Chapter 9 Study Notes – Builders Risk
Known as Course of Construction, all construction sites require property insurance for physical structures, business interruption insurance for the potential loss of income if projects are delayed due to an insured peril, and liability insurance for legal liability for bodily injury or property damage arising out of the ownership and use of the premises and operations of building the structure.
Each project requires individual assessment of its exposures and each policy is tailored to insure the particular risks involved.
SCOPE OF WORK
The scope of work affects the type of insurance you suggest. New buildings require insurance on a builders risk form. Additions, alterations or renovations to an existing building – insurance depends on how extensive the work is.
Permission Clause
Grants the insured the authority to proceed with additions, alterations or repairs as required without having to inform the insurer in advance and obtain specific permission in each case – although subsequent increases in limits to be insured should be advised promptly.
Permission is generally considered only to apply on relatively minor work (adding shelving; interior partition walls) – underwriters consider extensive work to be a material change in risk. The client is obliged to advise the insurer of work being contemplated in advance (high percentage of structure changes, changes to bearing walls, roof replacement)
RISK ASSESSMENT
Begin risk assessment by ascertaining scope of work (new building, additions, alteration, renovations) and projected occupancy.
Next establish details of location, construction, protection and limits of insurance required.
Then determine policy term required (usually projected length of construction job) and the identity and experience of the builder.
New Buildings
The most basic type of construction. Values insured apply to solely to the building and the liability hazards arising out of the use and ownership of the premises and operations of the building and structure. Many insurers prefer to write this risk because the hazards are easily quantified and generally los risk.
However, new buildings on existing sites already occupied represent demolition and site clearing exposures in addition to other builders risk exposures. These are extremely hazardous and are usually performed by contractors specialized in this work. Proof of liability insurance from the sub-contractors that is equal to, or at least the same limit as, your client’s is necessary.
Potential hazards associated with safe disposal of demolition debris and possible pollution liability requires disposal expert’s consultation.
Due to the high hazards associated with demolition risks, there are a limited number of insurers willing to underwrite the liability insurance for this class of risk.
Additions
To an existing building can either be vertical (adding more storeys) or lateral (expanding floor space outwards). Either way, insurance is required for the existing structure and the new extension. The new structure is insured on the builders risk form and the existing structure on a completed building form, making sure adequate values are apportioned to each form.
Some insurers exclude insurance for existing structures in their builders risk wordings so, to avoid confusion, place the builders risk with the carrier already insuring the existing structure whenever possible.
Copies of project engineering reports and plan drawings help the underwriter to assess the property and liability risks. Increases in size and value of the risk can affect the insurer’s capacity for the property risk and you may have to arrange for other insurers to subscribe. The liability hazards depend on the work being done.
When adding storeys to an existing building, the strength of the foundations determines whether or not they can support the additional floors or if they have to be reinforced. If they have to be reinforced, the risk is much more hazardous and liability insurance would be more difficult to place.
When additions are lateral, if and how it communicates with the existing building affects underwriting decisions. Ideally, from an underwriting perspective, the addition is a freestanding building or an adjoining structure that does not communicate with the existing building. This way, the values of the new addition do not affect the insurer’s capacity for the risk and the liability risk is simplified.
If they fully communicate with the existing structure, underwriters will want to be assured that creating openings in the existing building will not weaken or compromise any support or bearing walls. The manner of joining may affect both the liability and the quality of the property risk.
Renovations or Alterations
Can be as simple as minor cosmetic or aesthetic changes to full-scale gutting of the building. Degree of risk and underwriters interest are affected by scope of work to be done.
Minor work (adding cabinets, painting, moving interior walls) can be done using the permission clause. Always determine the value of the work to be done and advise the insurer of the nature of work and any increased limit required. Both coverage and premium can be negotiable when the policy renews.
Major work (renovating to alternate use, gutting entire structure) requires the risk to be written on a builders risk wording. Because the risk comprises of new construction and existing structure, have any existing structure exclusions deleted from the wording and ensure the value of the existing building and the estimated costs of the renovation are included in the property insurance limits.
Material and methods used to build the structure affect the value of the building, type of insurance and availability of insurance (heritage buildings) and may require tighter security controls at the site.
Liability hazards for renovations can be minimal or extensive depending on complexity of the renovation. Generally they will be similar to hazards of new buildings or additions and hazards associated with demolitions.
