Does Your Builders Risk Policy Cover Soft Costs?

Work on the new office complex was progressing on schedule. The owner had lined up tenants for two-thirds of the space and was in talks with several others. The general contractor expected to finish construction on time. All that changed when fire broke out on the first floor late one afternoon. It spread from a stack of drywall awaiting installation to a pile of scrap plywood, where the wind picked up the flames and carried them to the structure. Drywall, insulation and plastic wiring all soon ignited. Firefighters were able to contain the blaze and limit the damage. However, it would now take an additional two months to complete the project because the contractors would have to clean up the debris from the fire and ensuing water damage, order replacement materials, and re-do much of the first floor’s construction. The owner faced the certainty of thousands of dollars in lost rents and additional interest on the construction loans.

The owner and general contractor had purchased a builders risk insurance policy to cover damage to the project. They would have coverage for the lost rents and interest expenses if the policy included special protection known as “soft costs coverage.”

Soft costs are costs or reduced income resulting from a delay in a project’s completion. They include expenses such as:

* Lost rents

* Additional interest on loans

* Additional real estate taxes

* Additional advertising costs

* Additional insurance premiums

Some builders risk policies have this coverage built in, while others provide it only if the insurance company adds it and charges an additional premium. The insurance covers the named insured for loss of income and additional expenses that result from direct physical loss of or damage to the covered property. There is no coverage unless the peril causing the loss is one that the policy covers for direct damage. For example, the policy will cover losses caused by fire but not losses caused by faulty workmanship. The lost revenue and extra expenses must accrue during the period starting a specified number of days after construction would have been complete if no loss had occurred and the date construction actually was complete. Some policies limit this period to no more than six or 12 months.

Soft costs coverage may provide one limit of insurance that applies to all covered losses, or it may have separate limits for different types of losses. For example, one company’s policy defines “soft costs” as loss of rental income, loss of gross earnings, additional interest and finance expenses, and additional expenses. The policy could have separate limits for each of these categories. A waiting period deductible applies, though some policies may apply a dollar deductible to losses that occur in a lump sum, such as legal fees. Some policies may also set a maximum amount that they will pay for any one month. They do not cover certain types of losses, such as those caused by strikes, breach of contract, design errors and omissions, lack of funds for repair or reconstruction, building laws and ordinances, and others.

The insurance company will determine the value of a loss by calculating the actual amount of income lost or extra expenses incurred during the delay period because of the delay. It will pay the amount of the loss or the amount of the insurance purchased, whichever is less.

A contractor should work with a professional insurance agent or broker experienced in arranging builders risk insurance. To make sure that the coverage terms and limits are appropriate, the contractor and broker should review the building contract, financing agreements, construction schedules, and other related documents. The type and amount of coverage will vary from one project to another, so it is important to give careful attention to each job’s particular circumstances.

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