What it is

Builder’s Risks is a term that covers a lot of ground.  Builder’s Risks Insurance is normally written as an inland marine form and is known by a number of name tags – course of construction – installation floater – builder’s risks. The policies are a property insurance form that insures a building from breaking of ground until (a) completion, or (b) until the building becomes eligible for permanent insurance. (Permanent insurance policies normally require 60% occupancy before they will allow the policy to go into force. Until then, it is considered as a vacant building.) The insurable value for the building is the replacement value of the hard costs of building the structure. Hard costs do not include the land, but they do include all the material and labor it took to build the structure.

The builder’s risk policy is designed to attach as or before the building materials begin to arrive at the site, and to have the building grow up within its insurance coverage.  That is why the rates are lower than those on a completed building or on a vacant building.  The hazard is only a small part of the contemplated value for the majority of the policy term.

Since the builder’s risks contract is not a standardized form, in most jurisdictions, it is important to understand the differences between the forms available.

Policy Forms

Form ALS-67 was the Cadillac of builder’s risks policies.  As an inland marine form, it operates as a “file and use” line of insurance. Hence, there are many variations of this form in commerce.  Some are written by domestic insurers for sizeable clients; others are offered by London syndicates. Typically, the policy covers all risks of direct physical damage, excluding earthquake and flood.  However, we have written this form to include both earthquake and flood when we had a receptive insurer and a willing client.

Form ALS-72 is very much in use in this country by domestic specialty insurers. It was a revision of the ALS-67 form, restricting coverage in areas such as “hot testing,” and “construction defect.” Courts felt that both of these were covered by ALS-67, although it was not the intent of the underwriters. Typically, this policy will insure the contemplated project for replacement costs of the structure, property in transit, property at other locations, and for soft costs.  Transit and other location coverage is usually a $100,000 sublimit, although many policies use smaller amounts, such as $25,000 or $50,000 sublimits. Most use 100% coinsurance clauses to make sure the values given the underwriters are correct.  Rarely will we see a policy written on an agreed amount or on a loss limit plan. Earthquake is the principal exception to this observation. It is frequently written on a loss limit basis—this means all losses are paid in full up to the amount of insurance, less the applicable deductibles.

ISO has a form that is used by the majority of the insurers subscribing to ISO form. It is not quite as broad in scope as the ALS forms, and it is not usually the form of choice for large projects.

Company Forms are usually used by those insurers who are trying to capture a large share of the builder’s risk pie.  Most model their product after the ALS-72 form, but give it their unique touch in the areas of off premises coverage, transit, and in the framing of the insuring agreement.  Coinsurance is another area in where there are differences between the forms, as well as the company’s practices regarding extending the policy if the project cannot be finished within the projected time frame.

Policy Periods

There is a developing trend in the industry to limit the number of extensions that underwriters will allow on a builder’s risk policy.  If your project is expected to take 18 months, you should purchase an 18 month policy, then, prior to expiration, carefully evaluate to see how many more months will be needed. That is the time also to ask if you guess wrong and need a second extension, will it be permitted.  Cutting the time frame too short can be very expensive, as it may force you to buy a vacant building policy on short notice to keep the lender happy. A vacant building rate will be twice or more than twice the rate charged on the builder’s risk form.

Soft Costs

Soft costs are those costs that will reoccur if the building is burned down on us before it is completed.  Included are such costs as interest expense, insurance costs, taxes, and other costs that would reoccur if the building is lost to an insured peril prior to completion.  Underwriters like to see a list of the soft costs submitted with the application for the building coverage.  Too many people have just guessed and plucked a number out of the air, making the underwriters feel it is important to have applicant’s define what costs they are including in the soft cost figure.  It is not unusual to see soft costs generate an insurable value that is 1/4^th to 1/3^rd the hard costs figure.

Errors found in Builders’ Risks Policies

Two big errors are often found in builder’s risks policies we are asked to review.  First, the framing of the insuring agreement is often inadequate.  It should be framed to encompass all those who have an insurable interest—owner, general contractor, subcontractors, and material men.  With some companies, this omnibus clause is already built into the form; however, the majority of the policies leave it up to the broker to properly draft the named insured.  As in property insurance forms, inland marine policies require that the insurable interests must be identified in the policy if there is to be any recovery.  For example, assume that the policy is written in the name of the project owner only.  The framer has $200,000 worth of wood at the jobsite, and has framed a good portion of the building which involved another $200,000 worth of wood and an equal amount of labor. The owner has not paid him for the $400,000 worth of completed work, nor for the lumber in the yard. Vandals torch the place.  Recovery will be limited to what the named insured has paid for unless the omnibus clause is used in the insuring agreement, or is incorporated into the policy language in the company form. One or two companies have incorporated it into the company forms.

The second error we often find in the policies we review is under insurance.  A large percentage of builder’s risks policies are written with a 100% coinsurance clause. One project we reviewed had a $5,000,000 limit of insurance.  We were asked to visit the site and review the policies.  We found there were four buildings, not the one described in the policy, and that the value was $20,000,000, not $5,000,000. Fortunately for this insured, he had not suffered a loss, for if he had, he would have collected less than 25 cents on the dollar.  Co-insurance is an honesty clause. If it is violated, it imposes what some refer to as a “top end deductible.” In the example, the deductible exceeded 75% of the values in place.  Fixing the problem was expensive since the buildings were half built when we were brought in.

Builder’s Risks Earthquake

There are insurers who will write builders all risk policies including earthquake and flood, but they are usually limited to $2,000,000 maximum exposures.  We often have to place the earthquake need on a separate policy due to reinsurance requirements. Course of Construction Earthquake is readily available for nearly all kinds of construction. Builders building in California should consider seriously the purchase of earthquake for their frame projects.  These projects are most vulnerable to earthquake loss when they have just been framed and have not yet been sheer walled.  A serious rolling earthquake can loosen a lot of nails very quickly.

Installation Floaters

Occasionally, we provide an installation floater to subcontractors who are to install equipment into a building, or to a carpenter or cabinet man who feels he has lots of assets exposed and he cannot tell if his assets are covered under the builders risks policy purchased by the owner or contractor or not.  So he buys a policy to cover his material at the jobsite, and his interest in material and labor in the project for which he has not been paid. An installation floater is a builders’ risks form that localizes the coverage to a particular subcontractor’s interest.  It may cover a specific site, or it may apply to any site where he has material and work which he has not been paid for.

Rates

Rates vary according to locality, size of job, time frame within which the job is to be done, history of the contractor, kind of construction, and a number of other factors. We have seen rates range from 3 cents per $100 to 55 cents per hundred of insurable values.  To determine what rate would apply to your project, we would need to have a completed application to discuss with the underwriters. There are so many factors which go into pricing these policies that it is impossible to generalize.

Deductibles

To keep your rates favorable, we recommend using a $2,500 or a $5,000 deductible.  For small and medium sized projects, the $2,500 deductible maximizes your credits.  On larger projects, the bar should be moved up to $5,000 or to $10,000 or perhaps $25,000.

Sometimes the insurer will make the decision for you by telling you the deductible will be such and such. When the underwriter does this, it usually means you can increase the deductible, but not lower it.

The builder’s risks policy is truly one of the vehicles that makes the building of your project possible.  You may lose a month or more of coverage if the bank insists you buy the policy by a certain date, even if the building cannot break ground until a later date. This situation is often brought on by a need for funding of the construction loan, so there is no alternative. It is just a cost of obtaining money.  The policy’s evidence of coverage is the key to the funds.  And those funds are probably going to pay for the liability insurance you have to have for the project so you can get the permit.

Application

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