Projected Occupancy
Insurance rates are affected by occupancy particularly if it impacts the style of construction and type of materials used so underwriters need to know the planned use of the building.
New residential construction (row houses, frame condos) are susceptible to arson whereby a fire starts at one end and with unfortunate wind conditions can destroy the entire project. Even the most well known, highly respected contractors with excellent past loss experience can have difficulty obtaining insurance.
Location, Construction, Protection
In addition to standard descriptions of property provided to the underwriter, in earthquake prone areas, additional information on building materials used to conform to standard required for earthquake resistance is required.
For all situations, underwriters are interested in:
- Soil conditions
- Proximity to waterways or lakes/rivers
- Exposures (neighbouring buildings)
- Municipal protection and water supply
- Site security
Soil conditions – will affect excavation for foundations. It can increase the potential of flood or sewer backup losses, wet or shifting ground can increase the liability hazards associated with construction (collapse) and will affect the materials that can be used to build the structure. Soil type and quality affect where extensions can be placed on the property or whether additional storeys can be safely added to an existing building.
Exposing Risks – adjacent properties increases the probability of damaging other structures when demolishing existing buildings or building new ones. Damage to other structures building, underground piping and wiring which may service both or interruption of neighbours businesses and restricted access while construction of the new building all affect underwriters appetite.
Fire Protection – adequate water supply is a concern whether it’s a new construction or in an established site. Just because there are hydrants doesn’t mean there’s any water. Underwriters are concerned that there is adequate distance between partially constructed buildings to provide a firebreak and prevent the spread of fire. Obtain a detailed site plan and ask client for details on all services to the site.
Security – Property insured is out in the open and vulnerable to theft, vandalism or fire and is a strong temptation to thieves or even the contractors own employees.
Construction sites are attractive playgrounds to children who can be injured on the site or with improperly secured equipment. Partially completed buildings are a temptation for vandals to start fires or vagrants can enter and spend the night. Electrical faults or space heaters could also be left unattended and start fires.
Appropriate risk management techniques can control or reduce the client’s exposure to losses arising from theft, fire, and liability by loss prevention practices.
Site security protects against arson, vandalism and theft and the size of the site dictates the type of security necessary. For many sites, fencing is appropriate which is locked at night. If the site is large enough, a security watchman on duty after hours with regular patrols is a preferred option. In all cases the security of the site should be the deciding factor.
To reduce liability risks to site visitors, recommend the client:
- Control access to the site
- Post signs prominently requiring:
o All visitors report to the site office; and
o Hard hats and safety footwear to be worn while on site.
Policy Term
Match the policy period requested to the projected length of the job plus an allowance for delays. Many projects exceed their expected time frame and insuring for a longer term initially will avoid the need to extend the policy later.
Extensions can be difficult to obtain. You may not represent the insurer any longer; your market may no longer write builders risk and underwriting rules may not allow extensions. If the insurer cannot extend the policy, you may have difficulty convincing another insurer to accept the risk.
Most underwriters don’t like to assume construction risks midway because they are accepting exposures they cannot assess (exposures from completed work). If you do get an extension, it will likely be at a higher rate than the original builders risk or the underwriter may impose coverage limitations that were not in the original policy.
Liability exposures for completed operations can continue for a considerable period of time after the building construction is complete. Wrap up policies can be issued and generally provide a period of completed operations cover – discussed later.
The Builder
The owner of the building can also be the builder or they can hire a contractor to do the work for them. If a contractor is hired, the underwriter may want to know of their experience, expertise and reputation as they are relevant to the risk assessment and can affect the quality of work being done.
Underwriters are more likely to request this information on larger projects ($5m to $10m) and sometimes they request information on both the contractor and the major sub-contractors. For earthquake zones, underwriters always ask for the experience of the contractors involved and the materials to be used in the structures. Loss history is also required whether the builder is a contractor or the owner of the building
INSURANCE COVERAGES
The type of insurance depends on the business of the insured and their interest in the project either as an owner; builder; contractor or developer.
