Chapter 2 – Property Loss Exposures
"Ingenuity, plus courage, plus work, equals miracles.” Bob Richards
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Introduction
This chapter will explore the various components of Property Loss Exposures, with an emphasis on:
Types of Property
Property Loss Exposures exist because property exists. Families own property, use it, depend on it as a source of income or services and rely on its value. For our purposes, property is any item with value. It may decline in value, or even become worthless if it is lost, damaged or destroyed.
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Different kinds of property have different qualities that affect the owner's exposure to loss.
Property can be classified in a number of different ways. One common approach is to
distinguish between real property (land and
attachments to the land, such as buildings)
and personal property (all property that is not real property). Insurance people use categories that relate to the insurance treatment of property. Most types of property are:
These categories overlap to some extent. Consider money and waterborne cargo. Money can be included in the contents of buildings. Cargo on a ship is a form of property in transit. These categories are listed separately here because they represent types of property for which specific forms of insurance have been developed.
Buildings
Buildings include more than bricks, mortar and other building materials. Most also include: plumbing, wiring, heating and air conditioning equipment that can lead to leaks, electrical fire and explosions. Most buildings contain some basic equipment: fire extinguisher, snow shovels, lawn mowers, outdoor furniture used to service the building and surrounding land. A high-rise building usually has elevators and may have specially designed portable platforms, hoists and tracks for use by window washers. This equipment is considered to be part of the building. Property permanently attached to the structure such as carpets, shelving, built-in appliances, or paneling is considered part of a building.
The exterior shell of a building, the outside walls and the roof, is exposed to damage from natural forces (such as hail) and from human forces (such as vandalism). Other events, such as a plumbing leak, may damage a building's interior primarily. Fire is a severe threat to both the exterior and interior of a building.
Dwelling Contents
A dwelling's contents may include furniture, televisions, stereo equipment, appliances, kitchen ware, groceries, clothing, sports equipment, tools, gardening equipment and many other items usual to the occupancy of a home. All of these items are referred to as the dwelling contents or simply contents. These items are grouped together for several reasons. First, they are normally located in
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the dwelling and they are exposed to essentially the same perils as the dwelling. Second, many of these items usually can be determined easily in the event of a loss.
High Value Property - Some items of personal property, many of which otherwise would be classified as dwelling contents, are worth considerable sums of money. This type of property is categorized separately, especially for insurance purposes, because of the ease with which it may be stolen and removed from the dwelling. Such items include coins, money, securities, silverware, precious metals, jewelry, gems, watches, furs and firearms.
Property with Intrinsic Value - Property with intrinsic value is property whose value comes from its essential nature of unique characteristics. It needs to be separately identified in the analysis of Personal Property Loss Exposures. An antique chair is an example of this type of property. Such items would need to be separately insured because property insurance contracts typically settle personal property losses on the basis of the cost to repair, the time to repair, or its replacement cost less depreciation. Property with intrinsic value to the owner may not be replaceable at any cost, and its value needs to be established at the time that insurance coverage is purchased. In addition to antiques, other items with high intrinsic value might include works of art, stamp collections, valuable papers and records, photographs and negatives, and computer software and media on which data are stored.
Business Personal Property - This is personal property owned by an individual's business or employer. Most property insurance contracts are written to provide coverage for the family’s limit or exclude coverage for business personal property. An individual who keeps business personal property at home may be financially responsible in the event of a loss to that property. Depending on the type of property insurance the individual carries and the value of the business personal property kept at home, additional insurance may be required to cover this exposure.
Motor Vehicles, WaterCraft, and Other Mobile Property - Personal Insurance covering dwellings and their contents typically excludes or provides only very limited coverage for mobile property. Physical damage to motor vehicles of all types, as well as aircraft, usually is excluded from coverage. Limited coverage may apply to watercraft and trailer. If a family owns any of these kinds of mobile property, it should be identified as such so that separate insurance may be purchased.
