Ordinance or Law Limitations Don’t Hurt Breadth of Protection

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by Christopher J. Boggs, CPCU, ARM, ALCM

Two primary Ordinance or Law endorsements exist within ISO’s arsenal of property forms: 1) Ordinance or Law Coverage (CP 04 05); and 2) Ordinance or Law – Increased Period of Restoration (CP 15 31). There also exists a Business Owners Policy (BOP) endorsement, the BP 04 06, that is essentially the combination of the two commercial property forms. Proprietary company forms exist in the marketplace, but this discussion focuses on the ISO forms. The concepts discussed should apply to non-ISO forms as well.

Understanding what triggers “ordinance or law” coverage is paramount. Ordinance or law protection responds only if: 1) the loss is caused by a covered peril (regardless of the form used); 2) the loss breaches the “major” damage threshold as defined and applied by the subject jurisdiction; and 3) the damaged structure must be lacking in some aspect of the local building code in effect at the time of the loss.

Any loss satisfying all three triggers activates the Ordinance or Law coverage. However, two coverage-limiting provisions require explanation before moving to the descriptions of the three coverage parts:

  1. The endorsements will pay only to the point necessary to meet the minimum code requirements applicable to the structure. The cost of going over and above the minimum code is borne by the insured. If, for example, the insured is not required by the building code to install a sprinkler system, but does anyway, the additional cost of the system is not covered by the ordinance or law endorsement because the insured is not doing to meet code; and
  2. Any costs to meet codes that were required to be met prior to the loss, but weren’t, are borne solely by the insured. For example, if the insured was directed by the jurisdiction to install a sprinkler system before the loss but didn’t, the policy won’t pay for its installation after the loss. This would violate indemnification since this is an expense the insured should have had before the loss.

Two Endorsements

  1. Ordinance or Law Coverage (CP 04 05) provides three distinct coverages:
    • Coverage A – Coverage for Loss to the Undamaged Portion of the Building;
    • Coverage B – Demolition Cost Coverage; and
    • Coverage C – Increased Cost of Construction
  1. Ordinance or Law – Increased Period of Restoration (CP 15 31). As its name suggests, this endorsement redefines the Business Income Policy’s definition of “Period of Restoration” to include any increase in such period resulting from the application of any ordinance or law. Simply, if the building code lengthens the “period of restoration,” the income lost during this extended period is included in the definition of “business income.” Without this endorsement, income lost during this extended period is paid out of the insured’s pocket.

Ordinance or Law Coverage (CP 04 05):
Coverage A – Coverage for Loss to the Undamaged Portion of the Building.
Coverage “A” responds when a major loss triggers the application of the local ordinance or law, yet part of the building is undamaged. Essentially, the actual loss in such a claim is not just the value of the damage, but the value of the entire structure since the remaining structure has been rendered unusable by application of the local building code.

Coverage “A’s” payment following a “major” damage loss relates directly to the policy limit of the underlying property policy. In essence, the maximum the insured can be paid is the total limit of coverage listed in the commercial property policy. The ultimate amount paid is a function of: 1) the location jurisdiction’s rule of major damage; 2) the actual amount of damage; and 3) the insured value of the building. Following is a simplified example of the application of this “limit” rule.

Replacement Cost at the time of loss: $500,000 (Assume the structure is insured to value and ignore coinsurance)
Rule of Ordinance or Law: Percentage Rule (50% of Market Value)
Amount of Damage: $300,000
Amount Paid by Coverage “A”: $200,000

In the example, the rule of law is based on market value, not on replacement cost or actual cash value (concepts common to property insurance). If the building’s market value were $400,000, it is possible that a $200,000 loss could trigger the ordinance or law coverage. In such a situation, Ordinance or Law’s Coverage Part A would pay $300,000. Why? The policy in this example is written on a “Replacement Cost” basis, thus the loss is settled on that basis regardless of the “market value” of the structure. Market value has no other concept within insurance except to trigger the Ordinance or Law Coverage in jurisdictions that apply this guideline.

