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Nailing Down Fundamental Insurance Coverage Issues in Builder's Risk Policies
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January 19, 2009
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By Amy J. Fink
Construction projects involve a substantial risk of accidental destruction or damage to structures, equipment and materials located onsite. In the construction business, “time is money.” Therefore, time is of the essence in obtaining indemnification of losses so that funds are immediately available to repair damage or replace property in order to avoid costly delay to a project. Ensuring that an appropriate insurance coverage program is in place before breaking ground is of paramount importance for parties involved in construction projects.
The traditional means for insuring against damage or destruction of a structure, such as fire insurance, generally are not available to cover new construction. However, coverage can be obtained through specialty policies, particularly builder’s risk insurance. Builder’s risk policies provide worksite insurance during the continually changing conditions on a building renovation or construction project. Following is an overview of some of the fundamental issues that should be considered in procuring builder’s risk insurance.
Property Insured
The standard commercial builder’s risk coverage form is a modified commercial property form. In contrast to standard commercial property policies, builder’s risk insurance provides coverage only for a structure identified in the policy’s declarations that is under construction. Indeed, courts have found that builder’s risk insurance does not apply unless the covered property is in the course of construction or renovation. See, e.g., 38 Sequoia Associates, LLC v. Lumbermens Mutual Casualty Co., 2004 U.S. App. LEXIS 23353 (2nd Cir. 2004) [court found that builder’s risk policy only applied to buildings in the course of construction or renovation and that intent to start renovations, coupled with the previous owner’s renovation work, did not support a finding of coverage under the policy].
In addition to the actual structure, builder’s risk policies generally provide coverage for foundations, underground pipes and drains, temporary structures such as scaffolding while they are at the insured location, and materials and equipment that are destined to become a permanent part of the project. However, issues may arise if valuable equipment or materials that are not intended to become a permanent part of the structure are damaged or destroyed. If funds are not immediately available to replace or repair damaged/destroyed equipment or materials, the project could sustain costly delays. Because there often is property belonging to numerous parties on a construction site, parties should consider who would bear the risk of damage or destruction of equipment or other materials in obtaining coverage.
Policy Period
Determining the policy period of a builders’ risk policy may not be clear-cut. Coverage under builder’s risk policies usually begins when construction commences. However, absent specific policy provisions, determining when construction begins can give rise to disputes, such as whether preparations that are not clearly construction or building materials delivered before the start of physical work on the structure are encompassed within the commencement of construction. See, e.g., Patton v. Aetna Insurance Co., 595 F.Supp. 533 (N.D. Miss. 1984).
Determining when coverage is terminated may be equally problematic. Typically, coverage ends when construction is completed, the insured no longer has an interest in the property, or the policy expires or is cancelled, whichever occurs first. Moreover, some policies provide that coverage ceases when the structure is occupied or put to its intended use. Disputes often arise when loss occurs at the end of a project, after construction is complete and the structure is occupied but punchlist and final completion work remains. See, e.g., Hartford Fire Insurance Co. v. Riefolo Construction Co., Inc., 81 N.J. 514, 10 A.2d 658 (1980) [although owner was using a school building, within meaning of builder’s risk insurance, the building still was “in the course of construction” because it had not been inspected and approved by Division of School Building Services, a prerequisite to school attendance].
To avoid disputes, insureds should ensure that their policy adequately defines the policy term and the events that constitute the commencement of construction and those that cause termination.
Valuation of Loss
Inherent in the nature of the construction process is fluctuation in the value of the structure. Accordingly, loss adjustment plays a significant role in determining the amount paid for damage to a structure. Provisions pertaining to valuation should be examined carefully because the amount covered may be significantly less than the actual loss depending on applicable policy language.
Exclusions
Builder’s risk policies typically are “all risk” policies, which cover all causes of loss not expressly excluded. Thus, knowing what is excluded by builder’s risk policies may be as important as knowing what is covered. There may be certain exclusions for acts of nature such as “weather conditions,” floods and freezing in the policies. However, these exclusions generally contain limitations as to their applicability and by virtue of the definitions of key terms. Because a construction site is exposed to the physical elements in ways and to an extent that fully completed projects are not, defining the scope of such exclusions and managing construction practices accordingly are essential.
In addition, many policies exclude loss caused by delay, loss of market, loss of use or any “indirect loss.” Loss resulting from design defect or faulty workmanship also typically is excluded. Because these types of loss could have a substantial impact on a project, obtaining coverage through endorsements should be considered.
Conclusion
Although many problems are common to construction projects in general, the unique aspects and contractual obligations of each project should be considered when procuring insurance. As is often the case with insurance policies, the adage “the devil is in the details” often is applicable in conjunction with builder’s risk insurance. The nature and extent of the coverage procured is a business decision that requires careful consideration of policy terms and conditions in order for a party to make an informed decision concerning the types of risk assumed.
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