Author: Jim Lobb, Best Lawyers© 2017 Real Estate “Lawyer of the Year” for Louisville.
What does a Builder’s Risk Insurance policy generally cover? Exclude?
Builder’s Risk insurance “coverage is usually written on an all risks basis and typically applies not only to property at the construction site, but also to property at off-site storage locations and in transit. Builder’s Risk Insurance can be written on either a completed value or a reporting form basis; in either case, the estimated completed value of the project is used as the limit of insurance.” AAIS representatives have advised me that they prefer the term “open perils” or “named perils” in general parlance, as opposed to “all risks”, and so if you deal with an AAIS representative or with AAIS forms you may see “open perils” or “named perils” language instead of “all risks” language.
As with all insurance policies, “the big print giveth and the small print taketh away”. This is an awfully broad and somewhat unfair characterization, considering that there is both market pressure and case law pressure on trade organizations to make their policies readable and to display their policy restrictions prominently. Even so, Builder’s Risk Insurance policies, like most insurance policies, start by providing broad coverage and then limit that broad coverage by exclusions. Consequently, it is important that you read and understand the terms of the proposed Builder’s Risk Insurance policy.
Since Builder’s Risk Insurance, to be most effective, should be tailored to the specific circumstances of your construction project, it is also important that you think through the project events, from your buyer/borrower/lender/contractor client’s perspective.
Finally, and in these authors’ opinions, it is most important that you work with a trusted insurance professional to negotiate the terms of the Builder’s Risk coverage at the same time that you negotiate the terms of the Construction Agreement or the Construction Loan documents. You should pay close attention to make sure that the insurance and indemnity provisions in these agreements “sync up” with the terms of the Builder’s Risk Insurance. And if the project risks are large enough, or unusual enough, you may even want to consider hiring an insurance consultant to advise you during your negotiations with the insurance broker.
During those negotiations, you should ask AT LEAST the following questions:
Can you use Inland Marine Builder’s Risk Insurance to cover your project? Or must you insure using an ISO or similar Commercial Property insurance policy?
Some states that enforce the Nationwide Marine Definition may not allow you to insure losses related to retrofitting, or the construction of interior improvements in or renovations to, an already completed building using Inland Marine coverage. In those states, you may have no choice but to use ISO Commercial Property insurance policy.
What property is to be covered?
The existing improvements?
Foundations, walls, sidewalks, parking lots, landscaping, signage, or utilities wires, cables, sewer or water lines?
Does it matter in your state whether the work is purely renovation work to an already existing structure instead of new construction?
Is your client constructing a “building” (generally considered improvements that will be occupied), or a “structure”? Do the Builder’s Risk Insurance policy and the endorsements refer properly to your client’s kind of improvements throughout the documents? And if they don’t, then do you have a potential gap in coverage?
Initial site work?
The materials that will be incorporated into the existing improvements as part of the construction work?
Does that material have to be onsite?
Or is it covered while offsite, in transit, or waiting to be put in transit?
Does the material have to belong to the policy holder?
What if it belongs to the contractor, who is not an insured under the Builder’s Risk Insurance policy?
Does that analysis change if the third party owner of the materials is an insured under the Builder’s Risk Insurance policy?
Based on the work that’s to be done, should that third party be an insured under the Builder’s Risk Insurance policy?
The contractor’s equipment?
If so, is this under the Builder’s Risk Insurance policy? Or an endorsement? And are there any equipment exclusions in the governing document?
Has the contractor provided a schedule of and values for the equipment which the contractor or the contractor’s employees will use on site?
Are office trailers, cranes, contractor work vehicles, scaffolding, fencing, concrete forms or other temporary structures designed to aid the construction, building blueprints and other valuable project papers covered?
Is debris removal to be covered?
Have you included an endorsement to expedite repairs?
Have you adequately identified the real and personal property elements which will be insured? For example, if the policy insures contractor’s materials or equipment under an “equipment floater”, you need to accurately identify the kind, quantity, and value of the equipment being insured. Ask whether you are buying coverage based on the replacement value or the depreciated value of the equipment, and make sure your statement of equipment value properly denotes whether the value is the replacement value or the then depreciated value of the equipment. If you overstate the value of the equipment (for example, by listing replacement value when the policy insures up to the depreciated value), you’ll wind up paying premiums based on those values but, in the event of a loss, will be insured up to only the actual value of the equipment. And what happens if the damage or loss occurs to new, unscheduled equipment that the contractor has brought onto the site?
What property is covered and what is your client’s insurable interest in that property under a Builder’s Risk Insurance policy?
For example, if the Builder’s Risk Insurance policy covers contractors, you may not need to negotiate a separate contractors’ “installation floater” endorsement. But remember that the policy covers only those parties with an insurable interest. The real estate owner does not have an insurable interest in materials owned by a contractor before those materials are installed into the improvements; nor does she have an insurable interest in the equipment owned and used by the contractor to construct the improvements. The parties should take care to make sure those insurable interests are protected. You also need to see whether the policy covers tools/equipment provided by the contractor’s employees. Does the policy cover the contractor’s liability if equipment rented by the contractor to do the construction is damaged or lost? The contractor may need to obtain a separate installation floater policy to cover some of these issues.
