Definitive figures are hard to come by, but indications are strong that “rehab” work will constitute a growing percentage of construction projects in the future.
The total spent on improvements and repairs to residential structures alone exceeded $255 billion in 2006, according to the U.S. Census. Commercial renovations add untold billions more.
Among other things, the soaring cost of gasoline may profoundly change the economic calculus that, for decades, made it more attractive to undertake new construction in expanding suburbs rather than invest in existing communities.
With the price of gasoline now approaching $4 a gallon, older, more condensed communities with mass transit systems are regaining their allure.
Another major factor driving growth in rehab work is less well-known but reportedly had an immediate impact: The introduction of new building code standards for renovation projects that are distinct from the standards governing new construction.
New Jersey took the lead in 1998 by enacting a “rehab subcode” that, in essence, relaxed building code criteria for projects involving existing structures. The state reported that rehab activity nearly doubled in volume in the two years following enactment of the subcode. Seeing those results, Maryland, Rhode Island, and North Carolina took similar action shortly thereafter.
Then, in 2003, the International Code Council issued a new model building code with flexible standards for existing structures. To date, it has been adopted as a statewide code in at least 14 states, and by municipalities in 13 others.
“A quiet revolution has been taking place in the way that state and local governments across the country regulate commercial and residential construction,” wrote researcher Philip Mattera, in a January 2006 report. “A new flexibility in the application of building codes is making possible the rehabilitation of structures that would otherwise have remained neglected or abandoned.”
For inland marine underwriters that write builders’ risk insurance, the implication of the rehab boom is that a growing share of premium in many markets will come from projects that include pre-existing structures.
Builders’ risk specialists know there is a world of difference between insuring “ground-up” construction--where the materials and supplies are new--and projects involving older, unfamiliar buildings that may have hidden hazards.
The most important consideration in insuring a rehab project is the decision whether to assume the overall commercial property exposure for the existing structure being worked on. That’s an exposure builders’ risk carriers typically seek to avoid, but one that may be unavoidable for competitive or
practical reasons as the market for rehabs grows.
The terms “renovation” and “rehabilitation” are often used interchangeably to refer to the restoration, updating, or conversion of an existing building.
For purposes of insurance, however, it would be best to regard them as distinct types of projects, says Valerie Lindstrom, director of commercial lines marine business in the Itasca, Ill. office of The Hanover Insurance Group.
In a 2004 white paper on the topic, she wrote that a project is a “rehabilitation” if it involves structural changes that could include the removal, replacement, and/or addition of load-bearing walls, supports , columns, floors, slabs, or openings in the floor.
“Generally, when the value of the construction work exceeds the value of the building shell, the risk can be classified as a heavy rehabilitation risk,” she wrote.
In contrast, “[I]f the value of the work is less than 40% of the value of the building shell, the risk can be classified as a renovation risk,” provided there are no structural changes involved.”
Examples of renovation projects include the replacement of window frames, the updating of electrical wiring, and the replacement of drywall. During renovation projects, buildings typically remain occupied with commercial property coverage in place.
According to Lindstrom, rehabilitation risks are exposed to risks of catastrophic loss to a far greater degree than renovation risks, as the former have often accumulated debris and combustible materials. Work on them often requires use of open flames to cut up old boilers and for other purposes.
Determining whether a project is a renovation or rehabilitation along the lines suggested by Lindstrom is a major factor in determining whether it would be best insured under a builders’ risk or installation floater policy.
Robert Guevara, AAIS vice president of inland marine, advises inland marine construction underwriters to look carefully for the possibility of insuring projects on existing structures with an installation floater.
An installation floater is clearly understood to apply only to property being installed, with certain specified exceptions. Presuming that one’s floaters have been kept up to date, an installation floater can be the most definitive way of avoiding exposure for loss to existing construction.
The standard Installation Floater available in the AAIS Inland Marine Guide provides no coverage for existing property on the site where an insured installation is taking place. In contrast, the Guide’s Builders’ Risk jobsite form provides coverage for collapse and increased cost due to enforcement of a building ordinance or law.
“When I’ve trained underwriters, I’ve told them to consider a project to be an installation floater risk when only one or a few features, such as roofing or drywall, are being repaired or replaced,” Guevara says.
“The more features that are being renovated, the more difficult it is to distinguish existing construction from property being installed, the more it becomes a builders’ risk type of exposure.”
AAIS does have one form in the Inland Marine Guide that provides both builders’ risk and installation floater coverage, but that form is intended for relatively large projects and explicitly excludes rehabilitation and renovation projects.
