1 BUILDER S RISK: AVOIDING COSTLY LESSONS MARCH 19, 2014 Jonathan McAnally Marsh Eric B. Smith Marsh Vincent Zegers Marsh Jeffrey J. Vita Saxe Doernberger & Vita, P.C. Atlanta, GA
2 Program Agenda Speaker introductions Often misunderstood coverages and illustrations Who should place the builder s risk policy? Successful placement recommendations Advice for owners/developers, contractors, and subcontractors Preparing for a favorable claim outcome Questions and answers Closing
3 Why Builder s Risk? Purpose: To protect insureds against damage and resulting loss to work in the course of construction, before it is accepted and delivered to the owner
4 Builder s Risk Two Key Policy Types: 1) All-risk coverage insures against all risks of loss except for those specifically excluded 2) Specified peril covers only those risks specifically enumerated within the policy -- The type of coverage acquired determines the burden of proof when coverage is disputed
5 Builder s Risk Three Key Elements: 1) Loss from Direct Physical Loss 2) To Covered Property 3) Caused by a Covered Cause of Loss
6 Direct Physical Loss Policies often require direct physical loss Sticks and bricks Most common: property that must be repaired or replaced
7 Direct Physical Loss Other Losses Sometimes Covered: Boiler & Machinery losses from mechanical breakdown Ordinance or Law losses when changes are required by a government entity Hot and Cold Testing Expediting Expenses overtime and other costs incurred Sue and Labor Coverage costs incurred to mitigate damages or prevent future damages Debris Removal Soft Costs
8 Important and Often Misunderstood Coverage Features Hard costs versus soft costs coverage At what time can you (re)incur those costs following a covered event under the BR policy and how much of the original soft costs should be allocated to the amount insured?
9 What Are Soft Costs? Additional costs made necessary due to delay in opening or delay in completion due to damage by an insured cause of loss Soft costs include additional interest expense, property taxes, advertising/marketing expenses, and continued general overhead In comparison, hard costs represent the amount it would take to physically repair or replace damaged or destroyed covered property
10 What Are Business Income Losses? Loss of anticipated income (such as rental income) that an owner would normally begin earning had the project been completed or opened on time
11 Soft Costs v. Business Income Soft costs and lost business income are NOT mutually exclusive Soft costs involve added economic expenses that result from property damage, while business income involves lost profits or revenues due to the delay in completion When property damage occurs, the owner often experiences both added soft costs and loss of business income Owner may have a need for both Soft Cost and Business Income (delay in completion) coverage
12 Increased Construction Costs Zurich v. Keating NJ Federal Court Tropicana garage collapse Project halted for 3 months and construction re-sequenced Contractor incurs Extended general conditions Delay charges Increased prices Court says: covered as a risk of physical loss or damage
13 Increased Construction Costs Oceanside Pier View, LP v. Travelers CA Federal Court Mixed-use building, shoring wall fails Construction interrupted, completion date delayed Contractor incurs Costs to redesign and repair shoring wall Increases to GMP Increased financing, fees and general conditions Court says: policy covers buildings being erected, not the unforeseen cost to build never-before constructed buildings
14 Flood & Windstorm Sub limit for named windstorm/earthquake/flood When a delay in start-up extension is covered under the BR policy would that amount insured for DSU be included under that specific sub limit? Yes, the DSU amount is included
15 Flood & Windstorm Houston Convention Center Houston Convention Center 429 F.3d 52 (2 nd Circuit.2005)
16 Specific v. General Policies Builders risk primary policy: Do you think that a specific builders risk policy should pay covered claims irrespective if there are other policies covering the same interest? Yes, a builders risk policy is a specific policy for the construction of the project and should be issued on a Primary basis without referring to any other policy covering the same interest (whether collectable or not)
17 Miscellaneous Issues Occupancy: While coverage for (early) occupancy can be granted through an endorsement is a potential loss of revenue/rent covered as well for earlier completed units? No, not if the trigger date has been adjusted to reflect a potential earlier completion date for certain units Cancellation features: Do you think that a builders risk policy should be non-cancelable by insurers (except for non-payment of premium)? Yes, a BR policy is designed to protect the Named Insured(s) for the entire duration of the construction term.
18 Exclusions Builders risk coverage is not standardized Excluded losses vary from policy to policy Common and critical exclusions include: A. Faulty Workmanship B. Subsidence Earth Movement C. Design/specifications D. Consequential damages
19 Faulty Workmanship Example 1 FAULTY WORKMANSHIP, MATERIAL, CONSTRUCTION OR DESIGN Example 2 The cost of making good or rectifying faulty or defective workmanship, material, construction or design We will not pay for loss caused by or resulting from any of the following: Defective, deficient or flawed workmanship or materials, or for expenses to redesign or revise flawed or defective plans or architectural designs.
20 Faulty Workmanship Typically undefined by the policy Courts say: Flawed quality of finished product Flawed process of construction Does not include equipment malfunctions May be ambiguous depending on facts
21 Faulty Workmanship Case Study The Scratched Glass Loss As high-rise condo project was nearing completion, a window washing company hired to remove dust, dirt and debris from the project windows, scratched a large % of the windows with abrasive cleaning cloths. Approximately $2 Million in damages Builder s risk insurer claimed that loss was excluded as faulty workmanship. Is window cleaning considered workmanship is it a product, is it a process? How far will courts stretch the meaning of the term workmanship?
