Advanced Analysis of Builders Risk Coverage and Claims

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1 Advanced Analysis of Builders Risk Coverage and Claims Presented By: Alejandra Evans Managing Director Aon Construction Services Group Tracy Alan Saxe Partner Saxe Doernberger & Vita, P.C. Colin Daigle Managing Director Marsh USA Inc.

2 Agenda Past Events that Drove Builders Risk Claims Why Builders Risk? Coverage Causes of Loss & Exclusions Pre-Loss Preparation Claim Response and Recovery

3 Past Events that Drove Builders Risk Claims Major Catastrophes Problems Encountered Lessons Learned

4 Why Builders 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

5 Key Builders Risk Considerations Who is Covered and for How Long? What is Covered? Uncovered Losses/Exclusions Limits/Sublimits Valuation Other Relevant Issues Policy Period Subrogation General Advice and Tips

6 What is Covered? Three Key Elements: 1) Loss from Direct Physical Loss 2) To Covered Property 3) Caused by a Covered Cause of Loss

7 What is Covered? Direct Physical Loss Policies often require direct physical loss Sticks and bricks Most common: property that must be repaired or replaced

8 What is Covered? Direct Physical Loss Other Losses Sometimes Covered: Boiler & Machinery losses from mechanical breakdown Ordinance of 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

9 Purely Economic Losses Not Covered Example: The installation of building materials that are not in compliance with contract specs Exception higher building costs resulting from direct physical loss should be covered Compare Keating with Oceanside

10 What is Covered? Covered Property Sample policy provision: 1. COVERED PROPERTY Covered Property means your property or the property of others. a. a permanent part of the project, while such property is at the job site b. Temporary structures, meaning scaffolding, construction forms, falsework, cribbing and other temporary structures at the job site described in the CNA LEGACY BUILDERS RISK 2005

11 Locations of property to be covered Policies cover property located on-site Policies often provide additional limited coverage (i.e. subject to policy sublimits) for (a) off-site materials and equipment, and (b) property materials and equipment in transit

12 Excluded Property Damage to existing property Exception needed where project includes renovation of existing structure Damage to property outside of the coverage territory Land Tools, equipment not to become a permanent part of the project Money, securities Lawns, sod, trees, shrubs, etc. Auto, vehicles LEX-PBR 2005 ACE 0219 (01/05)

13 Covered Cause of Loss 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

14 Uncovered Losses/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

15 Who is Covered? Owners, Contractors, Subcontractors, Others The Owner is typically the named insured, while others such as contractors, subcontractors, and financial lenders can be added as additional insureds Slide 19

16 Who Purchases Builders Risk? Owner? Contractor? Subcontractor? In most cases coverage is purchased by the Owner

17 Named Insured Builders risk policy wording usually, but not always, indicates that the Named Insured is responsible for the payment of deductibles Policy may define you and your as the Named Insured and thereafter provide that you are responsible for payment of the deductible When policy language is silent, it is possible that an additional insured may be held accountable for a deductible related to a claim submitted by the additional insured

18 Faulty Workmanship Typically not defined Can be considered Faulty Product or Faulty Process or both LEG I LEG II LEG III American Form

19 All Risk Coverage ALL RISK

20 Faulty Materials Exclusion ALL RISK Faulty Materials

21 Physical Damage Requirement 32 ALL RISK Faulty Materials

22 33 Faulty Materials Exclusion Broken Frames Broken Purlins ALL RISK Faulty Materials Damaged Electrical Conduits

23 Physical Damage Requirement 34 Broken Frames Broken Purlins ALL RISK Faulty Materials Damaged Electrical Conduits

24 Faulty Materials Exclusion and Resulting Damage Coverage excludes: faulty workmanship, material, construction, or design from any cause. covers: if physical damage not excluded by this policy results [from faulty materials], then only that [not excluded] resulting damage is insured * insurer not paying for costs to replace Faulty Materials only for resulting damage 35

25 Faulty Workmanship Some courts consider Faulty Workmanship ambiguous and construe the exclusion in favor of the insured, limiting the term to product or process, whichever is advantageous to the policyholder Some Courts alternatively find Faulty Workmanship to be unambiguous, finding that it precludes losses associated with faulty product or process Review language of exclusion to see if other words infer a product or a process Generally requires covered cause to be separate and distinct from the excluded loss

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27 Ensuing Loss Provisions Example of Covered claim Faulty construction (excluded) leads to infiltration of rain water (covered) which then causes damage (covered) Example of Excluded claim Defectively poured concrete resulting in damage because inspector did not properly test the concrete (No resulting covered cause of loss)

