Consider this scenario. A contractor undertakes renovation work on an occupied hospital building. The value of the contracted work is roughly $20M in a hospital with a replacement cost value of $500M and consists of mostly cosmetic updates to several floors of the hospital, but also some electrical, mechanical, and plumbing upgrades, including work on updating the fire suppression system. The contract states that the owner will provide a Builder’s Risk policy for the scope work on a replacement cost basis including all approved change orders.
As a contractor, you’re concerned with how to manage your exposure to damaging the existing building. Water damage exposure in particular is high with this type of risk if it’s not well monitored and controlled. Smoke and fire damage are possible also. What if something your employee or a subcontractor does ends up limiting access to occupied patient floors? Or damaging expensive medical equipment?
The exposure is surely real.
The growing cry these days is that contractors do not want to upset relationships with owners. No one wants to fight in the event of a loss. And certainly, no contractor wants a track record anywhere of awful words like “negligence” or “fault.” If the owner’s property carrier pays the loss on the existing operational hospital in this example, and in their investigation, they determine that the cause of loss was a fire started in the construction area, or a busted pipe in the construction area, then surely, they will subrogate back against the contractor to whatever extent the contract allows.
A quicker resolution – maybe?
If the finger is pointed at the contractor, the contractor typically does not want to deal with a long drawn-out investigation of liability, but rather just to be able to provide quick cash to the owner to address the problem quickly and effectively.
In comes a coverage extension under a Builder’s Risk policy called “Damage to Existing Property - Limited.”
- The intent is to provide some small sublimit of coverage by extension of the Builder’s Risk policy to cover damage to the existing real property of the project owner at the insured location that results from the contractor’s performance as required by written contract.
- With regard to the existing property, coverage does not extend to include personal property, utilities of any kind, mechanical breakdown, electrical injury, explosion, delay in completion or contractor’s extra expense.
- It is available usually by declaration to the carrier for an additional premium, and limits vary depending on the situation.
- It does not replace or substitute for General Liability Property Damage coverage.
- It must be required by written contract since that creates the insurable interest of the contractor in the existing property. In absence of an insurable interest, separate property insurance to address this potential issue will not accomplish the intended purpose. There are standard clauses in the AIA contract that states if the contractor requests additional coverages for BR, they can be added at the contractor’s sole cost and expense.
Open areas of concern
Even at best, Damage to Existing Property still leaves some open areas of concern. In the example presented, if a pipe bursts in the construction area, and water damage occurs over several floors both in and outside of the construction area, then the Builders Risk carrier would respond to the damage to construction areas, and the owner’s Operational Property carrier would respond to the damage to the operational areas. The owner’s Operational Property and Builder’s Risk carriers will subrogate the claim against the contractor’s General Liability property damage coverage to the extent allowable by the construction contract.
Many contractors are concerned that their General Liability coverage is subject to a large property damage deductible ($250,000-$500,000). While they should be funding for this deductible in the cost of insurance charged to the owner, they will argue that Builder's Risk typically carries much lower deductibles. And Builder’s Risk doesn’t worry about who is at fault or proving negligence, which can take quite a bit of time. It just pays first dollar with a low deductible and at a much quicker pace – right?
Not necessarily. In this example, the owner has clearly stated within the contract that they will provide the Builder’s Risk on the project itself. Therefore, there is no insurable interest of the contractor in the existing property. Therefore, damage to the existing property coverage would not contribute to this loss. The only remaining coverage is a General Liability exposure arising out of the negligence of the contractor.
What if the contract is amended so that there is indeed an insurable interest of the contractor – i.e. the owner has assigned the responsibility for the first $1,000,000 of any insured loss under the Builder’s Risk to the contractor for damage caused by construction works? Then the placement of damage to existing property coverage is appropriate, should be declared to the underwriter accordingly, and issued. But keep in mind that the contractor needs to be aware that the damage to existing property coverage they can purchase does not include the owner’s personal property, utilities of any kind, business income of the owner, etc. as previously outlined. The contractor still needs to address these items contractually and make sure their coverage is matched up properly.
Even if the contractor pays $1,000,000 on a first party property damage basis under the Builder’s Risk coverage, the owner may (probably will) still pursue recovery under the General Liability property damage coverage. There is nothing that prohibits the owner from doing so if they feel the contractor has liability for the damage caused.
Additionally, the construction contract defines the allowable costs of work. The contract typically includes as allowable costs, insurance coverage required by the contract. If damage to existing property is not required, then a savvy owner would not reimburse the contractor for this expense.
[A] waiver of subrogation must apply to both the work as well as the owner’s existing property at the site.
A proper waiver
The only real way to prevent an owner (or their insurance carrier) from suing the contractor for their liability is to get a proper waiver of subrogation in the contract. Without that waiver, whether a contractor places damage to existing property or not, the owner still has rights of recovery against the contractor. The best way to address this issue is to ensure there is a clear and sound contract relationship in the first place, and to proceed as collaboratively as possible in the event of a loss.
The waiver of subrogation must apply to both the work as well as the owner’s existing property at the site. The waiver must be a mutual waiver of subrogation that applies to the contractor, owner, and all subcontractors. If in this example the contractor is doing a $20 mil renovation on a $500 mil project, the only way to protect the contractor is by securing the waiver of subrogation to existing property as well as the work itself. How many (if any) contractors would carry $500 mil in limits? No owner is going to insure their own property, and then pay for the contractor to insure it as well as an allowable cost of work. Without the waiver, the contractor must either buy separate damage to existing property coverage or increase their limits for this exposure.
Like most other aspects of a construction project, the insurance and risk transfer program must be negotiated. In this case, unless the owner provides a mutual waiver of subrogation, the contractor must either buy separate coverage (DIC or Damage to the Existing Property coverage) or increase their liability limits to an acceptable level based on the risks involved in the project. In this case, liability limits would need to be able to address a potential $500M property claim plus potential business income loss.
When owners compare the cost for additional contractor coverage to the cost of the waiver of subrogation (typically no charge, only an assumption of a deductible by the owner), they understand the contractor’s position and agree to the waiver. In many cases, if the contractor offers to pay at least a portion of the owner’s potential deductible expense for claims arising from their negligence or the negligence of their subcontractors, an equitable agreement can be reached. Keep in mind that the contractor can pass most, if not all of this potential expense, if the claim arises from one of their subcontractor’s negligence.
A frank discussion between the owner and contractor is the best way to cost effectively address the potential risk of damage to existing property. It will help avoid more uncomfortable conversations later on.
About the Author
Based in Atlanta, Kristen Hoskinson is Underwriting Manager and National Master Builders Risk Program Leader for Construction Property. She helps contractors throughout the Southeast US region address their property insurance needs for large or complex projects, civil and engineered risk projects, She can be reached at kristen.hoskinson@axaxl.com
