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DBC: Sam Burke: Educate yourself about builder's risk insurance

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Sam Burke

Almost every homeowner insures their home. A typical homeowner's policy protects against fire, hail, theft, and other common perils. However, a typical homeowner's policy covers completed structures. Therefore, if you plan to build or have built a custom home or other significant structure, you will need to make sure you have insurance that provides coverage during the construction process.

Sam Burke
Sam Burke

Builder's risk insurance is a special type of property insurance for the construction process. Generally, builder's risk insurance is coverage that protects a person's or organization's insurable interest in materials, fixtures and equipment being used in the construction or renovation of a building or structure should those items sustain physical loss or damage from a covered loss.

Usually written for a specific project, builders risks policies will cover "named perils" of loss by external causes (such as fire or hail), but also may cover property damage by acts of third parties (theft or vandalism). Most builders risk policies are written on an "all risk" basis, meaning that the policy will cover all risks of property damage unless the cause is specifically excluded. Such policies may be referred to as ARBR (all risk builders risk) or CAR (construction all risks) policies. In addition, contractors will sometimes obtain builders risk "floater" policies that are not project-specific, but that will cover property damage at any project undertaken by the insured contractor, subject perhaps to lower limits than a project-specific builders risk policy.

Although coverage is often purchased by the custom builder or general contractor, property owners should purchase this coverage or contract with the builder or general contractor to be a named insured in the policy. 

Many times, proof of builder's risk coverage is necessary to comply with local city, county and state building codes. If you are the owner of the property and are commissioning new construction, you are the one most likely to suffer if construction is delayed because the builders risk policy was not in place. Further, some in the construction industry believe that it is the property owner who should have the builder's risk policy because they have already paid for the improvements to their land, and if the builder receives the funds directly from a claim, theoretically, they could abscond with that benefit. 

Therefore, it is far safer for the property owner to obtain the builder's risk policy, because they already own the building, even while it is under construction. If something happens to the under-construction project, then they should be the beneficiary and control how the funds are spent.

Although commonly written as an all-risk policy, common exclusions significantly limit what "all" means. By far, the most significant limit on builder's risk coverage is flawed workmanship. If your builders risk policy includes a faulty workmanship exclusion, you may need additional insurance coverage to protect you from this specific risk. 

Some insurance companies offer an endorsement to remove the common faulty workmanship exclusion. Every owner should inquire about this option and purchase this coverage if it is available. If such coverage is not available, then other options include performance bonds and/or well-drafted warranties in your construction contract. 

Always be aware that a contract is only as good as the person you contract with. If you have the world's best warranty and you make it with a contractor who is broke and changes his business name once a year, it's not worth the paper it is written on. 

One exception to this rule (at least as to the ability to perform) is insurance. Insurance is a highly regulated industry. Part of what that regulation makes certain of is that insurance companies have the funds available to pay the claims made on their policies. Especially in Texas, there is nothing that ensures a contractor can or will stand behind his construction warranty.

Other common exclusions from builder's risk policies include earthquakes and floods. In Texas, earthquakes are extremely unlikely, but flooding is not. Fortunately, FEMA maintains and updates flood maps regularly used for identifying suitable construction sites. Generally, if you are building outside of the 100-year flood plain, flooding will not be an issue. 

In most cities and counties in Texas, you are required to obtain a construction permit, one of the conditions of which is that you are not building in the 100-year flood plain. In lieu of or in addition to checking the FEMA maps yourself, your construction contract with your general contractor should include that they are required to obtain all necessary permits. If you are building in an unincorporated area outside of Denton County, I recommend you check with the FEMA map yourself.

Finally, be aware there are many soft costs that may not be covered by builder's risk coverage. A soft cost is money you lose during the time it takes to move forward with your project after a covered loss. Soft costs may include additional insurance premiums, legal fees and construction loan interest. Some policies will include soft costs, and some might not. If you discover that your builders risk insurance doesn't cover soft costs, consult with your insurance agent about adding supplemental coverage.

SAMUEL B. BURKE is certified by the Texas Board of Legal Specialization in civil trial law. He can be reached at sburke@dentonlaw.com or www.dentonlaw.com.