Property
Builders risk wordings are issued in the name of the owner or the building contractor only, however, they could be different people, each with an insurable interest in the project. Thus it is common to name both as insured on the policy. Sometimes the named insured also includes all contractors and sub-contractors to ensure coverage for all sub-trades (plumbers; electricians) working on the project
Usually property insured includes:
- Building under construction, addition, alteration or renovation
- Temporary structures at the site (fencing; temporary buildings; scaffolding)
- Some of the equipment used in construction (trailers used as offices; concrete forms)
- A small sub-limit for property off-site and/or at temporary locations (windows; doors in storage)
- A small sub-limit for property in transit within Canada and continental US
The intent of the builders risk is to cover only property to enter into and form the completed project. Contractor’s tools and equipment (incl. spare parts and accessories) is specifically excluded. To avoid any confusion as to what equipment is/is not included, confirm exactly which is which not (eg: service elevators on high rise buildings). The wording also doesn’t include stock or materials on-site but not yet incorporated into the building. Only what is part of the structure is insured.
Coverage is available on a named perils or broad form (all risks subject to exclusions) subject to a deductible. These wordings can vary between insurers so familiarize yourself with wordings used by your markets
A lack of consistency between insurers is the cost of making good faulty or improper material, workmanship or design exclusion. A form of insurance was available in the past that provided partial coverage known as rip and tear coverage.
Rip and tear cover was developed to provide insurance for the cost of removing a defective product from a project – tearing out and replacing defective concrete but not the cost of the defective concrete itself or the cost of new concrete to replace.
As this virtually is a guarantee of contractors work and the high incidence of claims, insurers became more and more reluctant to provide it and is vertically unavailable today.
Since a building under construction is significantly weaker than in a completed state, collapse becomes a serious hazard and often results from faulty design or defective material or workmanship. The IBC wording excludes losses arising from this peril but any resulting damage is covered, unless otherwise excluded.
Losses arising from flood, earthquake and sewer backup are generally excluded however, some insurers may extend coverage to include some or all of these perils by endorsement for an extra premium and subject to higher deductibles and/or reduced limits of insurance.
Builders risks generally contain by-laws exclusions. In older buildings, this could be a factor as they are less likely to comply with current by-laws and the work contemplated may not bring the building up to code in all areas. If the building is an historic one, there will be additional costs involved as well.
For new construction, by-laws would unlikely apply to a loss as the building permit would be granted only if the building is being constructed to the current code. However, if building code changes are pending, it is wise to suggest you client obtain by-law coverage. Also if a project is expected to take a long time, by-laws coverage is a wise decision.
Things to consider are building height restrictions; access for disabled persons; earthquake resistance standards.
Limits of Insurance – wordings indemnify on a replacement cost basis, therefore limits are normally the estimated completed value of the project. This total contract price or complete value for construction or renovation includes hard and soft costs.
Hard costs are costs to build the structure. Construction materials and labour to complete the project. However, some hard costs may not be part of the insurable value (paving a parking lot – part of construction but not subject to same perils as the building structure. The client also has the option of including various items in the amount insured (scaffolding; forms; hoardings; excavation costs; site preparation)
Soft costs are incurred in the design and administrative phases of the project. These include engineering and architectural design costs; interest expenses on construction loans; accountants or lawyer’s fees. If these costs are one time only, your client may not want to include them however, in a total loss these costs would be incurred again so any fees; interest costs, design and engineering costs should be included in the limit of insurance.
After calculating all costs, recommend the client add a buffer to allow for cost overruns:
- Design changes required part way through the project
- An increase in costs for materials
- Changes in building specifications because of a usage change
This avoids the possible necessity of amending the amount of insurance mid-term. Mid-term changes require additional premium which is not pro-rated but is applied from the inception of the policy because the rating takes into consideration the fact that the risk exposure (in terms of value) starts out small and increases as the project progresses. Rates are generally promulgated (made known) on the estimated value exposed per month.
Cessation of Coverage – When project is complete and before the building is handed over from contractor to building owner, a certificate of completion is usually completed. Done between the building contractor and the owner, the certificate is a check sheet where all items are signed off indicating both parties are in agreement about the work that has been done. Acceptance of the certificate signals the end of construction.
Generally you arrange the builders risk expiry date to coincide with the date the project is complete however, if completed early, coverage ceases on that date. The wording states that coverage can also cease:
- When the project or any part is used or occupied for any purposes other than construction, habitation or installing, testing or storing equipment or machinery, or
- When the project is left unattended for more than 30 consecutive days, or when construction activity has ceased for more than 30 consecutive days.
Maintaining contact with your client ensures that if any of the conditions that cause cessation of the coverage occur, you are in a position to advise the underwriter of these changing coverage needs. If there is a strike or weather delay – have the builders risk endorsed to continue the coverage during this period.
