(December 2008)
Grandfathering is an important tool in passing laws to improve the quality of new construction because it exempts existing structures and does not require them to comply with new laws and ordinances. Revolts and chaos would reign if existing buildings had to be upgraded each time a new code or ordinance was introduced!
The laws permitting grandfathering also specify when and under what circumstances an exemption ends. In many cases, an existing building must comply with new codes and ordinances when it undergoes a major renovation or after a significant property loss. A typical provision may require that the entire structure not currently complying with the code be brought up to code if it is damaged to the extent of 50% or more. The rationale is to make any necessary changes at the same time that construction is taking place anyway.
Insurance policies are contracts of indemnity. This means they return the insured to the condition that existed before the loss occurred and nothing more. They are not intended to improve the insured's situation. Compliance with codes and ordinances creates a betterment of the insured. That is why most insurance policies and coverage forms do not cover the cost of such improvements. Even the replacement cost valuation provision states that any changes required due to the existence of an ordinance or law are not covered.
Example: F & J Slaughtering was built outside the original city limits. Over the years, the city limits expanded and F & J, now inside the city limits, is in violation of the ordinance prohibiting livestock within the city limits. F & J was grandfathered when the zoning laws were enacted. A severe tornado destroys 75% of F & J's property. When it contacts the city and attempts to obtain building permits, it is informed that the slaughterhouse cannot be re-built because it violates current zoning requirements. F & J's only option is to rebuild elsewhere. Because of the ordinance or law exclusion, the insurance company pays only the cost of rebuilding 75% of the slaughterhouse at the current location. It does not pay for the expense of demolishing the undamaged portion of the building. It also does not pay any additional costs associated with rebuilding at a new site.
In light of this dilemma, what can an insured do to protect itself against the ordinance or law compliance issue?
1. CP 00 10–Building And Personal Property Coverage Form
The Increased Cost Of Construction Additional Coverage provides a limited amount of coverage to bring a damaged building up to code. However, it is available only if the optional replacement cost coverage is included. The limit is the least of $10,000 or 5% of the limit of insurance. This coverage is similar to that provided by CP 04 05–Ordinance Or Law Coverage.
2. CP 04 05–Ordinance Or Law Coverage
This endorsement is designed to meet the construction ordinance and law requirements imposed on most insureds. It includes three separate coverages, each of which is treated separately and apart from the others.
A. Schedule
The first part of the endorsement is a schedule that allows the insured to select the type of coverage desired. In addition, a limit of insurance must be provided if Coverages B and/or C are selected. Coverage B and Coverage C can be combined into a single blanket limit of insurance as an option.
A limit of insurance is not entered for Coverage A because it is dependent on the building limit indicated on the declarations. The insured cannot establish a value on a possible undamaged portion of the building that may need to be demolished. The rating for Coverage A is based on a rate surcharge applied to the total building limit.
B. Application Of
Coverage(s)
Certain conditions must be met in order for any of the coverages selected to apply. Coverage does not apply if these conditions do not exist.
1. The ordinance
or law provided must regulate building construction, repair or demolition, or
regulate zoning and land use requirements and be in effect at the time of loss.
Example: The Merrilltown city council fought for years to require that only buildings of masonry non-combustible or better construction be permitted in the downtown area. The ordinance was passed on February 1, 2008. Merrilltown Furniture occupied a large frame building downtown and was damaged by a large fire on January 28, 2008. When it applied for a building permit, it had to comply with the new ordinance. When Merrilltown Furniture requested coverage under the Ordinance Or Law Coverage form, it was denied because the law was enacted after the loss occurred.
2. The damage to the building subject to enforcement of the building ordinance or law must be from a covered cause of loss. If only some of the damage to the building is covered, the payment under this coverage is in proportion to the amount the covered loss bears to the total loss.
Example: Fair Weather Hotel does not have wind coverage in its package policy but it does include CP 04 05–Ordinance Or Law Coverage. Wind coverage is provided under a wind pool policy. A hurricane causes direct wind damage to the building and also downs a power line that starts a fire in the building, resulting in 50% of the building being destroyed. The claims representative determines that half of the loss is due to wind and the other half is due to fire. The coverage provided by CP 04 05 is limited to 50% of the total loss.
