During construction, any number of events — from natural disasters and theft of materials to a fire or vandalism — could thwart progress on a project and result in substantial additional costs. In such circumstances, how is the cost of replacement of materials and labor paid for? That’s where builder’s risk insurance comes in.
What is Builder’s Risk Insurance?
In a construction project, builder’s risk insurance is a type of property insurance that covers the value of the property under construction, including certain materials and fixtures that will be incorporated into the completed project. This is in contrast to a liability policy that is triggered when an adverse party brings a claim against an insured.
Damage to a property under construction is unlikely to be covered by other insurance policies in place. If a contractor or subcontractor damages the property under construction, all or some of the loss will likely not be covered per the "Your Work” exclusion of their General Commercial Liability policy. Likewise, an owner’s standard property insurance typically won’t cover losses that occur during construction or renovation projects. Builder’s risk insurance is a short-term policy specifically intended to protect against the risks that may arise during construction.
Key Builder’s Risk Considerations in Construction Contracts
When entering into a construction contract, the parties should pay attention to certain important aspects of the builder’s risk insurance policy. Key considerations include:
- Who will be responsible for obtaining the policy, and who will be named as insureds? Standardized contracts typically place this burden on the owner, but on certain projects the contractor may be in a better position to obtain a superior policy or more competitive pricing on premiums. Typically, at least the owner, contractor, subcontractors, and suppliers should be named as insureds.
- How long will the policy last? By their nature, builder’s risk policies expire after the project is completed. They are sometimes referred to as “course of construction” policies, in that the insurance is only effect during construction. They are not intended to insure against losses that occur after construction. It is crucial to know when such a policy will expire. Typically, builder’s risk policies will expire at some defined point of substantial completion — for instance, the issuance of a certificate of occupancy by the relevant government agency, when the owner accepts the project as complete, or when the project is ready for use as intended. It is critical that owner’s property insurance pick up coverage for the value of the new or renovated construction prior to the lapse of the builder’s risk policy.
- “All risk” or “named peril”? Builder’s risk insurance policies generally fall into two types of coverage, known as “all risk” or “named peril.” “All risk” policies are broader and provide coverage for essentially any loss other than those specifically excluded in the policy. “Named peril” policies provide coverage only for losses caused by specific kinds of loss named in the policy. Even “all risk” policies do not provide unlimited coverage, and they may exclude losses that are uninsurable or more appropriately covered by other policies, such as losses caused by earth movement, flood, or faulty construction. The contract language for the scope of coverage should not be broader than the actual coverage under the builder’s risk policy that will apply to the project.
- Are additional endorsements desired? Builder’s risk insurance typically does not reimburse insureds for the financial losses attributable to loss of use or business interruption. If such losses would be a significant burden to the owner, then the owner might consider seeking a policy endorsement that would provide coverage for financial losses attributable to the delay.
How do standard AIA forms address builder’s risk insurance?
Given the prevalence of American Institute of Architects (“AIA”) standardized contracts in the construction field, it is worthwhile to be aware of their default positions on builder’s risk insurance. The AIA updated many of its standardized construction contracts in 2017. The articles relating to insurance, including builder’s risk insurance, are now principally located in a new form exhibit to the stipulated sum and cost plus contracts, specifically AIA A101-2017 Exhibit A and AIA A102-2017 Exhibit A. Recognize, however, that some insurance provisions remain in the AIA A201 General Conditions, and in contracts that were not revised in 2017, such as the AIA A133-2009 between an owner and construction manager at risk. The new Exhibit A documents provide:
- Section 2.3.1 obliges the owner to obtain a builder’s risk “all risk” policy (or equivalent property insurance). The policy should cover the total value of the entire project, determined either by the contract price or a replacement cost basis. If the parties decide that the contractor will provide the builder’s risk insurance, such is indicated in via a check box at Section A.184.108.40.206.
- Section 220.127.116.11 specifically states that the policy should not exclude the risk of loss caused by “fire, explosion, theft, vandalism, malicious mischief, collapse, earthquake, flood, or windstorm” and should include coverage for loss caused by “error, omission or deficiency in construction methods, designs, specifications, workmanship or materials.”
- Section 18.104.22.168 states that, once the project reaches Substantial Completion, the owner shall continue the builder’s risk insurance policy or replace it with general property insurance that will continue through the period for corrections of the Work. Substantial Completion may be evidenced by an AIA Certificate of Substantial Completion, the AIA G704; however, recognize that Substantial Completion occurs per the terms of the underlying contract or as a matter of law, regardless of whether a certificate is signed. The period for correction of the Work is usually one year after the date of substantial completion. Given that, the default terms of the AIA require some combination of builder’s risk insurance and standard property insurance to continue from the beginning of a construction project until one year after completion.
Although builder’s risk insurance is a short-term policy, it is an incredibly significant policy to have in place during a construction project, and it is important that the parties know what the policy will cover and how it will interact with their other insurance policies.