For smaller rehab projects that truly fall into the category of “rehabilitation,” AAIS provides the Guide’s Builders Risk Rehabilitation and Renovation form, first developed in 2004 and recently revised.
This form stands out among builders’ risk forms in that it gives carriers the option to insure the entire existing structure for commercial property perils for the period of rehabilitation or renovation. Here’s how it works:
- On the schedule that accompanies the form, the underwriter enters a “building materials limit” for the property being created or installed, the exposure typically insured under builders’ risk policies.
- Separately, the carrier indicates whether it is providing coverage for the existing building and, if so, whether the structure is to be valued for a stated amount or for actual cash value.
- Then the underwriter enters an “existing building limit” for coverage of the structure identified in the schedule. A provision in the form specifies that the policy does not cover any standing building or structure, or any part of a standing structure, other than the existing building described in the schedule.
- The underwriter enters amounts for coverage extensions (e.g., debris removal), supplemental coverages (e.g., transit), and the deductible.
“[Insuring a rehabilitation project] is a challenge because you insure the existing structure differently from the work that goes into it,” says Guevara.
“That’s why the builders’ risk form and schedule for Rehabilitation and Renovation have two separate valuation provisions, one to deal specifically with the existing structure, and another one to deal with the work that goes into the project.”
Another benefit to this approach, says Guevara, is that it allows underwriters to insure what would be, in his opinion, an installation project with a form that is nonetheless labeled as “builders’ risk.”
According to Guevara, project owners and financiers often insist that work be insured by a builders’ risk policy, even when they continue to maintain other commercial property insurance on the structure.
In such cases, carriers using the AAIS Rehabilitation and Renovation form can simply indicate on the accompanying schedule that they are not insuring the existing structure.
For several reasons mentioned above, genuine rehab projects are considered to pose more risk than “ground-up” new construction, and the AAIS Rehabilitation and Renovation form reflects that by restricting certain coverages in comparison to those provided in other AAIS builders’ risk forms.
For example, most AAIS builders’ risk forms do not include exclusions or limitations on collapse coverage.
On the rare occasion when a new structure might collapse, builders risk carriers may end up paying for a loss, although in many cases the claim will be subrogated and may ultimately end up as a liability claim against a subcontractor or a retained business risk.
Existing structures represent collapse hazards, however, especially when work is being done on load-bearing walls in unfamiliar structures.
To reflect that added exposure, the AAIS Rehabilitation and Renovation form incorporates what has become the standard commercial property treatment of collapse: A general exclusion for collapse is built into the form, then limited coverage for collapse arising from specified “collapse perils,” which include standard named perils plus hidden decay, insects/vermin, defective materials, and others.
In addition, the AAIS Rehabilitation and Renovation form provides no built-in coverage at all for increased cost of construction due to a requirement to meet a building law or ordinance.
This can be a very significant exposure when dealing with older buildings.
Underwriters need to be mindful of the fact that there is
a chance that a builders’ risk carrier will end up providing building property coverage on a vacant structure for a long period of time.
“There are instances where a contractor or building owner will get a policy for rehab and renovation, then just sit on the project,” Guevara says. “Then, a loss occurs and the claims investigation determines there was no work done and no work permits granted.”
The Rehabilitation and Renovation form and schedule have been revised to preclude the possibility that a carrier will inadvertently assume prolonged exposure for a vacant building.
The form itself states that coverage for a vacant building is subject to a limitation expressed in the schedule. That limitation states that, unless building permits are obtained or work begun, coverage under the policy will be in effect for only the number of consecutive days indicated on the schedule.
Similarly, the schedule allows the carrier to indicate the number of days after completion of a project before coverage under the policy ceases. This is in addition to the standard builders’ risk conditions for the termination of coverage, including policy cancellation or expiration, acceptance of property by the owner/purchaser, abandonment of the project, or a cessation of insurable interest.
“A vacant building exposure is not a real rehab exposure,” Guevara says. “It is a completely different type of coverage that should be priced completely differently than you would for a rehab form.
“Since that issue has come up a few times, we’ve built in a capability to put a cap on the coverage [so] there won’t be coverage unless the insured has gone out and obtained the construction contracts or building permits.”
A full interview with Bob Guevara on the topic of insuring rehabilitation and renovation projects can be heard by going to www.AAISonline.com and clicking on the appropriate “AAISinsight” icon.
Insuring Rehabs 
