The American Institute of Architects (AIA) recently revised its builders risk insurance requirements in its model contracts. The purpose of this article is to summarize the major changes and provide tips to those who arrange builders risk policies.
AIA currently produces over 100 different standardized contracts or forms. Most construction contracts utilize one or more of these forms.
The most common general conditions form used in the construction industry is AIA A201. When AIA updated A201, it removed most of the insurance requirements and inserted these into a separate exhibit. The builders risk insurance requirements now appear in Section 11.2 of AIA A201–2017 and AIA A101–2017 Exhibit A.1 (Note: Any references below that start with an "A" come from A101–2017 Exhibit A; references beginning with an "11" are derived from the AIA A201–2017.)
Policy Sponsor Responsibilities
The owner remains responsible for procuring the required property insurance, paying the premiums and deductibles, and adjusting claims with insurers. The owner is no longer responsible for securing a bond post-loss but must provide a copy of the builders risk policy to the contractor upon written request.
One difference with the new AIA forms relates to expanded claim handling procedures. Section 11.5.2 requires the owner to notify the contractor of the terms of a proposed settlement and proposed allocation of insurance proceeds. The contractor has 14 days from the receipt of the notice to object. If the contractor objects, the owner may proceed to settle the claim, and any dispute shall be resolved pursuant to Article 15—Claims and Disputes (AIA A201–2017).
A.2.3.1 requires the builders risk insurance to include the interests of the owner, contractor, subcontractor, and sub-subcontractors in the project as insureds. This is a step in the right direction. Previously, AIA Section 11.3.1 required that the interests of the owner, contractor, and subcontractors of all tiers be included in the required insurance. Guidance was not provided as to how these interests were to be protected, so those that arranged builders risk policies muddled along.
However, the continued inclusion of "include interests of ..." is unfortunate. This phrase has spawned much litigation, particularly as respects the subrogation condition. It is hoped that AIA will delete the phrase in its next edition.
It should be noted that AIA chose to designate the identified parties as "insureds" rather than "named insureds." Builders risk policies typically utilize propriety insurance coverage forms. There are significant differences among these forms. With some forms, there are differences between the scope and/or level of protection afforded to "named insureds" versus "additional insureds." The goal should be to protect each of the stakeholders equally. (Tip: Brokers and agents should be aware of the differences in forms when they negotiate and place these policies.)
This is another area where AIA improved the requirements. Paragraph A.184.108.40.206 reads: "Unless the parties agree otherwise, upon Substantial Completion, the Owner shall continue the insurance required by Section A.2.3.1 or, if necessary, replace the insurance policy required by Section A.2.3.1 with property insurance written for the total value of the Project that shall remain in effect until expiration for correction of the Work set forth in Section 12.2.2 of the General Conditions." Section 12.2.2 of AIA A201–2017 outlines warranty periods.
This means that the owner has the option to replace the builders risk insurance at substantial completion with permanent property insurance. However, such replacement insurance must meet the insurance requirements in the AIA forms. If the replacement insurance does not accomplish this, the owner will have breached its contract. (Tip: If the builders risk is to be continued, the expiration dates of the applicable warranties must be determined so that the expiration of the policy can be decided on. When replacement property insurance is chosen (which will happen most often), care is needed to ensure that the property insurance fulfills all of the builders risk insurance requirements.)
Previously, AIA A201–2007 11.3.1 required that builders risk insurance be maintained until final payment has been made or until no person or entity other than the owner has an insurable interest in the property, whichever is later. The problem with this language was that final payment on a project could come months or even years after a project is put to its intended use. This offered little flexibility to the stakeholders.
Policy Form and Insured Perils
Section A.2.3.1 requires the property insurance to be on a builders risk "all risks," completed value, or equivalent form. The use of "equivalent form" seems to give some owners the green light to utilize their permanent property insurance (in lieu of a builders risk policy) to satisfy the builders risk insurance requirements. History has told us that permanent property insurance forms are rarely the equivalent of builders risk forms. (Tip: When a contractor becomes aware that an owner will use a property policy, it should request and review the actual policy to determine if the insurance requirements are met.)
Section A.220.127.116.11 sets forth the perils that may not be excluded (as opposed to those perils that must be insured against). The scope of perils is largely the same compared to the previous AIA edition, with a few exceptions.
This section now requires coverage against resulting damage from defective design, materials, and workmanship. This was an omission in the previous AIA form, as this area is a significant source of litigation. Other comments follow.
"Earthquake" may not be excluded, but there is no similar reference to "earth movement." (Tip: "Earth movement" is a broader coverage and may be more appropriate.)
"Flood" may not be excluded, but there is no similar reference to "water damage," probably because this peril is considered to be part of "all risk." (Tip: Because water damage losses are so plentiful, consideration should be given to listing this peril in A.2.3.1.)