Perils Affecting Property
A peril is a cause of loss. (There is much confusion between the definitions of peril and hazard). Some insurance policies even use the phrase "cause of loss" in place of peril. Most perils affect property by leaving it in an altered state. A fire may change wood to ashes. A collision may change a car to dented, twisted scrap. Some perils do not alter the property itself but they do affect a person's ability to possess or use it. This
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often happens when property is lost or stolen. It is still quite usable but it is not usable by its proper owner. Many insurance policies contain a list of covered perils or causes of loss. Policies may also list perils that are specifically excluded from coverage. Some policies cover all causes of loss. Policies may also list perils that are specifically excluded from coverage. Some policies cover all causes of loss except those specifically excluded.
The perils examined here are often mentioned in Property Insurance and are among the major causes of loss.
Most Property Insurance Policies cover a number of different perils but this is not always the case. Policies once covered only the peril of fire. Over time, insurance policies covering other perils have evolved. Because of the perils that have been added to fire policies, it is now possible for a single policy to mention the perils of fire, windstorm, hail, aircraft, collision and vehicle damage, riot and civil commotion, explosion, smoke, vandalism, sprinkler leakage, sinkhole collapse, volcanic action and certain other so-called broad form perils. Crime perils are covered in crime insurance and some package policies, while the perils of earth movement and flood may be covered in special types of insurance.
Other perils, such as maintenance perils and catastrophe perils, are generally uninsurable.
Perils and Hazards
The terms "peril" and "hazard"" are often used when discussing loss exposures.
A peril is a cause of loss. Examples of perils that cause property losses are fire, burglary, collision, and flood.
A hazard is anything that increases the likelihood of a loss or the possible severity of a loss.
Example:
Hazards need not relate to a specific peril. A general attitude of carelessness creates a hazard because it increases the likelihood of loss by many different perils.
Fire - Fire is one of the most serious of perils, however, not every fire is a cause of loss. A gas fire on a kitchen range, an oil fire in a home furnace, and wood fire in a fireplace cause no loss unless they get out of control.
Sometimes the term friendly fire is used to refer to fires that remain in their intended place. Fires that leave their intended place are called hostile fires. If this book were accidentally dropped into a fireplace, many fire insurance policies would not pay for the loss of the book, however, if sparks flying from the fireplace set the house on fire, a hostile fire would have occurred and the damage would be covered by fire insurance. When they do get out of control, fires burn property and also cause heat and smoke damage.
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Extinguishing a fire may also cause damage as fire fighters knock holes in windows and roofs and spray water on property to keep it from burning. Heat, smoke and water spraying could be considered separate perils. When these conditions occur because of a fire, the fire is the proximate cause of the entire sequence of damaging conditions or events. The proximate cause of a loss is the event that sets in motion an unintended chain of events contributing to the loss.
Sometimes fire takes place following another peril. Lightning may crack the walls of the house and set it on fire. An explosion may knock down a wall and start a fire. An earthquake may crack the foundations of a building and break gas lines, leading to a fire.
It is standard practice that policies covering the peril of fire also state that they cover the peril of lightening. The peril of explosion is almost always included in the same policy. While many Property Insurance Policies do not cover damage directly caused by an earthquake or flood, they do cover damage by a fire that might "ensue".
Damage caused by fire includes damage resulting from those conditions accompanying the fire (such as flame, heat and smoke) and those events that can be linked back to the fire in an unbroken chain of causation (such as explosion or collapse), resulting from the fire or damage by fire-fighting units or devices. It does not matter that the fire itself was caused by some other peril such as an earthquake.
If an insured had insurance covering the peril of fire but not the peril of earthquake, damage from fire would be covered even if the fire resulted directly from the earthquake. Through the eyes of the insurance policy, fire caused a portion of the loss. That policy would not cover the portion of the loss caused by earthquake damage.
A logical question is how to draw the portion of the loss confined solely to earthquake damage and the portion caused by fire, since the insurer will pay only for the latter. The answer will be quite difficult but the problem is not one unusual to the property insurance field. For now, the key point is the general concept of proximate cause rather than the practical loss adjustment dilemma.
Windstorm - Like fire, windstorm can cause serious damage to buildings and their contents, as well as, to other property. Windstorm includes hurricane and tornadoes but is not confined to those notorious disturbances. Less severe winds can also produce damage.
