Builders risk: A tangled web
Confusion reigns as coverage varies by contract, may apply to non-builders,
and is often litigated
By Donald S. Malecki, CPCU
Builders risk is a term used to describe a kind of property insurance to cover against fortuitous loss while a building or structure is under construction. Since coverage generally ends when the work has been completed, builders risk also is considered a temporary form of coverage.
The term builders risk, however, is somewhat of a misnomer, particularly when a dispute arises and the matter has to be settled by a court. The reason is that courts commonly think of builders risk as a coverage meant for contractors.
Admittedly, many builders risk policies are purchased by contractors. In many situations, however, prospective owners, on whose behalf construction is undertaken, have an insurable interest. Unfortunately, prospective owners are sometimes overlooked when this kind of coverage is contemplated.
Certainly, contractors have an insurable interest in the property, given that they usually purchase the materials and equipment necessary to construct the property. The interest of owners, however, should not be overlooked, because they commonly pay contractors as the construction progresses. It is for this reason that the term, course of construction, should be used in lieu of builders risk. At least, course of construction coverage does not suggest that coverage is limited to builders, i.e., contractors.
Purchasing builders risk early on
Another common misconception is that course of construction coverage should commence when the building or structure begins to take form. This can occur when the foundation is poured or when the joists are set into place. Actually, course of construction coverage should begin long before either one of those tasks is undertaken.
Of course, these policies, like most property forms, do not cover land, but the cost value of excavation work, site preparation and land grading are certainly subjects of insurance that should be covered. And, excavation work often takes place long before the first nail is struck.
Germane to the foregoing subject is the case of Glacier Construction Co. v. Travelers Property Casualty Company of America, No. 10-cv-01911 (U.S. Dist. Ct. Dist. Colo. 2011), where the contractor was hired to construct a water pumping facility at a cost of approximately $2.4 million and purchased an inland marine-type builders risk policy.
The contractor encountered unexpected groundwater dewatering issues during excavation. As a result, four dewatering wells were installed with pumps. The contractor then made a claim for the costs incurred.
The builders risk policy covered, in part, buildings or structures, including temporary structures while being constructed, erected or fabricated at the job site. This policy also covered site preparation. The insurer nonetheless denied coverage since there was no loss of or damage to covered property because there was no physical damage to any structure or temporary structure and land was excluded.
The court held otherwise because the four dewatering wells and submersible pumps were held to be temporary structures constituting covered property. Damage to them from the intrusion of water, soil or sand causing failure to the pumps was considered to be physical damage.
Strange as it may seem, a contractor in the case of Fontana Builders, Inc. v. Assurance Company of America, No. 2010AP2074 (WI Ct. App. Dist. II, 2011), did not purchase a builders risk policy on a house until it was nearing completion! The amount of insurance, which also might be startling to some, was $1.495 million.
Why anyone would wait until a project is nearly completed before purchasing a builders risk policy is difficult to understand. What is also puzzling is why an insurer would even entertain the idea of issuing a builders risk policy for the completed value, just as the construction is about to end.
As sometimes happens when a course of construction policy is purchased, the property sustains a loss. In fact, that is what happened in the above noted case when a fire virtually destroyed the house at the time of substantial completion.
Not unexpectedly, the insurer balked at paying the policy limit. While it had a number of reasons for not wanting to pay, one of the reasons was that the policy applied only to that part of the construction that occurred after the policy was issued. In other words, what property existed prior to the purchase of the policy was not covered.
The reason, as explained by the insurer, was that "covered property" under this policy did not include: "existing building or structure to which an addition, alteration, improvement, or repair is being made, unless specifically endorsed." Assuming it was liable, the insurer maintained that the maximum it owed for the loss was $159,000.
The court did not particularly like the insurer's argument. In fact, it stated it was concerned with the insurer's position, because the contractor paid a premium for the builders risk policy based on coverage for $1.495 million. To then assert that the insurer's coverage was limited to $159,000 was a questionable argument. The court, however, did not resolve that issue because it had other priorities.
