HOT TOPICS IN MULTI-USE BUILDINGS: INSURANCE, CONSTRUCTION AND DEVELOPMENT Philip K. Glick, CPCU, RPLU Two Liberty Place 50 S. 16 th Street, Suite 3600 Philadelphia, PA 19102 P: 267-702-1374 C: 610-551-4734 pglick@connerstrong.com INTRODUCTION AND OVERVIEW 1. Substantial increase in mixed use construction and development projects over the last several years. 2. Resulting potential increase in the range of operations, tenant exposures and resulting property and liability insurance claims. 3. Need to identify and then avoid potential gaps in insurance coverages needed. 4. Alternative approaches to structuring insurance coverage on a combined basis. 5. Managing potential claims and coverage complications arising from multi use projects. 6. Insuring frequently uninsured or unique exposures. 7. Insuring pure economic loss. 2 I. OVERVIEW OF SIGNIFICANT COVERAGE RESTRICTIONS A. General Liability Insurance 1. Recent Insurance Industry Coverage Changes: a. Several restrictive coverage endorsements have been introduced by the Insurance Services Office (ISO), an insurance industry organization that provides standard policies and endorsements. b. ISO now caps the limit of coverage extended to another party as an additional insured to the limit agreed to in the contract between an owner and general contractor or by a subcontractor to a general contractor. c. ISO now also limits contractual liability coverage extended to another party in accordance with state anti-indemnity statutes. 3 1
I. OVERVIEW OF SIGNIFICANT COVERAGE RESTRICTIONS A. General Liability Insurance d. Some insurance companies may limit their coverage for a specific contractor working on new mixed use projects such as: i. Excluding coverage for structural alterations. ii. Excluding coverage for demolition work. iii. Not covering residential projects particularly condominiums or for sale townhomes. iv. Not covering work in the five (5) boroughs of New York City. v. Imposing a height limit on work done. vi. Excluding or limiting coverage for claims for injuries of an employee of a subcontractor. 4 2. Insuring Construction Defects a. Coverage is largely dictated by state law as it interprets whether a general liability policy will cover all or part of loss due to defective workmanship. b. In most cases, coverage only applies for property damage caused by work performed by a subcontractor on the insured s behalf or the defective work of the insured contractor itself. c. Coverage for ensuing loss to other property due to defective work may be covered. d. In PA the courts have specifically stated that loss due to defective work including related consequential loss, even if caused by another contractor, are not considered an occurrence and so not insured (see Kvaerner and Gambone court decisions). 5 e. Fixing this gap in liability coverage by adding a specific endorsement: i. Kvaerner Endorsement; or ii. Amended definition of occurrence endorsement. iii. Need to add a similar endorsement on any Umbrella or Excess Liability Policy. f. Always need to determine what and when is an occurrence: i. Impact of a loss taking place after construction is complete. ii. Will there be coverage in place for a loss that occurs at some point in the future? iii. Including contractual language requiring future continued insurance coverage and indemnification. 6 2
g. Optional approach is for the Owner/Developer to purchase a project specific general liability and umbrella liability policy on the project to cover its interest on future claims including: i. Dedicated limits of coverage for the entire project construction period. ii. Fixed premiums and coverages over the entire construction term - as long as two (2) years or more. iii. Construction defects coverage can then be included for an extended period of time after construction is completed up to the shorter of the applicable state statute of repose or twelve (12) years. 7 h. Complications of Mixed Use Projects i. Construction defects claims continue to be a persistent problem in condominium projects such as from: - Bursting pipes or leaking sprinklers in upper residential floors causing damage to contents and improvements and betterments of office or rental tenants on lower floors. - Increased claims complications when other condo unit owners and tenants are insured with different insurance companies. - A small fire or water damage claim in a single residential condo unit or apartment can cause significant damage including loss of use to a commercial condo unit owner or another commercial tenant in the building. 8 ii. Solutions can include: - Requiring a waiver of subrogation endorsement on the property insurance for each condo owner or tenant to eliminate various property cross claims. - Including a waiver of subrogation endorsement on the General Liability policies for each owner and/or commercial tenant to avoid conflicts and extensive litigation. - Need to require and verify that any contractor working in any area of the project has adequate job site and construction defects coverage so that any ensuing losses are covered to protect each tenant or unit owner. 9 3
