Insuring Historic Buildings

When owners of historic buildings preserve, rehabilitate, and renovate their property they safeguard a little piece of history and culture and maintain a tangible link to the past.

Rehabilitating old buildings is better for the environment than constructing new ones since rehabilitation preserves existing materials instead of sending them to a landfill. Rehabilitation conserves natural resources as well along with the energy costs of manufacturing and transporting new materials to the construction sites.

Whether the owners of historic buildings rehabilitate their buildings or just live in them, they need insurance. However, due to the unique characteristics of many of the buildings, they are a challenge to insure. Historic buildings often require customized insurance treatment because they are more susceptible to certain perils. Because of the virtually unlimited variety of building designs, materials, and supplies, as well as custom craftsmanship and the lack of standardized fixtures they are usually more expensive to repair than more contemporary buildings.

Several different insurance programs may be appropriate for insuring historic buildings, and the choice of a form may depend upon whether the building is occupied for its intended use or being rehabilitated.

Historic Preservation Tax Incentives Program

The use of modern building materials while rehabilitating historic buildings can have a negative financial impact on building owners. By rehabilitating historic buildings within strict guidelines, building owners may be entitled to income tax credits. The government programs under which the credits are administered typically limit how repairs are made.

Recognizing the importance of preserving our building heritage, the federal government established a program of tax incentives for the rehabilitation of deteriorated historic and older buildings. The program is jointly administered by the National Park Service of the Department of the Interior (NPS), and the Internal Revenue Service of the Department of the Treasury, in partnership with State Historic Preservation Offices. The program was created to help save historic buildings from demolition and to encourage the reuse of old structures. It has been credited with the revitalization of communities, and the preservation of historic places that give communities their special character. The federal tax incentives include:

• Up to a 20 percent income tax credit for the certified rehabilitation of certified historic structures; and
•  Up to a 10 percent income tax credit for the rehabilitation of non-historic, non-residential buildings built before 1936.

The two credits are mutually exclusive and involve different rehabilitation standards. Several states have programs for state income tax credits that mirror the federal program. The NPS standards for rehabilitation take precedence over any state or local requirements or design guidelines.

It should be emphasized that tax credits are much more significant than tax deductions. Tax credits reduce the tax owed and returns received dollar for dollar, while an income tax deduction only lowers the amount of income that is subject to taxation.

Because of the tax credits that are involved in rehabilitating historic buildings, corporations and businesses with significant tax liabilities often invest in historical buildings, often in a limited partnership with the property developer, in order to gain the credits. For these types of investors, certain tax code limitations apply.

Twenty percent tax credit
The 20 percent federal tax credit is available to any project that the NPS designates as a certified rehabilitation of a certified historic structure. The NPS must certify that all rehabilitation projects are consistent with the historic character of the property. The tax credit is limited to commercial, industrial, agricultural, or residential buildings used for rental purposes that are depreciable. A building built after 1936, which would not be entitled to the 10 percent credit, is not necessarily disqualified. The credit is not available for buildings that are used exclusively as the owner’s private residence.

A certified historic structure is a building that is listed in the National Register of Historic Places, which is an arm of the NPS, or is a building that is located in a registered historic district and certified by the NPS as contributing to the historic significance of that district. The certification process involves a determination as to whether the building is consistent with the historical character of the property, and (in some cases) to the district in which it is located.

Qualified rehabilitation expenditures include the costs of the work as well as architectural and engineering fees, site survey fees, legal expenses, development fees, and other related costs.

To qualify for the credit, the rehabilitation must be substantial. The expenditures from the rehabilitation must exceed $5,000 or the adjusted basis of the building, whichever is greater. (The adjusted basis is generally the purchase price, minus the cost of land, plus improvements already made, minus depreciation already taken.) The following requirements also apply:

• The rehabilitation must be completed in two or more distinct stages of development;
• The property must be put back to use after the rehabilitation; and
• The building must be a certified historic structure after it is put back to use.

