Critical Coverage – Impact Covers in Project Specific Insurances

Among the most often overlooked and misunderstood coverages when insuring a construction project are soft cost and delay in start up coverages, both of which are optional but prevalent exposures for both the owner and contractor alike.

We need to first review all of the other “net income” and “time element” covers which are also available to be insured under a construction builders risk policy to fully understand exposure and amounts to be insured for each item.

Firstly, we have “Extra Expense” and “Expediting Expenses.”

Extra Expense: This pays for additional costs in excess of normal operating expenses that an organization incurs to continue operations while the impaired property is being repaired or replaced post loss.

Expediting Expenses: Essentially “acceleration expenses” if in event of loss, policy will provide cover for extra costs (such as overtime, express freight, higher early prices) incurred in fast tracking repairs or replacement of a lost or damaged asset, with the intent of mitigating the overall quantum of the loss. These expenses usually are not covered under a typical insurance policy unless specifically included.

These coverages are often provided by carriers at no additional cost to the premium and added as a frill cover. However, given its importance of being able to mitigate the overall impact of an insured peril, we have seen more often than not, that the limits provided are insufficient when called up and more often than not overlooked.

Soft Costs: Thirdly, we have “soft costs,” which are essentially those additional costs incurred as a result of a delay caused by a covered loss during the “construction” period. Some of the more common soft costs are interest charges on project financing, realty taxes or other assessments, advertising and promotion and additional accounting, legal, architectural, or engineering fees. (See an excerpt from a policy defining soft costs in next column.)

Soft costs can be considered recurring (i.e., interest charges on project financing and insurance premiums for the dedicated construction and performance guarantee insurance(s), etc.) and non-recurring (i.e., engineering fees). Recurring soft costs should be insured for 100 per cent of the respective annual value, whereas non-recurring soft costs are typically insured for a one time value. We usually benchmark the limit of this coverage as a percentage of their initial/aggregate value of these total costs, which is roughly 25 per cent.

Delay in Start-up: Lastly, we have “delay in start-up” insurance which is time element coverage for property under construction. The delayed start-up is intended to provide coverage for “future income loss” following substantial completion, which results from a delay in the completion of the construction project when the delay is caused by an insured peril. Coverage is intended to include all expenses which would be incurred and will continue in the event of claim; this also includes the “net profit” loss which would have otherwise have been earned had no loss occurred.

For the project owner, it will possibly mean a delay of the facility being put to its intended use/occupancy, so instead of earning potential revenues they are incurring additional expenses. For the contractor, this could mean an extension to the project which translates into additional carrying costs in order to have the project completed.

Loss from an insured peril may be partially managed with the appropriate use of both the “extra expense” and “expediting expenses” coverages, provided that adequate limits of insurance were procured in the first place. Depending of the severity of the loss, once the project is brought back on track and back to its pre-loss state, invariably the schedule will be ‘pushed out’ to rectify the loss, at which point the contractor will incur a “delay” in the project.

Soft costs are exposures for both the contractor and owner alike, which if faced with an insured peril will immediately affect both entities’ balance sheet, if not readily addressed. Since the basic principal of insurance is to bring the insured back to its pre-loss state, the onus of ensuring that the margins for both entities will be achieved rests solely on the parties procuring not the cheapest cover but the best coverage to protect their interest in the first instance.

Peter Smith is senior vice-president, Construction, and Barrie Ngeh is account executive, both of Aon Risk Solutions.