Builders Risk: 5 Common Coverage Exclusions and Clauses

Between rapidly changing construction trends and increasingly sophisticated risk mitigation tactics, property owners and contractors have a deluge of details to keep in mind when they’re working to complete a project.

These individuals trust you to help them secure effective builders risk coverage for their various exposures—and that means you need to hone an expert understanding of policy language.

Here are five builders risk coverage exclusions and clauses that could have a significant impact on a client’s ability to recover from a loss.

Exclusions to Address

Faulty design, materials and workmanship: Almost all builders risk policies contain exclusions for faulty design, materials and workmanship. However, most also include an ensuing loss exception, “which basically says if the loss is caused by an otherwise insured peril, the resulting loss will be covered,” says Steve Coombs, president of Risk Resources, a risk management and insurance consulting firm.

Consider a project that involves constructing a concrete parking garage. The contractors install a faulty beam, and 80% of the way through construction, everything collapses. “Under most policies in the U.S., what’s excluded is the faulty beam. But if collapse is an otherwise insured peril, the resulting loss should be covered,” Coombs explains.

“Many carriers have developed coverage terms to broaden how a builders risk policy could potentially respond to a loss resulting from faulty workmanship,” agrees Sharon Primerano, chief underwriting officer for The Hartford’s marine practice. “Typically, the broadened coverage is available with a higher deductible and additional premium, and can also be sub-limited.”

Another option is using one of three standardized exclusions developed by the London Engineering Group (LEG), which limit the exclusionary scope. LEG 1, a total exclusion, provides no coverage—period—in the event of a loss caused by faulty design, materials or workmanship. LEG 2, however, excludes only rectification costs for preventing damage.

“Let’s say there’s faulty electrical equipment at a construction site that causes a fire—this would exclude the cost of replacing and installing that faulty component, but the rest of the loss is covered,” Coombs explains.

LEG 3 provides the broadest coverage by excluding only improvements to the original material, design or specification. In the same example as above, “let’s say we should have never used that component—we should have used a totally different component that costs 10 times as much,” Coombs says. “What LEG 3 excludes is the cost of the upgrade.”

Already prevalent in Europe and Canada, LEG endorsements are now becoming “fairly common on large construction projects in the U.S.,” Coombs observes. “Three years ago, I would have said $100-million projects only. But now I’m seeing some of these endorsements on projects $50 million and up. As time goes on, you’re going to see them being introduced in projects that are smaller and smaller, because they bring some certainty.”

Concurrent causation: Coombs calls these exclusions, which cropped up in the 1980s to protect insurers against losses with multiple causes, the “broadest yet.” Although the terms vary greatly between forms, concurrent causation exclusions deny coverage for loss or damage caused directly or indirectly by any number of specific, listed perils—regardless of any other cause or event that contributes concurrently or in sequence to the loss.

Consider a beachside hotel construction project that sustains $10 million worth of damage after a hurricane. “Let’s say $9 million of that is caused by wind and $1 million is caused by flood, and in the builders risk policy, they have coverage for wind but they don’t have coverage for flood,” Coombs says. “An unsophisticated consumer might think they’d at least get $9 million. Depending on the actual wording of the exclusion and applicable insurance laws, they may get nothing.”

Coombs, who co-wrote “The Builders Risk Book” with Don Malecki, says concurrent causation exclusions are becoming more extensive in builders risk policies. “It’s something agents need to be very careful about when reviewing proposals from different insurance companies,” he warns. “Nearly all of them have some sort of concurrent causation language, but if you have a list of 10 [excluded perils] vs. a list of only four, there’s going to be a big difference in coverage.”

Partial occupancy exclusions: As renovations continue to pick up steam in the construction industry, many buildings are occupied before construction is complete, says Christie Lucas, vice president of commercial product management at Erie Insurance. “The owners want to start generating revenue as soon as possible, so perhaps they will fill the first space and then continue with the remaining space to start getting some revenue in,” she explains.

That’s a problem for your contractor clients, because most builders risk policies contain some kind of partial occupancy exclusion. “Agents need to have that removed if the building’s going to be occupied at any time during construction,” Lucas says. “For an individual building, you can purchase a partial occupancy endorsement that’s basically like a permit. If the agent fails to do that, it could be a costly E&O issue.”

Clauses to Watch

Separation of insureds: Nearly all builders risk policies insure multiple parties—the owner, the general contractor and the subcontractors. But most don’t contain a separation of insureds clause, which protects each insured individually. “What that means is if one insured violates a policy warranty or condition, that impacts all insureds,” Coombs explains.

For example, a builders risk policy may require the general contractor to keep the entire construction site lit and surrounded by an eight foot-tall fence. “Let’s say that the owner secured that policy and the general contractor doesn’t get a copy of it, so they don’t even realize this warranty is in the policy,” Coombs says. “And it turns out that there was no eight-foot fencing around the entire site, and then there’s a loss—there’s no coverage for anybody.”

Coombs notes that in Europe and in Canada, separation of insureds clauses are “standard stuff,” but the U.S. insurance industry has been “slow to catch on.”

Other insurance: Many builders risk policies contain this baffling clause, which states that in the event that any other insurance applies to a construction project, the builders risk policy is excess.

“If someone buys a builders risk policy, they intend for that builders risk to be primary insurance—that’s the reason they’re buying it,” Coombs says. “They understand the contractor may have separate liability insurance or something, but the purpose of a builders risk policy is to provide funding for repairs or reconstruction so that the parties don’t sit there and spend years litigating.”

Slowly but surely, the industry is developing endorsements to confirm that their policies are primary. “But it’s real slow,” Coombs says. “Agents and brokers should be careful to ask for an endorsement which confirms primary coverage, just for contract certainty.”

Jacquelyn Connelly is IA senior editor.