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Insurance Law

BUILDERS RISK INSURANCE - New Appleman on Insurance Law Library Edition, Chapter 50

James Bobotek   By James P. Bobotek

Chapter 50 provides an examination of builders risk insurance.  A builders risk policy is a form of property insurance that covers the interest of owners, contractors, subcontractors, and others involved in a construction project.  It insures them against the risks of property damage to the project.  As a general rule, builders risk policies are intended to apply during the course of construction, erection, or fabrication, and not to the dismantling of a building or structure.  Builders risk insurance may also be utilized to insure projects in which existing property is being renovated.

Section 50.01 of the chapter provides a description of builders risk coverage and the reasons for obtaining it.  A builders risk policy usually covers the structure under construction and materials, fixtures, supplies, machinery, and the equipment to be used in the construction. It also covers property of others for which an insured may be liable, and removal of debris of covered property that is damaged in a covered loss.  It may also provide coverage for temporary structures, scaffolding, worksite trailers, landscaping, and excavation work. It also provides some coverage for work to be incorporated in the structure, but stored offsite.

Builders risk policies typically provide broader coverage than commercial property policies utilized to provide first-party coverage for a construction project.  For this reason, they are the preferred type of property coverage on a construction project from the perspective of all project participants.  Unlike commercial general liability policies, builders risk policies typically include all project participants as insureds.  This is because all such participants have an insurable interest in the construction project.  In addition, an insurer cannot generally subrogate against its insured.  By including themselves as insureds under the builders risk policy, project participants are provided a level of comfort that subrogation efforts against them will be barred.

Cross Reference: See Chapter 49 for a discussion of subrogation.

Section 50.01 also discusses differences in policy forms that are offered to provide builders risk coverage.  No matter what form is used, almost all builders risk policy forms provide coverage under one of two basic premises: "all-risk" or "named peril" coverage.  All-risk policies, which are the most common type used, insure against all risks of direct physical loss or damage to insured property except those risks that are specifically excluded.  In contrast, a named peril policy insures against direct physical loss or damage to covered property or to insured property where the loss is caused by any of the specifically named perils or causes of loss. 

Section 50.01[3][d] discusses the various type of forms used in builders risk coverage.  While the Insurance Services Office ("ISO") offers standard builders risk forms, those forms are not commonly used today because they provide coverage on a narrower basis than many insurers' manuscripted forms.  Market demand has encouraged insurers to offer broader coverage on non- ISO forms.  Because these forms are manuscripted, the coverage provided under them varies widely. 

Section 50.01[4] addresses the various forms of duration of coverage set forth in builders risk policies.  Some builders risk policies specify dates on which coverage starts and ends, while others provide coverage from the time construction begins until the project is completed.  Almost all builders risk forms state that coverage applies during the "course of construction."  Coverage may terminate on a specified date, or on the occurrence of a particular event, such as completion, occupancy or acceptance by the owner.

Section 50.02 addresses the structure of builders risk forms.  In general, protection under a builders risk policy should not be limited to the party that purchases the policy (usually the property owner). Typically, the terms of the construction contract between the owner and the contractor establish that the interest of the general contractor and all subcontractors and sub-subcontractors must also be protected under the builders risk policy.  The intent is to minimize overall cost and disputes among the parties by purchasing a single insurance policy that will cover the interests of all parties in the event of covered damage to the project.  Often, a single builders risk policy is purchased by either the owner or the contractor, and all parties required under the contract to be included in the policy are designated as named insureds.  Courts usually do not find coverage under a builders risk policy unless the insured has an "insurable interest" in the damaged property.

Section 50.02[2] discusses the key issues in builders risk policy insuring agreements.  The three key elements of the insuring agreement that must be satisfied are (i) whether there was direct physical loss or damage, (ii) whether the damage was to covered property, and (iii) whether the damage was caused by a covered cause of loss.  This section notes that the direct physical loss or damage requirement is frequently litigated.  Most courts interpret the phrase "direct physical loss" as actual loss of property.  Similarly, most courts define the phrase "direct physical damage" to include distinct and demonstrated physical alteration in property.  One issue that frequently arises is whether the word "physical" modifies "loss or damage," or just "loss."  Courts are divided on this issue.

Property covered under a builders risk policy usually includes the structures on the construction site, as well as materials that have not yet been incorporated into the structure.  Materials being moved on site that will ultimately be used in construction, such as scaffolding, warehouses, and other temporary structures may also be covered by a builders risk policy.  Builders risk policies vary as far as what qualifies as covered property and in the way that the policies identify what property qualifies as covered property.

With respect to covered causes of loss, builders risk policies cover fortuitous losses resulting from damage to the construction.  These policies can either be "all-risk" policies that ensure all risks not in specifically excluded from the policy, or "named peril" policies which only provide coverage for specific perils as set forth in the policy.  One of the key differences between these two types of policies is that of the burden of proof.  Under an all-risk policy, the insured must only show a prima facie case of physical loss or damage, and the burden then shifts to the insurer to demonstrate an applicable exclusion.  Under a named peril policy, however, the insured must not only demonstrate a physical loss or damage loss and that the property is covered under the policy, but also that the loss was caused by a named peril.

The fortuity requirement is the one exception to the principle that when coverage is written on an "all-risks" basis, all loss or damage to covered property is insured unless specifically excluded. This is the requirement that a loss must happen by chance for coverage to apply. 

