When building construction occurs as either ground-up new or renovation
of an existing structure, most risk management professionals assume that the
exposure requires a builders risk policy. Is this assumption correct? It
depends on the details—the information necessary for the risk management
professional to decide whether the construction exposure needs a builders
risk insurance policy or another property policy that can or does provide same,
similar, or better coverage than a builders risk insurance policy. The devil
is in the details as the correct insurance response to the construction
exposure may not be obvious. The exposure review starts with the insurable
interest of the various parties to the construction contract to build the
new building.
Insurable Interest
The first step to determine the appropriate first-party (property)
insurance policy for an individual or organization is to establish the
party's insurable interest. Insurable interest is the legal concept that an
insured (i.e., first named insured and any other insured) on a property
insurance policy must have a financial interest in an object (building) and
will suffer some degree of financial loss if the object is damaged or
destroyed. The named insured may be one or more parties depending on how
construction will be conducted such as the owner, the owner's general
contractor ("GC") when the owner does not act as GC itself, and any
subcontractor(s) ("sub") hired by the owner or GC. The construction contract
will identify the various parties involved in the building construction.
The owner that builds for itself will have an insurable interest
throughout the course of construction. The GC will likely have an insurable
interest from beginning of construction until final acceptance and payment
by the owner. Subs, when hired to do portions of construction, will have a
period of insurable interest from inception of their work for the GC until
final payment and acceptance of the work by the GC. How can these three
unrelated interests all have an insurable interest in the same building? The
owner has a direct damage exposure during the time of construction equal to
(1) its funds expended for any of its own labor and supplies and (2) for
payments made to the GC and/or subs. In turn, the GC and sub have a direct
damage exposure equal to their labor, supplies, and profit. The named
insured in this example may be ACME Building (ACME) as owner, ABC General
Contractor as GC, and any subs hired by the owner or GC.
New Construction: Builders Risk Policy
Let's assume that ACME does not have any other buildings, so it does not
have another property insurance policy that may be considered for the new
construction. What does ACME do? It has two options: (1) purchase a builders
risk policy itself to cover the construction exposure; or (2) enter into a
construction agreement with the GC and make the GC responsible for placement
of the builders risk policy. The coverage terms, conditions, and policy
limits should be the same whether coverage is obtained by the owner or the
GC.
Is direct damage the only exposure for ACME? Likely not. There may be
other costs that need to be insured. If the building will produce an income
stream quickly after it's completed and put to its intended use (rental
space), it may have a business income exposure during construction (loss of
rents). The owner may have other costs, such as architectural,
engineering,
financing, and
legal fees
(soft costs) that may be incurred if the building is damaged during
construction. Soft costs can be insured but may need to be added by a
specific endorsement to whatever property insurance policy is used to insure
the builders risk exposure.
In either option 1 or option 2, the named insured will be the same: each
party's interest will need to be identified, such as ACME Building (owner),
ABC General Contractor ("GC"), and any subcontractor thereof. Does it matter
which interest is the first named insured? It can, as the first named
insured in the policy will receive notice of cancellation and/or nonrenewal,
can make changes to the policy (increase or decrease coverage), can receive
return premiums, and is solely responsible for any deductible. The first
named insured issue should be reviewed carefully by both ACME and the GC to
ensure that various notices and responsibilities rest with the proper named
insured.
The builders risk policy, whether obtained by the owner or the GC, will
need to be carefully reviewed, as with any property insurance policy, to
make sure that coverage terms (property insured, soft costs, etc.) and
perils insured are appropriate for the exposure (i.e., special perils
including flood and earthquake) and that the limit will satisfy all
insurable interests including whatever is required specifically in the
owner's mortgage agreement and the construction agreement between the owner
and GC. Special consideration will need to be made as to amount of
deductible and which party is responsible for its cost—the owner or GC—even
if the policy is obtained by the GC. The construction agreement must be
clear as to the policy deductible responsibility if it will not be the sole
responsibility of the first named insured.
A building owner such as ACME may be able to obtain a builders risk
policy on its own but may find that the GC is able to secure the policy with
better coverage terms and a more competitive premium. A GC should not be
overlooked as having the potential to obtain a better builders risk policy
for an owner. The minimum coverage requirements for the builders risk policy
do not change based on which party procures it—the owner or GC—as the policy
must address all exposures and satisfy all insurance requirements in
mortgage and construction agreements.
Other Commercial Property Insurance
In our first example, ACME was having a building constructed and did not
have any other property insurance policy(ies) to consider for the
construction exposure. Let's change the scenario, and now ACME will
construct a fourth building and has a commercial property policy in effect
for its other three buildings. What options are available to ACME as the
owner?
ACME may be able to use its existing building and personal property
coverage form for the construction exposure instead of a separate builders
risk policy. Deciding which policy to use—builders risk or the existing
building and personal property policy—will require scrutiny to ensure that
both options provide necessary coverage terms and conditions. This review
can become complex as many property insurers use independently filed policy
forms for builders risk and building/personal property policies. These
policies may also be different from Insurance Services Office, Inc. (ISO),
filed forms. Some property policy forms easily provide coverage for a
builders risk exposure equal to that which may be provided by a builders
risk policy. The devil is in the details to ensure that the most appropriate
policy is chosen for the construction exposure.
There are some new construction issues to consider when comparing
building and personal property coverage, whether as a monoline policy or
coverage within a package policy (businessowners or other) to a builders
risk policy. Remember, even if the boilerplate policy has some construction
coverage, the underwriter may not be comfortable with the actual exposure
when notified and may not provide coverage beyond any stated coverage terms.
