Owners and contractors buy builder’s risk insurance to manage the risk of loss or damage related to construction projects – and for peace of mind – or to put it another way, for good feeling (a nod to the movie Flashdance for you Baby Boomers).
But that feeling of serenity can easily disappear and instead, turn to a sinking feeling when an actual loss incurs and it’s time to assess losses and file a claim. Claims filed with insurance companies can become battles, and builder’s risk policies can be rigged with unexpected land mines that insurers will use to minimize or eliminate payouts.
It’s a problem of perception versus reality. The insured believes conceptually that determining the insurable risk is a simple and straightforward process and, as a result, will at times not spend sufficient time reviewing the policy details. The reality is insurance policies are complex and require a healthy dose of skepticism and often counsel. You would think the gap would not be so large, but legal cases abound with disputes between insurance companies and their clients over ambiguities in polices and differences in how policy provisions are interpreted. It can seem like almost everything can be argued.
So how can you avoid that sinking feeling? It doesn’t all have to do with wrangling over disputes with the insurer. It starts with determining exactly what is covered and the amount of coverage. Builder’s risk insurance should include all materials used in the course of constructing the finished product. But clarity between the insurer and the insured is critical: Are materials in-transit or still off-site covered? Are necessary but temporary structures and scaffolding in construction covered? What about site prep costs and underground pipes? Is the contractor’s equipment covered? Is leased equipment covered? Owners and contractors should attempt to include in their policy coverage everything used in construction that can be subject to damage. Most importantly, they should have a detailed and comprehensive understanding with the insurer of what is and what is not covered. The goal is to have no surprises.
When considering the amount of insurance, a good cost accountant is important to have on board. For most builder’s risk policies, insurance limits are established by use of either the “completed value” form or the “reporting” form. The completed value form is generally used when only one project is being insured, whereas the reporting form is used when multiple projects are insured and requires monthly updating.
Regardless, the amount of coverage must capture all relevant costs to ensure the insurance limit is not inadequate. Not only should the insured amount include hard costs (i.e., amounts to repair or replace loss or damage to covered property such as items discussed above), but it should also include a component for overhead and soft costs. Overhead or indirect costs include certain payroll costs, insurance, rent and other costs necessary to carry out the construction activity. Soft costs are those incremental costs incurred in the event of construction delays such as additional loan interest, financing costs on construction loans, professional fees, fees to keep labor forces intact and costs to store idle equipment. And finally, keep in mind insurance limits are not set in stone. Construction contracts are often revised for change orders which can significantly increase costs; an ongoing review of coverage amounts is critical in pursuing the primary goal of “no surprises.”
Determining the covered property and coverage amounts are generally matters that, in the event of a claim, are not likely to be disputed by the insurance company. So what are some of the areas of ambiguity that insurers have chosen to argue?
Let’s start with the issue of determining when coverage ends, because this can be a moving target. In many cases, policies will terminate coverage when the project is considered complete. But what happens if a fire damages the property after completion—but before the contractor has been paid? Consider the case of Baker v Aetna Insurance Co. In this instance, the court ruled the contractor did not have an insurable interest and could not recover under its builder’s risk policy. A “completed” project can take on many interpretations, including when a Certificate of Occupancy has been issued, when the property is occupied or even partially occupied, when a property is ready for its intended use, and when the contractor and owner agree the project is done. Policy provisions will generally include various triggers that terminate coverage at the first occurrence of one of those events. Owners and contractors should understand these triggers, agree to them and have them forever etched in their minds.
And what about when coverage begins? This also can be a point of contention. Builder’s risk policies generally provide coverage during the course of construction. But what about damages to materials stored before construction begins? Again, courts have ruled in favor of the insurer. In the case of Newman v National Fire Insurance Co., the court concluded the policy was for losses during construction and, as a result, coverage was not in effect.
Still, most disputes between insured parties and insurance companies relate to “all-risk” (or “all-perils”) policies and the exclusions and limitations clauses contained in those policies. All-risk polices (versus “named peril” policies such as fire, wind, flood, etc.,) provide coverage for all losses that are “fortuitous” or excluded by a specific policy provision. Insurance companies litigate against claims for damages they consider not to be fortuitous or accidental under the premise the loss was created through misconduct of some type; the loss could reasonably be expected to happen; or the loss was somehow intentional.
For these all-risk policies, the more common disputes relate to coverage exclusion provisions and limitations. You may think you have a valid loss claim – you have a “peaceful easy feeling” – then the insurance company drops the hammer…the loss is not covered because an exclusion applies.
This is where most of the land mines are scattered. These provisions take on many forms and live in the grey area. There are too many to list here but include the following and will state the insurer is not liable for losses resulting from:
- An increase in the insurable risk by any means within the control or knowledge of the insured since the time the policy originated
- Faulty, inadequate or defective design or workmanship
- Wear and tear and any defect or quality in a property (e.g., rust, corrosion, decay) that causes damage to itself
- Settling, cracking, shrinking or expansion of the foundation
Many more examples exist and are manifest in related litigation. To keep peace of mind, make sure to take a close look at your builder’s risk policy and consider legal counsel for significant projects.