Courts have found it contrary to public policy and violative of basic insurance principles to permit insurance recovery for losses that are certain to occur.  As a result, the "fortuity" doctrine serves as a threshold to coverage in many first-party insurance claims. Under builders risk policies, the loss or damage, rather than the acts causing the loss or damage, must be unexpected at the time the policy is issued.

Cross Reference: The fortuity requirement is further discussed in Chapter 1.

Section 50.02[3] discusses some of the more typical builders risk policy exclusions.  By far the most important exclusion in the builders risk context is that known as the "defective or faulty workmanship" exclusion.  The premise for this exclusion is that insurers do not want to incur the costs of repairing or correcting faulty work, as such costs are considered a risk of doing business. Because the exclusionary language varies so much among policies, it needs to be reviewed very carefully.  In addition, courts do not agree on what conduct constitutes defective workmanship.  Some find the exclusion ambiguous, while others do not interpret identical language in the same fashion. 

Generally, faulty workmanship exclusions can be grouped into two categories.  The first category consists of those exclusions that do not include an "ensuing loss" provision.  If the faulty workmanship exclusion does not have an ensuing loss provision, and faulty work results in physical loss or damage to other property in the project, both the cost of repairing the faulty work and the resulting damage to other property are excluded from coverage.  The second category consists of those exclusions that include an ensuing loss provision. Typically, if the faulty workmanship exclusion has an ensuing loss provision and faulty work results in physical loss or damage to other property, the cost of repairing the faulty work is excluded, but the resulting damage to other property is covered. 

Section 50.02[3] also discusses several other exclusions. Among those are defective design or specifications; latent defect or inherent vice; earthquake or volcanic activity; flood; mudslide; sewer or drain backup; pollution; wear and tear; ordinance or law enforcement; guaranty or warranty; mechanical or electrical breakdown; intentional acts; employee dishonesty or infidelity; liquidated damages; asbestos; mold, mildew, or rust; fungus or wet rot; and delay and consequential loss; among several others.

Section 50.02[4] provides an analysis of exceptions to builders risk policy exclusions.  Builders risk forms currently in use include many exceptions to exclusions, with language varying significantly among the forms used by different insurers. In general, these exceptions can be broken down into three distinct categories. The first consists of ensuing loss or damage exceptions. The second includes "cost of making good" exclusions with "damages resulting from" exceptions. The third category includes "peril or physical damage not excluded" exceptions.

Section 50.03 analyzes builders risk policy coverage extensions. Generally speaking, a builders risk policy has a similar structure as a typical property policy, which includes sections containing extensions of coverage and additional or optional coverages.  Unlike the coverages falling under the "all-risk" form of policy, these coverage extensions often have several common factors, which include being subject to sublimits of liability, possibly being excess to other insurance placed on the risk, and complementing policy limitations and exclusions.  While many of the coverage extensions are similar in nature, there is little uniformity among policies issued by different insurance companies.  In analyzing these extensions, it is imperative that the policy language be reviewed closely.

The transit extension of coverage applies to property materials from the point of shipment to unloading at the project.  This extension typically excludes property in the course of manufacturing and is subject to sublimits.  Upon arrival and unloading at the project site, the property coverage then transfers to the builders risk form with its separate limits.  Temporary structures coverage is another popular coverage extension.  This coverage frequently applies to subcontractors' materials, equipment and supplies even when the subcontractors are not insured under the builders risk policy.

The builders risk coverage extension for collapse is similar to the named peril extension commonly seen in commercial property or personal lines property policies.  This extension typically takes the form of a named-peril coverage extension that specifically exclude settling, cracking, shrinking, bulging, or expansion.  Litigation involving the collapse extension often involves interplay with the policy exclusions for faulty workmanship.

The debris removal coverage extension provides coverage for clearing away debris resulting from a covered loss.  A frequently litigated issue is whether this extension is limited to removal of covered property itself, or includes removal of damaged property used in the course of construction but not built with the purpose of integrating the property into the final product. Courts addressing this issue have generally held that the debris removal provision includes the cost of removing debris that may not necessarily be covered property.

Another popular coverage extension is delay in completion, or "soft costs" coverage.  Delay coverage may also be referred to as "time element" coverage because the size of the loss for many types of covered losses is directly impacted by the length of the delay.  In most builders risk policies, virtually all of the estimated costs for completing the project are built into the estimated completion value of the project and are included under the policy's basic coverage for damage to the project.  For example, if a fire causes covered damage to the partially completed building, the policy will cover not only the costs of labor and materials required to repair or replace the damaged property, but the cost of the insurance, overhead, and contractor profit involved in that repair or replacement.  This coverage exists in the policy's basic coverage for damage to the project, not in the policies "soft costs" coverage. In builders risk insurance, "soft costs" coverage only comes into play when a covered loss results in a delay, and then it refers only to additional amounts incurred for the specified types of expenses as a result of the delay.

James P. Bobotek, a Senior Associate with Pillsbury Winthrop Shaw Pittman LLP in Washington, DC, concentrates his practice on a variety of insurance coverage, risk management and risk allocation issues, with an emphasis on those arising in the construction industry.  A frequent speaker and author on construction-related insurance coverage issues, Mr. Bobotek regularly assists policyholders in analysis, litigation and resolution of insurance coverage claims and disputes.  Mr. Bobotek counsels clients in formulating risk management strategies, obtaining insurance cover, and developing contractual insurance requirements.  He also represents owners, developers, and contractors in preparation, review and negotiation of development, design, construction, and related agreements.

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