If You Don’t Understand It, Don’t Pretend You Do: Builder’s Risk Insurance (Part 2)

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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)

Latent defects

Faulty workmanship

Whatever is already covered by a warranty

Defects in design

Settling or most causes of collapse

Dishonest insureds or their dishonest employees

Inventory shrinkage

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.



  1. Kevin Connolly says:

    I somehow missed this conversation last week, so I beg your pardon for my tardiness. I am first and foremost a construction lawyer. Builders Risk coverage is crucial to managing the risks of construction.
    One point where I beg to differ with last week’s commentary is on the ‘standard’ form of builders’ risk coverage. There are two main currents in BFR coverage, and for one of them—Commercial Property coverage—there is a standard ISO form: CP 00 20. Many producers make fun of the form, suggesting that no serious developer uses this coverage form. Those producers are wrong. Interiors, like any project that is not straight out of the ground, cannot be covered as inland marine in those State (to include New York) that enforce the Nationwide Marine Definition, and many projects cannot be covered except as commercial property. Over the course of its life, the typical NYC Commercial Building will encounter many times more value in interior projects than it cost to build the base building. Interiors are the heart of the NYC Construction Trade: but they are not inland marine.
    Now the Inland Marine Market is the preferred market when available. IM offers a wide range of coverage forms that should be approached as if they were manuscript forms. For avoidance of doubt, that means you need to read the entire policy and to do so carefully. Of course, “RTFP” is the perpetual mantra of coverage lawyers in all cases, but this is especially important in IM coverage. I am as big a fan of IM as the next fellow, but I practice in New York, where the Nationwide Marine Definition is alive and well. This means that a building in the course of construction may not be written as an IM risk if the building is complete. “Complete” means the Work is actually finished; or the certificate of occupancy has been issued; or the owner or any space tenant has taken beneficial occupancy. Renovation, repurposing and interior fitouts are not inland marine exposures.
    So when a developer decided to expand his six-story apartment house to 11 stories—the most allowed by zoning—the building was ineligible for coverage as Inland Marine. It had to be written as Commercial Property. One advantage resulted: the premium was large enough to access the Free Trade Zone. We negotiated a manuscript General Change Endorsement that included collapse of the existing structure due to the construction of the five-story building on top of the existing structure. In the final policy, the whole exposure was rolled up into a Commercial Package Policy with BPP and Builders Risk coverage parts, and a highly-modified Common Policy Conditions document that coordinated the coverage parts with each other and the construction documents.
    The most notorious difference between the CP 00 20 and most IM forms is the exclusion (from the ISO form) of coverage for collapse in the course of construction. Securing collapse coverage under the ISO form requires an endorsement, CP 11 20. That endorsement provides a generous coverage grant, more generous in fact than many IM forms provide. For example, the use of rotten or other defective materials is a covered cause of loss under the CP 11 20 endorsement, something that is often contested under IM forms.
    Another difference: materials are not covered under the ISO form unless they are at the site or suitably stored within 100 feet of it. IM forms sometime say they cover materials and equipment intended for incorporation into the Work regardless of their location within the coverage territory. This clause should always be coordinated with the construction contracts, which often require worldwide insurance coverage of the Work.
    Any property policy that is written with the Commercial Property Conditions form (CP 00 90) will contain a clause that vitiates the entire coverage part for all insured parties if any insured party engages in serious misconduct, to include misrepresenting the risk, a claim, or the interest of the insured in the risk or the claim. (“Risk” is used here as a term of art, meaning the nature and extent of the insured property and operations.) Therefore, avoid making anyone an additional insured on the Builders Risk (or any other property) policy. The interested parties—contractors, trades, suppliers—are usually protected by construction trust fund statutes that make the Owner (or whomever else receives the property insurance proceeds) hold the insurance proceeds in trust for the parties who built the project. They do not need to be additional insured parties, and once they understand how they are protected and why Additional Insured status imperils everyone’s coverage, most construction players withdraw the demand for AI status. They may request that a bond be posted to cover the handling of the trust funds, and that right is included in the AIA’s A201 flagship form of General Conditions, Subparagraph 11.3.9.
