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When businesses or individuals want buildings to occupy for whatever use, unless they want to buy a building already in exist-ence, it is customary to approach a building contractor to construct a building for them.

Among the many items to be considered will be insurance on the property while under con-struction. The most common coverage to use is Builder’s Risk Insurance, a specialized coverage designed specifically to apply to buildings while under construc-tion, also including materials and supplies pertaining to the con-struction. Other possible options to use instead of Builder’s Risk coverage will be discussed later in this article.

Whether it be a nationally recog-nized construction management company erecting a skyscraper in a major city or a small contractor building a home at the end of a neighborhood cul-de-sac, the potential for accidents or schedule interruptions must be addressed in the planning stages of any building project.

Individually or as a group, the latter being more beneficial, owners, general, prime, or subcon-tractors must try to anticipate the most likely contingency scenarios they may encounter on a project. Whatever the potential hazard, adequate coverage must be obtained and contingency proce-dures must be developed. This will facilitate the most efficient transition through the loss period, thus enabling the project to get back on schedule with all parties ideally being made whole again. This issue of Adjusting Today, co-written by veteran adjuster Michael D. Grady and insurance expert Paul O. Dudey, will explore in detail Builder’s Risk coverage and provide insight to the many considerations policyholders should focus on when obtaining this coverage.

Stephen J. Van Pelt, Editor

Editor’s Note

Specialized Coverage

for Construction Projects

Builder’s Risk

Insurance

Michael D. Grady — Adjusters International New Jersey

Paul O. Dudey, CPCU

struction contract, the Builder’s Risk coverage may be purchased by either the contractor or the building owner-to-be. In either case, though, all parties to the project who may have property involved in the construction should be named in the policy. This can include the owner, the contractor, any subcon-tractors (and there will frequently be many of them), any sub-subcontractors employed by the subcontractors, the financial institution supplying money for the project, and perhaps even architects and engineers involved in the project.

As can be seen, this is quite a complex list of insurable interests. It should be studied before the contract is com-pleted, if possible, and the list of interested parties included or refer-enced in the contract. The apportion-ment of insurance costs should also be spelled out in advance. Some of the parties may have their own insurance and wish to be included, with their own coverage applying only as excess, in order to avoid involving their own insurance for any claims on the project.

Many options are available under the Builder’s Risk coverage. They depend on the policy’s provisions and the perils or risks to be insured against. These should be studied before the contracts are drawn and, ideally, spelled out in the contract to avoid misunderstanding and conflict among the various parties in the event of loss.

POLICY PROVISIONS

Most Builder’s Risk policies follow the Insurance Services Office (ISO) forms, which are the basis for the discussion that follows. There are also

According to a broker specializing in Builder’s Risk coverage in Red Bank, N.J., placing coverage for his

Builder’s Risk clients can be as simple as a quick phone call or an online application. It can also include an elaborate underwriting process requiring the prospective insured to fully disclose financial details, loss history and building plans. This broker performs their own underwriting and limits their Builder’s Risk clientele to builders of small to medium-sized projects in the surrounding area. When dealing with new clients that are homebuilders, the broker requires, at a minimum, documentation supporting the number of homes built yearly, information on the project financing and the builder’s loss history. Com-mercial builders are held to stricter requirements including, but not limited to, maintaining site security, special lighting, and perimeter fencing. There are also code requirement exposures that must be addressed during the underwriting process.

In the Red Bank, NJ, area there are

numerous bodies of water, ranging from the Atlantic Ocean to small canals. Set back requirements, in some cases up to 1,000 feet from tidal waters, must be met by the builder in order for a Builder’s Risk policy to be placed. There are also separation requirements, often as much as 100 feet or more, from other structures. It is also possible to place Builder’s Risk coverage on the remodeling of an existing structure, as long the struc-tural integrity is not altered. Any structural modifications proposed will result in additional underwriting and engineering analysis, thus making the insuring process more costly and time consuming.

Established clients can have a policy issued within minutes. Typically, when insuring smaller homebuilders the mortgagee will be a named insured on the policy. If the builder qualifies, some carriers will allow the policy to be in the name of the homeowner. Lastly, the price paid for Builder’s Risk will vary with the size and complexity of the project.

Obtaining Builder’s Risk Coverage

*Information contributed by Mr. Craig Fowler, Vice President of York-Jersey Underwriters, Inc.

a number of insurers with independent forms which may or may not closely follow the ISO forms. When these are encountered, they should be examined carefully to determine in what ways they provide more — or less — coverage than the ISO forms

considered here.

Several approaches are available for Builder’s Risk coverage. They include the Basic form, the Completed Value form, and Monthly Reporting form.

