Pitfalls to Avoid and Money-Saving Tips
Builders Risk insurance is really a misnomer because it has nothing to do with liability insurance or getting sued. It’s simply property insurance on a construction start.
In some parts of the country, it’s also referred to as Course of Construction insurance.
Some of the perils covered by Builders Risk are fire, wind, theft, and vandalism. It typically does not cover perils such as earthquake, flood, or wind in beach zones unless the policy has been specifically endorsed to do so.
If you’re going to properly set up your policy, coverage should be effective prior to when the materials are delivered to the job site. Coverage ends either upon closing of the sale, occupancy, or the policy expiration date. After coverage expires due to sale or occupancy, the new owner should take out permanent property insurance on the building such as a Homeowners policy or a Commercial Property policy.
Should a Builder Allow Owners to Provide Their Own Builders Risk on Custom Jobs?
Based on my experience this is very risky. I’ve seen problems arise when the contractor loses control of the transaction.
First, the owner may fail to procure coverage even if the building contract requires him to do so.
Second, the owner may purchase an inferior policy with unacceptable coverage problems that are covered below.
It is strongly recommended that the builder always take out the Builders Risk policy to make sure that these common problems don’t arise. The builder could lose tens or hundreds of thousands of dollars and be put out of business if the owner makes a mistake and if a claim is not covered as a result.
Common Coverage Problems
Below are three of the most common Builders Risk coverage problems that we see when we analyze policy forms that are offered by our competitors. These problems are typically found on policy forms used by insurance carriers that specialize in writing personal insurance. In other words, the ones that advertise most frequently on TV.
- Exclusion for the theft of building materials before they’re permanently attached to the building structure. If your policy has this exclusion, it could be an expensive mistake if a heating and air unit or other expensive appliances or materials are stolen shortly after delivery.
- Collapse of the building structure. Several years ago, one of our builder clients had a collapse to the tune of about $30,000 when the unbraced framing of a house blew down during a severe thunderstorm. It would have been bad news had he had the collapse exclusion.
- Policy form does not allow the builder to insure reasonable profit. If you don’t have coverage for profit, you’ll end up having to build the structure two times but only get paid for your profit once. That doesn’t make sense because the purpose of insurance is to make you whole after suffering a loss. I strongly recommend that you should always buy your policy from an insurance carrier that allows you to insure profit and profit should be built into your estimated value for your start.
Reporting and Payment Options
Below are the three most popular ways to insure your Builders Risk exposure ranging from the most expensive to least expensive and most time consuming to least time consuming to administer.
A single shot policy means that each start has its own separate Builders Risk policy with a policy term of one year. It’s the best policy for builders with five or fewer starts a year, remodelers, and commercial contractors.
The advantage of the single shot is that there are no volume commitments in terms of the number of starts that you must have to qualify with the insurance company.
The disadvantages of the single shot is that there is no premium returned if you sell the start before the end of your one year policy term and it involves the greatest amount of administrative hassle. In other words, every time you have a new start, you must play communication tag with your agent to get a quote and bind coverage.
The monthly reporting form used to be our most popular Builders Risk form for builders with six or more starts. The builder completes a reporting form on a monthly basis that details the prior month’s new starts including their estimated completed values. Once reported, a start is covered for one year.
The builder also reports any starts that are greater than one year old and still not sold. These old starts must be renewed for an additional annual term.
The premium due is computed by multiplying the rate that’s listed on the form times the estimated total completed values for all new starts and re reports. The completed monthly form and check are mailed to the insurance company.
The advantages are that the rates are slightly lower than the single shot and self-reporting reduces the administrative hassle of playing communication tag with your agent on every start.
The disadvantages are the potential for forgetting to send in the monthly report or to re-report the starts on the unsold dwellings that are over one year old. Failure of the insurance carrier to receive the form or failure to re report an unsold dwelling can result in no coverage on a start. This is the reason why we now recommend that most of our client use the annual audit form (see below) instead of the monthly reporting form.
The annual audit is the preferred form for covering builders with six or more starts. It’s taken the place of the monthly reporting form as the most popular way to insure larger builders within our agency.
The policy set-up premium is based on the projected 12-month number of new starts multiplied by their average estimated completed value plus the completed value of homes in existing inventory for greater than 12 months. The total combined values are multiplied by the rate to determine the policy set-up premium
A payment plan is offered to spread the cost over nine months.
After the end of the policy year, your actual number of starts and values are audited and the final cost of the policy is determined. If the audit premium is greater than the policy set-up premium, you owe additional premium upon audit. On the other hand, if the audit premium is less than the policy set up premium, you get a refund.
The main advantage is that there are no concerns about forgetting to send in a monthly report and the resulting lack of coverage on a start. And, the rates are discounted compared to the single shot policy.
Determining the Proper Insured Value
Determining the proper insured value or limit of coverage is critical in both protecting yourself and in not overpaying. Most Builders Risk policies require the policy limit to be set at the estimated completed value, which includes not only labor and materials, but overhead and reasonable profit as well.
One of the biggest money-saving tips is that non-repeatable expenses should be excluded from estimated completed value including land cost, real estate commissions, landscaping, impact fees, and architect fees. This one tip could save hundreds of dollars off your premium every year.