3. Avoiding Other Gaps in General Liability Coverage a. Need to avoid any limitations on type, location or scope of work. b. No limitations or exclusions regarding claims. i. By employees of contractors on the job. ii. For claims arising from uninsured or underinsured subcontractors. Potential for additional premiums that may be payable by a general contractor or project developer in the event its subcontractor s are not adequately insured; or Potential for a deductible or increased deductible to be payable by a general contractor (or owner) for claims against them due to gaps in a contractor or subcontractor s liability policy. 10 B. Property Insurance Including Installation Floater and Builder s Risk Coverages 1. Basic Form of Coverage a. Installation Floater Covers interior work or additions to a building. b. Builder s Risk Covers new ground up construction and renovations to a building shell plus coverage on the new work or renovations. c. Need to coordinate property coverage during construction or renovations to cover the interests of all owner(s) and tenant(s). 2. Valuation a. Coverage can be for full replacement cost new for old. b. Actual Cash Value = Replacement Cost less depreciation. c. Stated Value Specific agreed limit such as for existing old building shells. 11 B. Property Insurance Including Installation Floater and Builder s Risk Coverages, Continued 3. Covering Broad Insured Perils a. All Risks or so called Insured Perils specific coverage may still not cover: - Backup of sewers and drains. - Underground water damage. - Flood and Earthquake. - Full Collapse vs. Imminent Collapse Coverage. 12 4
B. Property Insurance Including Installation Floater and Builder s Risk Coverages, Continued 4. Limits of Coverage Needed a. Building shell. b. All improvements including equipment to be installed under the direction of the owner / property developer. c. Property while in storage and transit. d. All additional furniture and fixtures and other equipment. e. Covering tenant or condo unit owner(s) custom upgrades. f. Covering potential additional costs due to building code upgrades that may apply to repairs after a fire or other insured loss. 13 B. Property Insurance Including Installation Floater and Builder s Risk Coverages, Continued 5. Covering Other Related Economic Loss a. Soft costs following a physical damage to the building during construction including: i. Additional construction loan costs and interest payments. ii. Additional architect or engineering fees. iii. Additional insurance premiums, property taxes, utilities and other operation costs. iv. Additional marketing, legal, accounting and other fees. 14 B. Property Insurance Including Installation Floater and Builder s Risk Coverages, Continued 5. Covering Other Related Economic Loss, continued b. Prospective loss of rents or delay in completion costs. i. Foregone rents reflecting signed leases or expected signed leases and loss of income during repair or rebuilding period. c. Extra expenses incurred to get back on schedule after a property loss. d. Special additional financing related exposures such as for any historic tax credits. e. Coverage for LEED and other Green Building Certification Expenses. f. Need to project, quantify and then insure prospective income losses for each distinct area of a mixed use project. 15 5
II. POTENTIAL COVERAGE AND CLAIMS RELATED ISSUES ARISING FROM MIXED USE PROJECTS A. Town Center Project 1. Combined condo structure with ground floor retail set up as a commercial condo unit. 2. Upper floors Set up as a second residential condo association with its own policy and each condo unit owner buying a condo homeowners policy. 3. Possible property insurance solution by having all risk property coverage written in one policy for all building structures and including commercial tenants alterations and additions and common elements of the residential condominium association. 16 II. POTENTIAL COVERAGE AND CLAIMS RELATED ISSUES ARISING FROM MIXED USE PROJECTS A. Town Center Project 4. Coordinating property coverage needed for all owners / tenants. a. Setting property deductible levels for each owner. b. Including a waiver of subrogation and liability between all parties related to property coverage placed for the building elements and their own contents coverages. c. Clear documentation defining the common elements / areas that will be insured jointly. 