Before March of 2020, the commercial real estate (CRE) market was in a strong position. Since the second week of March, when COVID-19 was declared a pandemic spreading quickly around the globe, the CRE industry was affected immediately. Trade activities and businesses were shut down. During the subsequent months, many businesses have discovered how to make remote working more viable. In fact, they have announced that work-at-home models will continue into the future, even after a vaccine is introduced. This new possibility is causing a decline in CRE leasing volume. Tenants are not renewing leases and eliminating or greatly reducing office space that once housed workers who collaborated in person. The evolving economic situation has had a significant influence on commercial property owners and how property insurance responds to the resulting vacancies.
Defining Buildings, Vacancies, and Coverage
These once vibrant, occupied buildings that are now sitting vacant can result in no or limited insurance coverage. But, what is the insurance definition of vacant? The devil is in the details. With so much square footage sitting non-operational, might the commercial property policy's vacancy limitation apply to an otherwise covered loss? Unfortunately, there is no single answer. The question forces policyholders into the coverage form to understand what they bought. You see, not all policies are created equal. Whether the property is considered vacant is a function of policy language.
Before we address vacancy, we first have to define the word "building" and how it is different if you are the tenant or the landlord. The standard property form in the insurance industry is published by the Insurance Services Office (ISO).
- If the tenant is the policyholder, the ISO definition of "building" is the unit or suite rented or leased to the tenant.
- "Such building is vacant when it does not contain enough business personal property to conduct customary operations."
- When the policy is issued to the owner or general lessee of a building, the ISO definition of "building" means the entire building.
- "Such building is vacant unless at least 31% of its total square footage is rented to a lessee or sublessee and used by the lessee or sublessee to conduct its customary operation and/or used by the building owner to conduct customary operations."
Based on ISO wording, the building is vacant if there are no or not enough tenants or lacks the equipment necessary to conduct customary operations. The goal is to penalize the insured only if/when the building cannot be used for its intended purpose because there is no equipment in the building. Remember, ISO vacancy provision is based on the presence of stuff, not people. Note that buildings under construction or renovation are not considered vacant.
Some insurance carriers use proprietary forms rather than ISO. In one form, "vacant" means that "70% or more of the rentable square footage of a building at an insured location is not being actively used by you or a tenant for its intended purpose." Vacancy in this form is activity-based rather than stuff-based.
Does that make you want to pull your hair out? Wait, there's more! ISO's vacancy provision (as well as many proprietary forms) takes effect after 60 days of the defined vacancy. If the building is vacant, the policy completely excludes any loss caused by:
- Vandalism;
- Sprinkler leakage, unless you have protected the system against freezing;
- Building glass breakage;
- Water damage;
- Theft; or
- Attempted theft.
All other losses caused by a covered cause of loss are paid, but the claim payment is reduced by 15%. It would be quite a shocking experience to have a major vandalism claim denied or a fire claim reduced by 15%. Some carriers suspended endorsement of the vacant provision during the early months of the pandemic. As states reopened, many carriers resumed applying the vacancy conditions.
Building owners can adopt measures to mitigate these exposures and help protect one of their largest assets. The measures should focus on supervision, upkeep, the building's utilities and systems, communication, and security. Click here for a checklist you can use as a guide to plan and implement a response to a building becoming vacant.
We can't end this article without giving you some hope. Please contact us to discuss your unique situation. Let us know if you are concerned about vacancy. We may be able to negotiate with the insurer to waive the vacancy provision and include a Vacancy Permit for an additional premium charge. If not, coverage designed for vacant buildings is available on the market. Yes, it is expensive but the exposure could be millions of dollars. It is so important for CRE owners to keep us informed of the occupancy conditions in their property so proper coverage can be obtained.
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