C. Exclusions
It is normal for an insured to seek pollution coverage in every insurance coverage form or policy. The coverage provided by this endorsement does not include any coverage for pollution, fungus or mold, even if an ordinance or law requires cleanup of a contaminated or affected building. In addition, there is no coverage for the costs associated with any testing or response to pollutants at any site.
D. Coverage
1. Coverage A–Coverage For Loss To The Undamaged Portion Of The
Building
Property insurance usually applies only to damaged property. This coverage does just the opposite and provides coverage for undamaged property. The Building And Personal Property Coverage Form covers the damaged property. This coverage applies to the undamaged portions that must be destroyed because of a law or ordinance that controls construction.
Example: McKinley Department Store is a five-story, joisted masonry building in the downtown area. A city ordinance requires that all buildings two stories or higher be of masonry noncombustible or better construction. Grandfathered buildings must conform to this ordinance if they sustain damage to the extent of 30% or more. A fire destroys 40% of the building. McKinley is informed of the ordinance and told that it cannot rebuild the structure as is. In addition, it must demolish and remove the remaining 60% because it does not meet current construction requirements. Coverage A applies to the undamaged 60% of the building. CP 00 10–Building And Personal Property Coverage Form applies to the damaged 40% portion.
2. Coverage B–Demolition Cost Coverage
Providing coverage on the undamaged portion of a building is not enough. In order to rebuild the structure, the undamaged portion must be removed and the site cleared to allow for new construction. This coverage allows the insured to anticipate the expense of demolishing an older structure. This requires a separate limit of insurance. This limit should be selected carefully and after much thought and review because of the high costs of demolition. The actual costs of demolition and site clearance are covered up to the limit of insurance indicated on the schedule.
3. Coverage C–Increased Cost Of Construction
a. This coverage is important for any company subject to the Americans with Disabilities Act (ADA) or any of a number of similar or related local, state and federal ordinances affecting construction, reconstruction, repairs, remodeling and renovations after a loss. Many of these ordinances and codes are helpful with the cost of compliance being relatively inexpensive and easily accommodated in new construction. However, similar compliance in an existing building or structure following a loss is considerably more expensive and difficult to accomplish. In addition, these costs are not included and covered under most insurance policies and coverage forms.
Example: Golden Years Nursing Home has served the needs of the aged in the community for decades. The building is masonry construction with plaster walls. The hallways in certain areas are rather narrow but open to spacious open areas. A fire that starts in the kitchen damages the kitchen and dining hall. When building permits are obtained to repair the damage, Golden Years is told that the hallways must be widened to meet ADA standards.
b. This coverage pays the increased costs to repair the damaged portions of the building up to the minimum requirements of the ordinances and laws. It also pays the costs to remodel or even rebuild the undamaged portions of the building to bring them into compliance with the minimum requirements of the ordinance or law. The buildings do not have to be demolished before this is implemented.
Example: Golden Years meets these requirements because covered property is damaged by fire, one of the covered causes of loss. Golden Years incurs increased costs in the course of repairing, rebuilding or replacing the damaged part of the covered property in order to comply with the enforcement of an ordinance or law.
This coverage applies only if the building is actually repaired, remodeled or rebuilt for the same or a similar occupancy. The occupancy can be changed only if the law or ordinance requires an occupancy change due to current land use or zoning restrictions.
Example: Golden Years looks at its options after the loss. One is to change from a home for the aged to a restaurant. After a review of its policy and this coverage form, Golden Years realizes that this coverage does not apply and is not available if it decides to rebuild as a restaurant because it is not the same or a similar occupancy.
One unusual feature of this coverage is that certain types of property normally excluded may be covered. If any of the property listed below must be altered because of requirements of a building ordinance or law, the increased costs for the alteration are covered:
Example: The building inspector from the local health department visited Golden Years after the loss and informed it that an additional drain was needed in the kitchen to comply with health department requirements. Since this requirement was in effect before the loss and is a minimum requirement to obtain health department approval, the cost of the additional drain is included.
