Builders Risk: Needed Changes to AIA General Conditions

Coverage Duration

AIA Paragraph 11.3.1 requires that the builders risk insurance be maintained until final payment has been made or until no person or entity other than the owner has an insurable interest in the property, whichever is later. The problem with this language is that final payment on a project can come months or even years after a project is put to its intended use. I am aware of a large metropolitan airport where final payment did not occur until years after the airport opened. It is unreasonable for the purchaser of the builders risk insurance to be responsible for continuing to insure beyond substantial completion. Allowances are needed that permit the project owner to insure the residual exposure under its permanent property insurance.

Use of Sublimits

AIA Paragraph 11.3.1 specifies that the required insurance must be insured against the total value of the entire "project." This amount is comprised of "the initial Contract Sum, plus value of subsequent Contract Modifications and cost of materials supplied or installed by others." Such insurance must be on a replacement cost basis. Nowhere in this section is there latitude for insuring against any of the required perils (as set forth in 11.3.1.1) for anything less than the full replacement cost amount. As such, sublimits (reduced limits) are not permitted, but builders risk policies routinely incorporate sublimits. This puts purchasers of the builders risk policy in breach of their insurance procurement responsibilities. A provision should be added that allows reduced limits for specified perils that are agreed to in writing by the project owner and general contractor.

Named Insured Status

AIA Paragraph 11.3.1 mandates that the interests of the owner, contractor, and subcontractors of all tiers be included in the required insurance. Guidance is not provided as to how this is to be accomplished, so those who structure builders risk policies muddle along. Usually the parties are either included as named insureds or additional insureds.

Two thoughts arise. First, the reference to "include interests of …" should be banished from builders risk insurance requirements (and builders risk policies). This phrase has spawned much litigation, particularly in respect to the Subrogation Condition. Second, these parties should be designated as named insureds. Keep in mind that most builders risk policies utilize proprietary forms. No two proprietary forms are alike. Depending on a particular form, it may be permissible to utilize additional insured status versus named insureds (in these forms, the additional insureds would be treated the same as named insureds as respects all coverage). However, the problem with some policy forms relating to additional insured status is that the additional insureds do not have the same coverage as named insureds (two common examples relate to transit and off-site storage locations).

This current deficiency could be corrected by replacing the last sentence of 11.3.1 with the following: "This insurance shall include as named insureds the Owner, Subcontractors and Sub-subcontractor in the Project." ²

A corresponding change is needed in 11.3.1.2 (to address builders risk insurance when secured by the contractor).

Additional Insured Perils

AIA Paragraph 11.3.1.1 requires the property insurance to be on an "all risk" or equivalent form. This paragraph then enumerates a list of perils that must be insured by the builders risk insurance. The following perils are notably missing.

• Earth movement ("Earthquake" is listed, but "earth movement" is broader and more appropriate.)
• Water damage ("Flood" is listed, but "water damage" is different than flood and should be listed.)
• Terrorism
• Resulting damage from defective design, materials, and workmanship (Discussed separately below.)
• Equipment breakdown (Discussed separately below.)

Paragraph 11.3.1.1 should be modified to include these additional perils.

Resultant Damage from Defective Design, Workmanship, and Materials

The most litigated insurance provisions in builders risk policies are the exclusions relating to defective design, workmanship, and materials. The scope of applicable exclusions typically used by US underwriters range from a total exclusion to exclusions that provide coverage for resultant losses. Here is an example of a total exclusion.

We will not pay for loss or damage caused by or resulting from faulty, inadequate, or defective designs, specifications, workmanship, or materials.

Here is an example of an exclusion that makes an exception for resultant loss from ACE Form ACE0728 (10/13).

Cost of Making Good:

The costs that would have been incurred to rectify any of the following had such rectification been effected immediately prior to the LOSS:

A. Fault, defect, error, deficiency or omission in design, plans, specifications, engineering or surveying;

B. Faulty or defective workmanship, supplies or materials;

However, if direct physical LOSS by an insured peril ensues, then this Policy will provide cover for such ensuing LOSS only.

For the purpose of this Policy and not merely this Excluded Cause of LOSS, insured property, or any portion thereof, shall not be regarded as damaged solely by virtue of the existence of any condition stated under A. or B. above.

Assume a support column in a concrete parking garage is designed incorrectly, leading to a collapse of the entire garage during construction. The first exclusion above precludes coverage for the entire loss. The second provision excludes damage to the faulty column, but the collapse of the balance of the garage should be covered. As such, it is highly advisable to have a builders risk policy with ensuing loss exceptions to these exclusions.

The current problem is that the AIA builders risk insurance requirements do not mandate ensuing loss exceptions to these exclusions. This should be added to the insured causes of loss in Paragraph 11.3.1.1.

Equipment Breakdown (Sudden and Accidental)

AIA Paragraph 11.3.2 mandates boiler and machinery insurance if "required by the Contract Documents or by law." Even when required, separate boiler and machinery insurance applies only to pieces of equipment ("objects") that are in use or connected and ready for use. Increasingly, builders risk policies incorporate exclusions for losses caused by or resulting from equipment breakdown, explosion, and electrical injuries. Sudden and accidental events should be insured by a builders risk policy.

I am aware of a recent coverage problem in this area. A tree outside a structure undergoing construction toppled over in a windstorm. The tree took down power lines, which resulted in significant damage to electrical panels and other equipment within the structure. The loss was excluded by the builders risk insurer due to an "electrical injury" limitation.

Other Issues

All builders risk policies should have a "separation of insureds" or a "severability of interest" clause. Such a clause should clarify that coverage will remain intact for insureds that do not contribute to a breach of a policy condition or warranty. ³

All builders risk policies should eliminate or heavily modify "other insurance" clauses to specify that the coverage afforded by the builders risk policy at the insured project is primary. ⁴

In a perfect world, there are other things that I would like changed. It would be positive if all builders risk insurance were written on inland marine forms in lieu of property forms, but reality dictates that small projects with short durations may be appropriately insured under a permanent property policy (with revisions as needed). Similarly, I would like to see all resultant mold damage (which results from an otherwise covered peril) insured, but the fact of the matter is that underwriters will generally provide only modest sublimits for this exposure. There are other less important issues that I would like to see, but if AIA worked on the ones listed, all stakeholders would benefit.