Mind the Gap
By Marc McNulty, CIC, CRM
ORDINANCE OR LAW COVERAGE
You need to be able to explain—and sell—this important protection
Ordinance or law. We’ve all heard of the coverage, but how many of us actually know how it works? As the name suggests, it has something to do with regulations and building codes … but can you explain it to a client? More important, can you explain it well enough that they buy adequate coverage on their commercial building(s)?
The unendorsed CP 00 10 10 12 (Building and Personal Property Coverage Form) provides only a small amount of coverage for “increased costs incurred to comply with the minimum standards of an ordinance or law in the course of repair, rebuilding or replacement of damaged parts” of a covered building. In fact, the amount is $10,000 or 5% of the building limit, whichever is less. Depending on the age and size of the building, this might not be enough coverage.
Before we dig into how to address this exposure with your clients, make sure you are able to explain to them why this coverage isn’t automatically included with building coverage.
[Giving clients] real-world loss scenarios—including situations they’ve never even thought of—will help you sell more coverage, reduce your E&O exposure, and build trust with your clients.
I spoke with one of our regional field claims managers and he summed it up perfectly. He stated that insureds “think these types of repairs should just be part of the normal claim process. They don’t understand that the policy is intended to pay for direct physical damage, and this is not direct physical damage.”
Therein lies the issue: Ordinance or law coverage is triggered by a direct physical loss but, as we will soon see, the coverage can actually pay for losses associated with an undamaged portion of the building!
Why it matters
As mentioned above, the CP 00 10 provides some ordinance or law coverage, so at least your clients aren’t totally bare. This wasn’t always the case. The same regional claims manager told me about a fire claim he handled years ago when ordinance or law coverage wasn’t automatically included. As soon as the electrician touched the wires in the building as part of the repair process, he was required to bring the entire electrical system up to code. It was an expensive job, and the insured had to foot the bill.
Although forms have been adapted to address this issue, some elements of this claim scenario still present problems. Your clients can face significant costs to bring wiring, plumbing, and HVAC systems up to code after a loss to their building. And if they don’t have enough coverage, they will have to absorb the costs on their own (or potentially from your E&O insurance).
How to fix the problem
ISO offers the CP 04 05 09 17 Ordinance or Law Coverage form that can fill the gaps for these situations. The form has three coverage parts:
- Coverage A: Loss to the undamaged portion of the building
- Coverage B: Demolition cost
- Coverage C: Increased cost of construction
In addition, this form offers a post-loss ordinance or law option that provides coverage in the event an ordinance or law is initiated or revised after the loss but before the commencement of reconstruction or repair.
Coverage A applies in the event a partial loss to a building renders the undamaged portion of the building unusable or causes it to be condemned. Although the loss is partial, the insured still will experience a total loss because the building is no longer usable. This coverage indemnifies your client for loss of the undamaged portion of the building.
This is not a separate limit of insurance. Rather, when Coverage A is selected, it will be included in the policy’s limit on the building. Therefore it’s critical that you insure buildings at 100% of their replacement value so this coverage will be maximized in the event of a loss.
Let’s assume you have a client whose warehouse caught fire and 75% of the structure was damaged. The remaining 25% of the building was deemed to be unusable. Ordinance or law Coverage A will allow the client to receive the full building limit, which is great, but if the client needs to bear the cost of tearing down the remaining 25%, it doesn’t have enough coverage to rebuild the structure, correct?
Not quite! This is where Coverage B comes into play. This portion of the ordinance or law endorsement covers the cost to tear down the undamaged portion of the building and remove the debris.
That’s where things can get tricky, however, as there isn’t an exact method to calculate how much coverage is needed. Between $2 and $5 per square foot may be a good rule of thumb, so under a worst case scenario you could multiply the dollar amount chosen by one half of the building’s square footage (because half of the building would have to be damaged for demolition to be ordered). This formula may not accurately account for demolition costs in your area, however, and may not allow for dealing with special hazards such as lead paint or asbestos.
Now let’s go back to our claim example. Let’s assume your client has Coverage A as well as an appropriate limit of Coverage B to tear down and remove the undamaged portion of the building. Your client then works with an architect and builder to develop an estimate of the cost to rebuild the warehouse, but the price tag is higher than the limit of insurance. After doing some digging, your client discovers that some additional costs are associated with complying with current building codes. In addition, costs are involved in replacing underground pipes, which are excluded in the CP 00 10.
Do not fear! Coverage C will fill the gap, as it pays the additional costs associated with bringing a building up to code whenever it is being repaired or rebuilt. Again, there isn’t an exact method for determining the appropriate amount of insurance, but Brent Winans noted in his IRMI Expert Commentary piece, Explain Ordinance or Law Coverage to Avoid E&O Claims, that “bringing a building up to code will usually be .5% to 1% for every year the building is old.”
Finally, keep in mind that Coverage C also covers the following costs, so you’ll want to factor these into the limit you propose to your client:
- Excavations, grading, backfilling, and filling
- Underground pipes, flues, and drains
Rather than use the CP 04 05 endorsement, many insurers have chosen to build ordinance or law coverage into their property enhancements. For example, a carrier might include a $150,000 or $250,000 blanket limit that applies to accounts receivable, peak season for business personal property, personal property of others, valuable papers and records, and so on.
That blanket limit typically will include coverage for demolition costs and increased costs of construction, whereas loss to the undamaged portion of the building will automatically be included up to the building limit. Check with each of your carriers to see how their property enhancements will apply, and make sure your client is comfortable with the blanket limit that is being proposed because it can be eroded by payments for damage to other items in the event of a single claim.
Although it’s difficult to run through every single what-if loss scenario with your clients, giving them some real-world scenarios—including situations they’ve never even thought of—will help you sell more coverage, reduce your E&O exposure, and build trust with your clients. It may not be sexy, but ordinance or law coverage addresses very real exposures for your clients; and adding it to their insurance program will help them—and you—sleep better at night.
Marc McNulty, CIC, CRM, is vice president of insurance operations at The Uhl Agency in Dayton, Ohio, and has been with the agency since 2001. He divides his time among sales, marketing, technology and operational duties. You can reach Marc at firstname.lastname@example.org