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Insurance Abstract
The invention pertains to a financial product having an insurance
component covering only an amount of capital at risk that exceeds
a replacement cost of an asset collateralizing the capital. The
product includes a payment component that provides a payment equal
to at least a portion of the amount of capital at risk in excess
of the replacement cost of the asset, upon loss of the asset. In
the preferred embodiment the payment may be substantially equal
to the amount of capital at risk in excess of the replacement cost.
Insurance Claims
1. A financial insurance product comprising:an insurance component
covering an amount of capital at risk that exceeds a replacement
cost of an asset collateralizing said capital, said insurance component
requiring that said asset be insured by at least one separate insurance
policy for the replacement cost of said asset; anda payment component
providing payment equal to at least a portion of the amount of capital
at risk in excess of said replacement cost upon loss of the asset
and subsequent to substantial payment of said replacement cost of
said asset by said separate insurance policy.
2. The financial insurance product of claim 1, wherein said payment
is an amount substantially equal to said amount of capital at risk
in excess of said replacement cost.
3. The financial insurance product of claim 1, wherein said insurance
component requires a total loss of said asset.
4. The financial insurance product of claim 1, wherein said capital
at risk is at least one loan.
5. The financial insurance product of claim 4, wherein payment
is not provided if the at least one loan is defaulted prior to the
loss of the asset.
6. The financial insurance product of claim 1, wherein said asset
is a group of assets.
7. The financial insurance product of claim 6, wherein said payment
component provides payment equal to at least a portion of an amount
of capital at risk in excess of said replacement cost of at least
one asset within said group of assets upon loss of at least one
asset within said group of assets.
8. The financial insurance product of claim 1, wherein said insurance
component is a follow form of an underlying basic policy.
9. The financial insurance product of claim 8, wherein said insurance
component can include or exclude perils such as mold, lead, terrorism,
or demolition accordingly as the basic policy includes or excludes
said perils.
10. The financial insurance product of claim 1, wherein providers
of said at least one separate insurance policy have a strong credit
rating.
11. The financial insurance product of claim 1, wherein said replacement
cost is determined using a Marshall Swift Report.
12. The financial insurance product of claim 1, wherein the product
is contracted on a basis of five years or less and said product
contract is renewable.
13. The financial insurance product of claim 1, wherein said capital
at risk is a portion of one or more loans collateralizing said asset;wherein
said one or more loans are those in existence or made at the time
of execution of the insurance product or granted subsequent to execution
of the insurance product.
14. The financial insurance product of claim 1, wherein a premium
is paid for said insurance product, wherein said premium is determined
by standard actuarial practices.
15. The financial insurance product of claim 1, wherein said asset
is commercial real estate.
16. The financial insurance product of claim 1, wherein said asset
is residential real estate.
17. The financial insurance product of claim 1, wherein said asset
is industrial equipment.
18. The financial insurance product of claim 1, wherein said asset
is retail inventory.
19. The financial insurance product of claim 1, wherein said asset
is a natural resource.
20. The financial insurance product of claim 1, wherein said asset
is a ship.
21. The financial insurance product of claim 1, wherein said asset
is oil.
22. The financial insurance product of claim 1, wherein said asset
is intangible property.
23. The financial insurance product of claim 1, wherein said asset
is intellectual property.
24. The financial insurance product of claim 1, wherein said asset
is rights to a revenue stream.
25. The financial insurance product of claim 1, wherein said asset
is a shipment of goods.
26. The financial insurance product of claim 1, wherein said capital
at risk is bonds.
27. A financial insurance product comprising:an insurance component
covering only an amount of capital at risk that exceeds a replacement
cost of an asset collateralizing said capital; anda payment component
providing payment equal to at least a portion of the amount of capital
at risk in excess of said replacement cost upon loss of the asset.
28. The financial insurance product of claim 27, wherein said insurance
requires that said asset be insured by at least one separate insurance
policy for the replacement cost of said asset.
29. The financial insurance product of claim 28, wherein said payment
component provides payment only subsequent to substantial payment
of said replacement cost of said asset by said separate insurance
policy.
30. The financial insurance product of claim 27, wherein the payment
is an amount substantially equal to the amount of capital at risk
in excess of said replacement cost.
