What are the Traps in Wrap-Up Exclusions? What if a Condo/Coop Doesn’t Rebuild After a Loss? What Does ‘Reside’ Mean in a Homeowners Policy?

 Who said these topics aren’t related? They all begin with a W. It’s WWW; not the world wide web of the Internet but the world wide web of insurance.

What Are the Traps in Wrap-Up Exclusions?

Wrap-up programs combine general liability, workers compensation and umbrella insurance coverage for all contractors working on large construction projects. They are also referred to as an OCIP—Owner Controlled Insurance Program or CCIP— Contractor Controlled Insurance Program; the alternate names tell it all. It’s an insurance program controlled by the owner or the general contractor (GC). The owner or the GC place the insurance for the project with one insurance company. The wrap-up covers all those involved in the project. If contractors want the work, they must obtain and pay for coverage through the selected wrap-up insurance program. They don’t use their own broker and insurance company. Wrap-ups were first developed to cover the construction of defense plants during World War II and have become universal for large projects. Just how large depends on the state of the insurance market and insurers’ desire to write business. The argument for wrap-ups is that they promote efficiency in claims handling, loss control and administration, which can reduce costs for the owner or GC and provide more seamlessly effective protection for all parties. Furthermore, wrap-ups are designed to minimize cross claims and third-party over1 claims. The argument against them, from the contractor’s point of view, is that they can create gaps in the contractor’s insurance protection and damage the contractor’s relationships with its own insurers.

To avoid duplicate coverage and charges the wrap-up project is eliminated from the contractor’s policy. Two ISO endorsements are available to do that: CG 21 31 05 09 [Limited Exclusion – Designated Operations Covered by a Consolidated (Wrap-Up) Insurance Program] and CG 21 54 01 96 [Exclusion – Designated Operations Covered by a Consolidated (Wrap-Up) Insurance Program]. There’s only one difference between the two forms, but it’s a big one. Both endorsements exclude coverage for bodily injury or property damage liability arising out of ongoing operations and products-completed operations coverage at the location covered by the scheduled wrap-up. And they both state that coverage is excluded whether or not the wrap-up coverage is identical to that provided by the contractor’s policy and even if the limits of the wrap-up policy are not adequate to cover all claims.

The wrap-up policy receives the premium, so it’s the policy that the contractor will have to rely on. Its regular insurers are not receiving any premium for the wrap-up project, so they’re not going to provide any coverage. You can’t argue with that. But here’s the key difference between the endorsements: CG 21 31 provides that the exclusion does not apply when the wrap-up policy has been cancelled, nonrenewed, or is not in effect for any other reason except exhaustion of limits. CG 21 54 says that the exclusion does apply even if the wrap-up policy is no longer provides coverage, regardless of the reason. CG 21 54 poses a real problem for contractors who are covered by a wrap-up instead of their own insurance. A contractor has no control over the owner’s or GC’s decision to cancel the wrap-up insurance. Cancellation by the insurer for non-payment of premium may provide only10- days notice. Even if the contractor is aware of the non-payment notice, arranging coverage in 10 days can be a major challenge. Insureds often depend on their broker to help them avoid a lapse in coverage. The broker on a wrap-up policy represents the owner or GC; it owes little or no duty to the contractor.

If you insure contractors who are covered by wrap-up policies, check which exclusion endorsement is attached to the policy you write for them. CG 21 54 could leave the contractor holding the bag and leave you with a very unhappy client.

 What if a Condo/Coop Doesn’t Rebuild After a Loss?

Here’s an item from my email box this month. An insured in Westchester County asks:

 Can I come up short in the event of a total loss to my Coop building? In the case of a total loss of a coop building due to a fire, (etc.),… what kind of coverage should unit owners have to make sure they receive the total appraised value of unit, to cover a mortgage let’s say, outside of the personal belongings…. or would it be the association’s responsibility? If so, what am I looking for in the (association’s) building insurance coverage that would guarantee this coverage?

The quick answer is that if the property is rebuilt and the insurance proceeds are sufficient to pay for the reconstruction, the unit owners will be fine—they better have sufficient additional living expense coverage to tide them over the long period that they may be out of their units and sufficient contents and improvements coverage, but that’s true even if the loss is confined to just one unit.

However, suppose the building is substantially damaged and is not rebuilt. A common provision in offering plans for condos provides that if the damage exceeded 75% and 75% of the unit owners elect not to rebuild, the property is to be sold and the net proceeds of the sale together with the net insurance proceeds distributed to the unit owners in proportion to their interests in the common property. The letter writer is correct; that’s where a problem may arise for the unit owners. And it’s the coop’s or condo’s insurance that’s involved in the problem.

An offering plan that I just reviewed provided that the amount of insurance on a replacement cost basis was to be $34 million. The plan showed that the total selling price of the units was $48 million—a difference of $14 million. $4 million of the difference was accounted for by the cost of the land, but there’s still $10 million to be accounted for even if we assume that the land can be sold for $4 million. (That may not be a good assumption because of the cost to demolish and remove the damaged existing structure that may not be covered by insurance—more about that below). What’s that $10 million composed of and does it have any value if the property is destroyed and not rebuilt? It’s primarily composed of the developer’s soft costs such as expenses for advertising and selling the units, legal and accounting fees, and, of course the developer’s profit. If the building is destroyed and not rebuilt, those items go up in smoke. Therefore the unit owners might not receive an amount equal to the appraised value of their units. Mortgages on individual units are based on appraised value, which can be much more or much less than the bricks and mortar cost of the buildings, so the unit owners may not even receive enough to cover their mortgages.