Ten percent tax credit
The 10 percent tax credit is available for the rehabilitation of buildings placed in service before 1936. It applies only to buildings rehabilitated for nonresidential uses, but hotels qualify because they are considered to be used commercially. Rehabilitation projects undertaken for the 10 percent credit must meet the following parameters regarding the external walls and internal structural framework:

• A least 50 percent of the building’s external walls existing at the time the rehabilitation began must remain in place as external walls at the work’s conclusion;
• At least 75 percent of the building’s existing external walls must remain in place as either external or internal walls, and
• At least 75 percent of the building’s internal structural framework must remain in place.

Rehabilitation Standards
The larger (20 percent) tax credit given for the rehabilitation of historic buildings is due to the greater historical value of the buildings. However, an advantage of the ten percent tax credit for pre-1936 buildings is that there is no formal review of the project plans or work.

The standards for the rehabilitation of historic buildings are more stringent and are as follows:

1. A property shall be used for its historic purpose or be placed in a new use that requires minimal change to the defining characteristics of the building, the site, and environment.
2. The historic character of a property must be retained and preserved. Removing historic materials or altering of features and spaces that characterize a property shall be avoided.
3. Each property is recognized as a physical record of its time, place, and use. Changes creating a false sense of historical development, such as adding conjectural features or architectural elements from other buildings, shall not be undertaken.
4. Changes that were made over time, but have acquired historic significance in their own right, shall be retained and preserved.
5. Distinctive features, finishes, and construction techniques or examples of craftsmanship that characterize a historic property must be preserved.
6. Deteriorated historic features shall be repaired rather than replaced. Where the severity of deterioration requires replacement of a distinctive feature, the new feature shall match the old in design, color, texture, and other visual qualities and, where possible, materials. Replacement of missing features must be substantiated by documentary, physical, or pictorial evidence.
7. Treatments such as sandblasting, which cause damage to historic materials shall not be used. Surface cleaning of structures must be undertaken using the gentlest means possible.
8. Significant archeological resources affected by a project shall be protected and preserved.
9. New additions, exterior alterations, or construction must not destroy historic materials that characterize the property. The new work shall be differentiated from the old and must be compatible with the massing, size, scale, and architectural features to protect the historic integrity of the property and its environment.
10. New additions and adjacent, or related, new construction shall be undertaken in such a manner that if removed in the future, the essential form and integrity of the historic property and its environment would be unimpaired.

Going outside the standards can result in a building owner losing the tax credit. According to the NPS there are only four main circumstances in which material substitutions can be made. They are as follows:

1. Historic materials are no longer available;
2. There are no craftsmen skilled in the craft required;
3. There are flaws inherent in the original material; or
4. Building and life safety codes require a change.

Since qualified buildings must be used for commercial purposes despite the fact that they might not have been designed for such use, there is some leeway given so that the buildings can be functional. The preservation of the building's exterior façade is emphasized while more leeway is given on the interior. Material that cannot be seen in the interior of walls is not required to be used or installed with outdated methods. For example, the use of modern insulation is encouraged in the rehabilitation of historic buildings.

Note that the tax credit guidelines do not place any obligations on the insurer or the building owner. The standards function for the purpose of qualifying a building owner obtaining a tax credit. The tax credit standards are not requirements imposed upon insurers in regard to settlement terms. 

However, if a building is a part of a historic district or is a landmark, organizations such as historic-district committees, or municipal ordinances, may also have control over changes to the building. 

Builders' Risk

When historic buildings are renovated or rehabilitated, builders risk policies are often used to provide coverage for contractors, building owners, project managers, lending institutions, or others. All the parties to a construction project with insurable interests are often, though not always, added as named insureds.

AAIS recently announced the release of a revision of the Builders' Risk Coverage - Rehabilitation And Renovation Coverage form. The form provides coverage for existing buildings and structures while in the course of rehabilitation or renovation. Certain coverages and limits are triggered by entries on an accompanying schedule. Separate limits are entered for building materials, for the property being created or installed, and for the existing building. This approach allows underwriters to customize the coverage to the risk and also to insure installation and renovation projects with a builders risk form.