Replacement Cost” is placed in quotation marks in the above paragraph to indicate the difference between the actual definition and application as it relates to insurance coverage, and the insured’s understanding and belief of what the term means. This gap is explored in a later section of this article and in a previous series.

Coverage “A” follows the underlying commercial property policy lead regarding the payment on a replacement cost basis or an actual cash value basis. Additionally, the coinsurance provision in the underlying property policy applies to ordinance or law as well since any loss triggering coverage, in effect, results in a total loss.

When the replacement cost option applies, the commercial property policy combined with the ordinance or law Coverage Part A pays the lesser of:

  • The amount actually spent to repair, rebuild or reconstruct the building to the same height, floor area, style, and comparable quality; or
  • The limit of insurance.

These payment options apply whether the building is rebuilt on the same or another premises. However, if the building is constructed on another premises, the policy limits its payment to what it would cost on the original premises.

Coverage A and the commercial property policy combine to pay the lesser of actual cash value or the limit of insurance if the structure is insured on an actual cash value basis or is not repaired or replaced.

A schedule of the specific locations to which this coverage part applies must be provided because Coverage Part A cannot be written on a blanket basis. This is the only one of the three ordinance or law coverage parts which does not have a blanket limit option.

Premium for this coverage part is a percentage of the building premium. The additional premium is approximately 15 percent of the net building premium excluding earthquake.

Coverage B – Demolition Cost Coverage. Coverage “B” fills the gap created by and between the commercial property policy and Coverage Parts “A” and “C” of the Ordinance or Law coverage. Specifically, Part “B” pays the cost to demolish the undamaged portion of the partially damaged structure and remove it from the premises.

When a “major” loss occurs, the commercial property policy and Parts “A” and “B” of the Ordinance or Law Coverage endorsement apply concurrently as illustrated below to ready the site for the replacement structure.

Commercial Property Policy pays:

  • The value of the actual damage to the insured structure
  • The cost to remove the debris of the damaged structure.

Ordinance or Law – Coverage Part “A” pays:

  • The value of the undamaged part of the structure rendered unusable and valueless by the application of any ordinance or law.

Ordinance or Law – Coverage Part “B” pays:

  • The cost to tear down the undamaged part of the structure
  • The cost to clear the site of the debris resulting from demolition of the undamaged part.

Once the site is clear, construction on the new structure can begin.

Coverage “B’s” limits are chosen by the insured and are available on a scheduled (per building) basis or blanket (one limit for all buildings) basis. Blanket limits can apply to coverage “B” alone or Coverages “B” and “C” can be combined into a single blanket limit encompassing all insured locations. The last blanket limit option is a combination of scheduled coverage and blanket limit allowing the insured to purchase a combined (blanket) Coverage B and Coverage C limit but apply it to scheduled locations only. This option requires the insured to complete the Statement of Values endorsement (CP 16 15) indicating which locations are to have this coverage. Coinsurance requirements do not apply to Coverage B.

Calculating the Coverage “B” premium is simple. The additional premium is developed by dividing the chosen Coverage “B” limit by 100 and multiplying that quotient by the net building rate at whatever coinsurance limit is being used. The net rate used should not include Agreed Value or Inflation Guard factors.

Following

Coverage “C” (Increased Cost of Construction) is detailed in the next post along with the effect of building codes on the period of restoration and business income coverage. This series ends with a discussion of how to best calculate the amount of Ordinance or Law coverage required.



From: “Jurisdictional Intervention: The True Cost to Rebuild”
By: Christopher J. Boggs, CPCU, ARM, ALCM, LPCS, AAI, APA
Reprinted with permission from The John Liner Review,
Volume 22, Number 1; Spring 2008.
Copyright 2009, Standard Publishing Corp., Boston, MA.
All rights reserved.
www.spcpub.com


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Comments

  • December 5, 2009 at 5:32 pm
    terry hendrickson says:

    We’ve been talking to our property owning clients for over 5-7 Yrs. now.
    No ‘prospects’ we’ve talked to –durning the same period –have ever had a conversation regarding ‘Bldg. Ord.” with their current agent.
    Wonderful question to start a ‘new relationship’!!

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