Building Codes are BAD for Your Insureds: Why Ordinance or Law Coverage is Necessary!

Transcription

1 Main Idea: The application and enforcement of Building Codes can turn a partial loss into a total loss. Section I Gaps in Coverage Create Need for Ordinance of Law Coverage I. Commercial Property Policy (CPP) Coverage Gaps A. ISO s CPP pays to repair or rebuild the property that suffered direct damage caused by a covered cause of loss. B. Policy wording specifically excludes loss resulting from or arising out of the enforcement of building codes: 1. Loss Condition E.4.b. in ISO s Building and Personal Property Coverage form states: The cost to repair, rebuild or replace does not include the increased cost attributable to enforcement of any ordinance or law regulating the construction, use or repair of any property. 2. Optional Coverage G.3.f. (relating to replacement cost) in the same form states: The cost of repair or replacement does not include the increased cost attributable to enforcement of any ordinance or law regulating the construction, use or repair of any property. 3. Exclusion B.1.a. in all three of ISO s Cause of Loss forms specifically excludes any loss caused by the enforcement of any ordinance or law. C. Additional Coverage 4.e. gives back a small amount of coverage for the increased cost of construction (only one part of the ordinance or law coverage) 1. Only if the building is covered on a replacement cost basis 2. Only pays the lesser of: 5% of the building value or $10, Other provisions/limitations apply II. Business Income (BI) Coverage Gaps A. Definition F.3. Period of Restoration in both of ISO s BI forms specifically excludes any increased period required to rebuild due to the enforcement of any ordinance or law B. Also applies exclusion B.1.a. from the cause of loss forms C. There is no give back in BI coverage for any loss resulting from the application of building codes III. Businessowners Policy (BOP) applies the same wording as the CPP and the BI forms

2 Section II Sources and Enforcement of Building Codes I. International Building Code Council II. The Federal Government A. Life Safety Codes B. National Electric Code C. ADA Codes D. Etc. III. States and Local Jurisdictions A. May amend a Federal or model code B. Flood Plain Management IV. Historical Societies V. Enforcement Section III Jurisdictional Definition of Major Damage Triggers Need for Ordinance or Law Coverage I. Major Damage A. Not necessarily a defined term in building codes B. A term used to define the point at which a damaged structure must be brought into compliance with the current building code II. Each state uses its own definition of major damage. It could be an objective standard or a subjective standard. III. Two Most Common Rules A. The Percentage Rule B. The Jurisdictional Authority Rule

3 Section IV Ordinance or Law Requirements and Limitations I. Limitations on the building codes to which ordinance or law coverage applies -Which ordinance or laws are not addressed or responded to by the various ordinance or law forms? II. What must occur before the endorsements respond A. Direct property loss B. Caused by a covered peril C. Loss must breach the major damage threshold as defined by the local jurisdiction D. The damaged structure must be lacking in some aspect of the local building code III. Coverage Limitations A. The forms only pay the amount necessary to meet building code requirements placed on the structure B. The forms will not pay to meet building codes the structure was required to meet prior to the loss C. Coverage is subject to the limits purchased Section V Ordinance or Law Coverage Forms for Commercial Clients I. Ordinance or Law Coverage (CP 04 05) II. Ordinance or Law Increased Period of Restoration (CP 15 31) III. Ordinance or Law Coverage (BP 04 06) Section VI Ordinance or Law Coverage (CP 04 05) I. Three Coverage Parts A. Coverage A Coverage for Loss to Undamaged Portion of the Building B. Coverage B Demolition Cost Coverage C. Coverage C Increased Cost of Construction