5. Requiring each party to carry General Liability insurance and adding the other entities as Additional Insureds for claims brought against each other if due to the other s negligence. 6. Including waiver of subrogation endorsement on each party s Liability coverage. 17 B. Medical Office Tower Over Parking Garage and over First Floor Retail Space 1. Common first floor lobby with common elevator service all three (3) elements. 2. Complications Ownership / Maintenance and Insurance. a. Elevators going through all three (3) units. b. Building electric, plumbing and HVAC shared by all unit owners. c. Managing security issues between three (3) separate elements. 3. Insurance solutions including: a. Placing all risk property insurance on all combined real property and alterations and improvements. b. Requiring broad general liability and adequate umbrella coverage from each separate unit owner or user. c. Owner requiring additional insured endorsement with waiver of subrogation endorsements on each separate owner s / tenant s liability policy. 18 6
C. Combined Condo Association with Two (2) Units Including Residential Condo Association as One Unit and Separate Office Building as Another Condominium Unit 1. Combined maintenance provided for both tenant exposures. 2. Combined security operations. 3. Insurance coverage on all common elements placed for the combined condo association s building. 4. General Liability coverage placed under: a. One Policy insuring all common elements. b. Separate policy for residential condo owner for its operations. c. Separate policy for the interior space of the office unit. 19 D. Residential Condo Association Over First Floor Retail Space with Separate Parking Operations 1. Shared lobby and elevator service. 2. Parking operations. a. Used by residential unit owners for separate monthly fee. b. Used on hourly basis by customers of retail tenants. 3. Shared insurance solutions similar to mixed use projects in A. and B. above with coordination of property insurance and general liability insurance needed. 20 III. USE OF WRAP-UP INSURANCE PROGRAMS TO MANAGE LIABILITY COVERAGE AND REDUCE COSTS FOR NEW CONSTRUCTION OR RENOVATION PROJECTS A. Overview of Wrap-Up Approach 1. The owner, construction manager or general contractor purchases the workers compensation, general liability and excess liability coverage for all contractors working on the job site. This modifies the traditional insurance approach, which is that the owner requires all contractors to provide workers compensation, commercial general liability and excess liability for work performed on the project and the owner pays this insurance cost as a pass-through or line item of the contractor s bid. 2. There is an integrated safety program on the project. 3. Claims are processed and managed centrally. 21 7
4. Broad Liability Coverages are negotiated and placed in one General Liability and one combined set of Umbrella / Excess Liability policies. a. A dedicated limit of Umbrella Coverage applies to the specific project not shared or eroded by claims on other jobs. b. Broad policy terms and conditions can be locked in. c. Coverage and premiums can be locked in for up to three (3) years during construction. d. Coverage can be included for completed operations / construction defects claims that occur as long as twelve (12) years after completion of construction up to the state s statute of repose. 22 B. Distinct Types of Wrap-Ups or controlled Insurance Programs 1. Contractor Driven (CCIPs) Placed and managed by the General Contractor. 2. Owner Driven (OCIPs) Placed and managed by the owner / developer. 3. Project Specific Covers insurance on one specific job. 4. Rolling Wrap-Up Provides coverage for a series of agreed separate construction projects. C. Coverages that can be provided under a Wrap-Up 1. The basic core coverages a. Workers Compensation and Employer s Liability b. Commercial General Liability c. Umbrella Liability 23 2. Other coverages that can be provided: a. Builder s Risk: Coverage purchased for the benefit of all parties and should include a waiver of subrogation for all parties. b. Project Professional Liability: Provides direct coverage for the architect, the owner, the engineer and their sub-consultants all under one combined policy. c. Owner s Protective Professional Liability: Provides protection for the owner only on excess basis over each individual architect s and engineer s professional liability. d. Environmental / Contractor s Pollution Liability: Provides coverage for environmental / pollution events. e. Subguard: Contractor Default: This is only available to a construction manager at risk or the general contractor. 24 8
