Some unfortunate phrases have become part of the insurance lexicon and are apparently impossible to dislodge.
“All risk” is one of them. Property/casualty professionals learn quickly that virtually no policy covers all risks, in a literal sense.
“Open perils” is a more precise (or less imprecise) alternative for describing policies that cover first -party property losses arising from all perils except those explicitly excluded.
Still, “all risks” continues to pop up in articles, regulations, legal documents, and industry texts.
“Soft costs” may be another established term that obscures more than it clarifies, says Robert Guevara, AAIS vice president for inland marine.
The term “soft costs” generally refers to certain expenses required to complete a construction project that has been delayed due to unexpected physical damage.
In contrast to “hard costs” for labor and materials, soft costs are generally not considered to be directly related to physical construction. Rather, they are commonly perceived to entail non-construction costs such as taxes, marketing expenses, interest payments, and finance charges.
The soft costs endorsement provided in the Builders’ Risk section of the AAIS Inland Marine Guide lists 10 types of soft costs: advertising, design fees, professional fees, financing, lease administration, realty taxes, general administration, lease expenses, permit fees, and insurance premiums.
Builders’ risk is one of the traditionally nonfiled classes of inland marine insurance, so it is not surprising to find considerable variance among what different carriers list as “soft costs.”
Whereas the AAIS endorsement lists 10 categories of soft costs, forms from national carriers exhibited on one website list seven or eight categories of soft costs, and a checklist provided online by a brokerage firm lists 14 different types.
Unfortunately, says Guevara, the common understanding of “hard costs” as construction-related and “soft costs” as ancillary obscures a more important distinction.
That distinction, he says is between original project costs--”hard” or “soft”--that are part of a covered loss, and additional costs incurred because of changed circumstances after a loss.
According to Guevara, the former are typically covered under an unendorsed builders’ risk policy, without the need of a “soft costs” endorsement.
To illustrate, suppose a project is partially destroyed due to an insured peril and needs to be re-designed.
Depending on the circumstances and the valuation of the builders’ risk exposure, there may be coverage under an unendorsed builders’ risk policy for engineering and architectural fees needed to replace the lost value of the original specs.
Given that, Guevara notes that, “there is often coverage in a standard builders’ risk policy for certain construction costs that are loosely called ‘soft costs’.”
Claims disputes can arise, however, when brokers or risk managers use the term “soft costs” to characterize certain losses, and are told by a claims rep there is no coverage because the insured has not purchased a soft costs endorsement.
Without the endorsement, a project owner or contractor that suffers a loss will typically find itself without coverage for fees, taxes, interest, and other expenses that are in excess of the original project costs calculated for the builders’ risk valuation.
“We’ve been hearing about more and more claims disputes related to this,” says Guevara. “I wish we could get rid of the term ‘soft costs,’ but it’s an established part of the business.”
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Property/casualty companies that insure construction contractors now have access to a new program that provides several inland marine construction coverages in a single policy form.
A new Contractors’ Combination policy form and endorsements were recently added to the Inland Marine Guide, a leading source of policy forms, rating procedures, and underwriting guidelines for the traditionally nonfiled classes of inland marine insurance.
The Contractors’ Combination base form covers four types of inland marine construction exposures that are typically insured by separate forms:
- Contractors’ equipment and tools;
- Builders’ risk;
- Installation floater; and
- Electronic business equipment.
Coverage for builders’ risk and contractors’ equipment is provided on a scheduled basis, and schedules are provided. However, the base form also includes a supplemental coverage with separate sublimits for unscheduled equipment and tools.
Installation floater coverage is provided on a blanket basis, so covered installation projects do not have to be scheduled. Also, electronic equipment (including computers, copiers, phone systems, etc.) is covered while at locations occupied by the insured; the locations do not have to be scheduled.
Companies writing Contractors’ Combination policies are advised to use the rating which currently exists for each applicable Guide class (Builders Risk, Contractors’ Equipment, etc.) to rate Contractors’ Combination coverage.
The Contractors’ Combination policy introduces new provisions designed to eliminate confusion in the construction market over the definition of “soft costs” (see main story on page 6).
Nearly 30 endorsements and sample schedules are provided with the Contractors’ Combination policy, including the following:
- Electronics Coverage - Equipment And Tools: Covers off-board electronic equipment used to communicate with or keep track of contractors’ equipment while at a jobsite.
- Additional Coverages Endorsement - Equipment And Tools: Extends coverage to construction trailers and their contents.