31. A method of insuring against loss of an amount of capital at
risk, comprising:covering an amount of capital at risk that exceeds
a replacement cost of an asset collateralizing said capital, said
insurance component requiring that said asset be insured by at least
one separate insurance policy for the replacement cost of said asset;
andproviding a payment equal to at least a portion of the amount
of capital at risk in excess of said replacement cost upon loss
of the asset and subsequent to substantial payment of said replacement
cost of said asset by said separate insurance policy.
32. The method as set forth in claim 31, further comprising requiring
a total loss of said asset.
33. The method as set forth in claim 31, further comprising requiring
that said asset be insured under a separate insurance policy covering
at least said replacement cost.
34. The method as set forth in claim 32, further comprising providing
a payment after substantial payment of said replacement cost of
said asset by said separate insurance policy.
35. The method as set forth in claim 31, wherein said replacement
cost is determined by a Marshall Swift analysis.
36. The method as set forth in claim 31, wherein said asset is
commercial real estate.
37. The method as set forth in claim 31, wherein said asset is
residential real estate.
38. The method as set forth in claim 31, wherein said asset is
industrial equipment.
39. The method as set forth in claim 31, wherein said asset is
retail inventory.
40. The method as set forth in claim 31, wherein said asset is
a natural resource.
41. The method as set forth in claim 31, wherein said asset is
a ship.
42. The method as set forth in claim 31, wherein said asset is
oil.
43. The method as set forth in claim 31, wherein said asset is
intangible property.
44. The method as set forth in claim 31, wherein said asset is
intellectual property.
45. The method as set forth in claim 31, wherein said asset is
rights to a revenue stream.
46. The method as set forth in claim 31, wherein said asset is
a shipment of goods.
47. The method as set forth in claim 31, wherein said capital at
risk is bonds.
48. The method as set forth in claim 31, wherein said capital at
risk is one or more loans.
49. The method as set forth in claim 31, wherein said asset is
a group of assets.
50. The method as set forth in of claim 49, comprising providing
a payment equal to at least a portion of an amount of capital at
risk in excess of said replacement cost of at least one asset within
said group of assets upon loss of at least one asset within said
group of assets.
Insurance Description
FIELD OF THE INVENTION
[0001]The present invention generally relates to asset risk management,
and more particularly to a financial insurance product for insuring
the value between a replacement cost of an asset and loans granted
on the market value basis of the asset.
BACKGROUND OF THE INVENTION
[0002]Insurance, or the transference of risk from one entity to
another in consideration of a premium, has evolved over time into
an innovative area of economics and finance. Insurance first developed
in relation to risk associated with fire wherein properties were
insured against destruction or loss in the case of that particular
peril. Later, special coverage was developed for the risk associated
with acts of vandalism and malicious mischief. Standard insurance
policies were also developed that contained terms where risks outside
those listed were excluded under the contract. However, over time,
all-risks eventually were covered unless it was specifically excluded
from the policy. Sections of contracts were then created having
listings of risks not covered under the policy, which would be covered
only if endorsed back to the policy by negotiated request by an
endorsement. With such innovations, the insurance field has developed
many variations and nuances in dealing with risks to become the
complex intersection of business, finance, and economics that it
is today.
[0003]One major area of risk management is in dealing with real
property or real estate. A major risk often involved in transactions
related to real estate is the possibility of destruction or loss
of a real property or home. This risk is further exacerbated by
loans made by a financial institution with the building or home
as collateral and the loan based on the fair market value of the
property. Currently, there are multiple instruments and policies
in the art that address the risk of loss of a building or home,
but do not adequately address the interplay between the loss and
the full amount due on a loan.
[0004]Typically, the real estate area is classified into two major
divisions, that is residential and commercial. For residential homes,
a major type of insurance is Homeowner's insurance. Homeowner's
Insurance protects homeowners from casualty losses or damage to
the home or personal property and from liability damages to other
people or property. Some types of homeowner insurance can cover
a guaranteed replacement cost of the house if elected, which is
the cost of physically replacing the house including construction
and materials beyond the stated amount listed on the declaration
page of the policy. However, in the event this guaranteed replacement
cost is not elected and a loss occurs, then a gap may be created
between the replacement cost and loan value of the property.
[0005]Another type of insurance is Private Mortgage Insurance (PMI).
