An insured’s church burned down on July 8, 2016. His automatic increase endorsement proprietary to the carrier is written on a three-year term, from Dec.15, 2013 to Dec.15, 2016. In the loss appraisal, the adjuster states that the automatic increase applies from Dec. 15, 2015 until the date of loss.

A building limit of $500,000 was assigned on Dec.15, 2013 and never amended. The endorsement reads:

Building Limit - Automatic Increase
a. The Limit of insurance for Buildings will automatically increase by the annual percentage shown in the Declarations (4%).
b. The amount of increase will be:
(1) The Building limit that applied on the most recent of policy inception date, the policy anniversary date, or any other policy change amending the Building limit, times
(2) The percentage of annual increase shown in the Declarations, expressed as a decimal (example: 4% is .04), times
(3) The number of days since the beginning of the current policy year of the effective date of the most recent policy change amending the Building limit, divided by 365.

Q: "Should the increase apply from the date of policy inception, Dec. 15, 2013, until the date of loss?”

A: “Initially, the adjuster appeared to be correct. A common misunderstanding regarding the commercial property inflation guard option is that using it increases coverage limits at renewal. This is true for homeowners insurance, but not for commercial property. In general, the inflation guard is not a set-it-and-forget-it option. You still need to monitor policy limits, and the insured is responsible for increasing the limits as necessary.

But one key factor alters the usual application of the inflation guard option in this situation: This is a three-year policy. Also, rather than being billed as an inflation guard, this coverage is specifically labeled ‘Building Limit - Automatic Increase.’

The provision creating confusion for the adjuster is b.(1), which reads:

‘b. The amount of increase will be:(1) The Building limit that applied on the most recent of policy inception date, the policy anniversary date, or any other policy change amending the Building limit….’

One interpretation of this wording is that the additional amount of coverage is based on the limit shown on the declarations on the most recent anniversary date. Because the declarations page showed $500,000 on the anniversary date, the additional amount the adjuster calculated appears to be correct.

However, the b.(1) wording means that the amount of coverage to which the increase applies is the most recent date a policy change was made—either by the insured or by action of the policy. The automatic 4% increase specified by the policy wording does exactly what it says: amends the policy limits 4% per year. This increase qualifies as a ‘policy change amending the building limit.’ Plus, provision (a) specifically states, ‘the Limit of insurance for Buildings will automatically increase by the annual percentage shown in the Declarations.’ That's pretty clear—the limit increases annually.

Based on that logic, the building limit should automatically increase throughout the policy term. Only one question remains unanswered: How much coverage is available at the time of the loss? At the time of the loss, the estimated available coverage around $553,009 is as follows:

Value on date of loss (July 8, 2016)  = $553,008.70 ($540,800 x 1 + (.04 x (206/365))). The adjuster's initial conclusion and calculation are incorrect.

By the way, the same logic applies to ISO's inflation guard option when attached to a three-year policy. SO's inflation guard rules read, ‘This optional coverage automatically increases the amount of insurance by a selected percentage. The selected percentage applies proportionally for each day of the policy.’ If the policy term is one year, the limit increases over the year; if it’s three years, the limit increases over the entire term of the policy.

You can find further proof in the rates. The inflation guard rates for a three-year policy are triple those for a one-year policy. Obviously, ISO also expects the coverage amount to increase throughout the policy term.

One last caveat: Even though the endorsement increases the limit throughout the policy term, it does not automatically increase the amount of coverage on the renewal policy. The insured must request any increase on the renewal. Again, it's not a set-it-and-forget-it option.”

Chris Boggs is executive director of the Big “I” Virtual University.

This question was originally submitted by an agent through the Big “I” Virtual University’s Ask an Expert Service. Answers to other coverage questions are available on the VU website. If you need help accessing the website, request login information.