The basic ISO Builder’s Risk form simply provides a fixed amount of insurance, often with a coinsurance clause. Because, by their very nature, buildings under construction increase in value as construction progresses, the limit of insurance must be increased progressively as construction proceeds, especially when a coinsurance clause applies. This unwieldy feature makes the basic Builder’s Risk form quite undesirable, and it is little used.

COMPLETED VALUE FORM

Under this form, the limit of insurance is set at the expected completed value of the project, with a coinsurance clause applying. If, as is frequently the case, actual cost of the project ex-ceeds the initial estimate, when this is discovered, it is necessary to increase the limit accordingly, or a coinsurance penalty can result in any loss.

Care must be taken in determining the limit of insurance to be applied. Common errors include:

1.) Using the amount of the construc-tion loan as the limit of insurance. Unless the loan is substantial, e.g. including the value of the land, the amount of the loan will almost always be less than the completed value of the structure.

In a recent claim, an insured funded a significant portion of a building project with cash, did not include this amount in computing the completed value, and placed coverage only for the financed amount. The insured learned a hard lesson when the insurer applied a 50% coinsurance penalty to a $5.9 million loss.

All risk deductibles can range from

$500 to $25,000 or more. Specific

deductibles for a project such as

commissioning/hot testing a gas

turbine can be $250,000.

Deductibles, which relate to delays

in opening, soft costs and business

income can range from 10 to 60

days.

monly figured at 10% each, been included in the completed value? Some builders opt to leave these items out when determining a project’s com-pleted value. This will turn out to be a critical mistake in the event of a loss. Because these items represent up to 20% of the completed values, omitting them would set the limit at only a portion of the completed value, produc-ing a serious coinsurance penalty in the event of a loss.

3.) What other insurable values, if any, have been left out, resulting in inad-equate insurance?

4.) Have items excluded from the coverage been included? Land value is a major item excluded.

Including excluded items will result in overinsurance and extra cost with no benefit in the recovery of loss. In determining this, the insurance form should be examined carefully, as various items - excavations, underground work, and others - may be excluded. The list of exclusions may vary with the form in use. 5.) Cost overruns are commonplace in construction projects. When one occurs, to avoid a coinsurance penalty at time of loss the limit of insurance should immediately be raised accordingly.

An insurance buyer may opt to pur-chase a Reporting Form Builder’s Risk policy. Under this form, a limit high enough to cover the expected com-pleted value is chosen, and the actual value of property at risk is reported periodically (usually monthly) to the insurers.

Care must be used with this form to: 1.) Submit the reports of values in a timely fashion. Late reporting can produce a penalty because the values are increasing monthly, and a loss between the report due date and the time the report is submitted will usually be underinsured.

carefully, and include the value of all covered property, the value of materi-als in place, as well as materimateri-als and supplies on the premises but not installed. Also include covered prop-erty of contractors, subcontractors, architects and engineers, to the extent that these items of property are included in the insurance. Don’t overlook the value of leased equipment on the premises for which the contrac-tor or subcontraccontrac-tor has responsibility to insure.

The reporting form is frequently used by contractors who have numerous jobs going simultaneously and can be used to insure them all under a single program of coverage. The policies can

coverage for new locations (usually requiring that new locations be de-clared within a stated number of days — 30 days is the most usual — of the start of construction).

PERILS COVERED

Several levels of perils coverage (now renamed by ISO as “Causes of Loss”) are available, including limited perils (Basic Form), Broad Form and “Spe-cial Form” (formerly known as “All Risk”) coverage. The price will vary directly with the number of perils included.

The Basic Form covers what old timers will remember as Fire, Extended Coverage, Vandalism, Sprinkler Leakage, Sinkhole Collapse (but not Mine Subsidence), and limited Volcanic Action coverages (but not Earthquake or Earth Movement). The Broad Form covers all of these Causes of Loss and adds Falling Objects, limited Glass Breakage, Weight of Snow, Ice, or Sleet, limited Water Damage (but not Flood), and as an additional item, limited Collapse coverage.

The Special Form, rather than covering named causes of losses, applies to any Accidental Cause of Loss not

specifi-attention must be paid to the exclu-sions. While the exclusions under the ISO and AAIS forms are fairly well understood and have been defined in court cases, there are many indepen-dent forms that may differ in their language from the standard forms, and their exclusionary language may actually take away coverage that would apply under the ISO and AAIS Broad form.

Especially with independent forms, attention must be paid to the Exclu-sions to be sure that significant cover-age has not been taken away. Where excluded coverage is needed, as with earthquake or flood, if the insurer will not offer to extend the coverage, separate coverage for any of these risks desired must be sought.

EXCLUSIONS / PERILS NOT INSURED

Among the more important perils not covered under any of the Causes of Loss forms for Builder’s Risk insur-ance are Steam Boiler Explosion, Ordinance or Law, Earth Movement including Earthquake, Flood and most External Water Damage.