Most mortgage loans made on homes are often 70%-80% of the value
of the home, due to down payments. However, if the loan to value
ratio is higher than 80%, often lenders will require PMI in order
to protect themselves in the event of a default. Upon default, any
shortfall in the outstanding balance of the loan subsequent to foreclosure
is paid by PMI insurance. Additionally, only a few insurers offer
full guaranteed replacement coverage, whereas others offer only
a corridor of 110% thru 125% of the value stated on the declaration
page.
[0006]The difficulty is that neither homeowner's insurance, PMI
nor any other insurance policies address the gap between replacement
cost and outstanding loan balance in the event of a loss of the
home, and furthermore such policies make up only a small piece of
the market. This gap is ameliorated somewhat by the fact that mortgage
loans are often only 75-80% of the appraised market value of the
home. However, if a loss were to occur early on, or if the house
was not appraised accurately, a large gap could be outstanding making
it difficult for the homeowner to repay the loan, especially considering
that individual homeowners typically have less cash reserves or
economic leveraging power than commercial entities. Commercial real
estate comprises larger risks and exposures due to the fact that
it can involve multibillion dollar transactions with high amounts
of leverage, and little or no loan to value discounts. Furthermore,
the complexities of the transactions address many more factors and
intricacies, with multiple parties taking on and insuring different
risks.
[0007]Another type of insurance is automobile gap insurance, which
is an elected optional benefit the consumer purchases at the time
of sale/lease. This insurance covers the difference between the
actual cash value (depreciated value of the vehicle) and the loan/lease
obligation balance in the event of a loss of the asset.
[0008]Often commercial lending involves a primary insurance contract
that provides a broad base coverage. On top of the primary, insurance
can be provided for excess "layers". The layers can be
divided such that, e.g., the first 10 million dollars may be handled
by one or more carriers, and the next 10-50 million may be assumed
by other carriers, and above that still other carriers.
[0009]In addition to the primary base coverage, there are many
other possible modifications of insurance contracts, such as "wrap"
contracts, which are intended to "wrap" around existing
base policies making up for shortfalls. One type of "wrap"
contract is Difference in Conditions (DIC) contracts which fill
in gaps or extend coverage outwards beyond the basic policy, on
an all-risks basis, subject to certain exclusions, which are assumed
to have been covered by the base policy. Furthermore there are drop-down
clauses or contracts where one of the higher layers will "drop
down" and pay out on a lower layer under certain conditions.
Drop-down layers allow the possibility that an excess layer can
"drop down" into a primary layer.
[0010]Despite the wide variety of these and other variations of
insurance contracts, such insurance policies are still generally
directed toward replacement cost of a building up to a designated
value agreed to by the insured and the carrier rather than market
value of the asset or the amount of the outstanding loan. The building's
replacement cost can be determined by conducting a "Marshall
Swift" report which values a building's cost for replacement.
[0011]Generally, in both commercial and residential real estate
transactions, upon loss of a building or home, insurance policies
seek to place the policyholder back in the position they were in
immediately prior to the loss, with comparable quality materials
as the original home, and without any consideration of the loan
or mortgage which may be still outstanding. On the other hand, commercial
lenders base mortgage loan decisions on the existing fair market
value of the property, and view the transaction from the perspective
of what value the property would have in case there is a default
in order to recoup the loan made on commercial real estate. Lenders
have therefore focused more on what occurs in the case of default
and less on what occurs if there is a total loss of the property
due to covered peril. As a result, there may be a significant gap
between the replacement cost of the property covered by insurance,
and the value owed on the loan originally made based on the market
value of the property.
[0012]With rising property values, and ever increasing loans, the
gap between replacement cost and outstanding loan amount increases.
Also, in favorable market times, additional loans could be taken
on the property thereby further increasing the gap. Therefore, on
the side of lenders, as well as directors and officers with duties
to shareholders, an ever increasing risk develops on the outstanding
loan. In the event of loss of buildings where the gap is large,
inability for owners to pay down the loan increases as well. This
can lead to defaulting on the loan and large losses to the lending
institutions. In the event of a fire, earthquake, terrorist attack,
or other peril, where multiple buildings or other assets are lost,
the financial impact could be great and widespread.
[0013]The foregoing discussion of commercial and residential real
estate is exemplary, whereas loans and indebtedness are obtained
with a wide variety of assets as collateral. Gaps between replacement
cost and outstanding loan value can exist on all types of assets
which creates uninsured risk across a broad spectrum of markets
and economies.