4 II. Coverage A Coverage for Loss to Undamaged Portion of the Building A. The unendorsed CPP only pays to repair the damaged portion of the structure B. The insured loses the use and value of the undamaged portion of the building that can no longer be used and must be torn down C. Coverage A pays the difference between the CPP and the total value of the building III. Coverage B Demolition Cost Coverage A. Pays the cost to remove the debris of the undamaged portion of the building that must be torn down B. Fills the gap between what the CPP pays and what Coverages A and C of the ordinance and law form pays: Coverage C: Increased Cost of Construction CPP: Cost to removed DAMAGED portion of building CPP: Cost to rebuild DAMAGED part of the building Cov. B: Cost to remove UNDAMAGED portion of building Cov. A: Value of the UNDAMAGED part of the building IV. Coverage C Increased Cost of Construction A. Pays the additional Cost to bring the structure up to current building code: 1. The cost to reconstruct the damaged portion of the building 2. The cost to reconstruct the undamaged portion of the building 3. The cost to remodel the undamaged portion of the building B. Covers the cost of real property specifically excluded in the CPP 1. Cost of excavation, backfilling, and filling 2. Building foundations and pilings 3. Underground pipes, flues, and drains C. Four requirements must be met for Coverage C to respond 1. Building must be intended for similar occupancy 2. The building must actually be rebuilt to receive payment 3. Repair/replacement must be completed as soon as practicable but within a maximum of two years 4. The policy must be written on a replacement cost basis V. Extending Coverage A. Coverage A must be written on a scheduled basis (no option for blanket limit) B. Coverage B and Coverage C 1. On a scheduled, per building basis (Coverage B only or Coverage C only) 2. Coverages B and C combined on a scheduled basis (CP must be used) 3. Single coverage blanket basis (Coverage B or Coverage C) 4. Coverages B and C combined on a blanket basis C. How can coverage be combined 1. Coverage A only 2. Coverage C only

5 3. Coverages A and B without C 4. All three coverages (A, B, and C) VI. Choosing Limits A. Coverage A: No choice to be made B. Coverage B: Chosen by the insured. Below is one method 1. Determine the worst-case scenario (the maximum square footage of building that may remained undamaged yet have to be removed because of building codes) 2. Determine the average cost per square foot for demolition and removal of that amount of that amount of undamaged square footage 3. Multiply step 2. by step Example: The building is 25,000. Because of the local jurisdiction s application of the building codes it s possible that only 10,000 square feet of it would have to be severely damaged to trigger the requirement that the whole building would have to be brought into compliance with local building code. That means that up to 15,000 square feet could still be standing and have to be torn down. If the debris removal cost in the area is $7.00 per square foot, the Coverage B limit would need to be $105,000. C. Coverage C 1. Choosing a limit for Coverage C is complicated by several factors: a. There is a difference between the insurance industry s meaning of replacement cost and true replacement cost (in the minds of the buyer) b. Cost estimators, such as Marshall Swift/Boeckh, develop replacement cost using current national building codes c. Contractor estimations of the cost to rebuild are based on all building codes d. The unendorsed CPP won t pay to bring the building up to current building code 2. The limit is little more than a guess made by the insured, but here is one easily explainable and defensible method: a. Choose a percentage of the building value from 1% to 3% (the older the building, the higher the percentage) b. Multiply the chosen percentage by the building s Replacement Cost c. Multiply the answer by the age of the building d. Example: 20-year-old building with a RC value of $1 million using 1% per year cost average ($1,000,000 * 1%) * 20 years = $200,000 Coverage C limit

6 Section VII Ordinance or Law Increased Period of Restoration (CP 15 31) I. Period of Restoration Defined or Redefined A. Unendorsed Business Income Forms: F.3. "Period of restoration" means the period of time that: a. Begins: (1) 72 hours after the time of direct physical loss or damage for Business Income Coverage; or (2) Immediately after the time of direct physical loss or damage for Extra Expense Coverage; caused by or resulting from any Covered Cause of Loss at the described premises; and b. Ends on the earlier of: (1) The date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or (2) The date when business is resumed at a new permanent location. "Period of restoration" does not include any increased period required due to the enforcement of any ordinance or law that: (1) Regulates the construction, use or repair, or requires the tearing down, of any property; or (2) Requires any insured or others to test for, monitor, clean up, remove, contain, treat, detoxify or neutralize, or in any way respond to, or assess the effects of "pollutants". The expiration date of this policy will not cut short the "period of restoration". B. The CP endorsement alters essentially one sentence in this definition: "Period of restoration" includes any increased period required to repair or reconstruct the property to comply with the minimum standards of any ordinance or law, in force at the time of loss, that regulates the construction or repair, or requires the tearing down of any property. II. Effect on Business Income Coverage A. How business income limits are developed (simplified version) 1. Insured develops the 12-month business income exposure using the Business Income Report/Worksheet (CP 15 15) 2. Insured estimates the worst-case period of restoration (POR) as defined above 3. The POR is divided by 12 the result is the coinsurance percentage 4. The coinsurance percentage is applied to the 12-month BI exposure to develop a limit of coverage (may require altering as there are only certain acceptable percentages). B. The endorsement alters how the period of restoration is calculated because it adds the additional amount of construction time directly related to the application of the building codes. C. What must be accomplished during the period of restoration 1. Direct property loss must be adjusted 2. Authority having jurisdiction must decide if building has surpassed the major damage threshold 3. Plans must be drawn

