What Lease Writers (And Others) Don’t Understand About Builders Risk Insurance Coverage

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When a lease makes a specific reference to “Builders Risk” coverage, we know the conversation is going to go sideways. That’s because the proponent of that provision rarely knows anything more about that kind of insurance than can be intuited from the words: “Builders Risk” itself.

Here is an opening premise: the normal (ISO) coverage form for “Building and Personal Property Coverage” does not pertain to buildings under construction. [The ISO, or Insurance Services Office, is an association of insurance companies and it promulgates commonly used insurance forms. Many, but not all carriers use these forms. So, people who really want to know what is or is not covered always need to look at the policy itself. Those who draft leases might want to requires insurance policies to be on ISO forms or be on the functional equivalent of those forms.]

Here is a second premise: The ISO form for “Builders Risk” uses values based on the completed building, inclusive (yes, inclusive) of foundations, paving, and similar items that are not covered in the usual form for “Building and Property Coverage.” If less than the completed value is declared, the insured will be subject to co-insurance limitations. For example, if the actual completed value is twice the declared amount, the insured will only get paid for half of any otherwise valid claim.

There is a third premise: A Builders Risk policy, like the Building and Property Coverage Policy, can be endorsed for debris removal, pollution cleanup, and some other things. Additional coverage for building supplies or landscaping can be obtained. There are some other kinds of coverable risks, such as tools and construction equipment, but a discussion of those items is best had with an insurance expert, not with us at Ruminations.

Now, for the CRITICAL fourth premise: It is probably stupid to use an unmodified Builders Risk policy when, as is most often the case in lease negotiations, you are really talking about alterations or renovations. In those cases, there is, or certainly should be, a property insurance policy already in place, one that will stay in place, Typically, that will be the ISO Building and Property Coverage Form (and usually with a Special Form coverage part).

So, in the case of renovations to an existing building, there will already be property insurance in place, almost certainly obtained and maintained by the landlord. All that needs be done is to buy an endorsement – it is called (in ISO parlance), “Builders Risk Renovations.” It adds coverage for the improvements, alterations, and repairs being made. Basically, aside from not covering foundations (because they are already completed), this endorsement extends the underlying property insurance to the improvements being done, and does so in a way that co-insurance concerns are eliminated.

So, what does this add up to? By having the landlord add the builders risk coverage to its existing policy (at the tenant’s expense if the tenant is doing the renovations), you get: (a) a landlord who controls the coverage and doesn’t have to monitor its tenant; (b) the right party, i.e., the tenant, paying for the extra cost of such coverage; (c) no gap in coverage; (d) no battles between different insurance companies; and (e) no throwing premium money down the sewer.

What this also translates to is getting lease writers to understand how builders risk insurance really works and getting them to write “smart” lease provisions instead of insisting that a tenant “obtain” builders risk insurance, something we see far, far too often. Having the landlord obtain the insurance coverage at its tenant’s cost is the “smart” way to handle builders risk coverage when it is meant to cover alterations or renovations. If you start out with this concept, the lease should take less time to negotiate, you can reduce the “distrust” element between negotiators where each thinks the other is jockeying for advantage, and the interests of each of landlord and tenant are better served.

As to when a tenant is building from scratch, Ruminations, once again, strongly suggests that landlords control the insurance by getting it themselves and having their tenants pay the premiums.

By the way, those who write loan documents might also pick up a few hints by reading this posting and applying its concepts.

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Comments

  1. Dan Kopp says:

    Ira, you continue to provide new information. I’d say 100% of the forms I use and see require the tenant to carry it. I wonder if I’m going to have to fight with my clients’ risk management folks to change this.

  2. Insuring builders risk projects under the permanent property insurance of the landlord is often fraught with problems. Permanent property policies generally contain gaps compared to what is required to be covered under the construction contracts. Look at the standard builders risk/property insurance requirements set forth in the different model contracts (for instance, AIA A201-2007). For instance, It is doubtful the permanent property policy will cover (1) the proper parties (owner, contractor and subs of all tiers), (2) property wherever located (e.g., goods in transit, goods at storage locations) or (3) all the enumerated perils. That is just for starters. Large owners of real estate also have large deductibles. When there is a loss and the owner has a $250K deductible who is responsible for that?

    When securing the appropriate insurance, one must consider both the insurance requirements in the lease with the insurance requirements in the construction and design contract documents.

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