Builder’s Risk Insurance: A Solution for Complex Construction Projects

In the construction industry, risk manifests in a myriad of ways — specific and detailed contractual risk requirements, complex insurance programs and technical understanding of what the project requires.

At a fundamental level, not fully understanding the critical role insurance plays in bidding, building and successfully completing a complex construction project is not only a lost business opportunity; it can lead to unexpected or catastrophic results.

Insurance is where the money is, and when a project experiences loss, delay or impacts, insurance should always be a part of the initial triage of deciding what to do next to get the project back on track.

1. Builder’s Risk: Why Choose It?

Builder’s risk insurance is, in a nutshell, property insurance designed to cover the interests of multiple parties involved in the construction, erection or fabrication of structures against physical loss or damage, usually written on an “all risk” basis. Builder’s risk insurance allows the transfer of construction risk from the contractors to the insurer. In the U.S., Builder’s risk insurance is derived from the British Contractors All Risk (CAR). The main difference is the CAR may also include liability coverage.

Most builder’s risk policies are written as a manuscript policy, not insurance services office or “ISO” forms more commonly used with liability or commercial general liability (CGL) policies. The elegance of a manuscript policy is that it can be tailored to fit the project, to cover complex risks, highly specialized work, and equipment often seen in very large construction and infrastructure projects. Because most builder’s risk policies are “all risk” policies, the breadth of coverage is found in the “lead-in” language to the exclusions and the specific wording of the exclusions themselves. An “all risk” policy does not mean an “all loss” policy. The lead-in language that embodies a jurisdiction’s principles of causation can be dispositive.

2. What Does It Cover?

Builder’s risk insurance typically covers “direct physical loss or damage” to:

• Buildings or structures during construction. There is usually an inception date and a completion/termination date.
• Other specified property intended to become part of the building or structures under construction; may include improvements such as civil works, foundations, excavations, tunnels and underground property.
• Demolition is not usually included.
• Temporary structures related to construction.
• Can also contact separately endorsed coverages for bodily injury, extra expense, soft costs from delay in completion or opening.

3. Who Is Insured?

Most builder’s risk policies should include a broad omnibus insured clause covering as named insureds, the project owner, general contractor and subcontractors of every tier.

Product and material suppliers and vendors are not usually included as insureds. By broadly covering these professionals performing the work on the project, the often-complicated contractual insurance compliance and additional insured endorsement forms issued can be eliminated.

Because such issues are often an area that generates an abundance of disputes resulting in litigation, selecting an insurance policy such as a builder’s risk policy can allow for better risk management practices. Fewer arguments over whether the correct additional insured endorsement form was selected, more time spent on getting the work done.

4. What Exclusions to Watch For?

The most litigated exclusion is the generically styled “faulty workmanship exclusion.” Understanding how the language of this exclusion has evolved is helpful.

American London Sturge (ALS) 1967/1972 Policies

The ALS 67 exclusion contains the following language: “Cost of making good faulty or defective workmanship, material, construction or design, but this exclusion shall not apply to damage resulting from such faulty workmanship, material, construction or design.”

The ALS 72 exclusion changed the scope slightly by slightly altering the “damage resulting from” language and instead referring to “physical damage” resulting from “such faulty or defective workmanship or material.”

Neither of the ALS forms contain causation language; loss or damage “caused by” or “resulting from” the defective workmanship are not excluded.

In Allianz v. Impero 654 F. 2d 16 (E.D. Wash 19E) a federal court in Washington interpreted the language of ALS to require damage to property separate from that being worked on. Many courts have held the exception to the exclusion retain coverage for all aspects of the repair/rebuild except for repairing or replacing the project.

London Engineering Group (LEG) Exclusions

Because the dollar value, sizes scope and complexity of many construction projects are always increasing, construction professionals managing complex works within their organizations are aware of the important roles builder’s risk policies can fulfill in meeting the insurance needs of such projects. Most construction risks or large projects are insured by a number of builder’s risk insurers, each taking on a participating share of the risk being insured. Many builder’s risk policies contain LEG exclusions. There are three types of these exclusions:

• LEG 1: An outright (total) defect exclusion.
• LEG 2: Excludes the cost that would have been incurred to rectify a defect prior damage taking place.
• LEG 3: The least restrictive of LEG exclusions. Allows coverage for the defective damaged property but excludes the cost of improvement of materials, workmanship, design, plans or specifications.

The LEG 3/96 was slightly amended in 2006 to include a reference to the patent detrimental change (a “patent defect” is a deficiency apparent by reasonable inspection). In 1996, the London Engineering Group (LEG) introduced the three LEG defects exclusions to foster insurance industry consistency, while allowing insurers latitude to provide the breadth of the coverage they desire. These LEG exclusions have become more popular in the U.S., particularly with the large construction projects. But up until Sept. 29, 2023, there had not been one published court decision in the U.S. interpreting the meaning of the LEG 3 exclusion. South Capital Bridgebuilders v. Lexington Insurance Co. changed all that when the federal district court in Washington, D.C., found such a clause ambiguous, ruling against the insurer, and denied the insurer the ability to restrict coverage. The court stated: “to find the clause ambiguous one need only attempt to read it. Lexington managed to squeeze in a run-on sentence, an undefined term, several misinterpretations, and a scrivener’s error … The Extension is internally inconsistent and bordering incomprehensible. SCB’s [contractor] statement that the Extension is ‘convoluted’ is an understatement.”

Ouch. With that assessment, the court held the insurer liable for breaching the builder’s risk policy.

5. Where Are We Now on LEG 3 Exclusions?

If the intent of the LEG underwriters was to cover only damage and exclude the cost of improvements after the South Capital Bridgebuilders opinion, what constitutes “damage” under a builder’s risk policy is certainly open to argument. American courts currently interpret “damage” more broadly than many insurers believe it should be interpreted. It is also presently unclear whether “improvement” means:

• Remediation of a defect, or
• Improving a nondefective condition

Leaving such issues unresolved can have profound implications in the cost of remediating defects, depending on whether the defect is in workmanship, design or materials.

Compared to other types of insurance policies needed and available to insure complex construction projects, builder’s risk policies can provide a viable business alternative to traditional CGL policies with various additional insured endorsement forms.