Real Estate Development – Protecting Your Profits

by Preston Cavignac, CPCU, CIC

Developers take significant risk. Studying market conditions, analyzing trends, predicting future demand, placing debt and equity, and acquiring permits and entitlements are some of the activities that occur prior to construction. Assuming construction goes well, there will be a finished product that was based on analytics developed years prior. Now that product has to perform.

But what if construction doesn’t go well? What if there was property damage during construction? What if there were construction defect claims post-completion? If not insured properly, these claims will eat away at profits. Owner Controlled Insurance Programs (OCIPs), also known as Wraps, and Builders Risk policies, also known as Course of Construction insurance, are specialized products designed to insure developments. They include various manuscript forms, endorsements and exclusions which make them unique and different from standard property and liability policies. These policies can last anywhere from one year to over a decade, so it’s important that they are written correctly and understood by all parties.

OCIPs are a commonly used liability insurance product for ground up developments. They “wrap-in” all owners’, general contractors’ and subcontractors’ general liability exposure into one policy. OCIPs are designed to pick up third party bodily injury and property damage as a result of premises/operation and completed operations liability. Note, OCIPs provide coverage for general liability. They can be endorsed to cover workers’ compensation and pollution, but ordinarily they don’t. They can also be endorsed to cover professional liability although only for bodily injury and property damage, not consequential or economic damages. This is important because even if the OCIP provides some professional liability coverage, it’s not meant to replace the design professional’s E&O policy.

The OCIP’s main allure is decreased litigation once claims occur. Instead of dealing with multiple parties, with multiple insurance policies, with multiple provisions, with multiple attorneys, there is one policy that represents all insureds. This saves both time and money, but it also puts more pressure on the OCIP to perform. OCIPs require a tremendous amount of negotiation and often take months to complete. Generally, both peer review and OCIP administration are conditional requirements prior to binding. Peer review, or quality control, is a second set of eyes who review plan documents and construction during the building operation. Specialist OCIP administrators track insurance certificates, provide a risk assessment and create the OCIP manual. The OCIP manual outlines the purpose and details of the policies and is distributed to all enrolled parties. It is pertinent that the details in the OCIP manual are mirrored in the subcontract agreement either by manuscript edits or by an addendum.

Builders Risk policies are designed to cover property, both installed and on premises (as long as it is intended to be installed), during the course of construction. A proper Builders Risk policy should include all subcontractors working on the job as insured. This allows the policy to respond to any covered loss regardless of who owns the property at the time of loss.  These policies may also respond to property in storage and/or staging areas depending on how the policy is written. Like other property policies, Builders Risk may include coinsurance provisions, high deductibles, low limits or other endorsements that are intended to confine or restrict coverage. Flood and earthquake exposures should always be discussed as they are legitimate concerns in most states. It is important that these policies are thoroughly reviewed so all parties are clear on what is covered and what isn’t. Between the OCIP and Builders Risk, the development’s general liability and property coverage should be met.

Contractual requirements dictate responsibility. The contracts between owner/architect, owner/general contractor, and general contractor/subcontractors will play an important role in how claims are handled. The general theme is to pass as much responsibility downstream as possible, although some recent senate bills have been passed in an attempt to level the playing field. All subcontractors will be required to maintain insurance outside of the OCIP in the chance that offsite claims co-mingle with the development project. The normal contractual wording should be in place regardless of the OCIP or Builders Risk policies (indemnities, additional insured status, waivers of subrogation, etc.). The OCIP manual needs to be tied into these contracts as it summarizes the purpose and details of coverage. It states the limits, deductible allocation, intended coverage, and each party’s responsibilities.

OCIPs, Builders Risk, peer review, OCIP administration, and contractual requirements make up the necessary protections needed for developments. These agreements have a major role in determining the success of a project. If there are coverage gaps, errors made in the administration or subpar contractual requirements, the success of the project is at risk. These types of policies are highly specialized and they need to be written correctly. When done properly, they can appropriately protect the profits of developers and investors.