If the client takes possession and partially occupies it before it is completed, advise your underwriter. If a small completed portion is used as a construction office or a show home, advise your underwriter as you may wish to continue insurance under the builders risk form.
Other cases where occupancy can take place before completion:
- Work to be completed is minor (touch up painting; landscaping that doesn’t preclude tenancy; testing of heating equipment)
- The finish work cannot be completed due to climate conditions
- Final payment has not been made to the building because there has been a hold-back to cover unexpected expenses or warranty work
For these cases, decide whether to request continuance of the builders risk or to replace coverage on another property form and ask what work is still to be done. It is usually more advantageous to change the insurance to a completed structure wording as the rate and deductibles can be more attractive. If more work is still to be done, request an endorsement grating permission to complete and occupy the structure. The underwriter will want to know to properly assess the risk.
Testing and Commissioning – heating and air conditioning equipment; boilers or conveyor belts may require testing before the building is considered complete. Review the construction contract to determine if testing and commissioning cover is required. The owner will probably require testing prior to accepting the building. If the contract is unclear, ask the client or builder if any testing is required and request the testing schedule to arrange testing and commissioning cover. Coverage is not automatic. Most builders risks wordings exclude this coverage. You will need to request an extension be added to the builders risk to insure it; or delete or amend the applicable exclusion in the builders risk wording. Coverage is added for a specific time period and is subject to its own rates and deductibles. Clarify who is responsible for this insurance because it may be the equipment manufacturer or installer who is required to obtain this coverage.
Blanket Builders Risk Insurance – if your client is a contractor specializing in construction risks, it may be advisable to arrange a blanket builders risk policy on a reporting basis rather than for each project.
Obtain details of the type of construction the client does:
- Construction material such as concrete; frame or brick
- Contract prices for the smallest, average and largest job undertaken
- Locations of existing and planned sites
- Municipal protection
Policy is arranged to insure all buildings under construction of an agreed type and length of construction up to a certain size of job. The contractor reports details of each job as he secures the contract including values; estimated completion time; construction materials; protection; planned occupancy and whether it’s new, addition or renovation construction. Rates are pre-set on specific construction types or a blanket (average) rate is established that is reviewed annually. Provisional premium is charged and adjusted annually according to values reported.
If projects exceed the terms of the blanket policy, a specific builders risk may be more appropriate.
Business Interruption
If there is a delay in completion due to an insured peril, as well as the direct damage loss, the client may suffer a loss of future business income or incur extra expense to maintain the construction project schedule despite the loss. These are insurable on a variety of forms. Just like the business interruption form already discussed, business interruption wordings for loss of future earnings are follow form wordings – loss of income is insured for the same perils and conditions as the property direct damage form. Also known as advance earnings forms or delayed earnings forms
Identify the client’s exposure to determine which coverage, or combination of coverages is appropriate:
- Delayed rents to cover the loss of future rents due to a delay in complete of project as a result of an insured peril
- Delayed opening to pay for lost revenue resulting from an insured delay in the completion of a project. Can b for the complete loss of income; loss of sales; additional costs of financing (or refinancing); any additional design and construction costs necessitated by the delay.
- Extra expense to insure extra costs incurred to maintain the business during the delay; arrange for overtime to speed up construction; pay extra costs associated with obtaining new supplies from another source
- By-laws endorsement to insure additional costs incurred as a result of the construction time extended to comply with changes required to comply with local by-laws
Business interruption insurance limits are assessed based on type of insurance chosen and amount of income expected to be lost. Remember to include extra expense costs that may be incurred because of the delay.
Liability
Exposures can be varied and extensive. Especially true if demolition takes place as part of the project. Any entity involved in the work faces exposures both during and after completion of the project.
These include:
- Injury to children playing on improperly secured equipment
- Damage to underground cables or pipes due to excavation
- Fire damage started by plumbers torch
- Fire emanating from hot tar pots used by roofer
- Tools dropped on passersby
- Parked cars being damaged by painting overspray or dripping concrete
- Improperly sealed window frames leaking at a later date
- Faulty concrete causing foundations to shift or collapse
Claims arising from these and other incidents will be directed against everyone associated with the project.
The general contractor is well advised to maximize their liability limits; to require all sub-trades carry insurance to the same limits and to have the sub-trades provide proof of that insurance. Sometimes, the owner or general contractor asks to be added to the sub-contractors liability policy as an additional insured. Request that a specific person be designated to request and obtain all proof of insurance from all contractors and to ensure all insurance remains in force until the end of the project.
