Note: This guest blog post is by Brent Winans, Vice President of Clear Advantage Risk Management in Delray Beach, Florida (www.clearadvantagerisk.com). He provides fee-based (no insurance sales) risk management consulting services to larger clients and serves as an expert witness on both sides of agent errors and omissions cases across the country.
Even if your building is insured for replacement cost, if you do not have Ordinance or Law coverage, you probably do not have the protection you think you have.
A standard replacement cost policy will pay to replace “new for old,” but only if the building codes (ordinances or laws) do not require a better “new” than you had before. For instance, if your building does not have hurricane shutters or hurricane windows and the new code requires them, your replacement cost policy will pay the cost for replacing your original windows but will not pay the increased cost for new hurricane windows or hurricane shutters.
And there is more. The paragraphs below give an overview of what the standard replacement cost policy will not cover in the ordinance or law arena.
The standard commercial replacement cost property policy will not cover:
- The value of the undamaged portion of a building when the code requires it to be demolished. For example, a $10MM building is 50% destroyed, and the local code requires that the undamaged remainder of the building be demolished. The standard insurance policy will not pay for the undamaged portion of the building which must be destroyed. In order to be insured for that, the building owner needs to have purchased Ordinance or Law Coverage A. When it is purchased, it is usually automatically included for the full limit of insurance that applies to the building. As this example shows, even a brand new building needs Ordinance or Law coverage.
- The cost to demolish the undamaged portion of the covered building and to clear the site. In the above example, the standard replacement cost policy will pay to clear away the debris from the original fire. It will not pay to demolish the undamaged portion of the building and clear the site. In order to be insured for that, the building owner needs to have purchased Ordinance or Law Coverage B. The insured must specify what amount of Coverage B it wants to purchase, since the coverage is not written on a “whatever-it-takes-to-do-the-job” basis.
- The increased cost of construction which is due to the enforcement of building ordinances or laws – for a.) the undamaged portion, b.) the damaged portion and c.) items excluded from the standard policy. Here are three scenarios:
- No coverage for bringing the undamaged portion up to code. Let’s assume that a $10MM building is 40% destroyed. In this case the local building code requires that the undamaged 60% of the building also be brought up to code at a cost of $600,000. The standard replacement cost policy would not pay the $600.000. (It would also not pay the $400,000 to bring the damaged portion of the building up to code, which is explained further in the next scenario.)
- No coverage for bringing the damaged portion up to code. Let’s assume that the above $10MM building burns to the ground and that the portion of the replacement cost which is attributable to bringing the building up to code is $1MM. The standard replacement cost policy would pay only $9MM for the loss, and would leave the $1MM uncovered.
- No coverage for foundations, etc. If a building is destroyed, the local code will often prohibit the reuse of the building foundations, etc. The standard replacement cost policy excludes coverage on the cost of building foundations and pilings, underground pipes, flues and drains; excavation, grading and filling. (It does this, presumably, because they are not damaged in most losses.) That means that the $10MM “replacement cost” of the building in the example does not include those items. Let’s assume that the cost of these items is $500,000. The standard replacement cost policy would not cover that $500,000.
In order to have coverage for the above items, the building owner needs to have purchased Ordinance or Law Coverage C for an amount sufficient to pay for the increased cost to bring the damaged (and any undamaged) portion of the building up to code, including the foundations, etc. In the above total loss scenario, that would mean they needed to purchase $1.5MM of additional insurance.
Determining the amount of Ordinance or Law coverage that is needed is generally outside of the expertise of both building owners and insurance agents. Some building owners use a rule of thumb that demolition costs for buildings will run at least $5.00 per square foot for bricks and mortar type construction, and the average cost of bringing a building up to code will usually be .5% to 1% for every year the building is old.
Now that we have all of the information above, let’s apply it to an example. The owner has a 30 year old, 100,000 square foot masonry building with a replacement cost of $10MM. How much Ordinance or Law coverage should he carry?
- Coverage A (value of the undamaged portion of the building) – the full $10MM limit.
- Coverage B (cost to demolish the undamaged portion of the building) – If the worst case scenario under the local code is a building that is 50% damaged must be destroyed, then 50,000 square feet x $5.00 per square foot would require $250,000 of Coverage B.
- Coverage C (cost to bring both the damaged and undamaged portion of the building and the foundation, etc. up to code) – 15% would require $1.5MM Coverage C while 30% would require $3MM.
- So the insured would need the full policy limit for Coverage A and would need from $1.75MM to $3.25MM for the combined coverages B and C.
But the above “rules of thumb” may be far from the mark on any particular building. A customized appraisal by an appraiser who is knowledgeable about local building codes may be needed in order to make an accurate determination.
One other reality of the insurance marketplace is that sometimes insurance companies are not willing to sell all of the Ordinance or Law Coverage that an insured needs. Then it will be up the insurance agent to find the company that is willing to provide the most Ordinance or Law Coverage at an affordable cost.
This is an overview of coverage and does not deal with the many different conditions and limitations which may apply in your own policy. You will want to read your policies and consult with your insurance agent, risk management consultant, or attorney to understand how Ordinance or Law coverage applies to your own situation.
Content of this blog is drawn from the article, Explain Ordinance or Law Coverage To Avoid E&O Claims, originally published by International Risk Management Institute, Inc., Dallas, Texas, in the Expert Commentary section of IRMI.com, copyright International Risk Management Institute, Inc. Reproduced with permission of the publisher. Further reproduction prohibited. For more information or to schedule a free demo of IRMI Products, visit www.IRMI.com.
(IRMI is a resource to which I and the Merlin Law Group subscribe. I strongly recommend that all adjusters and agents use IRMI as a basic insurance reference. This article was first written in an IRMI publication that is available to the public, but readers of this blog would be foolish not to subscribe and access valuable private content. Subscribe to IRMI and make more money! Here is the link to subscribe.) —Chip Merlin