Our previous article ended with several examples of coverage limit gaps created by the application of local building codes. This post will discuss those examples further and end with a highlighted discussion of the HO 04 77 endorsement.

Loss/Gap and the Reality of Building Codes

In all the prior examples, the greatest ordinance or law expense is the cost associated with the undamaged portion of the house (the cost to tear down and rebuild to current code). However, consideration must be given to the fact that it is not likely a house could be 80 percent damaged and not be declared a total loss or at least a constructive total loss (unless it's a magic fire that just stops and causes no further damage). This massive cost and gap in coverage limit is most likely to be found in a house that suffers 50 to 60 percent damage.

Discounting the costs associated with the undamaged part of the house, the cost to bring the entire house up to current building code could, itself, use up and greatly exceed the ordinance or law coverage offered in the unendorsed homeowners' policy. In the first example, the cost to bring the entire house up to current code is $60,000 (3,000 square feet times $20 per square foot) leaving the homeowner out of pocket $30,000.

The difference between the cost to rebuild the structure as it stood and the cost to bring it to current building code is largely a function of the house's age and the rapidity and breadth of changes in the building codes adopted by the authority having jurisdiction. Agents should have a good handle on the major changes between the time the house was built and the current building code. With that recommendation made, it is impossible to know all applicable building codes, several volumes of manuals are necessary to hold them; but the agent can undertake to know the major changes involving major requirements such as are contained in the national electric code, the applicable flood plain management codes and other MAJOR changes (ADA guidelines and changes in building procedures and materials since the house was constructed).

As stated earlier, the building codes applicable to a specific house, while enforced by the local authority, can emanate from enumerable sources; but the good news is that ordinance or law coverage responds to ALL building codes, regardless of the genesis. The policy specifically states, "You may use up to 10% of the limit of liability that applies to Coverage A for the increased costs you incur due to the enforcement of any ordinance or law which requires or regulates…". "Any" has no limitation.

Homeowners' Endorsements NOT Altering the Ordinance or Law Exclusion/Limitation

Additional Limits of Liability for Coverages A, B, C and D (HO 04 11 or equivalent state-specific form). This form allows the insured to purchase an additional amount of dwelling coverage (Coverage "A") AFTER the loss occurs in the event that the estimated replacement cost purchased was less than the actual replacement cost (the old "guaranteed replacement cost" coverage). Once additional Coverage "A" limits are purchased, all other coverage parts increase in kind (based on the applicable percentages), including the 10 percent additional coverage for ordinance or law.

Endorsement provisions require the insured to: 1) carry 100 percent insurance to value; 2) allow the insurance carrier to adjust the limits based on replacement cost valuations completed; 3) allow the insurer to apply an inflation factor; and 4) notify the insurance carrier if any improvements are made that increase the value of the structure more than 5 percent.

However, this endorsement does NOT alter the ordinance or law exclusion in the loss settlement provisions. ISO's HO-3 form specifically states, "In this Condition C., the terms 'cost to repair or replace' and 'replacement cost' do not include the increased costs incurred to comply with the enforcement of any ordinance or law, except to the extent that coverage for these increased costs is provided in E.11. Ordinance Or Law under Section I - Property Coverages." The E.11. additional coverage is the 10% of Coverage A as discussed previously.

Specified Additional Amount Of Insurance For Coverage A - Dwelling (HO 04 20 or equivalent state-specific form). This is a modified version of the HO 04 11 containing all the same provisions and limitations. The major difference is that only Coverage Part A (Dwelling) can be increased. None of the other limits, including the ordinance or law limit, are increased. A second difference of this endorsement is that the amount of additional coverage available for purchase is limited to either 25 percent or 50 percent of the pre-loss Coverage A (whichever the underwriting carrier will allow).

The HO 04 20 uses the same definition of "replacement cost" as the HO 04 11; meaning that none of the additional costs required by the application of an ordinance or law are covered by the attachment of this endorsement.

