The point here is that the risk manager, insured, or broker should closely monitor the construction progress and report any changes in the anticipated completion date to the insurance company. This will avoid what could be significant shortfalls in the amount of the loss that is recoverable.
Thus far, we have discussed the need to identify, quantify and specify the total soft cost exposures in the policy. We have discussed other germane issues such as the meaning of the delay period and how the period of indemnity is determined. All of these issues could have a very significant impact on the evaluation and adjustment of a loss and ultimately the extent of the recovery by the insured. This, however, does not necessarily cover the complete exposure.
An additional critical element of delay coverage is business income and rental value. This coverage is intended to compensate the insured for income losses sustained as a result of the delay in the completion of the project. When discussing this coverage, one of the first questions frequently asked is: “If you have soft cost coverage, why is income or rental value coverage needed or vice versa?” We believe that a soft cost endorsement is incomplete without income or rental value coverage. These coverages are not mutually exclusive and neither one will individually provide comprehensive coverage for a loss arising from a delay in opening.
Prior to analyzing the rationale for including both rental value/ business income in a soft cost coverage program, we would strongly recommend that the loss determination clause include language providing that the loss will be measured based on the planned level of occupancy or the anticipated level of operations at stabilization. The reason for this is to completely eliminate any issue as to how the loss will be measured.
With respect to a building under construction, operations obviously have not yet commenced. Therefore, when a loss occurs that delays the anticipated completion date, the loss measurement should be based on full practical occupancy or planned level of operations; if not, the insured will not be made whole.
For example, consider an apartment project. Had the project been completed and occupancy commenced, there would have been a ramp-up to stabilization over some period of time. In the event of a loss that caused a delay in the completion, a measurement of the rental value loss based on the experience of the business (had no loss occurred), would not take into account the revenue generated at stabilization or full practical occupancy. However, when the repairs and subsequently the project is completed and the apartments begin to lease up, the owner/insured would experience a second ramp-up and thus would sustain an uncompensated loss or in other words, not be made whole.
In policies that do not include language providing for the planned level of occupancy, we believe that the insured is nevertheless entitled to the income that would have been generated on the basis of planned level of occupancy or operations based on the concept of actual loss sustained. However, this can be a contentious issue and in the interest of avoiding problems, a proactive underwriting approach that formulates the loss determination clause to correspond to a builders risk exposure will eliminate many of the loss measurement problems and facilitate the adjustment process.