Often, a major renovation requires the suspension of activities and occupancy during the construction. The Rehabilitation and Renovation form provides broader coverage to a building that is not occupied due to the rehabilitation, which is a significant advantage over other programs.

Vacancy Provisions

The Rehabilitation and Renovation 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. Values can be either on a stated amount or actual cash value basis.

Coverage extensions include Debris Removal and Limited Fungus Coverage. Supplemental coverages include Pollutant Cleanup And Removal, Temporary Storage Locations, and Transit.

The coverage extensions for Temporary Storage Locations and Transit are particularly beneficial for rehabilitation projects since the coverage provided for building materials that are not on-site is limited in other programs.

Temporary Storage Locations & Transit

With the Rehabilitation and Renovation form, the insurer has the following loss payment options which are similar, though not identical, with the loss payment terms of CP-12 building and personal property coverage part in the event of a covered loss:

• Pay the value of the lost or damaged property;
• Pay the cost of repairing or replacing the lost or damaged property;
• Rebuild, repair, or replace the property with other property of equivalent kind and quality, to the extent practicable, within a reasonable time; or
• Take all or any part of the property at the agreed or appraised value.

The applicable coinsurance percentage is indicated on the schedule of coverages. When it applies, the insurer only pays a part of the loss if the limit is less than the coinsurance percentage of the estimated value of building materials at the completion of the rehabilitation or renovation project. 

The Rehabilitation and Renovation form does not provide built-in coverage for the increased cost of construction due to a requirement to meet a building law or ordinance. However, the program offers coverage through the use of an Ordinance Or Law Coverage endorsement.

Rehabilitation projects pose greater and more numerous risks than new “ground-up” construction, and the Rehabilitation and Renovation form reflects that by restricting certain coverages that are provided in other AAIS builders’ risk forms.

Existing buildings, particularly old ones, represent more significant collapse hazards, especially when work is performed on load-bearing walls in unique structures. To reflect the additional exposure, the Rehabilitation and Renovation form builds in a standard commercial property exclusion for collapse. There is, however, limited coverage for collapse arising from specified “collapse perils,” which include standard named perils plus hidden decay, insects/vermin, defective materials, and others.

Historic Preservation Tax Credit Coverage
AAIS also recently released a new Historic Preservation Tax Credit Coverage endorsement and schedule. It can be used with the Builders' Risk Coverage - Rehabilitation And Renovation coverage form to provide coverage for the delay in receiving a tax credit for the rehabilitation of a historic building as well as the loss of a credit.

More specifically, the endorsement pays for a loss caused by a postponement or interruption in the insured's ability to claim against their tax liability a federal Historic Preservation Tax credit, or a similar state or municipal credit, resulting from a delay period involving a rehabilitation or renovation project to which a covered claim is made under the coverage form.

The endorsement provides a Loss Of Tax Credit coverage, which pays for the loss sustained caused by the loss of or reduction in the amount of a federal tax credit, or state or municipal equivalent, that otherwise would have been available with respect to a rehabilitation or renovation project if the loss or reduction results from direct physical loss to, or a delay period of, a rehabilitation or renovation project for which a covered claim is made under the Builders' Risk Coverage form.

The endorsement also provides a Delay In Receiving Tax Credit coverage, which pays for the loss sustained caused by a postponement or interruption in the insured's ability to claim against their tax liability a federal tax credit, or similar state or municipal credit, resulting from a delay period involving a rehabilitation or renovation project to which a covered claim is made under the Builders' Risk Coverage form.

Underwriting Historical Buildings

Regardless of the line of insurance that is used, an inspection is desirable to identify any special features and to determine the value of the building. Particular attention should be made as to whether the building is up to code. The roof, plumbing, and furnace may be of particular concern. Buildings constructed before the 1930s were built with ungrounded knob-and-tube electrical wiring, which poses a greater fire hazard. Profitably insuring historical buildings and older buildings in general, requires a great deal of experience and expertise.

Building value
Establishing values for historic buildings can be challenging. For example, an old home in a run-down neighborhood might have a resale value of only $75,000, but due to the materials such as plaster, old bricks, and custom fixtures used in its original construction, it would cost $250,000 or more to rebuild using original materials. Under most programs, the value of a building is the cost of rebuilding it with materials of like kind and quality. It should be noted that the question of whether drywall may be substituted for plaster has been an issue for litigation.

Owners of meticulously maintained historic buildings may have high expectations whenever they suffer an insurable loss. It is important that policyholders understand at the outset the policy limitations regarding:

• Settlement terms;
• Increased costs due to ordinance or law; and
• Personal property.

When policyholders are not aware of these limitations when they purchase their policies, the limitations are likely to become problematic in the event of a claim.

Settlement Terms
Very old built-in custom-made decorative fixtures that were built with unusual materials may be extremely expensive, or nearly impossible to replicate. In these cases, insurers typically strive to make repairs with materials that are compatible with the historic material in appearance. They often make every effort to match the details and craftsmanship of the original material and try to match the color, texture, and finish of the original as closely as possible. For instance, when a door that is 150 years old is destroyed, it might be replaced by a door that looks the same, but the new door might not be made of 150 year old lumber. For some owners of historic buildings, who aren't aware of their policy limitations, close isn't good enough.

Insurer options in applying terms for loss to building or structures

The Homeowners forms define "actual cash value" as the cost to repair or replace property using materials of like kind and quality, to the extent practical, less a deduction for depreciation. BP 0200, the Businessowners Special Policy, does not define the term, but specifies that actual cash value includes a deduction for depreciation. Both the Homeowners and Businessowners Programs also offer coverage options for functional replacement cost terms.

One of the differences between HO 0003, the Special Form, and HO 0005, the Special Building And Contents Form, is that the replacement cost terms in HO 0003 expressly do not apply to certain property including valuable rugs.

Coinsurance penalties used with the Commercial Properties form, Building and Personal Property Coverage Part (CP-12), vary from policy to policy. The form specifies that when a coinsurance percentage is shown on the declarations, the insurer only pays a part of the loss if the limit is less than the value of the covered property at the time of the loss multiplied by the coinsurance percentage. The part of the loss is determined using the following steps:

• Multiply the value of the covered property at the time of the loss by the coinsurance percentage;
• Divide the limit for covered property by the figure determined above; and
• Multiply the total amount of loss, after the application of any deductible, by the figure determined in b. above.

The most that will be paid is the value determined in c. above or the limit, whichever is less. CP-12 further specifies that the insurer has the option to:

• Pay the value of the loss;
• Pay the cost of repairing or replacing the loss;
• Rebuild, repair, or replace with property of equivalent kind and quality, to the extent practicable; or
• Take all or any part of the damaged property at the agreed or appraised value.

Note that the Commercial Properties Program also offers a Builders' Risk Coverage Part - Completed Value form and a Builders' Risk Coverage Part - Reporting Form.

There are a handful of insurers that offer special programs, with nonstandard forms and endorsements, for insuring historic homes and historic commercial buildings. Two companies dominate in regard to market share. These programs feature, along with other enhancements, more generous settlement terms such as historical replacement cost value or guaranteed replacement cost value. The terms often provide for the replacement repair and restoration of unique materials and recreate authentic workmanship if possible. Often, these policies also allow for a set percentage above the policy limit to replace a damaged building. Such Programs tend to offer higher special limits for certain personal property as well. Though some insurers have found these types of programs to be profitable, underwriting them requires a great deal of judgment by seasoned professionals. Other insurers have offered special programs for insuring historic buildings, only to find it unprofitable because an occurrence that results in a minimal claim under a standard program could result in a "run-away" claim under a policy with non-standard terms.

Increased Cost - Ordinance Or Law
When historic buildings are rehabilitated after being damaged, local ordinances or laws may require the project to adhere to the new building standards, which could be very costly. The coverage limit for the increased costs involved in repair to bring a building up to code, increased costs - ordinance or law, is much more likely to be an issue for historic buildings than modern ones since codes were either implemented or revised after they were constructed. For example, roof joists in old houses are often widely spaced and when repaired the joists may need to be spaced more closely, using more lumber that may be of larger size, to comply with modern codes. An even more expensive upgrade may be damage involving old electrical wiring, which could result in tearing out all the old wiring.