28 Subsidence Earth Movement Rapid v. gradual Man made v. naturally occurring event

29 Design Distinguish damage due to design work from damage due to improper implementation of design Importance of corresponding Professional Liability insurance

30 Consequential Damages Delay, loss of use, loss of market Direct v. Indirect damages Physical v. Non-physical

31 Anti-Concurrent Provisions Some exclusions contain anti-concurrent/antisequential language which preclude coverage even when the exclusion is not the proximate cause of loss May act to preclude coverage where particular cause of loss contributes to damage, whether or not such cause is a proximate, or dominant cause Sample Language: [The policy] shall not pay for loss, damage or expense caused by, resulting from, contributed to or made worse by any of the following, all whether direct or indirect, proximate or remote or in whole or in part caused by, contributed to or aggravated by any physical loss or damage insured by this Policy.

32 Exclusions Other exclusions contain exceptions for covered causes of loss that ensue from the excluded cause of loss (i.e. an ensuing loss )

33 Time Element Coverage Time Element Coverage (Soft Costs and Business Income) is it included?

34 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, and advertising expense In comparison, hard costs represent the amount it would take to physically repair or replace damaged or destroyed covered property

35 Sue and Labor Both an Obligation and a Right Covers cost associated with mitigation of damages Provision sometimes called Expense to Reduce Amount of Loss or Preservation and Protection of Property

36 Sue and Labor General Conditions: Must protect against a potential future insurable loss benefit to the insurer Actual damage required (in certain jurisdictions) Focus is upon In case of loss or damage, it shall be lawful and necessary for the INSURED to sue, labor and travel for, in and about the defense for determination that actual damage is necessary Reasonably imminent threat of damage required (in other jurisdictions) Reasonable in Scope (preventative measures must not be excessive)

37 Specified Peril Deductibles and Sublimits Commonly applied to high risk and/or high cost causes of loss including: Hurricane Earth Movement Collapse Wind Flood Soft Costs High deductibles and low sublimits can significantly marginalize coverage

38 % Based Deductibles % of loss Often ambiguous % of total project value (at time of completion, or at time of loss) % of segment of project being worked on (such as in a multi-phased project)

39 Valuation Replacement Cost Replacement cost affords compensation for the damaged property without deduction for depreciation Usually requires damaged or destroyed property to be replaced with property of comparable material and quality Compensation for damaged property which includes deduction for depreciation In builders risk context, such deduction is usually of minimal consequence given that there is little depreciation with respect to new construction Most relevant when damaged property is irreplaceable or difficult to replace

40 Subrogation Issues Subrogation allows an insurer to stand in the shoes of its insured and seek recovery against a third-party for losses paid to its insured under the builders risk policy Project owners and contractors typically wish to avoid subrogation claims, as they can be the targets of an insurer s subrogation action Subrogation causes distraction and strife between project team members

41 Subrogation - ATIMA Certain builders risk policies only provide coverage to additional insureds as their interests may appear ( ATIMA ) Insurers may rely upon this language in order to subrogate against an additional insured on the basis that the additional insured does not have an interest covered by the Builders Risk policy in the property that was damaged A. No coverage for liability claims, because AI s interest concerns first party losses B. Insurable interest limited to property/work which AI contributes

42 Subrogation Circumventing ATIMA Release of liability of contractors and subcontractors in construction contract Contractual provision utilized to preclude an insurer s right of subrogation, including ATIMA defense Release of Rights of Recovery (when adequate insurance exists) Waiver of Subrogation in Insurance policies Listing parties as Named Insureds instead of Additional Insureds Removing ATIMA language altogether Insurer may argue that subcontractor cannot rely upon contractual subrogation waiver when it has breached its contract by causing the property damage Minority perspective, but cannot be ignored

43 Waiver of Subrogation Waiver of subrogation can be included in insurance policy, as opposed to (or in addition to) release of rights of recovery found in construction agreement Objective is to have insurer waive any rights of subrogation against a project owner, contractor, or subcontractor, without any exceptions or loopholes No Rights LEX-PBR 2005

44 Duration of Coverage Project completion? Final payment? Acceptance of project by owner? Certificate of occupancy issued? ACE0219 (01/05) CP 20 04

45 Pre-Loss Preparation

46 Pre-Loss Preparation The Contract The Contract stipulates performance on the project and is therefore essential in managing performance. In a claim situation, the contract will be considered vs. the policy.

