By Mike Davidson, First Vice President, Alliant Construction
For many public entities, builder’s risk insurance is viewed as a routine contractual requirement for general contractors to procure as part of their overall project delivery responsibilities. While the contractor does carry risk on the project, the greatest concentration of risk sits with the public entity; the project is its asset, and not the builder’s. Although it may ease the administrative process to pass the requirement to a contractor, public entities face greater risks in allowing a third party to secure coverage for their assets and lose opportunities to benefit from obtaining their own builder’s risk coverage.
A construction project represents a significant investment of taxpayer funds for public entities, which in some cases is planned to drive additional revenue for the entity, and will most always be intended to serve the greater good of its citizens. Whether it be a new wastewater treatment plant, a courthouse, public housing, a new community center or regional health center, it is the duty of the public entity to protect the investment. When builder’s risk is held at the ownership level, coverage decisions can be made to protect the asset(s) rather than to satisfy a builder’s contractual obligation. This alignment of direct interest helps ensure that the program structure, limits, deductibles and coverages align directly with the public entity’s needs.
Tailoring Coverage to a Public Entity’s Unique Risks
There are two primary areas in which an owner’s interests diverge from the contractor and may be insured under a builder’s risk policy: owner procured materials + directly held contracts and risks from a delay to the project’s original completion date. By deferring the coverage to the contractor, a public entity is at risk where these interests may be underinsured or uninsured altogether.
Typical owner procured materials and contracts directly held with the public entity relate to furniture, fixtures and equipment (FF&E). These items may include art installations in public spaces, medical equipment in hospitals or vendor build-outs within food and beverage areas of a convention center. If a general contractor is holding the builder’s risk coverage, they cannot insure these separate contracts under their policy as they do not hold contract privity with those vendors. The public entity will then have to rely on each of the various vendors and contractors to carry installation floaters for the work, thereby increasing the overall insurance cost through a layered approach rather than a single policy covering all work on the project. In addition, the coverage procured by the vendors is unlikely to be as broad or contain the limit and quality of coverage extensions that would exist under a policy held by the public entity covering the project as a whole.
Builder’s risk policies can be written to cover project delays that arise from a covered cause of loss under the policy (fire, water damage, building collapse, etc.), but not those caused by performance or contractual issues of the contractor or design team. This coverage addition is commonly referred to as Delay in Completion or Delay in Start-Up (DSU) coverage.
The risks shared by a public entity and contractor that are insurable under DSU generally begin and end with insurance premiums and the extended general conditions of the contractor being onsite for longer than originally scheduled and contracted. There are varying additional risks the project owner will face that are not shared with the general contractor, which include:
- Loss of revenue
- Extended engagement costs for design team (design-bid-build and construction manager at risk delivery), owners reps and construction managers (design-build and design-bid-build delivery)
- Extended finance costs
- Advertising and marketing expenses
- Liquidated damages or fines owed by the public entity to third parties due to a delayed opening
While sophisticated and larger general contractors can have some of these risks covered under their policies on behalf of the owner, it is not always the case and further would not be included unless contractually required and agreed upon. This leaves public entities to a game of chance on whether their financial risks can be covered at all or managed correctly on their behalf. By taking control of the builder’s risk, they can ensure their specific risks have coverage designed and tailored directly for their needs.
Owning the Claims Process
As the first named insured on the policy, a public entity sits in the driver’s seat of the claims process. While this may be of limited importance for routine property damage claims, it is critical to be in control of a claim when it becomes complex and/or of significant size. Having direct access to your insurer with claims support from your broker becomes invaluable in navigating a lengthy claims process on significant claims. By having full control over the process, public entities can benefit by:
- Ensuring timely claim reporting and communication
- Having full participation in settlement negotiations
- Negotiating partial progress payments for claims involving long-term, high value repairs
- Ability to submit costs directly to its insurer that are incurred by the public entity outside of the direct property damage as a result of the loss
- Coordination of recovery strategies and project restoration decisions. When repairs may require alternative building plans to original specifications, this is important to help avoid or minimize denied costs due to perceived issues of betterment through direct communication with the insurer.