    When the commercial property form is in use, mechanical breakdown is an excluded cause of loss. Don’t assume the coverage is better just because the policy appears to be on an IM form: many IM forms exclude mechanical breakdown or significantly limit the coverage. The time in the life cycle when machines are most likely to fail is during installation, commissioning and testing. This risk should be attended to carefully in all cases, as even inland marine forms often contain limitations and conditions on coverage during the testing process. This is especially true if a machine or system is to be tested beyond its normal service parameters. Coordination is called for among the engineers who designed the system, the protocol for testing and acceptance, and the insurance coverage. Will the insurance pay the cost of replacing the item that failed, or only the cost of other parts of the Work that are damaged by the failure? Is there time element coverage for the delayed completion of the Work? Is that coverage adequate in light of the time needed to obtain replacement components or to design and implement a work-around?
    Coverage for Materials and Equipment can be quite tricky. Covered Property includes materials and equipment that is to become part of the finished construction, but in many cases the materials and equipment must be present at the Site (or within 100 feet of the Site). Some IM forms cover materials and equipment anywhere in the coverage territory, but this is not the end of the story. Coverage varies depending on whether these materials are “Your” property or the property of others. Coverage for property of others usually comes with a very small sublimit (the unendorsed CP 00 20 provides only $5000 in coverage for property of others).
    In most cases, the materials and equipment become the property of the Owner as soon as the supplier fulfills his contract—which usually occurs when the supplier ships the materials (if he uses a common carrier) or lays them down at the Site (if he uses his own forces). Beware if the Contractor obtains the Builders Risk coverage. If the contractor is the named insured under the builders risk policy and the Owner has legal title to the materials on site, there is a potential coverage gap.
    Even more daunting is what happens if there is a problem with the shipment. Under the law of sales, the risk of loss to goods that have been sold passes to the buyer as soon as the supplier ships (or sometimes delivers) goods that conform to the contract. If the goods are not right—for example the contractor ordered crema marfil limestone instead of the cosmetically similar and much more expensive Carrara marble—then title to the limestone remains with the contractor. Now the stone is covered only as property of others. The owner may in fact have no choice but to use the limestone (the marble may have a very long lead time). The contracts should always give the owner the option to accept nonconforming work. You may have a bit of a problem if you try to accept goods that were destroyed before you waived the nonconformity, but a good construction can defuse that trap if you ask nicely 
    The transit risk is often overlooked. Once a finished product leaves the manufacturers’ premises, the risk of loss ends up with the purchaser or end-user. The manufacturer’s insurance does not cover goods in shipment, and unless the builders risk policy covers goods in transit, those goods may lack any first party insurance until they arrive at the Site. (The carrier does have an enhanced duty of care, and common carriers’ legal liability insurance almost always pays in full, but almost is not the same as always, and delays in payment are likely to be greater than if you were claiming under a First Party policy.
    When there is a dedicated transit floater, issues can still arise. What if the shipment is upset during the process of introducing it into the site? Many times the article is simply too bulky to fit through the gate. If there is an upset getting the shipment over the gate you can expect the builders risk carrier to try to fob the loss into the carrier who wrote the transit floater, and vice versa. Apart from that scenario, the risk managers should pay attention to the gaps. The points at which changes take place are also the points where problems are most likely to arise.
    This is just one set of examples showing why it is important for the risk management team to understand the construction process as well as the construction contract documents. IN construction, we pay attention to the places in the Work where two different trades have to “join” their work. Too often, we don’t apply that same rule to the construction documents. The contractor might make sure that the design is constructible, and so pay attention to comparing the designs created by different engineers. Electrical, mechanical, plumbing and structure all have to fit together in the building envelope, but the same kind of attention often is not paid to coordinating the work done by the design team with the lawyers and risk managers. The result can be a disharmonious mess.
    There is value in making sure that all of the contract documents are consistent. The contractor is entitled to information about the project, including the legal and financial conditions.

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