What complicated matters with this case was that the prospective owners of the house had also purchased a homeowners policy from the Chubb Insurance Company with a $2 million limit on the house and $1 million on the contents. Following the fire, Chubb paid the named insureds $1.5 million for their loss.
What was unusual about the payment of this loss was that it was the contractor who actually owned the house at the time of loss, and not the prospective home owners. Sometimes people have to wonder why some insurers pay losses they should not pay and deny coverage in circumstances when coverage does apply.
As a general rule, personal property is not a covered item of builders risk policies. As a matter of fact, when personal property is placed in a building that has been under construction, it is evidence that the construction has ended. One of the few exceptions when coverage for personal property located in property under construction applies is when a prospective owner is granted a permit for occupancy.
A sequel to the above case was a suit by the prospective home owners against the general contractor's insurer of a CGL policy for damage to their personal property in the house owned by the general contractor. The house was legally occupied by the prospective home owners under a 30-day temporary occupancy permit.
The insurer denied coverage for this destroyed personal property based on the exclusion of personal property in the care, custody or control of the named insured. It turned out, however, that coverage was held to apply in this case of James F. Accola and Suzanne Pierce Accola v. Fontana Builders, Inc., Westfield Insurance Company, No. 2009AP2810 (WI Ct.App. Dist. II 2010).
The court here explained the test it uses to determine whether property is in the care, custody or control of the insured. Property is in the care, custody or control of the insured, the court explained, if it is "under the supervision of the insured" and it is a necessary element of the work.
In applying this test, the court stated that it agreed with the insurer that the personal property of the prospective owners was under the general supervision of the general contractor. The Achilles' heel, however, was that the court could not see how the personal property was necessary to the work involved in finishing or building the house.
In order to have won the argument over the "care, custody or control" exclusion, the insurer was required to have shown that the personal property of the owners was necessary to the work done by the general contractor, and that was not done.
Consider inland marine forms
It is a good idea to not simply choose a builders risk policy for a project owner and/or general contractor without considering the exposures. Sometimes contractors have loss exposures not only at the site of the construction, but also for materials and equipment in transit or at temporary storage locations awaiting transit.
When off-site exposures to loss exist, it will likely be an inland marine-type of builders risk policy that will cover that exposure. This is not to say that all inland marine-type builders risk policies are broad in scope. There are far too many differences to be definitive. But inland marine policies generally are broader than fixed-site policies.
Defective work problems
Whether a general contractor hires subcontractors to assist in the construction or not, defective work performed by contractors that is damaged or destroyed is not likely to be covered. Loss that ensues from such defective work, however, may be covered depending on the policy. It is impossible to be definitive here, too, but ensuing loss provisions vary, and the extent of coverage will hinge on the wording of the provisions and the fact pattern.
The point here is that a builders risk policy with an ensuing loss clause in-and-of-itself is a lot better than one that has no ensuing loss provision. One would be surprised how many builders risk policies are purchased today without ensuing loss provisions.
Don't forget soft costs
Discussing builders risk or course of construction insurance would not be complete without also mentioning coverage for soft costs. Briefly, soft costs represent the costs that are for those costs other than repairing or replacing physical loss or damage to covered property, i.e., the hard costs.
This also is a subject where it is difficult to be definitive. A common kind of coverage that should seriously be considered for many projects is delay in completion. Also within this category are interest paid on construction loans, financing costs and professional fees.
The important point here is that there is a lot to consider before a builders risk or course of construction policy is selected, and soft costs should be seriously considered. The problem is that many owners and contractors do not beleive they are going to have a loss in the first place and often forgo the purchase of soft costs.
It is not until a loss happens that the subject of proper insurance registers and, of course, it is too late then.
Donald S. Malecki, CPCU, has spent more than 50 years in the insurance and risk management consulting business. During his career he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates LLC, an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.