Improvements And Betterments

IMPROVEMENTS AND BETTERMENTS

(June 2019)

 

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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 must have a financial investment in the improvements and betterments in order to purchase the coverage. This means that coverage can be provided if the insured either installed or arranged for them to be installed and was not compensated by another. It also can be improvements or betterments that were made by a prior tenant and for which the insured compensated the prior 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 its value can be included as part of the coverage on personal property in CP 00 10–Building and Personal Property Coverage Form. Regardless of how it is covered, the following is how the items are valued when a loss occurs.

Valuation

If a covered cause of loss damages or destroys improvements and betterments during the policy term, payment is determined 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.

 

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 and those improvements cannot be removed. The cost of the improvements was $200,000 when the lease was signed in January 2007. A windstorm destroys the building in January 2017 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.


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, the settlement is based on the replacement cost of those improvements and betterment. However, the proportional method is used to determine the settlement when the repair or replacement option is not taken.

Definition

Improvements and betterments are generally 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.

 

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.

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 improvements to the real estate or to the building that the tenant or lessee installs, pays for or that it acquires at its expense. 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.

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.

 

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.

 

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.

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.