On the other hand, municipal ordinances or laws concerning historic buildings may also increase construction costs when building owners are required to use "outdated" materials or construction methods. As noted above, if a building is a part of a historic district or is a landmark local ordinances or laws may have control over changes to the building. Some ordinances specify and define appropriate materials and design guidelines. They may also require a permit review before buildings can be altered. Building owners that violate such ordinances can be subject to fines. 

Coverage for increased costs - ordinance or law

The Homeowners Program includes a coverage option for Increased Cost - Ordinance Or Law - Increased Limit Of Coverage that can be used to increase the limit to a level that is acceptable under the Company's underwriting guidelines.

The Businessowners program offers two endorsements of note. The first, Ordinance Or Law Extension can be used to increase the limit, as well as to add other provisions. The second, Increased Restoration Period - Ordinance or Law, can be used to amend the definition of the restoration period in the policy.

The Commercial Properties Program also offers an endorsement for Increased Restoration Period - Ordinance or Law. The Program additionally offers Ordinance or Law Extension - Increased Cost of Construction, which specifies that when a coinsurance percentage of 80 percent or more is shown on the declarations, limited coverage for increased costs of a covered loss resulting from the enforcement of any
ordinance, law, or decree regulating or requiring construction, use, repair, or demolition is provided.

Personal Property
Under the Homeowners Program, the built-in limit for personal property is not usually a problem for most insureds. However, some owners of historic homes have expensive collections of antique furniture or other historical items of great value to complement their homes, and the property may be more likely to exceed the Coverage C limit. Also, the forms' built-in special limits on certain personal property may also be an issue - especially for theft losses to items such as antique jewelry, silverware, and guns. For such property, the addition of an Inland Marine floater may be a good option for the insured.

Personal property coverage

The Homeowners Program offers the following endorsements:

• Coverage C - Personal Property - Special Coverage;
• Additional Limits Coverages A, B, C, and D; and
• Coverage C - Higher Limits on Certain Property, which provides options for higher limits for certain property including jewelry, silverware, or guns.

The Businessowners Program offers an endorsement for Fine Arts Coverage and the Commercial Properties Program offers an endorsement for Household Personal Property Coverage.

Bed & Breakfasts

Companies that insure bed & breakfasts probably insure historic buildings. According to the Professional Association of Innkeepers International, 90 percent of the country's 75,000 bed & breakfasts are historic buildings.

These buildings often blur the distinction between what is a home and what is a commercial building. Bed & breakfasts are sometimes written on an endorsed Homeowners policy that also covers business activities, a Businessowners policy, or a Commercial Properties policy.

AAIS's Home-Based Business endorsement can be used with the Homeowners Program, as well as with the Farmowners or Mobile-Homeowners Programs. Both property and liability coverages are provided for home-based businesses. The Manual includes a classification for bed & breakfasts. It is applicable to small operations with up to six rooms for overnight guests. The bed and breakfast must be owned and operated by one or more persons insured by the underlying policy. 

The Home-Based Business Coverage Part changes the coverage provided in Coverage B - Related Private Structures and Coverage C - Personal Property of the underlying policy with respect to the exposures of the Home-Based Business. Except for limiting coverage on signs used to identify the insured’s business, Coverage A – Buildings, is not affected by the Home-Based Business Coverage Part because it does not exclude business operations.

The Home-Based Business Coverage Part suspends the Business Personal Property limitation with respect to the insured business, so the entire Coverage C limit applies to business personal property as well as household personal property while on the insured premises.

The remaining special internal limits that apply to property covered under Coverage C apply to the property of the Home-Based Business with one exception: The limit that applies to securities, stamps, etc. does not apply to valuable papers and records related to the Home-Based Business. The Home-Based Business Coverage Part includes an incidental coverage for the cost to reproduce or replace valuable papers and records.

The valuation basis that applies to personal property for the underlying policy also applies to the personal property of the insured business.

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