The good news is total losses are rare and that, even in the event of a major loss, properties are usually rebuilt. But there can be a problem. Here are some reasons a condo or coop might not be rebuilt:

• The cost to rebuild may substantially exceed the amount of insurance. Estimates used to determine the amount of insurance are based on much more expensive than groundup new construction. And no estimate is completely accurate; if it were it wouldn’t be called an estimate.

• Debris removal is expensive. If the amount of insurance is equal to or less than the cost to rebuild, there won’t be anything left to cover debris removal other than the typical debris removal additional coverage. (ISO forms provide $10,000 additional debris removal coverage, which will be increased to the magnificent sum of $25,000 when the 2013 ISO changes are approved and implemented.)

• Flood and earthquake limits are often just a fraction of the full replacement cost of building. A large loss may create difficult problems in financing the reconstruction if the cost exceeds the insurance recovery.

• Changes in zoning laws may prevent rebuilding a building of the same size and plot-density or may forbid rebuilding entirely.

 What Can Be Done?

• The coop or condo should obtain increased additional debris removal coverage2. As I noted above, the $10,000 or $25,000 ISO additional coverage is grossly inadequate3. I’ve seen estimates for debris removal of $10 to $12 per square foot of the building. For a 100,000 square foot building, that’s over $1 million.

• Make sure the amount of insurance is 100% of a realistic estimate of the actual replacement cost. In their zeal to control insurance costs, insureds and producers frequently underestimate replacement cost.

• Increase the flood and earthquake coverage limits. One study reported that flooding to a depth of just 2 feet caused, on average, damage to a onestory building equal to 22% of the building value; for flooding that’s 5 feet deep the figures was 30%4. (Obviously the percentages for a highrise building will most likely be lower.)

• Be sure that the coop or condo has ordinance or Law coverage and that the limits are sufficient. Building ordinances or laws may impose requirements that greatly increase the cost of repairs.

• Coops and condos may need expert assistance to evaluate the amount of insurance needed.

Insuring the gap between market-value before a loss and the proceeds when a coop or condo is destroyed and not replaced is similar to auto-lease gap coverage. Here’s something to add to your wish-list: An endorsement to cover the potential gap in coop and condo insurance. I think it can be done. It could be tied to the unit owner’s mortgage balance to avoid the difficulty of agreeing on an accurate appraisal value. This is a great opportunity for a company that specializes in coop and condo insurance. It would differentiate them from their competition, give their insureds peace of mind, and give their producers a valuable prospecting tool.

 What does ‘Reside’ Mean in a Homeowners Policy? Take Three.

Where do you reside? A little formal for ordinary conversation, but it seems like an easy question to answer—however it’s one that’s tripped up a number of homeowner insureds. I’ve written in previous issues of the Insurance Advocate about the variety of circumstances that can cause insurance companies to decline coverage when they feel that the insured doesn’t “reside” in the dwelling5. A recent Court of Appeals decision indicates that what “reside” means is far from a settled matter.

On March 24th, 2005, Jona and Douglas Dean went to Northeast Agencies in Dobbs Ferry, N.Y., to purchase homeowners insurance to be effective March 31, 2005, the date they expected to take title to a house in Irvington, N.Y. When they applied for coverage, the Deans mentioned to the agent that house had “cosmetic damage that needed repairs.” It turned out that the house actually had extensive termite damage. As a result, the Deans couldn’t move into the house until repairs were made. Douglas Dean, with the help of family and friends, worked on the repairs—going there, he stated, almost every day after work. The policy was renewed on March 31, 2006. On May 15, 2006 a fire destroyed the building. The Deans had still not moved into the house.

Tower Insurance Company denied coverage stating two reasons: First, Tower said the policy covered “the dwelling on the residence premises” and, because the dwelling was unoccupied at the time of the loss, it did not qualify as a residence premises. Second, the policy was void because the insureds had intentionally concealed or misrepresented material facts.

On April 27, 2010 the New York Supreme Court ruled in favor of the insurer on the issue of residency6. That didn’t settle it. Despite its exalted title, in New York the “Supreme Court” is not the highest court. There are two higher ones, the Appellate Division of the Supreme Court and the Court of Appeals. The insureds appealed the decision to the Appellate Division. On May 10, 2011 it reversed the lower court. It held that the policy was ambiguous because it didn’t define “reside.”

The Appellate Court granted Tower the right to appeal to the Court of Appeals, which it did. And, hot off the press, on October 25 (I’m writing this on October 27, 2012) the Court of Appeals affirmed the Appellate Division’s ruling that “reside” is ambiguous.

This is troublesome; no insured moves into their newly-purchased residence simultaneously with closing title. Before my wife and I purchased our prior home, the home inspector we hired discovered termite damage. We closed title anyway. We were expecting our fourth child and we had to have a larger house. We didn’t move in until the damage was repaired about two weeks later. If the house had burned down during that time, would the insurer have disputed coverage? We certainly wouldn’t have been living in the house at the time of the hypothetical loss and, unlike Douglas Dean, I didn’t do the work myself. How long a gap voids coverage? Is it 2 hours, 2 days, 2 weeks, 2 months, 2 years? Was it our residence because we intended to live there? There’s no clear answer. This problem cries out for clearer wording from insurance companies and rating organizations. Let’s hope they’re listening.