[0014]What is needed therefore is a financial product that addresses
the gap between the replacement cost and the amount of the outstanding
loan and resolves the risk associated therewith.
SUMMARY OF THE INVENTION
[0015]The invention pertains to a financial product having an insurance
component covering an amount of capital at risk that exceeds a replacement
cost of an asset collateralizing the capital. The product includes
a payment component that provides a payment equal to at least a
portion of the amount of capital at risk in excess of the replacement
cost of the asset, upon loss of the asset. In the preferred embodiment
the payment may be substantially equal to the amount of capital
at risk in excess of the replacement cost.
[0016]Various aspects of the invention relate to covering an amount
of capital at risk exceeding a replacement cost of an asset. For
example, in one aspect of the invention, a financial service product
includes an insurance component covering an amount of capital at
risk that exceeds a replacement cost of an asset collateralizing
the capital. The product includes a component wherein the asset
is preferably insured by at least one separate insurance policy
with a Best Rating of A+IV for the replacement cost of the asset
and a payment component providing payment equal to at least a portion
of the amount of capital at risk in excess of the replacement cost
upon loss of the asset upon substantial payment of the replacement
cost of the asset by the separate insurance policy.
[0017]The asset can be made up of a group of assets, or properties.
In such an embodiment, payment can be made upon the loss of one
or more assets in an amount equal to at least a portion of the amount
of capital at risk in excess of the replacement cost of the one
or more assets in the asset group. Preferably, the amount equal
to at least a portion of the amount of capital will be an amount
substantially equal to the full amount of capital at risk in excess
of the replacement cost of the one or more assets.
[0018]Furthermore, the asset can be commercial or residential real
estate as well as industrial equipment, retail inventory, machinery,
industrial equipment, a ship, personal property, shipment of goods,
cargo, or natural resources such as oil, coal, gas, or minerals.
Furthermore, the asset can be intangible property such as a patent,
trademark, copyright, or other intellectual property. The asset
can also be a revenue stream, or licensing rights, or rights to
revenue stream from rental properties. The aforementioned assets
are all exemplary and not limiting for the current invention.
[0019]In yet another aspect, a method of insuring the value between
a replacement cost of an asset and loans given on the basis of the
asset comprises identifying an asset that collateralizes the capital
at risk as well as insuring only that amount of capital at risk
that exceeds a predefined replacement cost of the asset. Other embodiments
may include requiring that the asset be insured under a separate
insurance policy covering at least the predefined replacement cost.
Still further embodiments may include a step of making payment upon
a claim only after substantial payment of the predefined replacement
cost of the asset by the separate insurance policy.
[0020]Additional features and advantages of the present invention
will be readily apparent from the following detailed description,
the accompanying drawings and the claims.
BRIEF DESCRIPTION OF THE DRAWINGS
[0021]FIG. 1 is a graphical depiction of a gap according to the
present invention.
[0022]FIG. 2 is a block diagram of a method of insuring capital
at risk according to the present invention.
[0023]Like reference symbols in the various drawings indicate like
elements.
DETAILED DESCRIPTION OF THE PREFERRED EMBODIMENT
[0024]The present invention relates to a financial insurance product
and techniques for insuring the portion of an outstanding loan collateralized
by an asset that is in excess of the replacement cost of the asset
in the event of a total loss of the asset. Preferably, the asset
is separately insured by an underlying insurance policy for the
replacement cost of the asset.
[0025]The product and techniques can be used for any asset where
a loan is obtained on the asset. Preferably, the asset is insured
based on a primary policy for the replacement cost of the asset,
and where the loan amount exceeds the replacement cost. The product
insures the difference between the replacement cost of an asset
and the full value of the outstanding loan on the insured asset.
As used herein, the term "replacement cost" is the amount
of money required to replace an item or property to a pre-loss condition
without a deduction for depreciation. Activation of the instrument
by payment of the premium enables recovery from the insurer and
allows the outstanding loan to be paid off. Preferably, a premium
is paid for the insurance product that is determined by standard
actuarial practices.
[0026]Referring now to FIG. 1, a graphical depiction of a gap associated
with an asset is shown. As shown in the FIG. 1 example, the replacement
cost 1 is a value associated with physically replacing the asset.
