The take-away from last week’s Ruminations posting was supposed to be that if you really don’t understand “insurance,” align yourself with someone who does. Not doing so is like cutting and pasting text from a foreign language document hoping that is says what you’d like it to mean. If that point didn’t come across last week, perhaps this second part on the topic of “Builder’s Risk” insurance will push readers into finding an insurance mentor.
Last week, we wrote about policy forms for builder’s risk insurance and how there is really no standard form. We also wrote about who could and should be covered. Those who read last week’s posting would have seen some thoughts about what property is covered, what is not, and what can be added to the coverage. If you missed that, click HERE to see what was said. You’ll also see some thoughts about some additional coverages that can be included along with the basic coverages under the builder’s risk typical policy. So, that will be our launching point.
Builder’s risk insurance policies can be written in two ways: (a) to cover only specifically listed causes of loss; or (b) to cover everything other than what is specifically excluded. Almost everyone wants and buys the second kind. In the most common commercial property insurance policy form, that would be a “Causes of Loss – Special Form” coverage part. There being no commonly used form for a builder’s risk policy, that label might not apply exactly, but most agreement writers might want to call for “something like ‘Causes of Loss – Special Form’ coverage.” Our having written that now allows us to focus on causes that are almost always “excluded” from coverage unless one specifies that such risks must be included the policy. Some of these excluded items are readily available as “add-ons” by way of endorsement (and extra premiums). Some may be negotiable and some just can’t be had. If you really need to know which are which and we don’t tell you below (and even where we have), ask that “mentor” we suggested at the beginning of today’s posting.
Here are some “perils” that you can expect the basic builder’s risk insurance policy won’t cover:
War, government seizure, nuclear hazards
Rust, rot, wear and tear, animal-caused damage
Rapid temperature changes or extreme weather or freezing (unless steps were taken to guard against damage from freezing)
Flood, mudslide, seepage (but this can be “bought” back into the policy)
Earthquake (but coverage can be made available to some extent)
Equipment (e.g., boilers and elevators) breakdown (and this, too, can be added)
Whatever is already covered by a warranty
Defects in design
Settling or most causes of collapse
Dishonest insureds or their dishonest employees
Rain, snow or ice damage to exposed personal property
Damage from many different sources of pollutants (separate coverage may be available)
Asbestos removal and asbestos-related losses
Extra restoration expense by reason of subsequent changes of law (this coverage can be added)
Testing costs for certain equipment and building features (this can be added to a policy)
Delay losses, loss of use, contract or legal penalties, consequential losses (some coverage can be obtained)
Terrorism coverage is a complicated topic and an evolving one as well. Basically, one is unlikely to find an issuer’s “standard” builder’s risk policy that will cover losses due to terrorism, but such coverage can be added just as with a commercial property insurance policy.
An important and interesting coverage feature of a builder’s risk insurance policy is its ability, for an additional cost, to cover the costs of delayed construction when there has been an otherwise covered casualty under the policy. This is a type of “time element” insurance and can cover either or both loss of income (from expected use of the completed project) and “soft costs,” that are incurred above and beyond what would have been paid had there not been a casualty. An interesting type of “soft cost” that can be included, for an increased premium and if specifically obtained, is the penalty (more accurately, liquidated damage) that a contractor or other insured might incur because of late delivery. Keep in mind, however, that coverage for these penalties, just as that for any of the extra costs resulting from delay, must be associated with an otherwise covered casualty. This coverage is not intended to protect against failure to meet a delivery schedule unrelated to damage caused by an insured peril. There are exclusions for consequential losses (though some can be covered by endorsement). Inability to fund the restoration or inability to get subcontractors after the casualty is also an excluded cause of loss. There are others as well and a qualified insurance consultant can help the insured “buy” appropriate coverage. Lastly, policy holders can expect that coverage for delay expenses are tied to when a property would have otherwise been complete and often there is a waiting period after that expected completion date before the coverage would be triggered. Similarly, there will be an outside limit as to “how long” a period will be covered.