Water damage due to flood, waves or spray may accompany a windstorm. Many insurance polices cover windstorm but not water damage. When a loss occurs, it is not always easy to determine which damage is done by wind and which by water.
Hail - Hail consists of ice particles created by freezing atmospheric conditions. Hailstones the size of marbles, golf balls or baseballs can cause substantial damage to autos, buildings and other property in the open. Aluminum siding is susceptible to
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dimpling caused by hail. Even light hail not capable of damaging most property can cause serious crop damage by knocking grain kernels out of standing grain or by destroying blossoms on fruit trees.
Aircraft - Aircraft damage occurs when an airplane or satellite, or part of such an object, strikes property on the ground. Although such incidents are rare, the damage can be severe. Property near a flight path is more likely to incur aircraft damage than property at other locations.
Collision and Vehicle Damage - Collision refers to damage to a motor vehicle or watercraft resulting from its impact with another vehicle, vessel, or other object. Vehicle damage refers to damage by a motor vehicle to some other kind of property, such as a building. When a car runs into a house, the house suffers vehicle damage and the car suffers collision. Insurance policies that have collision as a covered peril usually also cover the upset or overturn of the vehicle either by naming the additional peril or by stating that the word "collision" includes upset and overturn. This practice resolves the question of whether physical contact with a road or land adjacent to it is a "collision".
Riot and Civil Commotion - While there may be legal distinctions between riot and civil commotion, both terms refer to approximately the same kind of unruly mob behavior. Insurance covering riot invariably covers civil commotion. While losses from these perils do not occur very often, they can be quite large.
Explosion - An explosion is a violent expansion or bursting accompanied by noise. Explosions include combustion explosions resulting from the igniting of gases, dust or other explosive materials. Combustion explosions are often followed by fire. Explosions may also occur when a pressurized object bursts, as in the case of the bursting of a tank containing compressed air. An explosion can destroy an entire building. Grain elevators and other buildings containing dust are particularly vulnerable. Explosion of boilers and other pressurized objects can unleash "unguided" missiles with enough force to match the damage done by dropping of a small bomb.
Smoke - Normal cooking in a home, restaurant, or industrial operations sometimes produces smoke. This normal smoke should not cause a loss. Sudden or accidental release of large amounts of smoke can result in considerable damage to walls and other objects.
Some property is susceptible to smoke damage. In a clothing or grocery store, a relatively small amount of smoke may cause considerable damage. When damaging smoke comes from a fire, the fire is generally considered to be the proximate cause of the loss. However, the sudden malfunction of a home's oil-burning furnace may result in the discharge of clouds of grimy, sooty smoke. In that case, the resulting damage is not caused by fire. An independent peril from the fire has occurred. Fortunately, Property Insurance Policies
naming the peril of fire almost always name smoke as a covered peril as well.
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Vandalism - Vandalism is the willful and malicious damage to or destruction of property. Examples of vandalism include: crafty spray-painting onto building walls, defacement of statues or other objects of art, and the multiple incidents of mischief that usually occur on Halloween. Some insurance policies refer to "vandalism and malicious mischief". Others simply use the term "vandalism".
In some instances, it is difficult to distinguish damage caused by vandalism from damage caused by riot and civil commotion’s. This usually present no insurance problem since the vandalism peril is normally not included in an insurance policy that does not include the riot and civil commotion peril.
Sprinkler Leakage - Many commercials and institutional buildings, as well as, some private residence are equipped with automatic sprinkler systems. An automatic sprinkler system is designed to discharge water (or chemical or gas) when a fire occurs, thus extinguishing or containing the fire. When a fire sets off a sprinkler, any water damage from the operation of the sprinkler is considered to be proximately caused by fire. Sometimes, however, an automatic sprinkler system discharges accidentally. The pipes may freeze and burst or a buildup of heat from some other cause other than fire may cause the system to discharge. Maintenance workers may accidentally bang a ladder against a sprinkler head and cause it to discharge. Such an accidental discharges are considered part of the sprinkler leakage peril.