E. Loss Payment
1. Coverage A
Loss payments vary, depending on the valuation selected. They are based on whether the basis of valuation is actual cash value or replacement cost.
When replacement cost valuation applies, and the building is repaired or replaced, the loss payment is based on the least expensive of the following options:
Note: This coverage does not apply to the increased cost of upgrading the type of construction to meet current codes. If the building construction must be changed from frame to masonry non-combustible, the additional cost to do so is provided under Coverage C–Increased Cost Of Construction.
When replacement cost valuation applies and the building is not repaired or replaced, or when actual cash value valuation applies, the loss payment is based on the least expensive of the following options:
Example: The Finway Pianos plant sustains explosion damage to the extent of 60%. Finway purchased Coverage A and its limit on a replacement cost basis is $2,500,000. The Finway family considers rebuilding but they no longer have the heart or will to continue the business. Finway decides to demolish the building and sell the land to the city. The amount paid in this case is the $1,000,000 actual cash value of the building.
2. Coverage B Specific Limit (not blanket)
If a limit for Coverage B appears on the schedule, the loss payment is based on the least expensive of the following options:
Example: Continuing the example above, Finway Pianos has a $150,000
Coverage B limit. The actual cost to demolish the remaining portion of the
building is $100,000. The cost to clear the site is apportioned with the debris
removal limit in
CP 00 10–Building And Personal Property Coverage Form. As a result the total
cost of demolition and debris removal is completely covered.
3. Coverage C Specific Limit (not blanket)
If a limit for Coverage C appears on the schedule, the insurance company pays for the increased cost of construction. However, it does not pay:
If the building is repaired or replaced at the same location, or if the insured decides to rebuild at another location, the most paid under Coverage C is the least expensive of the following options:
If the ordinance or law requires that the insured relocate its operations to a different location, the most paid under Coverage C is the lesser of either the increased cost of construction at the new location or the increased cost of construction limit of insurance indicated on the schedule.
Note: There is no payment under this coverage if construction does not take place.
Example: Finway Pianos had an increased cost of construction limit
of $500,000 because it planned to rebuild with a different kind of construction
if a loss occurred. In this case, Finway is not rebuilding. It asks for the
$500,000 in the settlement but the insurance company denies the request because
it is not rebuilding.
4. Coverage B And Coverage C Blanket Limit
If the insured requests a blanket limit to apply to both Coverage B and Coverage C, that limit is the most paid in any one occurrence. However, certain limitations apply. For example, with respect to demolition, the insurance company does not pay more than the insured's actual costs to demolish and clear the debris from the site after a loss.
In the event that increased costs are incurred during construction, the insurance company does not pay:
If the building is repaired or replaced at the same location, or if the insured decides to rebuild at a different location, the most the insurance company pays under Coverage C is the least expensive of the following:
If the ordinance or law requires the insured to relocate, the most the insurance company pays is the least expensive of the following options:
F. Endorsement Terms
Each building listed on the schedule is treated individually. All terms apply separately to each listed building.
G. Existing Ordinances
Or Laws
If the insured was previously notified and required to comply with ordinances or laws and has not done so, this insurance does not pay for post-loss compliance.
Example: Farley’s Restaurant was told it needed to install two additional drains in the kitchen to comply with current health department requirements but it ignored the order. When rioting occurred and the restaurant was damaged, Farley’s added the cost of the drains to the increased cost of construction. However, the claims representative refused to pay for the drains upon discovering the outstanding orders to install them.
H. Examples Of
Proportionate Loss Payment
This form provides an example of how coverage applies when a loss is only partially covered.
I. Definition
Fungus is defined. It is the same definition as the one used when the term fungus is used in other forms.
Please refer to PF&M Section 131_C004, Building Code Compliance Held Compensable By "Reasonable Expectations" Of Insured, in Court Cases, for information on a dispute involving mandatory construction.