Owners typically secure and maintain the required builders risk insurance. But is that really the best alternative?
Traditionally, the owner is the party that purchases the builders risk insurance applicable to a construction project. Standardized construction contracts produced by the American Institute of Architects (AIA), ConsensusDOCS, Engineers Joint Contract Documents Committee (EJCDC), and the Design-Build Institute of America (DBIA) all agree: the owner is responsible for purchasing and maintaining this insurance.1 Because most contracts allocate this responsibility to the owner, the alternative of having the contractor provide such insurance is often overlooked or not considered at all.
Responsibility for Uninsured Damage to the Project
Unless the construction contract specifies otherwise, the contractor bears the risk of accidental damage or destruction of a project prior to final completion and acceptance.2 Therefore, contractors have much at stake when it comes to how builders risk insurance is structured and applied. With broader builders risk coverage, the contractor reduces its overall uninsured exposure to loss. As such, savvy contractors are keenly interested in the breadth and composition of the builders risk insurance. An owner's philosophy should be aligned with the contractor, as the builders risk policy is intended to provide prompt funding following an insured loss. This allows the project to move forward, rather than grinding to a halt as litigation ensues among the parties.
After being subjected to uninsured losses associated with owner-provided policies, some larger contractors began securing what has become known as "master" or "practice" policies (hereafter referred collectively as "master" policies). Under such policies, contractors are able to insure multiple projects on a "rolling" basis. They are able to negotiate broader coverage generally, with tailored terms to meet individual project needs, at a lower cost overall. Many underwriters like this arrangement, because they are able to achieve greater spread of risk, lower their acquisition costs, and deal with those in direct control of the actual construction work.
By maintaining a master policy, the contractor benefits in two ways. First, it allows the contractor the opportunity to offer a ready-made builders risk policy to the owner and other stakeholders in a project, as an alternative to an owner-provided policy. Second, in the event an owner chooses to forego the contractor's policy and secure its own (in accordance with the contract requirements), the contractor can obtain a difference-in-conditions (DIC) or contingent coverage endorsement (commonly referred to as "wrap-around" coverage) under its master policy. This wrap-around coverage is intended to "fill in the gaps" for the contractor if an owner-provided builders risk policy proves to be deficient.
Master policies are not a new concept to those owners who are engaged in a continuous stream of projects. Such owners, particularly governmental bodies, universities and large corporations, often maintain their own master builders risk policies. This helps them to reduce costs and ensure uniform coverage, terms, and conditions. But for owners that only occasionally are involved in construction projects, master policies may be a new concept altogether.
A Contractor's Master Builders Risk Policy
A contractor's master builders risk policy includes additional features (as compared to a project-specific policy), which allow greater flexibility to insure multiple projects simultaneously. Besides broader coverage and higher sublimits, these policies often incorporate the following features.
Continuous coverage beyond the policy expiration date. (This applies to projects started prior to expiration of the master policy and may continue for an additional 12–36 months past expiration.)
A deposit premium with quarterly premium adjustments based on declared construction values.
A "menu" approach to rates, coverages, sublimits, and deductibles. (The contractor is provided with a predetermined schedule of rates which are applied based on various underwriting factors, such as project location, construction type, occupancy, sublimits, and deductibles. The contractor can customize coverage based on the requirements/needs of the stakeholders.)
Additional optional coverages such as hot testing, damage to existing property, and deductible buybacks.
Underwriters generally establish specified parameters for automatic acceptance into the master policy. However, some projects may need underwriter approval prior to the insurance coverage becoming effective. Examples where approval may be needed include projects with longer construction timelines, higher values, specified occupancies or types of construction, or those projects located in geographical regions subject to natural catastrophes.
With some policies, underwriters designate maximum insured limits for different construction classifications, such as frame, joisted masonry, masonry noncombustible or fire-resistive. For example, a recent policy reviewed contains these limits of liability: $50 million any single occurrence for any project except: $10 million any single occurrence for any project which includes, in whole or in part, joisted masonry structures or other structures of mixed construction incorporating frame construction; or $5 million any single occurrence for any project that includes, in whole or in part, frame structures. This type of arrangement can lead to confusion if these terms are not defined, if a project involves mixed construction, or if there are multiple buildings as part of an overall project. So, clarification is important at the outset.
Readers should keep in mind that these policies are largely nonstandard, with each insurer employing its own policy forms. The actual terms and conditions represent a negotiation between the buyer and the underwriter. While coverage can be broader than what an owner is able to secure, this is not automatic or guaranteed. Owners need to satisfy themselves that the coverage provided meets their needs. (In particular, an owner will want to make sure it is designated as a named insured and that the policy will operate as primary insurance and will not be excess of any permanent property insurance the owner has.) This review should not slow the process down, as the contractor already has the master policy in place and a copy should be available for review.
If it is mutually decided that the contractor will provide the builders risk insurance in lieu of the owner, the parties must still agree on normal handling issues, including: who will pay for the premium, retain the deductibles, handle claims adjustments with the insurer(s), and distribute claims proceeds to the insureds.
In addition, new responsibilities arise, which include those listed below.
Make contractor aware of insurance-related requirements contained in other contracts or agreements.
Provide instructions to the contractor regarding soft cost and delay coverage needs.
Require contractor to amend the master policy to reserve the soft costs and delay coverages solely for the owner.
Make appropriate changes to the construction contract (this assumes the owner drafted the contract to begin with).
At a minimum, meet the insurance and other requirements in its contract with the owner and as otherwise requested by the owner.
Structure the soft costs and delay coverages per the owner's instructions.
Adhere to reporting and other requirements in the master policy.
Provide evidence of coverage and a copy of the master policy to the owner and others (as requested).
The contract related issues bear additional discussion here. The contractor may not be privy to the development, financing, design, and other contracts entered into between the owner and unrelated third parties. The owner should advise the contractor of the insurance and other related requirements set forth in such agreements, so the contractor can modify the master builders risk policy accordingly. (Examples of such requirements include waivers of subrogation and additional insured provisions.) Otherwise, these requirements will not be addressed in the builders risk policy and the owner may find itself in breach of its contract(s).
Also, if the contractor provides the insurance, the builders risk related requirements in the construction contract must be modified to reflect the new arrangement. Whoever originally drafted the agreements (usually the owner) should direct legal counsel to make the changes as several amendments will be needed. For instance, if AIA Document A201–2007 (General Conditions of the Contract for Construction) is used, AIA recommends eleven changes to A201 when the contractor provides the builders risk insurance. These are listed in Document A503–2007, Guide for Supplementary Conditions. AIA A503–2007 can be accessed for free at AIA's website.
If the selected contractor maintains a master builders risk policy, it makes good business sense for the owner to investigate this alternative further. Many such policies provide broader coverage, higher sublimits, and improved terms and conditions, all at a reduced cost. If the owner and contractor mutually decide that the contractor will provide the coverage, the owner and contractor need to recognize the corresponding shift in responsibilities and act accordingly.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
1 For a detailed analysis of builders risk insurance requirements in different standardized contract forms refer to The Builders Risk Book, by Steven A. Coombs and Donald S. Malecki, published by International Risk Management Institute, Inc, in 2010.
2 See, for example, U.S Fid. & Guar. Co. v. Rob Homes, Inc., 323 So. 2d 105 (Miss. 1975) (building destroyed by fire).