Boiler Explosion may be covered by separate Boiler & Machinery insur-ance. It will not be needed initially,

nearby source, but as heating and mechanical equipment are installed and tested, this separate coverage should be considered.

Ordinance or Law is generally not a problem on new construction if the architect and project manager have done their job correctly, and the necessary construction permits have been obtained. However, if the Builder’s Risk coverage is used to cover value added on an addition or renovation project, this exclusion can produce problems, but can be elimi-nated by adding Ordinance or Law coverage by endorsement.

Earth Movement and Flood coverage are generally available only by sepa-rate policies, but the exposures are sufficiently severe to merit consider-ation, especially in, but not limited to, areas known to have potential expo-sure to these hazards. (Also see Difference in Conditions coverage later in this article.)

In areas with either of these expo-sures, many lending institutions require that the exposure be insured, along with conventional Builder’s Risk insurance, as the prerequisite to lending money on the construction project.

OTHER PROVISIONS

The Builder’s Risk form has a number of standard provisions beyond those noted above. They generally corre-spond with similar provisions of the basic Building and Personal Property forms. Among the more prominent are a Coinsurance or Value Reporting clause, Debris Removal Clause and clauses relating to how losses are to be

Especially with independent forms,

attention must be paid to the Exclusions

to be sure that significant coverage has

not been taken away.

reported and adjusted. For detailed discussion on the operation of these clauses, see any current property insurance text.

The Debris Removal clause merits attention. It applies only to the cost of removing debris of covered property following an insured loss, but not debris of property not covered by the

Builder’s Risk policy. Also, this cover-age is limited to 25% of the amount of property loss paid plus $10,000. In a “worst loss scenario” this may not be a high enough limit, so an increase in this coverage should be considered.

WHEN COVERAGE CEASES

Of particular importance is the “When Coverage Ceases” provision of Builder’s Risk policies. Unlike other property policies, the Builder’s Risk policy is intended to terminate after the building is completed and ready for occupancy, and it does not, unlike other property polices require a notice of cancellation. Permanent Building and Personal Property insurance must then be arranged.

This can be a trap for the unwary, because if a loss occurs after the Builder’s Risk policy ends, with no

permanent insurance in place, there will be no coverage for the loss. Typical provisions in the policy that end coverage include instances in which: the policy expires or is cancelled, the property is accepted by the purchaser, the insured’s interest in the property ceases, or construction stops with no intention to resume.

The most common clause states: “Unless we [the insurer] specify otherwise in writing, coverage ends 90 days after construction is complete, or 60 days after the building is occupied in whole or in part, or put to its in-tended use.”

This later provision is of fairly recent origin. Previously, coverage ended immediately when construction was completed or the building was occu-pied or put to its intended use. There was considerable confusion in the past about the precise meaning of this clause, which preceded the present language, but the present language has clarified the meaning somewhat.

PROPERTY OFF PREMISES

The standard Builder’s Risk policy offers only limited off-premises

100 feet of the premises in the open or in or on vehicles. When broader coverage is desired, for example if the contractor is responsible for incoming shipments of materials or supplies to be used in the construction, transit coverage can also be provided on the incoming shipments. Or if property to be used is stored at a separate loca-tion, awaiting use in the project, this must be recognized and, if called for, the coverage extended appropriately to include it.

ALTERNATIVE

BUILDER’S RISK OPTIONS

Rather than the Builder’s Risk cover-ages discussed above, it is also pos-sible to provide comparable, or perhaps even broadened, coverage under various Inland Marine forms. Limited Builder’s Risk coverage can be achieved in some cases under the BPP (Buildings & Personal Property) form’s Additions or Renovations extension, provided there is other property insurance in effect under the form.

HPR RISKS

On “Highly Protected Risk” (HPR) properties, commonly insured by the Factory Mutuals and others, Builder’s Risk coverage is available at a greatly reduced rate under their forms, which also offer somewhat broader coverage in a few respects.

DIFFERENCE

IN CONDITIONS COVERAGE

In addition to the primary Builder’s Risk Policy with its many exclusions and limitations, the buyer may wish to obtain a Difference in Conditions (DIC) policy. This is a very broad

In a relevant case, an insured failed

to properly cover contractor’s

equipment. A substantial fire

oc-curred and rendered all the braces

and forms useless. Because the

braces and forms were not intended

to become a permanent part of the

structure not only did the contractor

suffer an uninsured loss on those

items, the associated debris

removal was not covered either.

The ultimate cost to disassemble,

remove and haul the equipment

and materials involved was

signifi-cant.

policy to pick up such additional perils as flood, earthquake, and others. As with any other policy, however, attention should be given to any exclusions and limitations, and to the language used to dove-tail the DIC and basic polices to be sure that the

policies fit properly.

