Renovations Can Cause Homeowners Insurance Coverage Gaps

Relying on these policies leaves owners of expensive homes with significant holes in their coverage program that can lead to unexpected cash outlays. This article explains the dangers involved in home renovations and how to ensure proper insurance protection during a major renovation.

Let's begin by explaining a few key terms that we will be discussing.

What Is a Luxury Home?

For the purposes of this article, a luxury home is defined as a home that is valued at $1 million or more in replacement value.

What Is a Major Renovation?

The criteria commonly used to identify a major renovation are the following.

• The home will be unoccupied while construction is underway.
• The total cost of the renovations is budgeted to be 10 percent or more of the home's replacement value or $500,000, whichever is less.

What Are the Risks Involved with Major Home Renovations?

Properly insuring a home while it is under renovation is a critical component of the planning process, and it is not one that should be overlooked. Some of the largest losses that insurers experience occur to homes under renovation. The following is a quick list of some of the factors that arise during renovation projects that increase the risk of loss.

• Increased foot traffic from the workers leads to a greater risk of injury on the property.
• Luxury homes may have valuable objects inside that may be stolen.
• Workers use tools to renovate the house that can cause damage. Some of the tools used involve flammable material, such as blowtorches, paint thinner, floor sanders, etc.
• Unoccupied luxury homes under renovation are a target for vandalism, unauthorized use, and theft of building materials.
• Contractors make mistakes too. If they cause damage to the home, their policy should cover the associated costs. However, there are uncontrollable factors that need to be considered, such as a canceled policy due to a missed bill.

How Does the Homeowners Policy Limit Coverage for Renovations?

The homeowners policy is designed to insure an owner-occupied home. Insurers offer several pricing advantages and discounts for this type of insurance because they do not generally involve major renovations where the insured is not occupying the home. To maintain their pricing advantages and discount offers, they include language within their contract that may be used to exclude coverage for losses that arise during major renovation scenarios.

An example of language that has been used to deny claims for a loss to a home while unoccupied and under renovation is the definition of "residence premises." Some insurers define "residence premises" as the "one family dwelling where you reside." In situations where the home is not occupied during the renovation, this language can quickly make the certainty of coverage questionable.¹

Another example of how contracts limit coverage during renovations comes from home insurance contracts specifically designed to insure luxury homes. These insurance contracts include language similar to the below paragraph:

If you plan to renovate your home or construct an addition to the property with a budget that is more than 10 percent of the dwelling limit, $500,000, and/or it results in moving out of the house for any length of time, the insurance company must be notified beforehand. Otherwise, any damage to the property will not be settled on a replacement cost basis, but at replacement cost less depreciation. There is a special construction deductible (5 percent of the dwelling limit) that will apply to each occurrence in lieu of the base deductible on the policy as well."

Under this language, if a home's replacement value is $1 million, and the insurer is not notified of the renovation, the insured will have a $50,000 (5 percent of $1,000,000) deductible for a loss instead of their regular deductible. Their claims settlement will be reduced through the application of a depreciation calculation as well.

How Do You Get Coverage for a Major Renovation?

Anyone planning to renovate their home should discuss the insurance implications and risk management considerations with a personal risk manager/adviser or insurance agent who specializes in home renovation insurance. Once it is determined that a home will be under major renovation and a new insurance solution is needed, there are a couple options to consider. The correct option will depend on the home and the scope of the project.

• Strategy A: Adding Coverage to the Homeowners Insurance—It may be possible to ask the current homeowners insurance company to add renovation coverage. This is typically an option with insurers who specialize in insuring high-value homes.
• Strategy B: Builders Risk Insurance—If it is not possible to add the coverage to a homeowners policy, a builders risk policy can be purchased instead. This is typically available through insurers who specialize in construction insurance.

Each of these options has different coverages and features that should be considered during the insurance planning phase.