Are there separate limits for losses involving materials stored offsite, in transit, or stored onsite?
Are the limits different based on whether the policy holder or some other insured owns the materials at the time of the loss?
Are there different limits for losses due to earthquake or flood? If so, are the limits acceptable?
What parties are covered?
Owner, buyer, tenant, builder, general contractor, subcontractors, lender.
How are their interests alike?
Where do their interests differ?
Have you properly identified the AMOUNT of insurance coverage?[6]
Did you exclude the value of the land?
Did you include—
The expected completed value of the constructed improvements;
Does that value include excavation and landscaping work, and architect's fees?
Does that value include the insureds’ overhead and profit? If not, was is the omission intentional? And if it is, are you sure that the omission won’t lower the insurance/project value ratio to the point where coinsurance concepts begin to apply?
Did you build in a mechanism in the Builder’s Risk Insurance policy allowing you to increase the coverage amount if cost overruns or change orders increase the cost of the improvements?
Is there any reason why you wouldn’t or can’t structure the Builder’s Risk Insurance as an Owner Controlled Insurance Program (OCIP) or Contractor Controlled Insurance Program (CCIP)
If not, then between the two is there any reason why you wouldn’t opt for the OCIP over the CCIP?
How does the decision to acquire an OCIP instead of a CCIP affect coverage for materials and fixtures that start out belonging to the contractor? When does ownership of those materials transfer to the owner? And if there IS a coverage gap, can you address it by having the contractor obtain a separate installation floater?
Remember that you probably have the same potential problem, in reverse, if the parties decide to acquire a CCIP, but the property owner rather than the contractor owns the materials.
AGAIN--WHO HAS THE INSURABLE INTEREST? DOES THAT INTEREST TRANSFER FROM ONE PARTY TO ANOTHER DURING THE LIFE OF THE CONSTRUCTION PROJECT? IF SO, WHEN? AND HOW DOES THE OCIP OR THE CCIP ADDRESS THAT CHANGE IN INSURABLE INTEREST??
Is the policy an “all risks” policy? Or does it offer more limited initial coverage?
What risks are excluded by the policy?
Losses due to flood or earthquake? You can usually obtain endorsement coverage against these risks by paying an additional premium.
Collapse of the improvements during construction? Look carefully at your Builder’s Risk Insurance policy. Inland Marine Policy forms are reputed to vary widely on the issue of whether, and under what circumstances, the policy may cover some portion or all of the loss resulting from some kinds of collapse under some circumstances. You need to understand the extent of the coverage/exclusion related to this loss before your client buys the Builder’s Risk Insurance policy.
Faulty design; faulty materials; faulty workmanship?
Losses due to weather conditions?
Losses due to theft?
Delays due to strike, poor project management, or weather conditions?
Losses related to transit?
Losses due to transit problems?
A number of these traditional exclusions can be covered by endorsement. This is where you want to ask your insurance broker or insurance consultant to tell you what’s possible—and at what price.
Are any of those risks, excluded by the policy, later insured through one or more separate policy endorsements? If not, do you want to negotiate for that additional coverage?
Flood, earthquake, collapse of improvements, equipment failure or testing?
Soft costs, i.e. expenses incurred because of delays in construction resulting from the occurrence of an event covered by the Builder’s Risk Insurance policy?
Business income? Delay costs? Contract losses?
Theft losses?
Have you asked your insurance broker or insurance consultant to tell you whether other endorsements might apply to your transaction? In conjunction with this, you should look at the list of potential endorsements shown on the last page of the Attachment 7 Builders’ Risk Forms Comparison document.
If coverage is available through a policy endorsement for otherwise excluded risks, have you reviewed the endorsements to determine whether there are limitations on the coverage?
The Builder’s Risk Insurance policy will usually terminate at the earliest of the time when (i) the last insured’s financial interest ends; (ii) the buyer/owner acknowledges the construction is complete and accepts the property; (iii) the policy expires or is terminated according to the policy terms; (iv) the property is put to its intended use; (v) a specific, negotiated number of days have passed after the construction has ceased; or (vi) when the insured abandons construction.
Is the termination date in sync with the Construction Agreement, Lease Agreement, or Construction Loan documents requirement to acquire and maintain insurance.
Based on the circumstances of your construction project, do you anticipate that you will need to more precisely identify when the policy will terminate in order to prevent any ambiguity from arising concerning when any of these dates trigger? For example
What constitutes “complete”?
What constitutes “acceptance”?
Do those definitions change if your client is constructing a shell building in which internal improvements will be completed as tenants rent space? In which certificates of occupancy will be issued for the shell at one time and for particular portions of the completed space at another time?
Do all the insureds understand, and are they satisfied with, the terms of the subrogation provisions in the Builder’s Risk Insurance? Do those terms sync up with the Construction Agreement or Construction Loan documents?