By LeRoy Utschig, CPCU, CLU, ARM
This article will deal with builders risk exposures. I will explain what is normally covered. Then, I will point out some of the coverage points and exclusions that preclude coverage for normally occurring losses. After identifying an uninsured loss exposure, I will provide information about how to insure for that type of a loss.
The purpose of a builders risk form is to cover property that is under construction. The form is designed to start coverage at the very beginning of construction and to end when the project is completed. In this article, I will refer only to Insurance Services Offices' (ISO) Commercial Property Builders Risk forms. Inland marine forms also can be used to provide builders risk insurance. A future article will feature inland marine builders risk forms and, at its conclusion, I will explain why I prefer to use inland marine forms as opposed to property builders risk forms.
Theft coverage that isn't theft coverage
To illustrate some of the potential problems involved in using a builder's risk form, let's look at a hypothetical situation involving a developer who was having a strip shopping center built. No contractor was at the construction site over a long holiday weekend. When the contractor came to the job site after the weekend, he immediately noticed that the materials that were to be used for the construction were missing. This loss was reported to the developer's insurer. Shortly after reporting the loss, the adjuster called the developer and told him that there was no coverage for the theft loss. Coverage was being provided by ISO's Builders Risk Coverage Form CP 0030 and Special Causes of Loss--Special Form CP 1030. The developer's insurance agent argued with the insurer saying there was no theft exclusion on either form. When told to reread the forms, the agent found the theft exclusion in Form CP 1030. In the Limitations Section of the Special Causes of Loss form, he found the following:
"We will not pay for any loss that is a consequence of loss or damage as described in this section...Building materials and supplies not attached as part of the building or structure, caused by or resulting from theft..."
Upon asking if coverage could be provided for the theft peril, the agent was told that Form CP 1121, Builders Risk--Theft of Building Materials, Fixtures, Machinery, Equipment could be added. Form CP 1121 was added to the developer's builders risk policy.
As the project was located in a semi-rural area where crime losses were not common, the developer did not hire a watchperson to protect the premises while there were no workers at the site. A second theft of building materials loss occurred. Because a theft endorsement had been added to the builders risk coverage, both the agent and developer expected that there would be coverage for this latest loss. Both were surprised when the adjuster denied coverage for this second loss. This is the clause from Form CP 1121 that the adjuster cited:
"We will not pay for loss or damage by theft or attempted theft...unless a watch[person] is on duty at the described premises..."
My recommendation is that an agent either tell the client about the watchperson requirement or have the insurer remove it from the Builders Risk--Theft of Building Materials, Fixtures, Machinery, Equipment form. Of technical interest is that by having a watchperson requirement, the form could more properly be called robbery coverage.
Coinsurance clause
Let's further assume that while construction of this same shopping center was continuing, another loss occurred. This one was a substantial windstorm loss. As part of the adjustment process, it was necessary to determine the value of the property that already had been built and how much more value was to be added to complete the project. Due to a higher than projected cost, the value of the project, when completed, would be about 25% more than was originally thought. At the beginning of construction, the Builders Risk policy was issued for the anticipated completed value of the project. As the project was going to cost more than the amount shown on the policy, the adjuster applied a 25% coinsurance penalty to the windstorm loss.
In a builders policy, the coinsurance clause does not read like those we find in coverage on the Insurance Services Office's Building and Personal Property Coverage Form CP 0010. The full impact of the builders risk clause is to apply the equivalent of a 100% coinsurance clause. Here is the applicable clause from the Builders Risk coverage form:
"Need for Adequate Insurance. We will not pay a greater share of any loss than the proportion that the Limit of Insurance bears to the value on the date of completion of the building described in the Declarations."
Subcontractors' work: covered or not covered?
It is common for the various subcontractors on a construction project to install items at their own expense and, every 30 days, to be paid for the work they had done during the prior month. For instance, the electrical contractor is paying her employees and paying for all of the electrical material supplies for a month. At the end of the month, a person in charge of the project (project manager) approves the electrician's statement regarding the value of the materials and associated labor costs incurred to install the material. Subsequently, the electrician is paid for her costs incurred during the prior 30 days.
The aforementioned windstorm loss included damage to the electrician's work. Soon after the loss happened, the electrician asked the developer when she might expect to receive insurance payment for loss to the work she had completed but had not been paid for. She was told that the builders risk policy would not pay for her damage and that she should recover from her own insurance program. A heated discussion then ensued. The discussion ended after the developer and the electrician reviewed the builders risk policy and the construction contract that had been signed by the electrician.
The contracts for the construction of the shopping center were silent regarding payment for damage to a subcontractor's work. That is typical. I have never seen a construction contract that stated that the project owner would pay for damage to a subcontractor's work. Coverage for the subcontractor's work can be provided by the project owner's builders risk insurance. This seems to be an often-forgotten item when the construction contracts are drawn up.
Coverage for the subcontractor's work can automatically be covered by a builders risk policy. A limit of $5,000 is provided that, at the option of the insured, can apply to damage to subcontractors' work. This limit would apply to all of the subcontractors at a project. Usually the $5,000 limit is woefully inadequate. In the windstorm loss, damage was done to work installed by firms such as the hollow concrete block contractor, carpenter, plumber, heating and air conditioning and roofing contractors. The combined loss sustained by all of the subcontractors on the job totalled about $600,000.