47 Pre-Loss Preparation Project Documentation Goal: Document the Project Record to mitigate risk and enhance communication Reduces subjectivity of opinions Clear understanding of what s included Safeguard Records

48 Pre-Loss Preparation Project Cost & Budget, Pre-Construction Accurate Cost Estimate, Tied to Schedule of Values Determine the methods to track and report progress, and the frequency of updates and distribution Clear explanation of change order procedures Determine payment application process and documentation

49 Pre-Loss Preparation

50 Pre-Loss Preparation The Project Schedule Promotes logical thinking and alternatives Determines resources Tracks progress Identifies delays Facilitates recovery Meets legal proof requirements.

51 Pre-Loss Preparation Majority of delaying events uninsured Uninsured Events contractor delays, weather, owner changes, force majeure Insured Events delay in start-up, physical loss or damage (e.g. delay caused by faulty turbine during commissioning of Power Plant)

52 Pre-Loss Preparation Risk Exposures to Consider / Recovery Impacts Stipulated Construction Methods not Followed Ex.) concrete finishing Contractor Implements Unapproved Discount Alternatives Ex.) Less expensive method/item used by contractor than agreed

53 Pre-Loss Preparation Risk Exposures to Consider / Recovery Impacts Contract Allowances are Not Accounted for True up actual cost or value Price Includes Exempt Sales Tax Ex.) Gov t provides exemption for materials cost for pollution reduction design

54 Pre-Loss Preparation Consider A Loss Measurement Team Risk Manager On-site Construction Manager / Foreman In-house finance/accounting appointee Insurance Policy Consultant Forensic Accountant with Claims Expertise Forensic Engineer Independent Construction Specialist / Scheduler Attorney Other Specialists as required

55 Claim & Recovery Duties in the Event of a Loss Life Safety Notify police if a law may have been broken. Notice to Insurance Co.; Provide details. Protect covered property from further damage. Communicate and seek approval from Insurance Co. for loss related payments.

56 Claim & Recovery Duties in the Event of a Loss Allow adjusters to inspect damage, take samples, inspect books & records. Certify claim or loss events under oath/send signed and sworn Proof of Loss. Notify insurance company of demands, summons, claims related to the loss. Cooperate with insurance co in settling the claim.

57 Claim & Recovery Initial Claim Actions Activate the Loss Measurement Team Assign Responsibility for gathering data Insure that critical records are properly safeguarded Develop and maintain detailed asset inventory Who will quantify the damages Communication protocols

58 How to Quantify Damages - Key Elements Building Cost of Repairs Invoices with Labor and Material Formal Appraisal Business Personal Property Actual replacement costs Do not use book value Inventory Claim & Recovery Last physical inventory plus purchases less sales

59 Claim & Recovery How to Quantify Damages - Key Elements Property Damage Ongoing project-same vendors do repairs Cash flow: pay app v. insurance reimbursement Business interruption Length of indemnity period Projecting revenue streams / profits Contractual obligations: incentives, penalties Extra expense Projected normal costs Operating inefficiencies & Expediting costs

60 Claim & Recovery Pre-Loss Challenge to Claim Calculations Claim for costs incurred as a direct result of a covered event. Claim preparation may require analysis to remove added costs resulting from the owner or contractors performance, not precipitated by the loss event.

61 Claim & Recovery How to Quantify Damages - Tactical Establish Special Work Orders, Job Numbers, General Ledger Accounts, and Other Accounting Procedures to Identify and Capture All Claims Costs Examples of claim cost categories include: Protection and preservation Temporary repairs and replacement Permanent repairs and replacement Extraordinary and expediting expenses

62 Claim & Recovery How to Quantify Damages - Tactical LABOR: Separate overtime pay Straight time labor will go into the property damage claim, overtime usually will go into the time element claim. It is possible to get the adjuster to agree to compensate for salaried repair labor before a loss occurs

63 Claim & Recovery How to Quantify Damages - Tactical DELAY: Determination of delaying event Critical path analysis Delay analysis techniques Could be insured, uninsured or both Outcome contractor damages and/or owner levied liquidated damages and/or DSU claim against insurer

64 Claim & Recovery

65 Claim & Recovery

66 Key Reminders Give prompt notice Claim & Recovery Comply with policy s conditions (proof of loss, examination under oath, appraisal) Beware of contractual limitation of action provisions (typically 1 or 2 years from date of loss)

67 Tips Understand the project, your company s role, and exposure Carefully review the construction contract Carefully review the Builders Risk policy Ask questions!

68 Questions Alejandra Evans Tracy Alan Saxe Colin A. Daigle