E. Alternative of placing a Liability Only Wrap-Up: a. Coverages could include General Liability and Umbrella Liability only. b. Much lower deductibles can apply by not including the participating contractor s Workers Compensation Coverage - $25,000 to $100,000 per loss vs. $250,000 per loss when Workers Compensation is also included. 25 IV. OTHER SPECIALIZED INSURANCE EXPOSURES / COVERAGES A. Including multiple occupancies with or without multiple ownership entities creates additional exposures to loss such as: : 1. Retail tenants create potential leasing and property management disputes between landlord and tenant. 2. Restaurant or bar exposures create potential liquor liability exposures. 3. Parking operations create additional exposures such as from valet parking and damage to customer s or tenant s automobiles. 4. Increased Crime / Security Exposures. a. Arising from greater access due to multiple tenant exposures or uses. b. Use of outside alarm monitoring or other security firms and potential liability issues. c. Management companies can face increased risk in handling cash and other property of condo owner(s). 26 IV. OTHER SPECIALIZED INSURANCE EXPOSURES / COVERAGES B. Additional Specialized Insurance Coverage may be Needed to Insure These Additional Exposures such as: 1. Garage Liability Insurance covering liability claims arising from valet parking of tenant s or customer s automobile(s). 2. Garagekeepers Legal Liability Insurance to cover potential physical damage to cars parked at any garage that is part of a project. 3. Real estate related professional liability insurance covering the project owner or its leasing or management company for claims such as: a. Liability claims from tenants arising from property management or leasing activities. b. Claims from condo unit buyers related to real estate sales / brokerage activities. c. Claims from retail or office tenants against the developer or building owner or manager related to build out of tenant space including construction management or oversight services. 27 9
4. Tenant discrimination coverage for potential claims against: a. Building owner or rental agent from apartment renters. b. Owner / Developer from condo unit buyers or prospective buyers. c. Owner / Developer from commercial tenants. d. Owner or rental agent for potential employment related practices claims by commercial or residential tenants caused by employees of vendors on the premises such as those doing: i. Building maintenance ii. Security iii. Janitorial services iv. Other contractors or vendors 5. General Partners Liability and Directors and Officers Liability insurance for economic costs including legal defense costs and payments to: a. Outside investors in a mixed use project b. Contractors and other vendors c. Banks, bond holders, other lenders or creditors d. Government agencies e. Competitors 28 6. Liquor Liability where the mixed use owner/developer may: a. Hold one or more liquor licenses. b. Operate a related restaurant and/or bar. c. Operate a special events space or retail liquor store. 7. Pollution Liability Coverage a. Claims by tenants / condo owners arising from commercial use exposures such as: i. Dry cleaners. ii. Fumes or exhaust from restaurants. iii. Mold or legionnaire exposures from plumbing or air conditioning systems. b. On-going Pollution Legal Liability Coverage i. Lead paint or dust exposures. ii. Disturbance of asbestos. iii. Leaking fuel oil tanks. iv. Other Sick Building Syndrome type claims. 29 C. Covering Claims due to Pure Economic Loss 1. General Liability insurance only covers loss due to damage to property, i.e., physical damage to tangible property. 2. No coverage for other loss due to: a. Improper work itself b. Cost overruns c. Delay in completing not due to physical damage to property d. Completed work that does not meet the owner s or tenant s expected business needs. 3. Professional Liability Insurance Can Cover These Exposures a. Should be designed to cover: i. Property damage due to professional errors not insured under a General Liability Policy. ii. Pure economic loss not covered by a General Liability Policy. iii. Typical exclusion of claims due to express warranties or cost overruns. 30 10
4. Surety Bonds Including Subguard a. Coverage extends based on performance and other guarantees provided for in the Contract between the owner and general contractor and each subcontractor. b. The obligation for maintenance or rework is described and limited to the specific terms provided for in the contract. c. Coverage needs to protect the potential economic loss of each owner and/or tenant in a mixed use project. 31 11