Builders risk coverage insures against risk of loss from damage to property under construction, whether new construction or renovation of existing buildings. Builders risk coverage presents issues not normally associated with property coverage for existing buildings in use. This article will address some of these issues.1
Before deciding on the scope of builders risk coverage, the risk manager or other person responsible for obtaining the coverage must review the construction documents. There is an important interrelationship between the construction documents and insurance coverage. For example, and as a baseline, the documents will set out certain requirements for insurance coverage, along with indemnity provisions, waivers of subrogation, identifying who is to be insured under the policies, and, in some cases, limitations on liability. These must be carefully reviewed to make sure that the correct coverage is obtained.
In addition, do not rely on certificates of insurance. By their terms, they do not even purport to accurately describe the policies in force, much less guarantee that the specific terms and conditions required by the construction documents are in place. Instead, the construction documents' insurance requirements should be compared to quotes, binders, and, when issued, the policy. Any discrepancies should be addressed immediately with the insurance company. If certain insurance requirements cannot be met at commercially reasonable prices, that should be raised promptly with the parties to the construction contracts and, if necessary, the construction documents should be modified accordingly.
A primary consideration is what property to insure. On renovation projects, this is particularly important because the policy should insure both the existing structures and the new construction. For example, many recent development projects involve converting industrial or warehouse space into residential and/or retail space. This usually requires the existing building to be gutted, and all new systems and interiors constructed. The existing exterior envelope is a key component of the project, and coverage for damage to that envelope is very important to the success of the project.
However, many builders risk policies provide only actual cash value coverage for existing structures, not replacement cost coverage. Therefore, in the event of, for example, a fire on site, only the depreciated cost to repair the exterior envelope will be covered, which could be a 30-50 percent shortfall. If the project has a tight budget, that shortfall could be enough to sink the project, particularly if additional construction funding is not available. This last possibility is a very real concern when credit is tight, as it is in today's market.
For new construction, it is very important to have coverage for foundations, underground pipes, site preparation, excavations, temporary structures, scaffolding, construction forms, etc. Each of these can be very expensive to replace if there is no coverage in the event of a loss. The parties should consider whether off-site materials which will be incorporated into the building should be covered under the builders risk policy. In addition, coverage for contractors' tools and equipment, or materials which will not ultimately become part of the structure, must be confirmed.
The next consideration is who should be insured. The construction documents will usually require that the owner and the general contractor be covered by the same builders risk policy. All subcontractors of whatever level frequently are also covered. This will usually obviate the need for waivers of subrogation among the contractors and subcontractors, because the rule in most states is that a property insurer may not subrogate against its own insured.
Some builders risk programs insure certain material suppliers, others do not. If the material suppliers are not insureds under the builders risk policy, contingent business interruption coverage should be obtained which will cover any loss to a key supplier's facility. Otherwise, the project could be completely halted if, for example, the steel delivery is delayed for 3 weeks because of the fire at the steel plant, but there will be no coverage for the costs resulting from that delay.
The interrelationship between construction documents and insurance policies is also particularly acute when considering certain common policy exclusions, such as those for faulty design, faulty materials, and faulty workmanship. Most builders risk insurers will not provide coverage for the cost of making good defective design, workmanship, or materials. However, policy forms should be carefully reviewed to make sure that ensuing loss is covered. The law on ensuing loss in each state should be carefully checked to see whether an entirely new peril must result from the faulty workmanship, i.e., if faulty welding causes a fire, the fire is a new peril which is insured under the ensuing loss exception. Alternatively, if the roofers do not properly install the flashing, and water leaks through the roof and destroys interior walls, the insured should know before construction starts whether that will be considered an ensuing loss under the governing law, or whether it will be excluded as the direct result of the faulty workmanship. In this regard, construction document provisions on indemnity, consequential loss, and allocation of responsibility should be drafted with this type of situation in mind and should reflect the availability of ensuing loss coverage.
Once the property to be insured has been identified, the insured locations can be determined. Of course, the construction site itself should be an insured location. Important decisions should be made concerning property in transit (including whether all modes of transportation are covered), and, as noted above, whether property off-site, such as at the supplier's plant before it is delivered, will also be covered. This last can be very helpful because a fire at a manufacturing plant which destroys materials already manufactured for the project will trigger business interruption and soft costs coverage if property off-site is specifically covered.
Time Element Coverage
Two of the most important considerations in a builders risk policy are the type of time element coverage which is included and the deductibles. Time element coverage includes business interruption, extra expense, expediting expense, and "soft costs." This article will only address the last of these four, although that by no mean diminishes the importance of having appropriate terms, conditions, limits, and deductibles for the other three.
The purpose of soft costs coverage is to insure the economic risks caused by project delays resulting from a covered peril. The cost of repairing or replacing the damaged property will usually be covered by the property insurance and will include the cost of removing the debris of the damaged property, purchasing new materials, and the labor involved in replacing the damaged property with the new property. However, depending on the precise policy language, traditional business interruption coverage, including extra expense and expediting expense, may not pay for certain economic losses, such as advertising and promotional expenses, commissions or fees for the renegotiation of leases, additional insurance premiums for the necessary property and liability coverage to be in force for the additional time it will take to finish the project, interest on construction loans, taxes, and rental of construction equipment not specifically involved in repairing the damaged property.
Each of these items can be covered under a soft costs endorsement and will provide extra protection to the owner. Contractors may also incur substantial uncovered soft costs without the proper endorsement. For example, if the project is delayed 3 months because of a fire, general conditions will continue, sometimes at the rate of $10,000 or more per month. This may not be covered under the property coverage or the business interruption coverage. If it is a large project, subcontractors may require substantial additional fees to keep their men on site, as opposed to sending them to another job. Workers and equipment idled between the date of loss and the date reconstruction begins are most likely to be covered under soft costs endorsements, if at all. Storage, increases in labor wages, and building materials are other examples of soft costs incurred by contractors.
Policyholders should make sure that the soft costs endorsement includes the soft costs which will be incurred by all insured parties. Some endorsements, particularly if the policies are obtained by owners, will focus on the owner's soft costs, and may ignore the contractors' soft costs. If the general contractor obtains the policy, the reverse may be true. Therefore, the scope of the soft costs coverage should be specifically discussed by all the insureds. Another key issue is deductibles. Many soft costs coverages have deductibles expressed in waiting periods of days or weeks as opposed to dollar amounts. This can have the affect of wiping out a significant proportion of a soft costs claim, especially if adjustments to critical paths are practicable, even though costly.
In conclusion, builders risk coverage presents unique issues which should be addressed before construction begins. Policy forms are different and the precise terms and conditions necessary should be reflected in the construction documents and reviewed in detail by all concerned. If the parties involved in a construction project pay attention to detail up-front, it will minimize uninsured loss and help prevent unnecessary disputes between policyholders and insurers, and even among the policyholders themselves.
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1 For a more comprehensive list of issues to consider when purchasing builders risk coverage, see the Builders Risk Coverage Checklist (2008 ed.) in the IRMI Insurance Checklists reference.