Compared to fire, sprinkler leakage in most cases is not a serious threat to a building. Vulnerability of contents may be another matter, however. With some occupancy, such as dealers in paper products, sprinkler leakage losses can be devastating.
Sinkhole Collapse and Mine Subsidence - The action of underground water on limestone or similar rock formations may create empty spaces underground. A sinkhole collapse occurs when land suddenly sinks or collapses into one of these empty spaces. This problem occurs most often in Florida. A similar problem exists in states such as Pennsylvania and West Virginia because of underground mining. The mine subsidence peril is present when the ground surface sinks as underground open spaces resulting from the extraction of coal or other minerals are gradually filled in by rock and earth from above.
Volcanic Action - While Florida has its sinkholes and West Virginia has its mine subsidence, the Pacific Coast states of Alaska and Hawaii have volcanoes. The peril of volcanic action encompasses loss resulting from volcanic eruption such as Mount St. Helens.
The volcano action peril has an interesting history. At one time, many property insurance policies specifically excluded losses by volcanic eruption. Since there were no active volcanoes in the Continental United States, specific reference to volcanoes began to disappear from insurance policies as they were revised and simplified. When Mount St. Helens erupted
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for the first time, many policies did not specifically provide or exclude coverage for volcanic action but did not cover the peril of explosion. There was considerable debate over whether a volcanic eruption constitutes an explosion. Insureds seeing explosion as a covered peril and noting no formal policy definition of the term requested coverage for damage for the eruption. The outcome was that many losses were treated as explosion losses and claims paid. Today, most insurance policies once again mention the peril of volcanic action, either specifically providing or excluding coverage.
Broad Form Perils
Many Basic Property Insurance Policies cover damage caused by the specific perils discussed above. Other Property Insurance Policies often referred to as Broad Form Policies, add coverage against an additional group of perils. These other perils include:
Crime Perils
Theft - is a general term meaning any act of stealing. It includes the taking of money or property of another. Some insurance policies cover the peril of theft; others cover only a specific type of stealing; burglary or robbery.
Burglary - is a type of theft committed by someone who breaks into a building and illegally removes property. Insurance policies usually define burglary to breaking out of a building. Why? Thieves sometimes hide inside a building before it is closed for the night and make a forcible exit after stealing some of the contents. Most burglary insurance applies only if there are "signs of forcible entry or exits". A thief, who wrongfully enters or exits from a building through an open window or uses a stolen key, would not generally be considered a burglar for insurance purposes. The party suffering the loss might regard the event as a "burglary" but insurance policies usually require forcible entry or exits as a necessary part of burglary.
Robbery - is a type of theft committed by someone who takes property from a person in the presence of that person through use of intimidation or force. A purse snatching or a holdup is a robbery, a break-in is a burglary and both are thefts. Shoplifting is an example of a theft that is neither burglary nor robbery.
Theft of any kind may be committed by employees or family members, or by strangers. Theft by employees may be called embezzlement, employee dishonesty or a fidelity loss.
An increasing common form of theft involves the manipulation of computer records to transfer money or other property to someone who is not the rightful owner. Theft involving the manipulation of computerized records is called computer theft.
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Earth Movement
One type of earth movement, earthquake, is uncommon in most parts of the country, however, there are areas where earthquakes occur with some frequency and other areas where geologists predict a major quake will eventually occur. Property in these areas is susceptible to damage from earth movement.
Flood
Property owners, with “tongue-in-cheek”, sometimes define floods as “rising waters accompanied by a sinking feeling”. For insurance purposes, however, the term “flood” may encompass a variety of situations, including temporary overflow of inland or tidal waters, usually rapid accumulation of surface waters, and even mud-slides and collapse of land along the shore of a lake. A flood may be the result of rain or melting snow, or it may be the result of a burst dam or some other hazard of human origin.
Property located on low-lying land has a greater exposure to flood than property located in high areas. The U.S. Government has identified areas in many communities where the probability of an eventual flood is significant, although possible flood damage is not limited to property located within these so-called flood plains.
Policies covering motor vehicles and property in transit frequently cover the flood peril but it is excluded in most policies covering buildings and contents, however, coverage in limited amounts is available through the National Flood Insurance Program.