Liability wordings are generally subject to an annual aggregate with respect to completed operations or to the entire project. Always offer quotations for the limits the client requests and higher limits as options. Also, offer excess or umbrella coverage.
Certain construction operations are extremely hazardous:
- Demolition work involving blasting
- Tunnelling for underground cabling or pipelines
- Caisson work involving underwater work in a watertight chamber
Insurance for such activities is very limited – underwriters will have their own questionnaires to be completed. The XCU (explosion, collapse and underpinning) exclusion is standard in most liability wordings and it excludes bodily injury or property damage arising from these operations.
If your client is engaged in this type of work, ask for an amendment of deletion of this exclusion. Insurers will only offer low limits of insurance, subject to large deductibles to only the most experienced contractors with the best loss history.
If the construction debris includes hazardous materials special disposal rules apply. If the client is an expert in demolition, they will be aware of the action they must take. However, the legal liability arising from operations involving such materials may not be insured by the CGL and you should consider offering pollution liability to your client – only available from a limited number of markets and is underwritten rigorously through a separate application process.
Wrap up Liability – wording consists of the standard commercial general liability wording plus amendments to the named insured, description of operations and the aggregate limitation. Coverage is written to apply only to the specific project named.
The named insured includes:
- Architects
- Engineers
- Project manager
- Owner
- General contractor
- All sub-trades
Suppliers are not included as their liability exposure is product related not connected to the construction operations work.
Remember, although wrap-up will insure general liability exposures of architects and engineers, it does not insure their professional liability – separate E&O insurance is still required.
The policy term is written to coincide with the length of the project plus an agreed competed operations term – one to five years with limits dedicated to that specific project. The aggregate limit can be a multiple of the policy limit and completed operations coverage can be extended for a period up to two to three years after the project is completed.
Advantages of Wrap-up Liability include:
- All parties are insured on one policy
- Coverage is uniform
- Policy limits are dedicated to the project
- Loss history is insulated
- Costs can be controlled
When all parties are insured on a wrap-up form only one insurer is involved in a claim or lawsuit and generally all parties are defended by the same lawyer. This is advantageous because the interests of the owners and contractors on one construction project can overlap, however, the client should be advised that the limits of insurance don’t increase so they need to take into consideration the additional interests.
Uniform coverage – The owner or general contractor can control the scope of coverage ensuring all parties have adequate insurance and no contractor will lose his insurance mid-term. Financial stability is ensured through the policy term.
Wrap-up allows some flexibility for the owner employing smaller trades for the project who may not be able to afford high liability limits appropriate for the project.
Dedicated Policy Limits – Whereas the project could be insured on the individual participants CGL, the aggregate limits applies to any and all insured operations of the individual contractor making it possible for the limit of the policy to be exhausted responding to other prior claims leaving no coverage for the project itself. The Wrap-up policy’s limits apply solely to the project named.
Loss History insulated – from the client’s regular CDL policy and do not become part of his loss experience. This will be attractive to your client because many losses are caused by sub-trades, not the owner or general contractor.
Cost control – If one wrap-up liability policy is arranged for the entire project, there are generally lower costs, a negotiable deductible and uniform terms. If individual insurance is arranged for each contractor and sub-trade, the additional costs are added to the contract price.
Sub-contractor’s insurance – While the wrap-up liability does provide insurance for the project for each contractor, the completed operations exposure from the project continues even after the extended completed operations period provided by wrap-up ends. Individual contractors still require their own insurance. If they’ve arranged any special conditions in their policy that are not included in the wrap-up they would want the benefit of these terms to apply to any claim arising from the project insured on the wrap-up. Providing the contractor with the benefits of both wordings, excluding anything that is covered by the wrap-up policy from their own policy and arrange a difference in condition cover within the contractor’s own policy which will pick up extended completed operations and excess limits at a negotiated rate is your best service.
Arranging Insurance – Underwriters require a detailed application for wrap-up liability which includes:
- Named insured
- Location
- Construction
- Future occupancy
- Soil types
- Number of floors above and below grade
- Construction methods
- Qualifications and expertise of owner; general contractor; architect and engineers
- Existing liability insurance
- Loss history of all parties
Generally the party in control of the project will arrange the policy – owner or general contractor.
If the contractor is well known, it can be easier for you to negotiate comprehensive coverage. If not, it might be better for the building owner to arrange for insurance. That way, he can make sure the coverage is up to the specifications he requires.
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