If your client is about to begin a construction project, one of the first questions that should be asked is: “What happens if the all or part of the project is damaged prior to completion?”
Builder's risk insurance coverage is insurance purchased to cover the risk of damage to the insured’s work on a project during the construction process. Builder's risk insurance coverage serves a function similar to standard first-party property insurance, such as homeowners’ insurance policies, and like homeowner’s insurance policies, builder’s risk insurance policies protect the insured property from specifically identified perils.
Often, the project owner or the lender will require builder's risk insurance, and the cost of this coverage can be negotiated or transferred through your client’s construction contract. Even if the owner does not require builder's risk insurance, your clients should still consider carrying this insurance, particularly where the risk of damage to work in progress, or the cost of replacing that work, is substantial.
The coverage provided under a builder's risk policy is designed to reimburse anyone with an insurable interest in the property for accidental damage to that property during the construction process and prior to completion. Typical policies insure against "all-risks" of physical loss or damage to the property, such as damage caused by fire, lightning, wind and hail, water and gas leaks, explosion, smoke, riot, and vandalism.
Builder’s risk insurance also covers the costs of building materials and supplies that are intended to become a permanent part of the building while such materials and supplies are near or within the project area. This includes materials stored on-site during the construction process. Builder's risk insurance policies provide protection for the permanent structure, as well as the equipment and materials installed during construction. Almost all builder's risk policies provide coverage on a replacement cost basis, although actual cash value coverage is available for renovation projects and projects involving used or refurbished equipment.
Business interruption insurance or consequential loss/"soft cost" coverage can also be purchased through an additional endorsement to the builder’s risk policy, or through a separate policy. This endorsement protects the owner and contractor from financial losses incurred when the physical project is damaged during construction. Such losses often include loss of revenue, loss of investment income, liquidated damages, interest expense associated with debt servicing, loan fees to extend or renew, real estate or property taxes, architect and engineer fees, insurance premiums to continue coverage, as well as legal, accounting and other professional fees.
Endorsements available under the builder's risk policy can also be purchased to cover materials or equipment in storage or transit (a moveable property floater) and to provide coverage for subcontractors’ work in process (an installation floater). Other specialty endorsements are particularly important when the contractor is responsible for specific types of property during installation, such as compressors or other machinery, which are not covered by the standard builder’s risk policy.
Under most form contracts, such as the AIA A201, the owner is required to procure an "all-risk policy” in the amount of the total value of the project, or on a replacement cost basis. The insurance required under the A201 contract must include the interests of the owner, as well as the contractor, the subcontractors and the sub-subcontractors. If the owner elects not to purchase this insurance, the owner must notify the contractor. The contractor may then purchase the coverage and include the cost in a change order to the owner. An owner who fails to procure builder's risk insurance or notify the contractor of this fact is liable to the contractor for damages that would have been covered. In addition, under the AIA A201 contract, the owner must pay the costs of any deductible.
Most standard construction contract forms contain a waiver of subrogation provision through which each party waives the right to recover damages against the other for losses covered by insurance. Because some insurers prohibit these types of waivers without the consent of the insurance company, it is important for the party purchasing the insurance to notify the insurer if the construction contract contains such a clause.
Finally, like all other types of insurance, builder's risk policies have certain exclusions that either limit or eliminate coverage. Typically, builder's risk policies exclude losses resulting from faulty design or faulty workmanship. Because the exclusions will vary from policy to policy, it is important that you review the policy with your client at the time it is procured so there are no surprises.
Mr. Applefeld is a member of the Law Firm Adelberg, Rudow, Dorf & Hendler, LLC whose practice concentrates in the areas of construction law and insurance coverage law. Mr. Applefeld can be reached at (410) 539-5195 or dapplefeld@adelbergrudow.com.