For example, in relation to a building, the replacement cost 1 is
the cost of physically replacing the building with a new building,
including construction and materials. Preferably, the replacement
cost is insured by a primary insurance product and can often be
determined accurately using a Marshall Swift Report. Preferably,
providers of the primary insurance product have a Best Rating of
A+IV
[0027]The loan amount 2 is the total loan originally collateralized
by the asset based on its fair market value. The gap 3 is the difference
between the outstanding loan amount for the asset and the replacement
value of the asset. Hence, the gap 3 is the loan amount still owed
to one or more lenders after the replacement cost of the asset has
been paid by the primary insurer.
[0028]Preferably, the financial product is not a part of the primary
layer insurance contract and may be independent of and separate
from the underlying negotiated contract. As an additional separate
specialized instrument, the financial insurance product is in excess
of the primary and all excess layers and not considered a broadening
of the underlying insurance product. Preferably, the instrument
does not include any drop down clauses. Additionally, because the
product is separate from the underlying policy, the underlying product
may permit or grant permission to purchase excess coverage.
[0029]The product is based on a "follow-form" type policy
that follows the terms of the primary underlying policy, including
its exclusions as well as its coverage. For example, if the underlying
policy terms include or exclude certain losses from conditions such
as mold, lead, terrorism, demolition, then so would the product
of the present invention. Although separate and independent from
the primary policy, the insurance product in an embodiment of a
follow-form policy can follow the terms of the primary policy. This,
may therefore reduce negotiation costs as well as reduce complexity.
[0030]In one preferred embodiment, the product provides payment
only after the underlying layers and policies have been fully exhausted
in payment of the replacement cost of an asset and the lender still
is owed an outstanding amount of the loan. Preferably, payment is
not activated if the loan is defaulted prior to the loss and activation
of the underlying policy.
[0031]In certain situations, the ability to restore an asset to
its pre-loss condition may be limited by applicable laws or regulations.
For example, in a "down zoning" situation where there
is a loss to real property and current zoning rules do not permit
the property to be rebuilt to the same size or specification (i.e.,
prior to the loss the property included five floors and after the
loss the zoning board only permits three story structures), the
replacement cost of the asset is reduced. In an alternative embodiment
of the present invention, the gap between this reduced replacement
cost and the outstanding capital at risk is covered.
[0032]According to one preferred embodiment, the underlying base
coverage reflects replacement cost of the asset, and does not provide
only partial coverage. In this preferred embodiment, the assets
are insured to one hundred percent of the replacement cost value.
This is due to the fact that the product insures the excess loan
amount above the replacement cost. It is preferable that the basic
insurance carrier have a strong rating such that it reasonably can
be expected to pay on its policy in the event of a loss. Furthermore,
it is preferable to require the application for the instrument to
include a financial statement disclosure as well as grant permission
to obtain a credit and/or financial condition report such as a Dun
& Bradstreet report and a Marshall Swift real estate property
report of each asset to be insured. In one preferred embodiment,
the instrument is offered on a five year contract basis that is
renewable if all underwriting criteria and warranties are met. Other
embodiments may provide for other time periods. The premium can
be determined by standard actuarial practices as known in the art.
In a preferred embodiment, the premium may be paid in a first upfront
installment. In other embodiments, payment may be structured in
alternative ways.
[0033]Furthermore, if the outstanding loan balance collateralized
by the asset decreases during the policy period, the maximum amount
paid by the product remains the outstanding loan in excess of the
replacement cost. Therefore, as the principal is paid or loan is
reduced, the amount the instrument pays out, based on the gap, or
the outstanding excess loan is reduced as well. Therefore, the insurance
provider's exposure to risk can be reduced as the loan is repaid.
[0034]Alternatively, after initial signing of the loan, if more
loans are later taken based on the home or building or asset as
collateral, some embodiments may provide for the instrument to include
in its terms coverage for that new increased gap or outstanding
loan amount in excess of the replacement cost. Furthermore, the
initial or later loan amounts may be comprised of multiple loans
from one or more entities.
[0035]In one preferred embodiment, if any claim is in dispute by
arbitration or legal proceeding, the instrument is not activated
or triggered until resolution of the matter is resolved in favor
of the insured.
