Riding on our success with an insurance discussion last week about the meaning and implications of having someone’s insurance coverage be “primary and noncontributory,” we thought we’d risk a similar topic this week. [To see what Ruminations said about “primary and noncontributory,” click: HERE.]
There are two pretty common land use and construction approval concepts across the country. If a building is destroyed beyond a certain degree (by fire or otherwise), its reconstruction has to comply with current law. “Grandparenting” (f/k/a “grandfathering”) doesn’t allow you to put it back the way it was. Generally, when it comes to construction codes, new buildings and major reconstructions need to meet most new code requirements. For example, if the “old” building had 1/2 inch wallboard (which was lawful when built) and the current code requires 3/4 inch wallboard, 3/4 inch is the answer to your question.
As to compliance with land use requirements, the most common “threshold” is 50% destruction. In some jurisdictions, that is 50% of value; in some that’s 50% of floor area; in some it might be 50% of bulk volume. The “threshold” is jurisdiction specific. Look it up. Regardless of the threshold, if the damage exceeds that level, you don’t have the right to put the building as it was, if it didn’t conform to the land use requirements on the day the damage took place. So, if the building was a prior nonconforming use because it was a three-story building now in a two-story zone, you don’t have the right to rebuild three stories. You need to get a variance. The same goes for setback violations, and so forth. And, yes, sometimes you can’t get the variance and the building can’t be reconstructed.
How does the commercial property insurance policy respond to this when it is written to cover only the replacement cost of the building as it stood, or, if you don’t rebuild, will pay only an amount equal to an insurance industry’s deliberately non-intuitive term, the building’s ACV. That stands for “actual cash value” and includes the imposition of a “depreciation” or “wear and tear” discount. In most cases, that translates to payment of about 70% of the building’s replacement value.
When a building is damaged by reason of fire or other cause, governmental authorities may condemn the remaining undamaged or slightly damaged part and demand its demolition. Almost always, this risk and the extra cost to comply with current laws are not adequately covered by the ordinary commercial property insurance policy. The “standard” Insurance Services, Inc.’s (ISO’s) commercial property insurance policy (Form CP 00 10) will cover increased costs of governmentally mandated changes to the lesser of $10,000 or 5% of the direct damage to the actually damaged part of the building, and then only (as is almost always the case) if the basic coverage was for “replacement value.”
The very common ISO commercial property insurance “Causes of Loss” coverage parts (yes, all three versions) specifically exclude losses resulting from compliance with or enforcement of laws that regulate construction, demolition, repair or use of the insured property. Therefore, they all exclude coverage for losses or extra expenses when zoning laws change or construction codes have changed or when the reconstructed building now needs to meet more stringent ADA requirements.
Is there a “solution” you ask? Well, as with most things in life, with money comes a solution. This time, for the ISO policy, it is ISO Endorsement CP 04 05, “Ordinance or Law Coverage.”
[We don’t want to ignore the ISO Debris Removal Additional Limit of Insurance Endorsement CP 04 15 which, for the amount inserted on that Endorsement, increases coverage for debris removal above the built-in ISO policy coverage of $25,000. So, now we haven’t.]
We aren’t going to reproduce the actual Ordinance or Laws Endorsement. It is long and copyrighted. So, we’ll only tell you enough about it so that you can earn the right to participate in conversations about it and also know that this is coverage that is available to take care of the “coverage gap” we’ve described. Then, after consulting with a knowledgeable insurance expert, you can figure out if and when an agreement should require such coverage.
The Endorsement provides three distinct coverages, notably called “Coverage A,” “Coverage B,” and “Coverage C.” They are each triggered if, at the time of the loss, there is an ordinance or law that “regulates the demolition, construction or repair of buildings, or establishes zoning or land use requirements” and, as a result of that ordinance or law, it will cost more than the property policy would have paid in response to the loss. The three coverage enhancements only cover compliance with the minimum legal requirements. They do not pay for voluntary upgrades or even for the cost to follow recommended, but not mandated, actions or standards.
“Coverage A” responds to loss related to any undamaged portion of the building. You don’t choose “extra” monetary coverage. The basic insurance coverage remains as is, but if Coverage A is elected, the basic policy will cover the “loss in value of the undamaged portion of the building as a consequence of a requirement to comply with and ordinance or law that requires demolition of undamaged parts of the same building.” Without the “coverage extension,” the basic policy would not do so.
“Coverage B” covers the cost to “demolish and clear the site of undamaged parts of the same building as a consequence of a requirement to comply with an ordinance or law that requires demolition of such undamaged property.” One needs to select (and pay for) a chosen, stated amount of this “extra” coverage.
“Coverage C” is the “heart” of Ordinance or Law Endorsement. For that reason, we reproduce the Endorsement’s text that best explains it:
3. Coverage C – Increased Cost Of Construction Coverage
a. With respect to the building that has sustained covered direct physical damage, we will pay the increased cost to:
(1) Repair or reconstruct damaged portions of that building; and/or
(2) Reconstruct or remodel undamaged portions of that building, whether or not demolition is required;
when the increased cost is a consequence of a requirement to comply with the minimum standards of the ordinance or law.
However:
(1) This coverage applies only if the restored or remodeled property is intended for similar occupancy as the current property, unless such occupancy is not permitted by zoning or land use ordinance or law.
(2) We will not pay for the increased cost of construction if the building is not repaired, reconstructed or remodeled.
Coverage C actually covers items that the underlying commercial property insurance policy does not. Unlike the underlying policy, Coverage C extends to: (a) the cost of excavations, grading, backfilling, and filling; (b) foundations; (c) pilings; and (d) underground pipes, flues, and drains.
As with Coverage B, the policyholder chooses the amount of coverage and pays a corresponding premium.
Ruminations is not competent to lead its readers into the weeds (i.e., the thickets of insurance). Our only goal is to sensitive all of us about the insurance terms we casually toss into our agreements (or mistakenly leave out of them). And speaking of “leaving things out,” here’s one you’ve never seen in an agreement written by us or by our colleagues, the “Ordinance or Law —Increased Period of Restoration” Endorsement (ISO Form CP 15 31). It adds coverage for loss of income or expense related to delays caused by the need to comply with new ordinances or laws. We often see agreements that require one party or the other to “obtain and maintain” Business Income and Extra Expense coverage, and sometimes also see agreements with a requirement to carry “Ordinance or Law” coverage, but never see any that mandate coverage of business income losses and extra expenses related to the “extended” time it might take to comply with those new legal building requirements.
Although it is overwhelmingly the case that parties are called upon to carry “replacement coverage,” has anyone ever seen an agreement that actually calls for “Ordinance or Law” say “how much”? After all, Coverages B and C are purchased to a specified limit and the concept of “replacement value” is inapplicable to those coverages.
If you are in a role that calls upon you to actually buy these coverages (and others), you’ll certainly be in touch with an insurance professional. We hope today’s posting will enhance your understanding of the coverages we’ve discussed. More importantly, however, if you just sit back behind the wizard’s curtain, as we do, and write edicts into agreements over which we lord, then today’s blog posting should be another warning that none of us should extend beyond our reach. Just as we are lease, mortgage, loan agreement, etc. professionals, there are insurance professionals out there. Adopt one.
Excellent article and a good peak behind the insurance curtain