- Does the definition of "building" include new
construction as "covered property"?
- If there is a sublimit for "newly constructed
buildings," will the property insurer provide a sufficient
building limit for the period of construction?
- Is the automatic coverage for "newly constructed
buildings" conditioned to a time limit that is not only the
policy expiration date but also for a finite coverage
period, such as 30 days?
- Will the property insurer provide coverage for the
builders risk exposure when notified coverage is desired
beyond the automatic coverage period?
- If the property insurer will not continue coverage after
the automatic coverage period, will a builders risk insurer
be willing to insure new construction that has already
begun?
- How are materials destined for the new building covered,
and are there any distance limitations on storage sites that
may overly restrict coverage?
- Will the property insurer provide time element coverage
(loss of rents) as well as "soft costs" if requested by the
owner as named insured?
- Will the property insurer provide competitive coverage
terms for deductible and premium when compared to a builders
risk insurer?
- Will the property insurer add the interests of GC and
sub(s) as additional insureds or simply as loss payees for
their construction exposures?
- Does the insurer have the technical ability to provide
specific loss control services for new construction, such as
plan review?
It seems that many property insurers will provide some level of "builders
risk" coverage in their building and personal property forms for new
construction. The policy intent may be more for incidental exposures, such
as low limit and short coverage periods for "newly constructed" buildings.
It is better to discuss the planned construction exposure with the property
insurer well before any construction is begun to ensure that appropriate
coverage can be provided as needed. This is important as builders risk
insurers want time to underwrite the exposure and are often reluctant to
provide coverage to a structure that is already under construction. Builders
risk due diligence requires not only the policy review and comparison
process but also dialogue with each prospective insurer.
Renovation: Other Commercial Property Insurance
Let's consider policy and coverage issues if ACME as owner decides to
renovate and/or
expand one of its existing buildings
instead of constructing a new building.
Will this form of construction require a builders risk policy? Probably not,
as most property insurance policies readily cover this exposure without any
sublimit or time limitation other than policy expiration. In addition, it
would be difficult for one insurer to insure the owner's building structure
that is not undergoing renovation while another insurer is to solely cover
the owner's renovations.
We get an idea of coverage intent, as an example, from how ISO filed
forms address this exposure. ISO defines "building" in its building and
personal property coverage form CP 00 10 06 07 as "... If not covered by
other insurance: additions under construction, alterations and repairs to
the building or structure; materials, equipment, supplies and temporary
structures on or within 100 feet of the described premises, used for making
additions, alterations or repairs to the building or structure."
Even
though the property policy may provide coverage for the building renovation,
the risk management professional will need to consider exposure and coverage
issues, such as the following:
- Consider an increase in the building value to reflect
the increased value in order to alleviate possible
coinsurance penalties.
- Will the material supply storage as provided by the
policy adequately address the exposures created by the
renovation, or are policy changes needed?
- Will the property insurer provide time element coverage
(loss of income, loss of rents) as well as "soft costs" if
requested?
- Will the property insurer modify the named insured to
include not only the owner but also the GC and subs, and
restrict named insured status to the GC and subs to only
their interest in the newly constructed building?
Installation Floater
Is it possible for certain insurable interests to seek insurance for
construction exposures outside of the builders risk policy? Yes,
subcontractors such as electricians, plumbers, and heating, ventilating, and
air-conditioning (HVAC) installers may decide to separately insure their
exposures outside of an owner- or GC-provided builders risk policy by use of
an installation floater. This approach is not recommended when the builders
risk policy provided by the owner or GC can include all interests including
all subs. Why? Duplicate coverage may exist that may complicate loss
settlement and, at the same time, add duplicate insurance cost. If the subs
maintain separate installation floaters, then they will include this cost of
insurance when bidding a job, thereby increasing their proposed cost, and
may create an uncompetitive bidding situation for them and the GC. Separate
installation floaters will also mean that the cost of this insurance will be
billed to the GC and, in turn, to the owner (ACME), thereby needlessly
adding cost to the overall construction budget.
Are there ever sound reasons for a contractor, subcontractor, or other
party to use an installation floater? Yes, whenever the contractor is
building or installing something of value (electric wiring, HVAC equipment,
data/fiber-optic cable) and there is no builders risk policy that can be
used to insure its exposure. In these cases, the contractor can obtain an
annual policy with limits set on average and/or maximum installation
exposures at any one site to cover its exposures until accepted by and/or
paid by the owner or GC.
The installation floater, like the builders risk policy, will need to be
reviewed carefully, like any property policy, to make sure that coverage
terms for property and perils insured (i.e., special perils including flood
and earthquake) are subject to a limit to satisfy actual exposure at each
installation site and a deductible that is cost effective.
Conclusion
Buildings are constructed new and are renovated to become modernized or
assume new occupancies. The risk management professional has to consider the
construction exposure from various interests, such as owner, GC, and sub, to
ensure that each has appropriate coverage for its exposures. Insurers have
different means of covering the exposures, depending on insurable interest
presented and its underwriting ability. Existing policies may provide
required coverage either within boilerplate policy language or by specific
endorsement. Specific policies may be required (i.e., builders risk policy
or installation floater) to provide necessary coverage for the interests to
be insured. It is key to understand the exposures, coverage treatment
options, and the insurer's underwriting posture before construction occurs.