Building Projects: A Crash Course for Insurance and Risk Management

Building projects are an exhilarating time of growth for an organization.  Maybe you won a grant.  Maybe you’ve been saving money for a long time.  Maybe you just got a loan.  The money is in place, and now it’s time to start working through the logistics and insurance part of the process.

That’s where this article comes into play.  Insurance companies, banks, and contractors can suck all the joy out of an otherwise joyful time.

It’s the best of times.  It’s the worst of times.

My goal with this article is to share observations that made some construction projects go well.  I also want to share the most common insurance questions and risk management issues that I’ve encountered.

1.      Identify a project manager within your organization

Managing a construction project is very involving.  Banks have numerous requirements and work slowly.  Insurance companies have their process.  Contractors will need time.

Someone needs to be in charge of ensuring all these entities get what they need on time.  They will need to manage communication.  They will need to manage timelines.

The most stressful situations I’ve been involved with involved an owner or volunteer with innumerable responsibilities and struggled to keep the project moving smoothly.

2.      Identify all the key players in the building project.

The usual players are the contractor, the bank, and the insurance company.  Depending on your project, you might also need to include historical societies and local governments.  Make sure you know everyone who needs to be involved in the project.

3.      Give yourself lots of time.  Everything takes longer than you expect.

One of the most frustrating parts about working with giant financial institutions is that no one moves quickly.  And when you try to get an underwriter to move quickly, their immediate reaction will be to say no.

Here’s what a nightmare scenario looks like:

The bank spends six weeks underwriting your file.  They get to the very end of the underwriting process and you want to go to closing tomorrow so you can start construction next week.

Then you contact your insurance broker for the first time, and they explain it could take weeks to get the coverage you need.

Depending on your project, it could put your entire organization in a lurch.

The best way to prevent this is to ask all the key parties involved with the project what their needs will be as early as possible.

4.      What kind of project do you have?

Here are my three categories for building projects.  These are not industry terms, but it’s how I categorize projects in my mind.

a.      Minor Renovation project –  This is a project that does not change the overall cost of rebuilding the structure.   The project is cosmetic or for routine maintenance of the building.  This looks like tearing up the carpet, replacing the roof, painting, etc..

b.      Major Renovation project – Anything that would increase the end replacement cost of the structure or make the facility uninhabitable for some time.  This project can be adding or removing square footage, or gutting the structure to its studs

c.      New Construction – The structure does not exist currently.  You’re going to build it.

5.      What is a Builder’s Risk Policy and when do you need it?

Allow me to take a step back to explain why a builder’s risk policy exists by explaining how it fits in with normal property insurance.

Property insurance is designed to cover existing structures and the property inside the structure.

The structure has four walls and a roof.  It doesn’t move.  It doesn’t change.  The cost to rebuild is static.

Let me illustrate this by telling a story.  My wife and I bought our current home new.  When the salesperson showed us the lot it was a plot of grass.  We got a loan, we signed a contract, then the contractor went to work.  My wife and I drove by the house several times a week to watch the process.

First, it was a plot of grass.  Next, they moved some dirt.  Then they poured concrete for the basement.  Then they put up the wood frame of the house.  And one step at a time the structure looked more and more like a home.

As they built the house, the cost to rebuild the structure increased.  That’s the idea behind a builder’s risk.  The structure is worth more at the end of the policy period than at the beginning.  The value of the structure is constantly changing throughout the policy.  Furthermore, the structure is more likely to be damaged throughout the project because it’s more exposed.

Ultimately, the insurance company will decide when you need a builder’s risk policy.  But my suggestion is that you need it when you are either doing a Major Renovation project or a New Construction.

6.      How much coverage do you need on the Builder’s Risk policy?

Ultimately, the answer to your question is the construction cost in the construction budget.

7.      When does a Builder’s Risk Policy start and when does it end?

The policy should start when the contractor breaks down and ends when you occupy the building.

Your project manager should keep this in mind.  This requires communication between yourself, the contractor, and the insurance company.

8.      Who buys the Builder’s Risk policy?

This is something you need to negotiate with your builder.  I’ve seen it done both ways.

9.      What are soft costs?

Soft costs are indirect costs that are critical for a successful construction project.  But are not tied to the labor and materials.

They include the following:

Design and Engineering fees, Permit fees, Legal and Professional fees, etc…

These costs should be detailed in your construction budget and can be insured on your Builder’s Risk policy.

10.  What documentation does an insurance company need for the builder’s risk policy?

Underwriters typically ask me for the construction budget, the construction drawings, and the Gantt Chart.  This will tell them the cost of the budget, the extent of the renovation, and the timeline for the construction project.

They also who is the General Contractor.  This leads to my next topic.

11.  What insurance coverage should I require from my General Contractor?  And how much should I require?

For this section, I’m going to list coverages you should consider along with coverage recommendations.  Please keep in mind that you should consult with an attorney and an insurance broker for your specific project.

General Liability Insurance including Product and Completed Operations Liability — $1,000,000 General Liability per occurrence.  $2,000,000 aggregate.

Professional Liability Insurance — $1,000,000 General Liability per occurrence

Auto Insurance —  $1,000,000

Workers Compensation – Per state laws.  This coverage should be mandatory for anyone who works on your building.

Umbrella – The limit you require should depend on the size of your project.  An umbrella will increase the maximum amount that can be paid in a catastrophic claim.  If it’s a small project, you may not even require an umbrella policy.  However, the electrician who burned down Notre Dame couldn’t have enough insurance.

Pollution Liability – $1,000,000

Performance Bond – A performance bond protects you if in the event the contractor goes out of business in the middle of the construction project.  The bond limit you require should depend on the size of the project.

Conclusion

While it’s not possible to provide an all-inclusive guide for everything you need to know for a building project, I hope this gives you a jump start.  Every project will have its own issues.  But I hope that this article can provide a framework for approaching the project and your most likely questions.