7 4. A contractor must be found and hired 5. Building permits must be issued 6. Site must be cleared 7. Time required to rebuild 8. Time required to find new machinery, equipment, and/or stock D. If the building does surpass the major damage threshold, the additional time required because of the application of the building codes must be considered. This amount of time is not considered in the definition of POR in the unendorsed form: 1. Additional time required to tear down remaining structure 2. Additional time required to grade and prepare the land for building 3. Additional time required to build the structure a. Foundations, piping, etc. b. Increased square footage c. May have to construct using different techniques (flood plains, earthquake proofing, etc.) d. May have to have additional trades on site (installation of a sprinkler system) E. Additional time is essentially a guess. May increase the POR by up to 20% or even more F. Insured must recalculate the POR adding the time necessary to comply with building codes. Once the POR is recalculated, the BI limits are recalculated Section VIII Premium Development I. Coverage A Adds approximately 15% to the net building premium (unless earthquake is included as a covered cause of loss) II. Coverage B and Coverage C (Coverage Limit Chosen / 100) x Net Building Rate = Premium III. Increased Period of Restoration Increases the Business Income premium approximately 20% (in addition to the additional premium from the increased limit)

8 Section IX Ordinance or Law Example Building Information: Total Building Value: $2,500,000 Age of Building: 15 years Old 12-Month Business Income: $3,500,000 Occupancy: Manufacturing Square Footage: 25,000 Jurisdictional Law: 50% of ACV Coverage Information (w/o Ordinance or Law): Building Coverage $2,500,000 Business Income Coverage: Estimated POR: $2,450,000 (70% Co-insurance) 8 months 100 Fire Stop Wall 1 Story - 25,000 square feet Manufacturer 15 years Old 8 month POR 250 With Ordinance or Law Coverage: Coverage A: Included in CPP Coverage B: $62,500 Coverage C: $375,000 Increased POR Yes / $3,500,000 - BI 12 month POR (CP 15 31):

9 CPP Pays: Cost to Remove Debris of Damaged Part Cost to Rebuild Damaged Part as is 100 Undamaged Part 12,000 Sq. Ft. FIRE DAMAGE 13,000 Square Feet 1 Story - 25,000 square feet Manufacturer 15 years Old 12 month POR 250 Ordinance or Law (CP 04 05) Pays: Value of Undamaged Portion (Cov. A) Cost to Remove Debris of Undamaged Portion (Cov. B) Increased Cost to Rebuild ENTIRE Structure to Current Building Code (Cov. C) Loss Information: Square Footage Damaged: 13,000 sq. feet Value of Real Property Damaged: $1,300,000 Undamaged Square Footage: 12,000 sq. feet Value of Undamaged Property: $1,200,000 Actual Period of Restoration (POR): 12 months Actual Business Income Loss: $3,500,000

10 Claim Comparison: Loss Type Actual Loss Paid w/ CPP and both Ordinance or Law Endorsements Paid using unendorsed CPP and BI Only Building Damage: $1,300,000 $1,300,000 $1,300,000 Value of Undamaged Portion: (1) $1,200,000 $1,200,000 0 Demolition Cost Total (2) : $125,000 $125,000 $65,000 Increased Cost of Construction: $300,000 $300,000 $10,000 Business Income: (3) $3,500,000 $3,500,000 $2450,000 Total $6,425,000 $6,425,000 $3,825,000 (1) (2) (3) Remaining structure must be torn down due to the local building code requirements. Total cost of demolition and removal includes damaged and undamaged parts of the building at $5.00 per square foot. Period of Restoration is 12 months as a result of additional time required to comply with the local building codes. Without the application of building codes, the period of restoration would have been 8 months.