Maintenance Perils
Discussions to this point have concentrated on perils covered by most insurance policies. Numerous other perils can also cause loss to property.
These perils may not be covered even in the broadest Property Insurance Policies. Insurance works well for definite and accidental losses. Some of these excluded perils (rust, wear and tear, marring and scratching) involve the results of ordinary use and aging rather than unexpected damage. Others (water seepage, termites or pet damages) are preventable through property care and maintenance.
Catastrophe Perils
The insurance mechanism functions best when many insureds pay small premiums in order to provide a fund for payment of large losses incurred by relatively few insureds. Some perils that affect a great many people at the same time are generally considered to be uninsurable, since resulting losses would be so widespread that the funds of the entire insurance business might be inadequate to pay all claims. For this reason, most Property Insurance Policies exclude coverage against loss by catastrophic perils such as war and nuclear reaction.
Some exceptions: ships and their cargo may be endangered if they sail into an area
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affected by a localized war (one that flares up suddenly). "War risk" Insurance is available to cover ships and cargo unless the War Exposure appears extremely hazardous.
Similarly, limited amounts of insurance against nuclear reaction is available to the owners and operators of facilities that use nuclear materials.
Parties Affected when Property is Damaged or Destroyed
The party most affected when property is lost, damaged or destroyed is the owner of the property. Other parties affected may include:
The Property Owners
If the property has some value and is lost, damaged or destroyed, the owner of the property incurs a financial loss because of the cost of repairing or replacing the property.
Secured Lenders
When money is borrowed to finance the purchase of a car, the lender usually acquires some conditional rights to the car, such as the right to repossess the car if the borrower fails to make loan payments. This right gives the lender security. This lender is called a secured lender. When an individual or business borrows money to buy a home or a building, the property serves as a security for the loan and the secured lender is called a mortgagee and the borrower is a mortgagor.
When property is used to secure a loan, both the property owner and the lender are exposed to loss. Example: a fire destroys a mortgaged house, the mortgagee loses the security for the mortgage loan. Similarly, if a financed car is destroyed in an accident and the owner has no money to pay off the loan, the lender would have only a worthless banged up car to repossess. Insurance policies may protect this interest by naming a lender as a mortgagee or as a loss payee.
Users of Property
Some events result in losses to users of the damaged property, even thought they do not own it. Example:
Other Holders of Property
There is another group of parties who do not own property but are responsible for its safekeeping. Dry cleaners, TV repair shops,
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public truckers and many other businesses temporally hold property belonging to others. Holders of property entrusted to them by others are called bailees.
Potential Financial Consequences
The loss of property, or damage to it, may have undesirable financial consequences. The adverse financial impact may occur in any one of 3 ways. A property loss may: reduce the value of one's property, cause an increase in one's expenses or it may reduce one's income.
Reduction in Value of Property
When a peril occurs and adversely affects property, the property is reduced in value. The actual amount of the reduction in value can be measured in different ways, sometimes with differing results. If the property can be repaired or restored, one measure of the reduction in the value is the costs of the repair or restoration. A further reduction may occur if the repaired property is worth less than it would be worth had it never been damaged.
The same property may have a number of different "values" depending on the method by which the value is determined. For insurance purposes, the most common valuation measures are replacement cost value and Actual Cash Value. In certain situations, however, other valuation measures can be used.
Replacement Cost Value
The replacement cost of a property item is the cost to replace it with new property of like kind. Replacement cost means the money to build a new house like the one destroyed by fire or putting a new roof on a warehouse that has had its roof blown off by a windstorm. Some Property Insurance Policies agree to measure and pay losses on this basis.
Notice that this way of determining "value" ignores the fact that most existing property is not new. Taken in isolation, a new roof has a higher value than a fifteen-year-old roof. If the "used" roof is destroyed, how much money is needed to restore the building to use to put on another roof? The owner has no option but to have a new roof added. There is no resale market in used roofs or roofing material.