An installation floater could have been purchased by the electrical contractor to protect her loss exposure at the construction project. She did not have an installation floater or the financial resources to cover the $100,000 loss she sustained. Upon realizing this, she filed bankruptcy and, of course, did no more work on the project.
Two of the other subcontractors who had been working on the construction project also filed bankruptcy and walked off the job. It took time to find other subcontractors to replace the three who had ceased to work on the project. Reconstruction time was extended by three months due to the time needed to find replacement subcontractors.
Builders risk insurance can specifically address the issue of coverage for all of the subcontractors' work at a construction project. The builder can decide to cover or not to cover subcontractors' work. Coverage can be excluded using Insurance Services Office's Form CP 1114, Builders' Risk--Separate or subcontractor's exclusion. Coverage for subcontractors' work can be provided by using Subcontractor's Coverage Form CP 1115.
I have no recommendation about which way it should be handled. I do recommend that a conscious decision be made, prior to the beginning of construction, and that the decision be communicated to every contractor or subcontractor who will be working on the construction project.
The individual subcontractors will not need to have an installation floater if their work is insured under a builders risk policy for the project. Purchasing an installation floater is a way for contractors or subcontractors to protect the value of their work for which they have not yet been paid. If the builders risk policy for the project is not endorsed to protect the individual contractors on the project, I recommend that they purchase an installation floater or a similar form of coverage. In a future article, I will discuss installation floaters.
Business income
Let's assume that when construction on the shopping center started, it was anticipated that the construction would be done and the shopping center fully occupied within one year. Based on this, the developer had arranged for interim financing to cover during the time of construction for one year with the long-term financing of the shopping center to commence one year after the start of construction. While the construction was being done, the developer was busy having prospective tenants sign leases with occupancy to begin upon the completion of construction.
That windstorm loss caused a six-month delay in the opening of the shopping center. This meant that the developer lost six months of rental income. Loss of income is not provided by the builders risk form. However, coverage for this loss of rents exposure could be written by using the Insurance Services Office's Business Income (And Extra Expense) Coverage Form CP 0030.
Collapse during construction
Construction of the shopping center resumed after the windstorm loss and the replacement of the subcontractors who had gone bankrupt. Unfortunately, the shopping center's potential problems could still be far from over. Many shopping centers look like one long box. To avoid this "boxy look," the architect might have used a new design technique which included a roof with an unusual shape. During the installation of steel girders for the roof, one of the girders started to move and push on a side wall. Then, another started to move and push on the side wall. The first movements were about one fourth of an inch. Then the movement was for several inches. In a matter of moments the roof girders and side walls had collapsed. By the time the collapse was over, about one third of the shopping center was on the ground.
The contractor had used proper construction methods and was following the specifications for the roof's installation.
While viewing the loss, the adjuster asked many questions of the contractor regarding what happened and what the directions were for doing the work. He also picked up a copy of the directions regarding how the girders were to have been installed. A determination needed to be made as to whether the loss was caused by bad materials, contractor error, or faulty design. After reviewing the information, the adjuster decided that the loss was due to faulty design. He declined the loss citing the following from ISO's Causes of Loss Special Form CP 10300696:
"The term Covered Causes of Loss includes...use of defective material or methods in construction, remodeling or renovation..."
Collapse due to faulty design is not one of the perils included in the Collapse coverage. Coverage for this claim could have been provided by attaching ISO's Form CP 1120, Builders' Risk--Collapse During Construction. Here is its salient wording:
"Use of defective material or methods, or faulty design, plans specifications, or workmanship in construction, remodeling or renovation..."
For many losses at construction sites, it is difficult to determine if the loss is due to an error by the contractor or a design error. By using Form CP 1120, a collapse loss will be paid either way. There would be no need to determine whose fault caused the loss. An insurer would simply pay the loss.
Partial occupancy
The shopping center eventually moved toward completion and, as is typical with this type of project, some parts were completed and tenants were moving in while other parts were still being constructed. Ninety days after some tenants were occupying some stores and as construction continued at the other end of the shopping center, a small fire loss occurred.
The adjuster determined at what date the tenants had begun to move their furniture and fixtures into the shopping center.
The adjuster declined the loss, citing the following from the Builders Risk coverage form:
"The insurance provided by this Coverage Form will end when one of the following first occurs ... 60 days after the building described in the Declarations is: (a) Occupied in whole or in part..."
Because it is so common for tenants to move into a structure prior to the completion of the construction process, I recommend that this 60-day occupancy limit be discussed with every builders risk client. My preferred way to provide the coverage is to have the 60-day occupancy rule completely eliminated. Any underwriter can do this.
Summary
* Builders risk coverage does not include coverage for the perils of theft. Adding the builders risk Theft endorsement may not cover the exposure. Either the client will have a watchperson service at the site or endorse out the Watchperson clause warranty of Form CP 1131.
* A builders risk policy requires that the amount of insurance equal the value of the completed building. "Need for Adequate Insurance" is the name for this feature.
* A conscious decision should be made regarding whether the builders risk policy should cover the property of subcontractors.
* Any commercial property builders risk needs time element coverage to insure the potential loss of income due to a delay (caused by an insured peril) in the insured's being able to use the project.
* Add the Collapse endorsement to give a broader definition of causes of loss that can cause a collapse.
* Make sure a builders risk client understands the 60-day occupancy limit. Consider eliminating this limit. *
©COPYRIGHT: The Rough Notes Magazine, 1997