Contract documents

There is a wide variety of potential risks owners face during and after the construction of a project; however, this article isn’t intended to cover all of the risks but will touch on the different kinds of risks that might befall a construction project and might be detrimental to an owner. Some of these risks directly impact the owner and the well-being of the project; some of them are related to third-parties that might affect the owner if an event occurs on the project.

Construction Project Risks:

• Constructor Performance Issues
• Non-payment of subcontractors and suppliers
• Fire
• Wind
• Flood
• Vandalism
• Cybersecurity
• Business Interruption
• Damage to Existing Structures
• Personal Injury
• Professional Negligence

Two major considerations can help owners guard against these perils, and others, on any given construction project.

1. Acquire Payment and Performance Bonds

Payment and performance bonds are three-way contracts typically between the owner, the contractor, and the surety. In a payment bond, the surety stands behind the contractor to financially guarantee (up to the amount of the bond) that the subcontractors and materials suppliers will be paid what they are owed. If the contractor fails to pay a subcontractor or material supplier properly, they can make a claim for payment against the bond instead of filing a lien against the owner’s property. In a performance bond, the surety guarantees (again, up to the amount of the bond) the obligations of the contractor to perform the work and complete the project. Additionally, there are other, less apparent, potential benefits to the owner. You can read more explanations on how bonds provide potential benefits to owners in the Surety Bonds: What Owners Should Know article.

2. Obtain necessary insurance policies to manage and guard against risks

A comprehensive insurance program tailored to project needs is an indispensable means to manage risk on a construction project. So what kind of insurance should the owners consider and obtain?

Obtain property insurance written on a builder’s risk “all risk” policy basis

Property insurance protects the insured party or parties against losses or damage to their property. Builder’s risk is a type of property insurance that generally covers loss or damage to the construction work during the course of construction. It should be written on an “all risk” basis, which means the policy covers all risks of physical loss or damage to the property unless expressly excluded. Most builder’s risk policies cover damages from risks such as fire, explosion, theft, vandalism, collapse, earthquake, flood, and windstorm. The policy should also include coverage due to the negligence of the contractor. Not all policies are written the same, however, so the insured should review the policy to make sure that none of these risks are excluded.

What are some other considerations for an Owner when looking at a builder’s risk policy?

1. Confirm the total value of the builder’s risk coverage and the policy expiration date

On a project-by-project basis, the risk of a catastrophic event is pretty low. But, when it happens, it’s astronomically expensive. Therefore, the Owner should confirm that the builder’s risk policy covers the total value of the entire project on a replacement cost basis. The coverage of the total value should be at least the initial contract sum and any subsequent modifications. Moreover, the builder’s risk policy should also stay in play and be maintained at least until substantial completion. Varying policies are depending on the insurer, and some will allow the insurance to remain in effect afterward.

From the owner’s perspective, if the builder’s risk policy terminates upon reaching substantial completion, the owner should make sure to obtain follow-on coverage that continues on the project after substantial completion and until the expiration of the period for correction of the work. As an owner, you would not want to encounter a situation where substantial completion has occurred, then have a fire break out, which results in damage to the building while the contractor performs corrective work or punch list items.

2. Builder’s risk policy should include the owner, contractors, subcontractors and more.

The builder’s risk policy should include the owner, contractors, subcontractors, and sub-subcontractors as insureds as well as mortgagees as loss payees to adequately include those with an insurable interest in the property.

3. Make sure that you have everything the project touches covered in case the disaster happens.

While most builder’s risk policies will cover the project itself, if your project is remodeling or an add-on to an existing structure, the policy may not cover the existing structure. However, because the project is connected to an existing structure, it is unlikely that the damages would be limited to the project only. As such, we believe the owner should carry property insurance that is going to COVER EVERYTHING the project touches. Again, the policy should stay in place until the correction period is over. In addition, it should be on a replacement cost basis, as we mentioned earlier.

4. Think about other types of damage or losses that you might experience as a business.

There are certain things that builder’s risk or property insurance will cover, but there are a lot of other types of damage or losses that you might experience as a business. There are property extension coverages that you could consider or tie with the property insurance to cover some of those consequential damages that might result from a loss.

• Loss of use, Business Interruption, and Delay in Completion Insurance: Reimburses the Owner for loss of use of the Owner’s property or the inability to conduct normal operations due to a covered cause of loss.
• Ordinance or Law Insurance: Covers the reasonable and necessary costs for the temporary repair of damage to insured property and to expedite the permanent repair or replacement of the damaged property.
• Expediting costs Insurance: Covers the reasonable and necessary costs for the temporary repair of damage to insured property and to expedite the permanent repair or replacement of the damaged property.
• Extra Expense Insurance: Reimburses the Owner for reasonable and necessary excess costs incurred during the period of restoration or repair of the damaged property that are over and above the total cost that would normally have been incurred during the same period of time had no loss or damage occurred.
• Civil Authority Insurance: Covers losses or costs arising from an order of a civil authority prohibiting access to the project, provided such order is the direct result of physical damage covered under the required property insurance.
• Ingress/Egress Insurance: Covers loss due to the necessary interruption of the insured’s business due to physical prevention of ingress to, or egress from, the project as a direct result of physical damage.
• Soft Costs Insurance: Reimburses the Owner for costs due to the delay of completion of the work arising out of physical loss or damage covered by the required property insurance.
• Purchase and maintain general liability insurance The commercial general liability insurance products protect the insured party or parties against third-party claims and liability for bodily injury or property damage arising out of the business operations of the insurers.

Other types of Insurance

In terms of other non-property insurance policies, there is another policy that should be considered. One that is now explicitly called out in our AIA Contract Documents – cybersecurity insurance. As owners, you may ask how could a data breach or cybersecurity issue really result in catastrophic loss or damages such that I would want to carry insurance for it? Think about all of the ways that information is stored and transmitted digitally on a project, from building information models and project correspondence, to maintaining a central repository for all of the contracts and so forth. The costs associated with investigating and recovering from a data breach can be extensive. Additionally, if confidential or private information is compromised, satisfying obligations to notify those impacted can be significant. It is critical to think about the nature of your business and who is accessing which systems and where, and evaluate your risks.

Learn more about how to use insurance and bonds to manage risks as a construction project owner, watch on-demand webinar “Explore Insurance and Bonds as Risk Management Tools.”  Watch On-Demand >