Is the building "worth more" with a new roof? Probably, but that position focuses on market value and assumes conversion of the building to cash. Once damage occurs, most building owners merely want to restore the building to its pre-loss use as soon as possible. In most cases, this simply cannot be done without new materials. Since insurance coverages are designed to protect the property owners against reduction in value, property owners usually recognize the need for new materials in their method for determining a property's value.
Actual Cash Value
Actual Cash Value is a measure that does not ignore the fact that most property has
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been used. Actual Cash Value is usually defined by insurers as replacement cost value minus accumulated depreciation. Depreciation, as used here, is different concept from depreciation used for accounting purposes for 2 reasons:
First, while accounting depreciation follows certain accounting conventions, the depreciation component of Actual Cash Value considers physical condition, age, use and other factors affecting the remaining usefulness of the property.
Second, while accounting practices subtract depreciation from the property's original cost to the owner, the calculation of Actual Cash Value subtracts depreciation from the replacement cost. This point can make a dramatic difference between an item's book value and its cash value. Book value is the value of an asset as shown in a firm's accounting records. Book value always declines over time as the property wears out or is used up in contributing to the earnings of the firm (barring renovation or other unusual circumstances that might increase book value). The Actual Cash Value for insurance purposes may increase, however, as often happens with buildings. The replacement cost, new, of buildings rises faster than depreciation reduces the value.
Example: suppose a home was constructed several years ago at a cost of $75,000 and it would cost $100,000 to build the same home today because of higher costs of labor and building materials. The Actual Cash Value of this home might be $90,000, the replacement cost new today ($100,000) minus
depreciation (perhaps 10% of $100,000, or $10,000). The $90,000 Actual Cash Value of the home is higher than the Actual Cash Value when the home was new, even though the home was depreciated.
With certain kinds of property, both the replacement cost and Actual Cash Value produce the same result. If a firm buys 10 new copying machines and they are destroyed before being used, there is no depreciation to subtract from the replacement cost in determining their value. Replacement cost and Actual Cash Value is one and the same.
An Actual Cash Value settlement would not pay a homeowner the full cost of replacing a roof blown off in a tornado. Instead, there would be a reduction for depreciation. Example: a tornado does blow the roof of a ten-year old house and the roof otherwise would have been expected to last twenty years. Assume further that the cost of replacing the roof is $2,000. An Actual Cash Value settlement would pay $1,000. This approach reimburses the homeowner for the unused value remaining in the partially worn roof but it does not pay the entire repair bill. A replacement cost settlement would pay the entire $2,000 for the new roof.
Increased Expenses
When property is damaged, the property itself declines in value and the owner, or other affected party, suffers a corresponding loss. In addition, the owner or other user of that property may have to incur extraordinary expenses in acquiring a
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temporary substitute or in temporarily maintaining the property in usable condition. Example: a family whose house is damaged may have to stay in a hotel for awhile, at considerably greater expense than living at home.
Because so many variables are involved, it is difficult to estimate the extra expenses that might be required to stay in business following damage to a business property or to keep a family together and maintain its standard of living after a home is damaged. Determining the extent of a Property Loss Exposure involves consideration of the extra expenses required in the event of the loss of property.
Lost Income
Much property is used to produce income. When such property is damaged, income may be lost because the income-producing capacity of the property is reduced or terminated entirely until the property is repaired, restored, or replaced. Lost income may result if there is damage to property that is owned and rented to others part of the time. Others rent garages or rooms in their homes. If a loss makes such rental property unusable, the property owner will suffer an income loss until the property can be repaired and rented again.
Chapter 2 - Review Questions
1. Any item with value is considered:
A. insurance
B. money
C. securities
D. property
2. Fire, burglary and collision are examples of:
A. hazard
B. loss exposure
C. peril
D. all of the above
3. Careless smoking in bed is an example of:
A. peril
B. hazard
C. loss unit
D. none of the above
4. This peril includes hurricanes and tornadoes:
A. Windstorm
B. Earthquake
C. Fire
D. All of the above
5. An example of a maintenance peril would be:
A. Fire
B. Collision
C. Wear and tear
D. Windstorm
ANSWERS
1. D
2. C
3. B
4. A
5. C