Building the Right Builders Risk Policy
October 2011
Builders risk insurance is often
misunderstood; the nuances of coverage are often not addressed until an
actual loss occurs. A properly designed builders risk program will protect
your investment in your construction project not only for property damage
repair costs but also for business interruption losses and higher "soft
costs."
by Christopher M. Brophy, CPA
FTI Consulting
Jeffrey J. Vita, Esq.
Saxe Doernberger & Vita, P.C.
Builders risk insurance protects the owner of a construction project for
losses caused by many reasons, including fire, explosion, hurricane, fire,
flood, vandalism, and others perils. Most builders risk policies are written
on an "all perils" basis—the loss is covered from any cause, unless
specifically excluded by the policy. Coverage under builders risk typically
ends when the construction is complete. The premium charged contemplates
that the insured value of the project increases over the term of the policy
as the construction progresses.
While builders risk coverage is most often
considered in the context of commercial or residential construction, it is
an important aspect of coverage for many industrial or manufacturing
construction projects. For example, a chemical company building a new plant
may have builders risk coverage to augment its coverage under standard
property coverage.1
Time Element Coverage
A
builders risk policy generally covers business interruption or losses of
rent resulting from the delay in completion, which is referred to as the
"period of indemnity" or "period of restoration." Determining the period of
indemnity may require a detailed analysis of the preloss and postloss
construction schedules to determine the actual impact of the delay. Time
element coverage includes business interruption coverage, which provides
insurance for lost sales less costs that discontinue, and extra expenses
incurred as a result of the incident.
Rental Value Coverage
Rental
value coverage provides coverage for the loss of rent during the period of
restoration when the property has been damaged by a covered cause of loss.
If the property is used by the insured rather than rented, it typically
would provide coverage for the fair rental value of the property.
Insurance policies differ as to the methodology that should be used to
measure a time element loss, whether it be for business interruption losses
and extra expenses or rental value losses. The graph below shows the impact
of an incident on a construction project. Most construction projects go
through a "ramp-up" period after opening. In this case, the occupancy of the
building is projected to start at 0 percent at opening and increase to 90
percent after a ramp-up period. An incident occurred, which delays the
completion for several months. When the property does reopen, it goes
through the same ramp-up period.
Click here for illustration of the impact
of a catastrophe on a construction project.
Some insurance policies use wording more
aptly suited for first-party property insurance and define the period of
indemnity as beginning with the date that the loss occurred and ending when
repairs are complete. For a builders risk policy, this doesn't make sense as
the property would have no revenue during this period. (See A on chart.)
Others define the period of indemnity as beginning with the date that
construction would have been complete had there been no incident and ending
with the date that construction actually was complete. This is not optimal
either, as it reflects the projected revenue during the ramp-up period,
which will still occur and simply be shifted. (See B on chart.)
The best
approach, which measures the true actual loss sustained, defines the period
of indemnity as beginning when the ramp-up period would have ended had there
been no loss and ends when the ramp-up period is over after repairs are
made. (See C on chart.) Note that, in each case, the loss would be measured
as the occupancy at the level marked in red as compared to 0 percent
occupancy, as the property was closed for this period as a result of the
incident.
Keep in mind that a major catastrophe could have a detrimental
impact to the construction project, in addition to the delay in
construction. For example, a construction project expected to be complete
during a robust economy may suffer additional losses if the delay results in
opening after the economy has slipped into a recession. Also, the stigma
associated with occupying a property where a catastrophic loss occurred may
make it difficult to find tenants. Your broker can help you design a policy
that meets your specific needs and risk exposures.
Soft Costs
Most
builders risk policies include coverage for additional "soft costs" incurred
as result of the delay in construction. This should include all construction
overhead costs, such as:
- Additional interest (both on
construction and permanent financing)
- Real estate taxes
- Advertising expenses
- Insurance
- Architect fees
- Extended general conditions
- Bond and permit fees
- Legal and accounting
- Other administrative costs
Code Upgrades and "Green" Coverage
Some policies offer coverage for "change in law or
ordinance," which would reimburse the insured for costs incurred to upgrade
to new building codes in place at the time of the loss. Other policies offer
coverage to upgrade your construction to meet higher "green" environmental
standards.
Conclusion
Builders risk insurance, which is critically
important to building owners and others with projects in the development
phase, can be tricky and include wording that can be problematic should a
loss occur. Coverage that will properly and thoroughly address any lost
profit and additional costs, including "soft costs," must be carefully
considered. Other areas of coverage, which can be added as an endorsement to
your policy, should also be evaluated. Build the right policy, understand
your exposures, and be ready should you need to file a claim.
Christopher M. Brophy
is a managing director with FTI Consulting in the business insurance claims
practice of FTI's Forensic and Litigation Consulting business segment. He
writes the catastrophe risk management column for
www.IRMI.com. For background and contact
information for Mr. Brophy, see his full
biography.
Jeffrey J. Vita
is a founding partner of Saxe Doernberger & Vita, PC, a Connecticut-based
firm dedicated to the representation of policyholders in insurance coverage
disputes. Mr. Vita's practice focuses on the representation of business
policyholders in insurance coverage matters implicating various lines of
coverage including commercial general liability, directors and officers,
professional liability, commercial property, and pollution. Mr. Vita has
handled coverage cases related to construction, professional malpractice,
environmental, business interruption, employment, disability, title
insurance, and health care. He also has authored numerous articles on
insurance coverage issues and has lectured nationally on a variety of
insurance coverage topics including additional insured issues, bad faith
claims, priority and allocation of coverage, and builders risk claims. Mr.
Vita is a past chairman of the Insurance Law Section of the Connecticut Bar
Association and has been an Adjunct Professor of Law at the University of
Connecticut School of Law, where he taught "Current Issues and Trends in
Insurance Litigation." He can be reached at (203) 287–2103 or
.
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