In 2017, ISO filed a revision to its Ordinance or Law Coverage as provided on forms CP 04 05 (Ordinance or Law Coverage), CP 04 38 (Functional Building Valuation), and CP 15 31 (Ordinance or Law – Increased Period of Restoration).
It's possible that you're not familiar with these forms and how they impact a commercial property policy. Here's how we'll handle them. We'll talk about the forms, why your insureds want them, and the key changes that were recently implemented. Let's get to the biggest question?
How does the unendorsed commercial property policy handle ordinance and law coverage?
If you go searching your CP 00 10 for the Ordinance or Law Coverage, Exclusion, Limitation, etc., you won't find it. This form provides an additional coverage called Increased Cost of Construction. In applying this additional coverage, it is related to Ordinance or Law, but it isn't the same thing. Here are some of the provisions of this additional coverage.
The ordinance or law referred to in e.(2) of this Additional Coverage is an ordinance or law that regulates the construction or repair of buildings or establishes zoning or land use requirements at the described premises and is in force at the time of loss.
If we were to read the whole additional coverage, we would find that there are more restrictions than coverages here. We also find that the coverage here is limited to $10,000 or 5% of the building limit and applies only once the building is actually repaired.
If you keep looking, you will find an Ordinance or Law exclusion on the CP 10 30 (Causes of Loss – Special Form). Let's look at some specific language.
The enforcement of or compliance with any ordinance or law:
Regulating the construction, use or repair of any property; or
Requiring the tearing down of any property, including the cost of removing its debris.
This exclusion, Ordinance or Law, applies whether the loss results from:
An ordinance or law that is enforced even if the property has not been damaged; or
The increased costs incurred to comply with an ordinance or law in the course of construction, repair, renovation, remodeling or demolition of property, or removal of its debris, following a physical loss to that property.
So, what we find is a very limited coverage that may leave an insured with a significant gap that they must either retain or find another way to insure. They have no coverage if the code enforcement officer inspects the property and orders the remaining building demolished. There isn't even coverage to remove that debris once it's taken down. They have no coverage if the code enforcement officer requires system upgrades to the plumbing, electrical, HVAC, or other major building system.
Even with the building valued at replacement cost, that simply replaces the building to its condition at the time of loss. It doesn't provide upgrades to key systems. It doesn't provide for loss to the undamaged portion of the building. These are the reasons that the Ordinance and Law Coverage endorsement exists.
There are four coverages that CP 04 05 Ordinance or Law Coverage endorsement is designed to address. All of these are excluded without adding this endorsement to the commercial property policy.
Coverage A – Coverage for Loss to the Undamaged Portion of the Building
When there has been a covered loss to a building, the remaining part of the building may still suffer a loss. Depending on local building codes and regulations, if there has been significant damage to the building, what's left has suffered a loss of value. The local building code may require that the undamaged portion of the building be demolished before starting construction.
Remember what the covered loss was. It was direct physical damage to covered property. The undamaged portion of the building has not suffered direct physical damage. It's just lost value. It's essentially worthless because local officials will not allow the building to be repaired back to its state prior to the loss. They want the rest of the building removed and the whole thing rebuilt. Selecting Coverage A on this form provides coverage for this loss. By checking the box on the form, the insured has the full building limit available to rebuild this building.
Coverage B – Demolition Cost Coverage
We have another problem though. It's going to cost to demolish the rest of that building and remove the debris so that reconstruction can begin. That's where coverage B comes in. It provides coverage for those costs. Now the question remains, what will it cost to demolish and remove that undamaged portion of the building? That's the kind of question that we need to answer because the form wants us to provide a limit for this coverage.
How do we decide on the limit that we need here? That's the real question. Let me summarize my thoughts on this. Ask a few more questions. How much of the building must be damaged before it will need to be demolished? Are there any hazardous materials? How much would it cost per square foot to demolish and remove the debris? These are simplified answers to a complicated question. For a better treatment of this topic, I'd like to refer you to another article on MyNewMarkets.com, written by Chris Boggs, entitled How to Calculate the Correct Amount of Ordinance or Law Coverage.
Coverage C – Increased Cost of Construction Coverage
This is the place in the form that takes us back to the original additional coverage on the property coverage form. This coverage provides funds to upgrade certain key systems in the building as required by local ordinance. We remember that the policy already provides $10,000 or 5% of the building limit, but that may not actually cover the required upgrades. That's that this does.
This coverage also asks us for a limit so how much should we put in there. That's a harder question to answer than the coverage B limit. This may be a bit of a guess because it's hard to anticipate what system might be out of code. You might use a percentage of the building limit as your basis. You could also get a quote to replace the plumbing, electrical, roofing, and HVAC systems and use some percentage of that amount for your limit. Take a look at that article that I mentioned above for Chris Boggs' thoughts on the topic.
Post-Loss Ordinance or Law Option
This is a new part of the coverage as of 2017. The prior version of this form stated that coverage was for costs associated with ordinance or law in effect at the time of loss. This option allows for compliance with laws that are new or amended between the time of loss and the start of construction. We have to recognize that sometimes the adjustment of the claim and the beginning of construction (or demolition) might take a long time. During this time, laws can be passed that change how much it will cost to rebuild the building. This option provides coverage for those instances.