[0036]A further understanding of an embodiment of the invention
is disclosed in connection with FIG. 2. As indicated in block 4,
for the financial insurance product to disburse payment, as indicated
in block 14, there must be an asset covered by a basic insurance
policy for the asset's replacement cost and an outstanding loan
with the asset as collateral. As indicated in block 5, payment in
part of the loan by the debtor can occur and thereby reduce the
total amount of the loan outstanding. If the total amount of the
loan outstanding is reduced below the replacement cost due to partial
payment or other reason, as indicated in block 10, there is no loan
amount in excess of the replacement cost, and therefore, there would
be no payment activated by the financial insurance product as indicated
in block 13. However, if the loan still exceeds the replacement
cost, as indicated in block 6, then in order for payment to be activated,
preferably a total loss of the asset is required 7, and a payment
of the replacement cost of the asset by the underlying insurance
policy 11 needs to be made. If the loss of the asset and payment
of the replacement cost by the underlying insurance company occurs,
as indicated in block 7 and 11, respectively, then payment of an
amount substantially equal to the portion of the loan exceeding
the replacement cost is activated by the financial insurance product
as indicated in block 14. In an alternative embodiment, the payment
may not exceed the fair market value of the asset. The payment can
either first go to the debtor before the outstanding loan is paid
off or directly to the lender or to third parties in privity therewith.
[0037]Alternatively, there may not be any payments to reduce the
loan by the loan holder before a loss occurs, in which case, the
requirements of a total loss and payment of the replacement cost
by the underlying insurance policy must take place before payment
by the insurer will be required by the policy. Furthermore, if after
a loss of the asset as indicated in block 7, and if there is non-payment
or only partial payment of the replacement cost based on the underlying
policy as indicated in block 8, then preferably payment would not
be activated by the financial insurance product as indicated in
block 12. This is because the financial insurance product of the
present invention does not include any drop down clauses and covers
only the amount of the outstanding loan in excess of the replacement
cost.
[0038]Furthermore, in some embodiments, if there is a default or
failure to meet the terms and conditions of the underlying insuring
instrument, as indicated in block 9, then there would be no payment
under the financial insurance product.
[0039]In one embodiment, the instrument may be used with respect
to commercial real estate transactions. However, in other embodiments,
residential real estate may be insured as well. Such properties,
both commercial and residential, can involve single properties,
multiple properties, individual and joint ownership, as well as
a wide variety of other types of ownership or investments. However,
assets as commercial or residential real estate are merely exemplary
and not limiting for the present invention, as assets may comprise
many different types of properties, tangible and intangible.
[0040]Furthermore, in other embodiments the insured assets may
include boats, machinery or other assets where a loan is made based
on the present market value of the asset and the asset is insured
by a primary policy based on replacement cost, and where the loan
exceeds the replacement cost.
[0041]Additionally, in some embodiments, the asset can be a natural
resource such as oil, minerals, or coal. Also the asset can be cargo,
or any shipment of goods. This would provide additional hedges in
the case of loss of an oil tanker, or any ship or vehicle with cargo
or goods in transport. Such assets can be retail inventory, or personal
property or valuables such as jewelry or heirlooms. Also, an asset
can be intangible, for example patents, trademarks or copyrights.
Additionally, such an asset can be rights to licensing royalties,
or rights to a revenue stream. Such assets can be collateral for
any type of capital at risk, such as a loan or bonds, or other financial
instruments.
[0042]Furthermore, the asset can be a pool or group of assets or
properties, or the rents or revenue streams from such pool of properties.
Wherein if there is a loss of one property within the pool or group
of assets or of the entire pool, the present insurance product can
provide payment for a portion or the entire amount of capital at
risk above the replacement cost of such property or pool of properties.
[0043]The invention having been thus described, it will be apparent
to those skilled in the art that the same may be varied in many
ways without departing from the spirit of the invention. Any and
all such modifications as would be obvious to those skilled in the
art are intended to be covered within the scope of the following
claims. Although preferred embodiments of the present invention
have been described herein with reference to the accompanying drawings,
it is to be understood that the invention is not limited to those
precise embodiments and that various other changes and modifications
may be affected herein by one skilled in the art without departing
from the scope or spirit of the invention, and that it is intended
to claim all such changes and modifications that fall within the
scope of the invention.
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