There is no requirement for insuring "terrorism." (Tip: If this coverage is desired, A.2.3.1 should be revised accordingly.)
There is no requirement for boiler and machinery coverage. The previous AIA forms required boiler and machinery coverage if mandated by the contract documents or law (Section 11.3.2 of AIA A201-2007). Many builders risk policies cover this exposure because there are no applicable exclusions. Other policies must be changed by endorsement to add coverage. (Tip: Consider this relatively inexpensive coverage if exclusions apply. Surprisingly, losses can and do occur, particularly electrical injuries to systems and equipment.)
A.18.104.22.168 requires specific coverages. One of these is "testing and startup." Testing and startup is required only for "building systems." "Building systems" are not defined in the AIA forms reviewed but are generally considered to be any electrical; mechanical; plumbing; heating, ventilating, and air conditioning; sprinkler; life safety; or security systems. Previously, the AIA requirement was not limited to "building systems" and applied to all testing and startup. What is missing from the new AIA forms is "hot testing." Hot testing is startup, commissioning, operational, or performance testing of machinery and equipment. (Tip: If a project involves production type machinery, hot testing coverage should be required.)
Subjects of Insurance
There are two major developments regarding what must be insured by the required builders risk insurance. First, there is no longer a requirement to insure damage to property in transit or while at off-site storage locations. (Tips: Contractors need to be cognizant of this and secure appropriate coverages and also contractually require subcontractors to do the same. Insurance brokers and agents of contractors would be well served to include these coverages in the "practice" insurance programs of their clients since they know that the exposure to loss has shifted from the project owner to the contractors involved in a project.)
The second development is a requirement for insuring existing buildings. This has been a troubling area for stakeholders for many years. Section A.2.3.3 sets forth this requirement.
If the Work involves remodeling an existing structure or constructing an addition to an existing structure, the Owner shall purchase and maintain, until the expiration of the correction of Work as set forth in section 12.2.2 of the General Conditions, "all-risks" property insurance, on a replacement cost basis, protecting the existing structure against direct physical loss or damage from the causes of loss identified in section A.2.3.1, notwithstanding the undertaking of the Work. The Owner shall be responsible for all co-insurance penalties.
There should be the following coverage on the existing structure.
Be on a replacement cost basis
Include coverage against the same perils as required for the builders risk insurance
Be maintained until the warranty periods are over
Allow for waivers of subrogation including waivers in favor of the architect and architect's consultants as per Section 11.3.1
This is a significant change and probably came about because of uncovered losses and litigation involving "existing property" exclusions contained in builders risk insurance policies. This is a positive change but is another area that impacts insurance brokers. They need to be careful that the permanent property policies address these requirements. (Tip: Project owners have a responsibility to communicate with their brokers before construction projects commence to ensure its insurance dovetails with contract requirements.)
One other change is that the requirement for insuring architects' and contractors' fees and expenses arising from an insured loss now also includes claims preparation expenses (see A.22.214.171.124). (Tip: Brokers need to add this coverage to their list of requests when obtaining builders risk insurance.)
Use of Sublimits
Historically, the AIA builders risk insurance requirements mandated that the total value of the entire project be insured. This amount included the initial construction contract amount, change orders, and cost of materials supplied or installed by others. Nowhere in the requirements was there latitude for insuring against any of the required perils for anything less than the full replacement cost amount. As such, sublimits (reduced limits) were not permitted. But insurance practitioners agree that the clear majority of builders risk policies incorporate sublimits. This put the purchaser of the builders risk policy in breach of its insurance procurement responsibilities.
Section A.126.96.36.199 outlines specific coverages that are required. But it also serves as a "placeholder" for inserting sublimits. It is important for owners and contractors to agree on all insured limits and sublimits. The agreed upon sublimits should be inserted in this section. (Tip: Brokers should communicate all limits and sublimits to the project owner. The owner should then list the sublimits in A.188.8.131.52.)
I was hopeful that AIA would insert a requirement for a "Separation of Insureds" or a "Severability of Interest" clause. Such a clause would confirm that coverage remains intact for insureds that do not contribute to a breach of a policy condition or warranty.2 That did not happen with the latest AIA forms, even though this is a standard provision in builders risk policies in Canada and Europe.
I was likewise hopeful that AIA would require the builders risk insurance to apply on a primary basis. Many builders risk policies have "other insurance" clauses that specify that coverage is excess over any other insurance, which makes little sense and causes problems.3 Perhaps AIA will recognize the need for this change in a future form revision.
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1 Language and commentary regarding AIA A201–2017 and AIA A101–Exhibit A can be accessed from AIA's website www.aia.org.