- Additional Coverages Endorsement - Builders’ Risk And Installation Floater: Extends coverage under the Combination Form to covered property while waterborne. It also covers testing, personal property, and coverage for contract penalties.
- Additional Coverages Endorsement - Electronic Business Equipment: Can be used to provide coverage for incompatible hardware and media. The endorsement also provides foreign transit/location coverage and virus and hacking coverage for computers.
- Income Coverage - Equipment And Tools: provides coverage for loss of earnings caused by direct physical loss of or damage to covered contractors’ equipment.
- Percentage Deductible Endorsement - Equipment And Tools: provides a deductible that is a selected percentage of the value of covered property, subject to a minimum and maximum deductible amount.
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AAIS has taken an initial step to clarify the identification and treatment of construction costs in its new Contractors’ Combination policy recently added to the AAIS Inland Marine Guide (see sidebar).
To clarify the application of coverage, the Contractors’ Combination policy introduces two provisions:
- A statement is included in the valuation provision saying that coverage is provided under the base form for “related construction costs that are re-incurred,” provided they were included in the original valuation of builders’ risk exposure.
- A new soft costs coverage endorsement is labeled and worded to specify that it applies to “additional” soft costs beyond those that are part of the builders’ risk valuation.
“The extra valuation provision was added to clarify that the value of a building project may include construction costs that are sometimes referred to as ‘soft costs,’ such as engineer’s fees,” says Guevara.
“To be covered under the base form, those construction costs must be included as part of the limit for the builders’ risk project,” says Guevara.
“The term ‘additional’ was added to our soft costs endorsement to emphasize that coverage under the endorsement is for certain costs that are in addition to the value of the builders’ risk project.”
AAIS is contemplating even more substantial changes to its treatment of soft costs in an upcoming revision to the Builders’ Risk section of the Inland Marine Guide, says Guevara.
The revision will draw, in part, on ideas discussed at a session on soft costs at the 2006 annual meeting of the Inland Marine Underwriters Association (IMUA).
In a presentation at the IMUA event, Vincent Zegers, product line manager for property engineering for Swiss Reinsurance America, reviewed the treatment of hard costs and soft costs in U.S. builders’ risk forms today, and urged U.S. insurers to adopt an approach commonly used in Europe.
Among hard costs, he listed the cost of labor, construction material, overhead, scaffolding, and fees. For soft costs, he listed marketing fees, developers’ fees, refinancing costs, loss of income or profit, and loss of interest.
What truly distinguishes hard costs from soft costs, according to Zegers, is that coverage for the former is provided within a policy period, subject to a dollar deductible, while coverage for the latter is provided up to the end of a period of indemnity and is subject to a time deductible.
Given that, endorsed soft costs coverage often is not triggered until a certain period after a loss, typically 48 hours. (AAIS soft costs endorsements state that the waiting period is specified on the schedule accompanying the endorsement.)
Zegers holds, however, that certain “soft costs” are incurred at the time of a loss regardless of when they are contracted or paid for, and would be more properly insured if covered in the same manner as hard costs.
Among those costs are professional fees and refinancing charges that have to be paid in full no matter how long a project is delayed.
When such costs are insured under a time deductible, as is customary, the insured has an incentive to delay incurring an expense until after the designated waiting period.
That may not be advisable from a loss control perspective. A general principle of risk management holds that, the longer one waits to take action to address a loss, the greater the loss will be.
If an insured waits even a day or two to contract for needed services, the contractors or professionals may take other jobs and, in effect, add weeks or months to the completion of the insured project.
Other traditional “soft” costs, including loss of income, loss of rent, and interest expense, are directly related to the length of the delay in the completion of a project.
Zegers refers to these as “delay” exposures, “delay” being a term commonly used in Europe and increasingly used by U.S. construction risk professionals. Given that losses under such exposures are directly related to the time needed to complete a project, Zegers says they are appropriately subject to a time deductible.
Guevara agrees with Zegers, at least in part, and plans to shift coverage for some of the current soft costs into the builders risk valuation.
For example, Guevara notes that certain finance charges have to be paid in their entirety, no matter what the interest rate or other terms of a loan.
In the upcoming Builders’ Risk revisions, he proposes to split the coverage for finance-related soft costs between finance charges, which would be subject to the basic builders’ risk deductible.
Interest expense, a time element exposure, would be subject to a time deductible.
Guevara also plans to build some time element delay coverage, with a separate sublimit, into the Builders’ Risk base forms.
One thing won’t change, however. Users of the Inland Marine Guide will continue to see the term “soft costs,” much as Guevara might wish it would go away.
Soft costs, hard concept 
