage is rarely used. Although to avoid any confusion, a party who requires another to obtain and maintain CGL coverage would be wise to require that it be written "on an occurrence basis."

Coinsurance: Under coinsurance, the Insured has to bear a share of the loss if the Insured fails to purchase a minimum amount of insurance. The clause in effect penalizes a policyholder who underinsures the property by making the policyholder bear a portion of the risk of all losses, even a small one. Under a pure (100%) coinsurance clause, the Insured pays a percentage of the loss unless the property is insured for 100% of its value. For example, if the insured property is valued at $100,000 and the Insured has $60,000 in coverage, a $10,000 loss will result in a $6,000 payment by the Insurer. The $4,000 shortfall is usually called the coinsurance penalty. The policyholder remains responsible for $4,000, i.e., its 40% coinsurance.

Excess/Umbrella Coverage: The basic CGL policy is "primary," covering loss from bodily injury, property damage and personal injury to third parties, with set liability limits – on a per occurrence and aggregate basis. An "excess" liability policy increases the liability limits but not the scope of coverage (i.e., it often "follows form"), and sits on top of the primary policy, being triggered when the limits of the primary policy are exhausted. An "umbrella" policy is similar to an excess policy, but may offer different and broader coverage in addition to excess limits.

General Aggregate Limit: The General Aggregate Limit is shown on the policy’s declarations page, and it is the most that the Insurer will pay in any given policy year for all insured events, related or unrelated. Products-completed operations coverage is subject to a separate aggregate limit of its own. By the addition of an endorsement, the General Aggregate Limit can be made to apply on a location by location basis so that each location will have its own General Aggregate Limit. In addition, there are limits for each occurrence and sub-limits for particular types of coverage.

ISO: An acronym for the Insurance Services Offices, Inc. ISO is a provider of data, underwriting, risk management and legal/regulatory services to property and liability insurers and other clients. Many of the property and liability policies and endorsements found in commercial insurance programs are on standardized policy forms published by ISO.

Loss Payee: A person or entity, other than the Insured, to whom insurance proceeds will be paid by the Insurer. Frequently, lenders require that they be named as Loss Payees to control the application of insurance proceeds in accordance with the loan documents. Of all Insureds, the Loss Payee has the most limited rights. A Loss Payee clause may obligate the Insurer to include the Loss Payee in any payment due under the policy, but the clause neither defines an additional interest in that payment nor creates a right to payment greater than that owed to the Insured.

Mortgagee: A Mortgagee Insured under a property insurance policy acquires specific rights to the insurance proceeds in the event of loss. In the event of loss, multiple mortgagees on a single property are entitled to payment in the order of priority of their mortgages. Minnesota law further provides that payment to a mortgagee in this fashion satisfies the obligation of the Insurer to the Named Insured, to the extent of such payment. The mortgagee’s recovery is limited to the total amount of the indebtedness, payable to the mortgagee as its "interests may appear."

Named Insured: The person or entity named in the declarations page of the policy; or, if there are a number of Named Insureds, they may be listed in a Named Insured endorsement referenced in the declarations. In a property insurance policy, the property owner is often the Named Insured, but may not be if someone else purchases the policy. Named Insureds have the same full rights under the policy whether they are named on the declarations page, included as Named Insureds by endorsement, or defined as Named Insureds elsewhere in the policy. The acts of a Named Insured are covered by the insurance policy.

Named-Peril Insurance: A colloquial term for coverage wherein the insurance covers only certain risks of physical loss specifically named in the policy.

Rental Income Insurance: Also known as lost rents or rent continuation insurance. This insurance reimburses landlords for rents lost as a result of a covered peril. Lost rents may include operating expense passthroughs and other recurring charges, in addition to rent. This coverage is almost always obtained in connection with a property insurance policy, and it is typically required by a lender to the landlord.

Replacement Cost: Replacement Cost is one method for calculating an Insured’s loss under property insurance policies. Where the measure of recovery is Replacement Cost, the Insured will recover the actual cost to repair or replace the damaged property, whichever is less, with like kind and quality, without any offset for depreciation. To avoid an incentive for fraud, most property insurance policies provide that a loss will be paid on a Replacement Cost basis only if replacement is actually made, usually "as soon as reasonably possible," or within a stated period of time (e.g., two years) following the date of the direct damage. Otherwise, the Insurer will perform an ACV adjustment. Full insurable Replacement Cost normally does not include cost of excavation, foundations and footings, land or architect’s fees.

Self-Insured Retention ("SIR"): Where an Insured has a "Self-Insured Retention," the Insured covers the loss up to the retained amount, after which the Insurer begins to make payments. Frequently, the Insured will control and manage claims when they fall below the retained amount, with coverage only becoming available once the SIR limit is exceeded. Though similar, the SIR is not the same thing as a deductible. In the liability insurance context, a "deductible" provision requires that the Insurer handle the entire claim at the outset; only after the claim has been settled is the Insured required to reimburse the Insurer for the amount of the liability "deductible."

Standard/Union Mortgage Clause: A mortgagee clause that provides for the mortgagee to recover regardless of the acts or omissions of the policyholder. This type of mortgage clause is required in Minnesota.

Waiver of Subrogation: The waiver of the Insurer’s right, after covering a loss of its Insured, to "step into the shoes" of the Insured and sue the tortfeasor to recover the insurance payment. Each waiver of subrogation provision should contain a waiver of claims and a requirement that the insurance policy of the waiving party provide for an effective waiver of subrogation. When there is a mutual waiver of subrogation provision, this in effect creates a no-fault effect in a situation in which a claim might otherwise arise.