By contrast, when relying on a contractor’s policy as an additional insured, a public entity can be held out of the process altogether if a contractor is unwilling to provide transparency or access to the claim. Unless there is full support for participation from the contactor, the public entity will always be at arms-length from the claim for damage incurred to its project.
Coverage Transition to Permanent Property
Construction contracts will typically stipulate the duration that a builder’s risk policy must be maintained and when coverage needs to be transitioned to the public entity’s permanent property policy. When contractors control the builder’s risk, this process can become complicated due to administrative oversights, project disputes, delayed occupancy schedules or general misunderstandings regarding their responsibility to maintain coverage. If the public entity is unaware of the contractor’s policy lapse, a significant coverage gap ensues by leaving a nearly completed project uninsured.
Dependent on the project’s intended use, permanent property carriers typically will not accept projects until either a certificate of occupancy has been issued (traditional buildings) or the facility has been put to its intended use and final acceptance is issued by the public entity (infrastructure such as water treatment plants). If there is a dispute with the contractor and they allow coverage to lapse prior to these completion milestones being achieved, the public entity will need to procure builder’s risk coverage at a near 100% but not yet completed phase, which can be upward of three times the premium than would have been charged at the start of the project.
If a public entity is outright unaware that the contractor let coverage lapse too early and a loss occurs, the unenviable task of entering litigation with the contractor or paying for the loss out of pocket begins. Despite what a contract may say, this can occur on any project where the contractor is in control of the coverage. The simple fix to these potential coverage gaps is to hold the coverage at the ownership level. When the public entity holds the policy, the owner knows precisely when coverage ends, maintains the ability to hold projects covered through completion, and can then notify their carrier when the time is right to transition to permanent property. This approach eliminates uncertainty and provides full control over coverage transitions.
Cost Management
Until recently, pricing advantages between owner-procured and contractor-procured builder’s risk coverage were often negligible to the overall project budget. Recently it is becoming more common for public entities to obtain the coverage at a cheaper cost as contractors are often loading pricing with extensive mark-ups for potential deductible losses and/or over-padding their bids with pricing that ultimately comes in cheaper once they procure the coverage. With some contractors charging premiums exceeding 1% of total project cost, public entities have an ability to achieve significant savings to their project budget by taking on the coverage themselves.
Public entities that have robust capital improvement programs can further control costs by employing a Master Builder’s Risk program (MBR). An MBR is a policy structure that allows policyholders to cover multiple projects that commence within a one-to-two-year period, though do not have to be completed within that same timeframe. Each project remains covered according to its individual project schedules, even after the MBR expires. Much like a stand-alone placement, not all projects are guaranteed to be offered multiple extensions if needed, but most MBRs will allow for an adequate number of extensions if losses remain within norms and extensions do not become extensive. Additional advantages above stand-alone builder’s risk include:
- Better economies of scale for reduced policy rates and lower deductible structures
- Budget certainty to project costs for project premium allocation as rates are secured during the policy term
- Consistent quality of coverage for projects covered by the program
- Reduced procurement effort
- Enhanced negotiating leverage with the insurance market
Conclusion
The decision to procure builder’s risk coverage comes down to a simple reality: The premium will be paid one way or another within the project budget. The entity can either pay premium directly to its insurer with full transparency on the costs and achieve the benefits of a policy designed specifically to their unique risks, or it can pay a cost buried into a bid for coverage designed for the contractor to fulfill its stated obligation within the contract. There may be years of project experience for a public entity relying on the contractor option without issue, but as is often the case in construction risk, it is the catastrophic event and not the frequent one that should garner the strongest consideration. Maintaining control of this critical coverage remains the best option for a public entity when it is needed most.
