During the past few months, we have had numerous inquiries from clients with questions about "Builder's Risk Policies."  We thought it might be helpful to our construction industry friends to briefly discuss this concept.

In contrast to a traditional property insurance policy, which is typically an annual renewable policy, the policy term of a builder's risk policy matches the entire construction project term.  As such a builder's risk policy also offers a broad definition of named and additional insured's including owners, contractors, subcontractors and subcontractor employees, while the standard property policy typically only insures the policyholder.

As an example, in preparing an existing building for conversion from a densely occupied office property to a highly desired residential address, developers need to address the engineering and architectural issues and the financial security of the overall project.  They also should seek to ensure their interests are protected throughout the renovation project. A builder's risk policy can provide this financial protection through soft cost endorsements and delay-in-startup coverage endorsements.

The costs to build the actual building and improvements, known as hard costs in the industry, are things like supplying and erecting the brick-and-mortar. The costs incurred that are not tied directly to the brick-and-mortar elements, such as advertising, interest, permits, fees, and insurance, are known as soft costs. Another form of soft cost is anticipated rental income, which can be covered by a delay-in-completion endorsement to a builder's risk policy.

Soft cost coverage is triggered by a physical damage loss. The insured can then be indemnified for a scheduled soft cost loss less any applicable deductible, which is generally expressed as an agreed-upon waiting period.

A solid builder's risk product should be designed to indemnify (hold harmless) the developers from a covered loss. To properly protect an investment, developers need to know and insure the replacement cost of the existing structure. Obviously, this cost may differ significantly from market value and may not even resemble the acquisition cost.

Developers that seek a builder's risk policy that insures the existing structure are typically asked to present a thorough engineering report to the insurance underwriter.  The engineering report typically accompanies a replacement cost valuation prepared by a reputable party, such as an independent appraiser or the developer's insurance broker.

The insurance underwriter will then use the replacement cost value to establish a premium.  Usually the policy reflects the replacement cost as a sub limit of liability. The developer may also be asked to provide detailed plans to address the engineering challenges inherent in a conversion project.

For more information about construction industry related issues contact David B. Blain, CPA by phone at 717.761.7910 or by email at DBlain@macpas.com.  Mr. Blain is a Senior Manager in the Accounting and Auditing Construction Industry Group of McKonly & Asbury, LLP.