I could hear frustration in the property manager’s voice. He is responsible to a client that owns 5 commercial properties in the Greater Bay Area, in 5 different cities, and 3 different counties.
How can you keep track of the building code requirements of all the cities and counties, and know how to factor those into the potential replacement value of the properties to be insured, making sure that you aren’t caught short in the loss adjustment?
Says the property manager, “I’m willing to recommend that the owners pay more for the insurance, to know that they have adequate replacement cost coverage to include the code cost upgrades, etc.”
To review, the standard property policy doesn’t cover costs associated with the following three areas, known as Building Ordinance or Law (BOL):
- Coverage for Loss to Undamaged Portion of the Building. Building ordinances may require the undamaged portion of a building be replaced if the building is damaged by a factor of 60% or 70%, depending upon local codes.
- Demolition costs to the Undamaged Portion of the Building, as required by local building ordinances.
- Increased Costs of Construction, i.e., the costs to rebuilding the structure to current code requirements, generally more comprehensive and therefore expensive than those in place when the building was built originally.
Our insurer offers a coverage endorsement for Building Ordinance, but it’s limited to 25% of the building amount or $100,000, whichever is less.
In the case of our property manager above, the buildings he manages are 30 to 50 years old. They are well maintained, and some have received upgrades since they have been built. The fact is however, there may have been many incremental changes to codes over the years, and the compounding of these changes over 50 years may yield substantially more rebuilding cost than the $100,000 offered by the Building Ordinance endorsement.
How do we get this done?
Wouldn’t it be nice if we could get feedback from a local building department, or a local contractor on the costs associated with the needed code updates? Unfortunately, no one seems to want to commit to such cost estimates. In discussions with a local developer, we came to some unscientific conclusions, which are probably a good starting point. On buildings that are less than 20 years old, we may want to add $5-$10 per sq ft to replacement cost. On older buildings, it may be be $15 – $20 per sq ft. If the building was not sprinklered, and now must be sprinklered, that alone will add about $10 per sq ft.
So, for a 30,000 sq ft building that is 30 years old, you may want to add $500,000- $600,000 to the replacement value.
We must take our calculations to the underwriters and adjust the building values to include these added values. Underwriters may have some concerns depending on the quality of the property, as some properties may cross over the line and become what is referred to in the industry as a “moral hazard”. The concern is that there would be an incentive for the owner of an old outdated building to have a convenient fire.
In surveying various insurance companies about their practices regarding BOL, it seems there are no standard solutions. Every company has different endorsements and underwriting standards for the BOL exposures.
Bottom line: don’t make assumptions in this coverage area. Make your client aware of the BOL risk and work with your underwriter to provide adequate coverage for the replacement value of the building with increased costs due to updated code requirements.
Underwriters want to make sure that the losses that they are paying for are anticipated in the underwriting file and in the premium. The client wants to make sure they are “made whole” in the adjusting process. Getting a meeting of the minds on this issue between client and underwriter is an important consideration for making sure the policy fits client’s needs and expectations.
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