A commercial tenant is required by the lease to insure the improvements and betterments on behalf of the building owner. The ISO CP 00 10 Building and Personal Property Coverage Form provides for valuation of tenant's improvements and betterments under Item 7.

Valuation is determined at actual cash value (ACV) or replacement cost value (RCV) if purchased and repairs are done promptly. If repairs are not made promptly, then improvements and betterments are valued based on a proportion of the original cost plus a time factor depending on how many days are left in the lease. 

If the tenant uses the CP 14 15 (07 88) Additional Building Property endorsement to extend building coverage to an improvement or betterment, how does that change the valuation method in the event of a loss? The damaged items are still the tenant's improvements and betterments, and the valuation clause is specific to that wording. So, other than getting the building rate to insure them, how has valuation changed? 

If the tenant uses the CP 19 10 (06 95) Your Business Personal Property – Separation of Coverage endorsement, this allows the insured to manage specific business personal property exposures by removing the property scheduled in the endorsement from the list of covered business personal property in the underlying form, picking the limit of coverage. This endorsement allows the tenant to take advantage of the building rate, but the valuation after a loss has not changed, right?

Q: If the building owner decides they don't want the building repaired, or doesn't repair it “promptly," will only a portion of the value of these improvements and betterments be received? If the tenant is required by the lease to insure the value of their improvements and betterments, how can they do that without having it valued in a way that's dependent on the building owner making repairs promptly?

Response 1: It is true that if the building owner decides they don't want the building repaired, they will only get a portion of the value of these improvements and betterments, as well as the rest of the building the owner doesn't want repaired. ACV valuation applies to what is not repaired or replaced.

As to whether the repairs are done promptly, the building owner will largely control the prompt repair of the building. If the building owner doesn't act promptly, they have lost the opportunity for a RCV claim settlement.

ISO's CP 14 02 09 17 Unscheduled Building Property Tenant's Policy endorsement is a preferred way of insuring improvements and betterments compared to the endorsements you mentioned.

Another potential problem is that many leases give the landlord, and possibly the tenant, the right to cancel the lease if building repairs or replacement are not initiated within a specified time period. If the landlord or tenant invokes such a provision, the tenant may want to replace the improvement and betterments at another location. Does the tenant get to use the improvements and betterments insurance proceeds to do so? Or does the landlord retain control of the improvements and betterments insurance, even if it was the party that cancelled the lease? In the hundreds of leases I have reviewed, I have yet to see one that appropriately and equitably addressed this issue.

Response 2: I think the key is the exact wording of the lease terms that require the tenant to insure the property. If the tenant is required to treat the landlord as an insured, I'd argue that this property does not fit the definition of improvements and betterments—it's the property of the landlord and should be valued as if the policy was written in the name of the landlord. That returns the coverage to an ACV or RCV basis rather than the use-interest valuation described for improvements and betterments. 

This interpretation requires buy-in from the insurance company. To make it work, you need the lease wording, the ACV or RCV of the subject property, and the insurance company's agreement that this portion of the coverage will be ACV or RCV as opposed to the use-interest approach used for improvements and betterments. Explaining this will be difficult, but you can compare it to a situation where the tenant occupies the entire building and is required to insure it and name the landlord as an insured. Nobody would argue that a use-interest valuation would be appropriate in that situation.

Response 3: You may be overthinking all this. It is up to the insured to know what they agree to in the rental contract and ask their attorney if they are not clear. If they agree to replace the improvements and betterments, then they need RCV coverage. Otherwise, they can go with ACV to give the property owner the at-loss value of the improvements and betterments business.

If your insured is contractually required to replace the entire rented space, then they should have a full property policy in effect, at ACV or RCV as per the insured's or the insured's attorney's interpretation of the requirements of the rental contract.

Response 4: Most carriers will pay ACV until the damaged property is repaired or replaced, then pay the holdback depreciation if that is elected on the policy. 

In a situation where the building owner decides they don't want the building repaired, when the tenant leaves because the landlord doesn't want to repair the property, the tenant's betterments and improvements become the landlord's possessions. The carrier should still pay the ACV to the tenant, landlord and mortgage holder if applicable. There would be no holdback depreciation paid if the building is not repaired unless the landlord moves to another location—but then the landlord isn't our insured, so I guess it doesn't matter. 

I think there might have been a misunderstanding as to what tenant's improvements and betterments are. These are changes to the building made by the tenant. When the tenant leaves, these changes cannot be taken with them. For example, if the tenant installs wall sconces for additional lighting, these are now attached to the building and have become part of the building. These sconces become the landlord's property when the tenant leaves. If the tenant hangs art on the walls, that's a business personal property and is portable. Usually, installed counters and cabinets stay with the property. If that's the type of property that's being insured, then I don't think you need the CP 19 10 (06 95) because these things are not contents.

If the tenant improvements and betterments are attached to the structure, as in the case of sconces, then an adjuster will take the entire value of the building. The adjuster will not part out what is the tenant's and what is the landlord's when it comes to the building. The adjuster will make that distinction when it comes to contents.

Regarding the word "promptly," if it is not defined in the policy, then "promptly" is what a reasonable person would think "promptly" means. This is an unsatisfactory answer for both the agent, insured and adjuster. 

Response 5: Insure the improvements and betterments as part of the building using a RCV instead of under business personal property. Carefully review what the tenant is obligated to replace under the lease and carefully address adequate valuation. 

The tenant typically has a contractual obligation to both insure and replace improvements and betterments that may have been installed by a prior tenant 40 years ago. Insuring those under business personal property is a trap for this type of tenant. A major loss in a large industrial facility or a retail facility involves an enormous amount of time and expense. Take a careful look at business interruption exposures as well.

Disclose the obligation to the insurance carrier and insure under building coverage. This step also reduces the tenant's cost, as building coverage is less expensive than business personal property. 

This question was originally submitted by an agent through the Big “I" Virtual University's (VU) Ask an Expert service, with responses curated from multiple VU faculty members. Answers to other coverage questions are available on the VU website. If you need help accessing the website, request login information.

This article is intended for general informational purposes only, and any opinions expressed are solely those of the author(s). The article is provided “as is" with no warranties or representations of any kind, and any liability is disclaimed that is in any way connected to reliance on or use of the information contained therein. The article is not intended to constitute and should not be considered legal or other professional advice, nor shall it serve as a substitute for obtaining such advice. If specific expert advice is required or desired, the services of an appropriate, competent professional, such as an attorney or accountant, should be sought.