Most insurance policies provide coverage until the end date of the policy (assuming the premium has been paid). Builder’s risk policies are a little different. They won’t cover losses that happen after some date related to the building’s completion even if the policy period extends beyond that date. That makes sense because a builder’s risk policy is designed to cover losses that take place when “building” is going on. Depending on the policy itself, that might be when the building’s owner accepts it. Or, it might be a period of time, say 90 days, after it is occupied or it is substantially completed. Regardless of any other “end” date, coverage as to a particular insured will end when that insured no longer has an interest in the insured property. There are other formulations as well. And, don’t forget about coverage ending if the project is abandoned or possibly if left idle for 60 or 90 days. When calling for builder’s risk coverage, it would be wise to specify how long the coverage must continue. Among other reasons, that would let the parties know when commercial property insurance needs to be activated. [Of course, if the document writer doesn’t know the issue or doesn’t know what is available in the marketplace, such a provision, like many others, just can’t be sensibly written.]
There are other, less-than-obvious, issues about policy termination triggers. Think about polices that are written to end based on when a newly constructed building is first occupied (or re-occupied). That’s a common trigger because the risks inherent in an occupied property are different from those posed to a building under construction. But, does “occupied” mean by the first person in the building? Does it mean when occupancy reaches a certain level? What if a building is going to be occupied in stages? These issues are property-specific and this is something else to go over with an insurance mentor.
When one buys property insurance, it is necessary to “pick a number,” i.e., establish a coverage limit. For a commercial property insurance policy, that’s usually pretty easy. The buildings and structures are sitting there and someone can figure out their replacement values. With a project under construction, the replacement cost is a moving target. For that reason, a builder’s risk insurance policy can be written using two different forms: “Completed Value” or “Reporting.” Though a policy with a “Reporting” form allows for premium payments throughout the policy term as the insured “reports” the increasing amount of coverage based on how far along the project has progresses, it is the less popular form by far. One reason is that the maximum coverage is based on the last “report” before any damage takes place and if a scheduled report of value is late, the coverage limit following a loss could fall to 75% of that value. So, what one usually sees is a policy for the estimated completed value (replacement value) of the project coupled with a timetable for completion. The premium is based on something like the “average” value of the project between start and finish. This premium is paid up front and there may be annual reporting requirements, Of course, if the cost estimate is found by the insured to be too low, it must boost the policy coverage during the pendency of the project. When the project is completed, the premium is adjusted based on what actually took place. Coverage is most often written on a replacement cost basis though “actual cash value” coverage is available. For a newly constructed building, there shouldn’t be any savings for buying an “actual cash value” policy. Parties who are in the position to require someone else to obtain builder’s risk insurance should insist on use of a “Completed Value” form and replacement value coverage.
As with other property insurance policies, there will be deductibles and there will or can be “sublimits” for certain types of property or certain types of risk. For example, the coverage for materials stored off-site could carry a lower limit than what is kept at the actual construction site.
In Rumination’s race to an end, we’ll mention two more things about builder’s risk insurance. First, like in a commercial property insurance policy, the coverage can be lost if the insured does not keep required “Protective Safeguards” in place. In a commercial property insurance policy, where the premium or underwriting has been based on the presence of a fire sprinkler system, you’ll find that the policy will require that such a system be in place and be active (unless the insured has notified the carrier about a needed, temporary “turn-off”). Incomplete buildings won’t have sprinkler systems, but policies can and do require protection, such as fences and watchpersons at job sites. Failure to abide by protective safeguard requirements can invalidate a policy.
Lastly (about the builder’s risk policy itself), the willingness of the carrier to waive its subrogation rights (i.e., allow the insured to release possibly responsible people yet still have insurance coverage) is far more complicated than where a normal commercial property insurance is involved. For one, as was pointed out last week, there really is no standard form of builder’s risk insurance policy. So, one can’t rely on the “built-in” subrogation waiver one finds in the standard Insurance Services Office, Inc.’s policy coverage form; it needs to be affirmatively written into the builder’s risk policy. It is, however, commonly available for situations where there was a written waiver of claims agreement in place before the insured loss. Second, a builder’s risk policy is intended to cover a waterfall of insureds: owners, lenders, contractors, subcontractors, sub-subcontractors, and design professionals among them. The contractual and working relationships between and among those parties is complex as are the possible claims one or more may have against one or more of the others. Here, again, the assistance of a knowledgeable insurance consultant is critical.
Allow Ruminations to finish where it started. If most of what you now know about builder’s risk insurance came from this week’s and last week’s postings, you will be in deep trouble when you start writing about what you want someone else to carry in the way of builder’s risk insurance. And, you’ll be in similar deep trouble if you try to buy such coverage from a broker who knows as little as does Ruminations. This really is specialty coverage and should be seen as that, both when including its requirement in your lease, mortgage or other agreement as well as when buying it.