An effective construction insurance program requires the dovetailing of several different policies in order to protect each project stakeholder. General liability and workers’ compensation are critical elements of insuring a construction project, but the keystone is builders risk coverage. Builders risk, often called “course of construction,” is a first party property coverage designed to insure the real property under construction. The coverage is purchased by one party, but the policy ideally will extend protection to all parties that may have an insurable interest in the real property. Standardized builders risk policies are the exception; most insurance companies choose to create their own manuscripted forms and coverage varies greatly. Because no two construction projects are the same, it is important to analyze what could go wrong and then tailor the builders risk coverage to match those exposures.
The key to an effective builders risk policy is understanding the contract’s insurance requirements and indemnity sections. The insurance section specifies who is responsible for buying the builders risk insurance and exactly what coverage it includes. The indemnity section of the contract establishes the party that will be responsible for various losses that could occur during the course of construction, and under what circumstances the parties to the contract have waived their recovery rights against one another. It is also helpful to review the project’s financing documents to determine the coverage the lender requires.
Normally, either the owner or the general contractor is responsible for buying the builders risk policy. Regardless of who purchases the coverage, all project stakeholders—including the owner, general contractor and all the subcontractors—should be included as named insureds.
All stakeholders should be included because the ownership of a construction project is more complicated than the ownership of a completed operating facility. During the course of construction, the project owner is seldom the sole owner. The general contractor and the subcontractors often have an interest in the property until it is complete and they are paid. As owners or partial owners of the insured property—or as creditors of the insured, to the extent the labor and materials are advanced—the contractors and subcontractors have a valid insurable interest.
Waiver of Subrogation
Including all the stakeholders on the policy also helps prevent the builders risk insurer from attempting to recover (subrogate) from the general contractor or any of the subcontractors for losses allegedly caused by their negligence. However, simply naming the stakeholders on the policy may not be enough to preclude the insurance company from subrogating in every case.
To ensure the insurer cannot subrogate or recover, a waiver of subrogation provision should be included in the construction contract. Basically, each party to the contract agrees to waive its right of subrogation against the other to the extent that the damage is covered by the course of construction policy. Such an agreement can be found in the AIA standard form agreements.
In addition to the building or structure being constructed, the description of covered property normally includes all fixtures, materials, supplies, machinery and equipment. The definition of “building” can be expanded to include:
- temporary structures;
- office trailers;
- underground works;
- sidewalks, paving and other hardscape;
- landscaping; and
- boiler and machinery.
Project participants also need to consider their income statement exposures. These soft costs include expenses necessary to rebuild a damaged structure, such as:
- construction loan interest;
- real estate and property taxes on the construction at the project site;
- design and consulting fees;
- legal and accounting fees;
- insurance premiums for builders risk and, if appropriate, general liability;
- advertising and promotional expenses; and
- loss of rental income.
Generally, the course of construction policy provides coverage for a specific location. Most policies also extend coverage to property in transit and property temporarily at other locations. Appropriate limits must be established for these coverages.
Most builders risk policies are written on an “all risk” or special peril basis. In other words, everything is covered unless it is specifically excluded. Common exclusions include:
- wear and tear;
- rust or corrosion;
- inherent or latent defects;
- animals, birds, vermin and insects;
- intentional damage;
- ordinance or law and testing;
- pollutant cleanup;
- mechanical breakdown; and
- hot testing.
Many of these can be deleted for a specific cost, and the exposure and cost to do so should be evaluated.
A relatively short list of property is not covered under a builders risk form:
- contractors’ tools, equipment and machinery;
- landscape; and
Termination of Coverage
Most builders risk policies include specific provisions that determine when the coverage ends. These triggers vary from form to form. Of special note is the occupancy clause, which states coverage will cease upon occupancy (in whole or in part). Care must be taken to ensure the carrier grants a “permit to occupy” if there is potential for occupancy during construction. Following are a few examples of termination clauses:
- policy expiration or cancellation;
- occupancy (in whole or in part);
- when the building is put to its intended use; and
- upon formal acceptance by the owner.
Builders risk insurance is complex, but if structured appropriately it can serve as the backbone of a successful risk management program for a construction project.