Builder’s Risk Insurance: What’s Really Covered?
Builder’s risk insurance—a form of property insurance—covers property on construction sites (e.g., the building in progress, surrounding area, etc.). Sounds pretty clear, right?
Not so fast. There’s a great deal of confusion about what a builder’s risk policy actually covers when damage occurs. When it’s time to assess losses and file a claim, you might find the policy contains unexpected provisions that minimize or eliminate payouts.
It’s a problem of perception versus reality. The insured believes that determining the insurable risk is a simple and straightforward process and won’t spend sufficient time reviewing the policy details.
However, insurance policies are complex and require a measure of review (and sometimes counsel). Legal cases abound with disputes between insurance companies and their clients over policy ambiguities and differences in interpretation. It can seem like almost everything is up for debate.
So how can you avoid potential problems? 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 otherwise 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 coverage includes. The goal is to have no surprises.
For most builder’s risk policies, insurance limits are established with either the completed value form or the reporting form. The completed value form is generally used when only one project is being insured. The reporting form applies 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. The insured amount includes both hard costs (i.e., amounts to repair or replace loss or damage to covered property discussed above) and a component for overhead and soft costs.
- Overhead (or indirect) costs include certain payroll costs, insurance, rent and other expenses necessary to carry out the construction activity.
- Soft costs are those incremental costs incurred in the event of construction delays. This includes additional loan interest, financing costs on construction loans, professional fees, fees to keep labor forces intact and costs to store idle equipment.
Reviewing your financial reporting, allocations, and cost centers above with your construction CPA is a key control.
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.”
Understanding Areas of Ambiguity
So what are some of the key areas to review?
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 vs. 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:
- 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
- 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 these events. Owners and contractors should understand these triggers, agree to them and have them forever etched in their minds.
When coverage begins can also cause problems. 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 vs. 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 confusion between insured parties and insurance companies relate to all-risk (or all-perils) policies and the exclusions and limitations clauses they contain. Unlike named peril policies such as fire, wind, flood, etc., all-risk policies 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 all-risk policies, the more common disputes relate to coverage exclusion provisions and limitations. You may think you have a valid loss claim, but the event could be excluded under your policy.
These provisions take on many forms and may live in a grey area. They can include the following:
- 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 (such as rust, corrosion or decay) that causes damage to itself
- Settling, cracking, shrinking or expansion of the foundation
Many more examples exist and are important to consider fully. To keep peace of mind, make sure to take a close look at your builder’s risk policy, ask questions, and consider professional guidance for significant projects.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.