Overhead and Profit: Its Place in a Property Insurance Claim



...& Surety Bulletins (FC&S), a National Underwriter Publication used by insurance professionals in the interpretation of property insurance policy provisions, is one notable example. In response to a question describing the practice of not including the costs of GCO&P as part of an ACV payment, an FC&S editor explained:

“Both [general contractor overhead and profit as well as subcontractor overhead and profit] are to be used in calculating final replacement cost, since they are obviously a part of the function of repairing or replacing the building, and it is from this that the actual cash value settlement is derived.”

An FC&S editor applied this same rationale in response to another question about an insurer’s refusal to include architect’s fees in its replacement cost payment: “When the home was new, the replacement cost on the first policy included the architect’s fees, because they were surely included in the purchase price. Rebuilding is no different. The replacement cost of a home includes everything that goes into it — not just the building materials. The architect’s fees should be paid as part of replacement cost.”

Why GCO&P Always Should Be Included

Arguably, there is no basis for an insurer ever to exclude the costs of GCO&P from the replacement cost calculation that is used in arriving at an ACV estimate and settlement based on the replacement cost less depreciation rule, even if the insured is not reasonably likely to incur such costs.

One reason is that many insurers include the cost of specialty contractor and subcontractor overhead and profit as well as sales tax in its replacement cost and ACV calculations, even if the contractor is not used and even if building materials are not purchased. As a result, many insurers pay for replacement costs policyholders never incur: those being the theoretical expenses of specialty contractors or subcontractors and sales taxes.

Once again it goes back to the simple premise that it is illogical for insurers to include some, but to exclude other, “contingent” expenses in its replacement cost calculation. In Gilderman , it was ruled that “All repair or replacement costs are, in theory, ‘contingent’ prior to being incurred.” Likewise, in Mazzocki , the court stated, “A replacement cost estimate is equally hypothetical or contingent as to all materials, labor and contractor services.”

Additionally, there is no real meaningful distinction between general contractor overhead and profit and that of the specialty contractor/subcontractor. Overhead is overhead and profit is profit.

Furthermore, many insurers include both general and specialty contractor/subcontractor overhead and profit when estimating the replacement cost that determines the limit of liability upon which a policyholder’s premiums are based.

As the Texas Department of Insurance so aptly stated in its bulletin, “if the insurer in determining actual cash value excludes costs that are included in the determination of liability limits, on which the insured’s premium is based, the insurer reaps an illegal windfall because the insurer receives premium on insurable values for which loss may never be paid.”

Let’s also not forget that, as a cardinal rule of insurance contract interpretation and construction, if a provision in an insurance policy is subject to more than one reasonable interpretation, then it is ambiguous and must be construed against the insurer and in favor of the insured.

The reasons for this rule are two-fold: