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October 18
09:35 2022


Insurance logic that strains logic

To agents and brokers is left the uneasy task

of explaining the vagaries of insurance economics

to clients in severe need. You are not to be envied 

By Joseph S. Harrington, CPCU

Is this the end of an era in Florida? In the wake of Hurricane Ian, how many devastated residents and prospective residents will decide that the Sunshine State is a nice place to visit but they prefer not to live there?

Ian’s massive hit to an already severely distressed property insurance market will bring several long-simmering issues in Florida insurance to a head. Among them will be the question of coverage for overhead and profit (O&P) charged by construction contractors to rebuild damaged properties.

Given the scope of the destruction in the areas affected by Ian, it is virtually certain that reconstruction work, even on individual residences, will involve multiple contractors and subcontractors working under the coordination of a general contractor. That situation creates the conditions generally recognized to justify a charge for “overhead and profit” as a line item in the replacement cost estimates.

“Overhead” refers to costs incurred by general contractors to coordinate and administer work by numerous contractors, often at multiple locations. These costs are not assigned to any particular project but are a shared expense for the benefit of all affected projects.

“Profit” is simply the amount a general contractor charges above its own costs to stay in business. Contractors in Florida will likely find themselves under formal and informal pressure not to “gouge” distressed property owners in search of “windfall” profits, but opportunities for profit will have to be substantial enough and stable enough to attract sufficient capacity to clear Florida’s huge backlog of repair work.

Tough questions; tough answers

“O&P” charges pose two questions for insurers and their policyholders:

  • Do O&P charges have to be covered at all, since they are identified as expenses distinct from the costs required to restore the insured property?
  • If a jurisdiction requires O&P to be covered, must some of that cost be included in an initial payment of actual cash value (ACV) to an insured? Or is it to be paid only after work is complete, the costs incurred, and full payment is made for replacement cost?

To some, the simplest answers would be: “Yes, O&P charges have to be covered, since O&P expenses are essential to completing the insured’s project;” and, “No, there is no need to pay those costs until they are incurred to complete reconstruction.”

Nothing is ever simple, however.

A requirement to cover O&P charges essentially commits an insurer to covering costs that are determined outside the scope of underwriting the insured risk. For the most part, this is managed by assessing O&P as percentages of the estimated costs to rebuild; thus, the costs of O&P are at least indirectly related to the risk as underwritten.

As for when payment for O&P is to be made, the determination depends upon how a carrier or jurisdiction determines ACV, and whether contractor O&P is an intrinsic part of the value of an insured structure.

If ACV is determined on the basis of the fair market value of a building, the case is stronger for excluding coverage for O&P unless and until it is restored on a replacement cost basis. If, however, ACV is determined as the replacement cost of a structure minus depreciation, insureds will insist that O&P be considered part of the replacement cost.


Is O&P then to be depreciated? Insurers may be tempted to say no, since O&P costs are current costs incurred at present value. But to make that argument, insurers would have to contradict their expressed desires to depreciate labor costs in ACV loss settlements.

The ability to depreciate labor costs is crucial to insurer efforts to control the cost of roofing claims, in particular. Without the ability to depreciate labor costs, ACV settlement would save an insurer only the difference between the costs of the damaged, depreciated roofing and replacement roofing. The insurer would still be on the hook for all of the more substantial labor costs for replacing the roofing.

Thus, while it may seem logical to resist paying depreciated O&P payments in ACV settlements, or at the ACV stage of a replacement cost settlement, to do so would challenge insurer logic regarding labor.

To agents and brokers is left the uneasy task of explaining the vagaries of insurance economics to clients in severe need. You are not to be envied.

The author

Joseph S. Harrington, CPCU, is an independent business writer specializing in property and casualty insurance coverages and operations. For 21 years, Joe was the communications director for the American Association of Insurance Services (AAIS), a P-C advisory organization. Prior to that, Joe worked in journalism and as a reporter and editor in financial services.

About Author

Rough Notes Editor

Rough Notes Editor

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