Renovation Insurance

Insureds who choose to add renovation insurance to their existing home insurance should ask the following three basic questions.

• How will the cost of the insurance policy change?
• What will they need to do to maintain the insurance?
• How will their coverage change?

How will the cost of the insurance policy change? As discussed earlier in this article, homes under renovation have a higher risk of loss than those that are owner-occupied and not under renovation. Additional risks add costs to insurers caused by claims; insurers need to balance these costs with additional premium charges. The following are the changes that are typically applied to a homeowners policy during a major renovation that result in an increased cost/premium.

• Premium credits and discounts are removed during the renovation/construction period (e.g., alarm credits, generator credits).
• Sometimes insurance companies will transition the policy into a new rating tier designed for homes under renovation.
• A vacancy surcharge will be added to the homeowners policy if the home is unoccupied during the renovation. This surcharge is usually about 25 percent of the home's annual premium after the discounts and credits have been removed (e.g., $1,000 × 25% = $250 additional premium for the year or $21 per month).
• A renovation/construction surcharge will be added to the homeowners policy. This surcharge is usually about 35 percent of the home's annual premium after the discounts and credits have been removed (e.g., $1,000 × 35% = $350 additional premium for the year or $29 per month).

Note: All surcharges and rate changes are only applicable while the home is under renovation and/or unoccupied. Therefore, insureds will only be charged while the home is under renovation/construction.

What will the insured need to do to maintain the insurance? Everyone wants to prevent a loss from happening. Insurance companies may require the home owner to comply with certain loss prevention strategies in exchange for covering the home during the renovation. The following are some examples of strategies insurers may look for assistance with.

• The client should obtain a certificate of insurance from their general contractor with themselves listed as an additional insured.
• Verify that the general contractor's coverage is at least $1 million per occurrence.
• Place Underwriting Laboratories rated fire extinguishers in the house. One for every 1,000 square feet.
• Post "No Smoking" signs in the work areas.
• Install a temporary fire and burglar alarm system.
• Conduct pre- and postinspections of the home.
• If the home is valued at $5 million or more, there may be additional strategies to discuss.
• Place all flammable materials, such as rags and other combustible material, in a fireproof cabinet when not in use.
• Install temporary night-lighting.
• Add a driveway chain or perimeter fencing to prevent unauthorized access.
• Hire a 24-hour security guard.
• Install video surveillance cameras and engage a monitoring service to watch over the property.

Note that lack of compliance with loss prevention strategies can lead to policy cancellation.

How will the coverage on the homeowners policy change during the renovation? Insurers may also alter the coverage on the homeowners policy during a renovation to ensure adequate insurance is in place. The following are some examples of how the coverage can change during a major renovation.

• Guaranteed replacement cost coverage is replaced with conditional replacement cost coverage, which limits the coverage to the amount the home is insured for.
• Insurers may request the standard policy deductible be increased during the renovations.

There can be a lot of moving parts with this strategy, but this solution will provide peace of mind, excellent coverage, and a higher likelihood of a successful renovation without a major claim.

Builders Risk Policy

The process for working with a builders risk policy is very different from working with a homeowners policy. The coverage can be designed to cover only the home that is under renovation, or it can be designed to cover personal property, liability, loss of use, and other coverages if needed. Sometimes insurance agents may have to place two or three policies to cover a home during renovation if this strategy is used. Builders risk insurance is also a viable solution to cover a home under renovation.

Conclusion

The most important thing to remember for anyone who is planning to do a major renovation at home is to consult a personal risk manager or an insurance professional who specializes in this type of insurance. Once the conversation is started, the advantages and disadvantages of the various solutions can be discussed to find the one that is the best fit for the situation.

¹ For more information, see Bill Wilson, Where You Reside"—The "Where's Waldo^®?" Catastrophic Homeowners Policy 'Exclusion' That Could Bankrupt Your Insureds, Independent Insurance Agents and Brokers of America, first edition, October 2009.