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Bankruptcy’s Impact to Commercial Property Insurance

Filing Bankruptcy offers a fresh start yet comes with significant consequences.

Bankruptcy is a legal process that provides relief to individuals or businesses that are unable to repay their outstanding debts. Despite the potential for a fresh start, bankruptcy also brings significant challenges, especially regarding property insurance. Business and personal bankruptcy filings have increased by over 16% as of June 30, 2024, according to data collected by the US Bankruptcy Courts. For businesses alone for the same period, filings have increased by 40.3% from 2023 to 2024. Let’s explore how bankruptcy can affect property insurance and what clients need to know on how to best navigate this complex situation.

Types of Bankruptcy

There are several types of bankruptcy, but the most common for businesses are Chapter 7, Chapter 11, and Chapter 13:

Chapter 7 Bankruptcy
In Chapter 7, non-exempt assets may be liquidated to satisfy creditors' claims. It can lead to the loss of property, but it also discharges most unsecured debts.

Chapter 11 Bankruptcy
A reorganization bankruptcy where the business continues to operate while restructuring its debt. This type of bankruptcy is typically for businesses that might be able to survive if their operations and debt are reorganized post-bankruptcy discharge.

Chapter 13 Bankruptcy
This allows individuals to keep their property while repaying debts over a three to five-year period under a court-approved plan.

Impact on Property Insurance

Policy Continuation and Premiums

Policy Continuation
Filing for bankruptcy does not automatically cancel property insurance. However, insurers may exercise the right to change policy terms and conditions based on the insured’s current financial situation.

Premiums
Bankruptcy can affect credit scores, which insurers often use to determine premiums. A lower credit score may result in higher premiums for the immediate future.

Coverage Adjustments

Coverage Limits
Due to the increased risk perceived in financially unstable situations, insurers may adjust coverage limits.

Policy Terms
Some insurers may alter the terms of policies, such as increasing deductibles or excluding certain types of coverage.

Renewal
Insurers may be hesitant to renew policies for businesses who have filed for bankruptcy, due to them being viewed as a higher risk.

New Policies
Securing new insurance after bankruptcy can be difficult, often requiring higher premiums or less favorable terms.

Property Ownership Changes

Ownership Transfer
In Chapter 7 bankruptcy, if property is sold to pay off debts, the new owner will need to secure their own insurance.

Retention of Property
Under Chapter 13, property is retained, maintaining continuous insurance coverage is crucial to protect assets.

Tips for Managing Property Insurance During Bankruptcy

  • Communicate with Your Insurer
    Transparency with your insurer about your bankruptcy status can help negotiating better terms.
  • Shop Around
    Collaborate with your broker to explore alternative insurance options in the marketplace. Compare quotes from various insurers to identify the most competitive rates and coverage suitable for your post-bankruptcy needs.
  • Maintain Good Financial Habits
    Rebuilding credit by consistently paying bills on time and managing debt effectively can improve your insurance premiums over time.
  • Seek Professional Advice
    Consult with a bankruptcy attorney or financial advisor to understand rights and obligations regarding property insurance.

Bankruptcy code mandates that adequate insurance must be maintained during any pending bankruptcy case. If coverage is inadequate, the U.S. Bankruptcy Trustee may dismiss the debtor’s case. Given the hardened market of recent years, it’s crucial to understand policy provisions that may limit the payout of a loss to the amount indicated on the statement of value, regardless of the actual cost to repair or replace the property. Pay special attention to policy provisions like margin clauses, occurrence limits of liability, and other endorsements to ensure reported values match the actual replacement costs.

Maintaining adequate business interruption coverage is essential. When significant losses occur, organizations rely on business interruption proceeds to continue operations and cover extra expenses incurred. What is business interruption coverage?

  • Business interruption coverage is triggered by a covered cause of physical loss (e.g., fire, earthquake, flood, tornado, hurricane). This coverage compensates for lost revenue and any increased operational costs, helping businesses maintain operations or relocate temporarily if needed.
  • Contingent business interruption coverage offers similar protection if disruptions occur at a key supplier, customer, or third-party provider that impact an insured’s business operations. Unlike traditional business interruption coverage, contingent coverage is not triggered by a loss at the insured’s property but by events outside the insured’s control.

It is important for insureds to ascertain that coverage limits align with business operations and review them at least annually, and especially after any significant organizational changes like acquisitions or divestitures.

Finally, consider the financial resources needed to pay deductibles. In the current hardened market, many insureds have taken on larger deductibles, which could impact potential claims payouts in the event of bankruptcy. The insurance company is only liable for amounts exceeding its attachment point (greater than the deductible amount) and generally is not required to “drop down” to provide coverage below that attachment point unless the policy specifies otherwise.

Conclusion

Bankruptcy has far-reaching implications for property insurance, affecting premiums, policy terms, and long-term financial stability. By understanding these potential changes and taking proactive steps, insureds can better manage insurance needs during this challenging time. Remember, while bankruptcy can be a setback, it also offers a long-term opportunity to rebuild and secure a more stable financial future.

Navigating the complexities of property insurance during bankruptcy can be overwhelming. Not sure where to start? Contact a local OneDigital team to ensure your commercial property is adequately insured during and after bankruptcy.

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