Confusion over both forms is generated by a misunderstanding of the meaning of "replacement cost" used in the homeowners' form and the subject endorsements. Replacement cost means to replace with "like kind and quality." Basically this translates "to put back exactly what was there, like it was, using new material; but excluding the cost of any upgrades requested by the insured or mandated by any governmental authority."

The definition of replacement cost does not include the cost to do such things as:
• Raise the house three feet to get it above base flood elevation (BFE) to comply with the current flood plain management code;
• Add more electrical outlets to meet national electric code (NEC) requirements;
• Move the house back 10 feet to meet set-back requirements; or
• Widen doorways and raise counters to meet ADA requirements.

All of these costs result from governmental ordinances or laws and are examples of expenses not included in the definition of "replacement cost." So, even buying more Coverage "A" will not cover these expenses. The cost to meet any or all of these and other jurisdictional requirements will have to be covered under the ordinance or law extension, the endorsement increasing coverage (HO 04 77) or out of the insured's pocket (if there is not enough additional coverage from either of the other options).

In short, neither endorsement rescues the insured from the additional costs necessitated by a local jurisdiction's enforcement of the local building codes requiring a house to be brought, in its entirety, up to current building code.

Ordinance or Law Increased Amount of Coverage (HO 04 77)

Two ordinance or law endorsements exist for use with homeowners' policies: 1) the Ordinance or Law Increased Amount of Coverage (HO 04 77); and 2) the Ordinance or Law Coverage (HO 05 62). The HO 05 62 is attached when there is no automatic ordinance or law coverage provided by the homeowners' form. Coverage provided by this endorsement is the same as has been discussed previously except that the insured chooses the coverage limit desired.

However, since most ISO homeowners' policies include ordinance or law as an additional coverage (10 percent of "A" as reported), this article focuses on the use of the HO 04 77 to increase the amount of ordinance or law coverage.

Coverage breadth is not changed by the HO 04 77, only the amount of coverage. The insured can choose to increase the limits to 25 percent, 50 percent 75 percent or even 100 percent of Coverage "A." The premiums for each level is a percentage of the homeowners' base premium ranging from 13 percent (to increase to 25 percent of "A") up to 67 percent (raising the limit to 100 percent of Coverage "A").

The very first example presented in the first post developed an ordinance or law-induced claim expense of $165,000; that equates to about 55 percent of Coverage "A." Increasing the ordinance or law limit to 50 percent of Coverage "A" would increase the base premium by approximately 35 percent. A $1,000 premium would become a $1,350 premium; but that $350 is preferable to the out-of-packet expense of $135,000 presented in the example.

But, as previously stated, such a loss and extreme application of an ordinance or law claim is probably rare. However, it is still highly recommended and even professionally necessary to offer additional amounts of ordinance or law coverage, at least the 25 percent option. In some states, Florida being one, the agent is required to offer the 25 percent and 50 percent alternatives; and the insured has the option to purchase or reject the offer of coverage (by signature).

Conclusion

Ordinance or law coverage is more commonly discussed and highlighted in commercial property conversations, but rarely is such a discussion carried on with personal lines clients. As was presented in this three-part series, the lack of this coverage has the potential to be very expensive to the insured (and potentially the agency if an errors and omissions suit results).

Without being overly dramatic, ordinance or law is a very real homeowners' exposure often overlooked during the personal lines risk management and insurance planning process. Agents should offer the protection and explain the exposure as clearly and quickly as possible; especially to clients in a home 10 years old and older. A great marketing opportunity may be to write a letter to clients owning older homes to explain their new exposure and present a solution. Regardless, do not ignore this potential out-of-pocket expense faced by your homeowner clients.

The next post will provide agents a sample letter that can be sent to clients to explain this gap in coverage. Hopefully the letter will serve two purposes: 1) as a marketing tool to let your homeowner clients know that you are looking out for their best interest; and 2) as an errors and omissions protection. If one of your clients suffers major damage leading to an ordinance or law problem that is not paid by insurance; being able to prove in court that you notified the insured of this potential gap will go a long way towards helping you win the case.