22 Faulty Workmanship Case Study Otis Elevator v. Factory Mut. Ins. Co. [T]he term faulty workmanship does not encompass the damage at issue. The tram itself was not faulty workmanship in the sense 353 of F.Supp. a flawed2d product 274 because (D. Conn it already 2005) had been completed at the time of the accident. The tram was not a flawed process because the construction of the tram already was complete... By either definition of faulty workmanship, defendant s claim that the tram is faulty workmanship when sent at full speed, overloaded and without brakes, is forced. The accidental property damage to the tram cannot be termed faulty workmanship. It is simply accidental damage resulting from subcontractor negligence unrelated to the...as one court has observed, if subcontractor-fault were entirely excluded as a covered peril, the all risks peril expressly insured would Project involved the installation of an automated people mover at a large airport. Two tram cars, a buffer, and an airport wall were damaged during the testing of a tram, which mistakenly did not have the secondary breaks activated. The resulting claim under the project builders risk policy was rejected by the insurer quality as faulty of any workmanship. product or process. The court held that the failure to properly set the tram s breaks did not constitute workmanship become perilously and thus was close not excluded: to a policy insuring no risk.
23 Faulty Workmanship Ensuing Loss Exception Ensuing Loss Provisions But if loss from a Covered Cause of Loss results, we will pay for the resulting loss. but does that include the defective part itself when physically damaged?
24 Faulty Workmanship
25 Faulty Workmanship
26 Faulty Workmanship
27 Guidance on Who Should Secure Builder s Risk Coverage Which party bears contractually the risk of loss? Will there be a delay in start-up extension covered under the BR policy? Are there any phased handovers contemplated prior to the final completion date? Could this risk be covered under the owner s master fixed property program? Could this risk be covered under a master builders risk program in place through either the owner or general contractor (advantages and disadvantages of master programs). Best Practices: Foster a collaborative approach to structuring the most appropriate coverage and limits. Handling of insured and allocation of deductibles under the policy.
28 Guidance on Who Should Secure Builder s Risk Coverage Stand-Alone Builder s Risk v. Master Builders Risk Approaches
29 Key Elements of a Successful Placement Strategy If possible, start the process at an early stage Check the insurance requirements and if there are any ambiguous requirements circle these back to the owner/lender for clarification Fill out the BR application form as much as possible so there is no or little room for interpretation Check all the boxes (including all of the above) so you have not missed anything Ask for a pre-agreed Loss Adjuster so that in case of a claim all parties know who to engage If you have not secured the BR policy yourself ask for evidence of insurance by getting a copy of the Binder and eventually the BR policy (including all endorsements)!
30 Key Elements of a Successful Placement Strategy Review entire contract, including Exhibits, Appendices, etc. Analyze project exposures, don t rely solely on completing application. Project data is critical: Construction Budget Examine for critical lead-time items. Remove uninsurable items. When contractor purchasing cover, should owner-supplied items to be contemplated? Construction Schedule Identify critical phases of project. In multi-phase projects, separate delay triggers can exist. Is permission to occupy completed phases/project needed? Site Plan/Project Layout Identify potential off-site storage/laydown areas. If renovation or installation, address exposure to existing property. Pro Forma Income Statement/Delay Costs What is project income less non-continuing operating expense? Estimated length of delay? Items requiring lead time?
31 Designing a Comprehensive but Efficient Program If project and/or storage areas are exposed to flood, NFIP coverage is available. If project is exposed to hurricane or earthquake: Utilize RMS Risklink or AIR to determine loss estimates. Where possible, separate phases within the project to minimize exposure to windstorm season. Remove various off-the-shelf policy restrictions Interior water damage exclusions. Include permission to occupy. Automatic extension of policy term/non-cancellation of policy. Pre-Loss Claims Reporting and Adjustment Process. If you are an Additional Insured on the owner/contractor policy, request a copy of policy wording.
32 Suggestions for Owners Named insured Collaboration Sharing of policy document Claims & deductibles
33 Suggestions for General Contractors Insured status Collaboration regarding coverage Policy documents Claims
34 Suggestions for Subcontractors Insured status Obtain copy of policy Claims
35 Submitting a Claim Timeliness of claim reporting Appropriate claim submittal content Forensic accounting support Insurer negotiations, strategies relating to disputes
36 Tips for Successful Claims Strategy Carefully review BR policy Give prompt notice Comply with policy s conditions (proof of loss, exam under oath, appraisal) Beware of contractual limitation of action provisions (typically 1 or 2 years from date of loss) Describe facts based on coverage terms in policy Challenge denials
37 San Francisco Fire March 11, 2014
38 THANK YOU! Eric B. Smith Marsh Jonathan McAnally Marsh Vincent Zegers Marsh Jeffrey J. Vita Saxe Doernberger & Vita, P.C
39 Marsh is one of the Marsh & McLennan Companies, together with Guy Carpenter, Mercer, and Oliver Wyman. This document and any recommendations, analysis, or advice provided by Marsh (collectively, the Marsh Analysis ) are not intended to be taken as advice regarding any individual situation and should not be relied upon as such. This document contains proprietary, confidential information of Marsh and may not be shared with any third party, including other insurance producers, without Marsh s prior written consent. Any statements concerning actuarial, tax, accounting, or legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as actuarial, accounting, tax, or legal advice, for which you should consult your own professional advisors. Any modeling, analytics, or projections are subject to inherent uncertainty, and the Marsh Analysis could be materially affected if any underlying assumptions, conditions, information, or factors are inaccurate or incomplete or should change. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Except as may be set forth in an agreement between you and Marsh, Marsh shall have no obligation to update the Marsh Analysis and shall have no liability to you or any other party with regard to the Marsh Analysis or to any services provided by a third party to you or Marsh. Marsh makes no representation or warranty concerning the application of policy wordings or the financial condition or solvency of insurers or re-insurers. Marsh makes no assurances regarding the availability, cost, or terms of insurance coverage. Copyright 2014 Marsh LLC. All rights reserved. [MA ]
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