WRAP-UP COVERAGE

On major projects, a “Wrap-Up” may be used, principally involving Liability coverage for all the participants, but it can also be expanded to include Workers Compensation, Builder’s Risk and other coverages on behalf of the entire group of participants in the project.

Some insureds prefer Wrap-Up coverage, as it protects their own coverages from adverse loss experi-ence, that may be encountered in the construction project. Others prefer to avoid Wrap-Ups as they find they and their own insurers can lose control under a Wrap-Up program.

BUSINESS INCOME / EXTRA EXPENSE / “SOFT COSTS”

Not covered by the Builder’s Risk policy is loss of Business Income, Extra Expense, or other Consequential Loss incurred after an insured property loss. Any of these, known in construc-tion as “Soft Costs,” may be included by adding Business Income, Extra Expense, or Consequential Damage forms to the Builder’s Risk Policy. A problem that must be overcome is determining the amounts of any of these coverages to purchase. Since there are not any exact costs available

“Soft Costs” are essentially extra expenses incurred as a result of a delay caused by a covered loss. Some of the more common Soft Costs are interest charges on project financing, realty taxes or other assessments, workers’ overtime, advertising and promotion, costs associated with lease renegotiations and accounting, legal, architectural, and engineering fees.

Typically these costs are not avail-able on smaller projects such as individual dwellings. On commercial projects, however, these unplanned expenditures can be rather costly. In some instances an insured may find the carrier reluctant to pay what it considers a covered Soft Cost. The following language, as taken directly from a basic Builder’s Risk policy, highlights this point.

Expenditures, during the Period of Indemnity, which would not have been incurred by the Insured if the Delay had not incurred; A. Interest upon money borrowed

to finance the contract work, B. Other as accepted by the

Company.

It is plain to see that during the adjustment process the language in “B” gives the carrier the discretion to include, or more importantly exclude, costs as it sees fit. When

such ambiguous language exists, the insured would be wise to come to an understanding with the carrier before a loss occurs.

In the case of a delay in opening, the insured should be aware that the estimated completion date may be what triggers coverage for Soft Costs. The following example will help to illustrate this point.

Assume a two-year project had an estimated completion date of Decem-ber 1, 200X. It is now August 1, 200X and the project is expected to be completed in one month on September 1, 200X, putting the project three months ahead of

schedule. Unfortunately, a fire occurs the evening of August 1, 200X. It is expected to take two months to effect the repairs caused by the fire. On October 1, 200X the fire repairs are completed and the final 30 days of the project can now be resumed. On November 1, 200X the project is completed one month ahead of schedule instead of three.

Because the delay occurred prior to the original completion date, allowing the builder to finish the entire project before that date, the carrier may take the position that no delay has oc-curred. If this were the case soft costs incurred during the two months of the fire restoration would not be covered.

AT04-1 3024

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Stephen J. Van Pelt

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TODAY

If there is an underlying principle to take away about Builder’s Risk insurance it is to understand the potential risks involved with a particular project and have an even greater understanding of the coverage purchased to minimize or eliminate those risks.

As with other areas of insurance the Builder’s Risk marketplace will change to adapt to growing needs. As pointed out in an article by Lisa S. Howard of The National Under-writer Company, Mr. Lorne H. Parker, risk manager for the Bechtel Group, states “there are a number of unmanaged risks that confront the construction industry. These include market risk, price risk, technology risk and political risk. Unfortunately insurers are currently not in the market to insure loss of market, price increases, unproven technology and unstable political environments as most of these risks are viewed as entrepreneurial or research and development in nature.”

Perhaps in the future coverage for these risks may find their way into a Builder’s Risk policy. In the wake of the terrorist attacks of September 11, ISO has modified a number of its forms to more precisely delineate how its forms will respond to a terrorist attack. In speaking with Mr. Domenic J. Yezzi, Jr., Vice President of Spe-cialty Commercial Lines, ISO, Inc., his indication was that no modifica-tions have yet been made to the Builder’s Risk form relative to this issue.

The Future of Builder’s

Risk Insurance

Michael D. Grady Paul O. Dudey

on future operations in the new build-ing, it is necessary to project a worst loss scenario. Estimates should be made for the following: How much money will be lost and how much extra expense will be incurred in the worst loss that could occur at the worst possible time?

What are the prospects for occupying the completed building on schedule that would be lost if completion is delayed by an insured loss? What additional expenses would be incurred to hasten

completion and occupancy?

Also determine whether Consequential Loss coverage is available for ex-cluded losses such as a strike which shuts down the construction, or loss at a key supplier, preventing or delaying delivery of needed construction materials to the site.

The answer to these questions will form the basis for estimating the amounts of these coverages to pur-chase.