Builder's Risk Coverage: An Ounce of Prevention is Worth a Pound of Cure

By David Weaver | April 15, 2008
While many checkmarks are needed to complete the to-do list during the builder's risk phase of a biofuel project, one of the most important-placement of the builder's risk coverage-is often overlooked. A builder's risk policy serves to protect the project against loss during the course of construction. While one would think that this might be one of the higher priority items during this phase, often it is not. In fact, it is often a last-minute decision, and that is not in the best interest of any involved.

Why this oversight happens is not clear. It may be due to the number of parties involved in the project during this time. Contractors, sub contractors, engineers, and lenders and equity partners are all providing input which, at times, can blur the lines of who has, and will take, responsibility for each different aspect of the construction process. It may be that the excitement of finally having enough cash available to get the project underway dulls the focus on some of the key issues that should be addressed. It could even be that there just isn't enough time to spend on each critical component, and so a path of least resistance is chosen. Regardless of the reason, it is important to know that the builder's risk coverage is a critical part of the project. It can set the tone for the facility and can have an impact long after the actual policy has expired.

Who Secures the Policy?
One initial, proactive decision that should be made related to builder's risk coverage is deciding who will secure the policy in the first place. Contractors often include the provision of a builder's risk policy within the scope of their responsibilities. While, from a simplistic point of view, that may seem like the easiest way to handle it, there are a number of reasons why it may be preferable for the owner to control the process instead.

First, within most projects, there are often items outside the scope of what the general contractor will provide. Office buildings, storage sheds, fire protection and even tank farms can be designated as the responsibility of the owner. If that is the case, it is very likely that these items would not be included within any builder's risk coverage a contractor may provide. In that instance, an owner would have to secure a separate policy for the work they are responsible for, which would then mean there are multiple policies in force. That is not ideal from a coverage or expense standpoint.

A second reason an owner should seriously consider purchasing the builder's risk coverage is that a contractor may not include delay in start-up coverage within their policy. A contractor's main concern is the property on site during the construction process and the replacement of that property in the event of a loss. While that is important, the lost income a plant would experience due to a loss during the course of construction should also be considered. During the operational phase of a plant, this is called business interruption or business income coverage. During the construction phase, this is called delay in start up. The absence of this coverage could be a real problem for lenders and investors who have significant dollars committed to the project. Additionally, even if delay in start-up coverage is included within the contractor's policy, often such items as soft costs and extra expense are overlooked in the calculations. Both of those items could be critical in the event of a loss and would be something an owner would want to make sure to include.
One final and important reason for an owner to consider purchasing the builder's risk policy themselves is the fact that, in the event of a loss during the construction process, it is much better, from an owner's perspective, to have control of any settlement rather than to defer that to someone who may have competing interests.

Design Considerations
After the decision has been made regarding who will ultimately carry the actual builder's risk policy, the next critical area of focus should be the design of the coverage to be implemented. Many potential landmines could remain hidden until a loss occurs, which is the absolute worst time to find out. The following are several such areas that are often overlooked:

Contractual obligations-Equity and lending agreements, feedstock and offtake arrangements, and lease contracts all carry expressed or implied insurance obligations. It is critical to any project owner to review any and all contracts to determine exactly what responsibility each party as and what obligations exist in the event of a loss.

Sublimits terms and conditions-Each insurance market within the biofuel space will often carry different sublimits, terms and conditions. Deductibles are one of the most obvious areas of difference, but there may be variance on many others including offsite storage, transportation coverage, earthquake and flood limits, and even how service interruption issues are handled. All sublimits, terms and conditions vary considerably from policy to policy. Until one understands and evaluates the differences and thus compares the options on an apples-to-apples basis, a risk exists that there will be a big surprise in the event of a loss.

Exclusions-This is another area often overlooked when binding or crafting coverage. What is considered a covered cause of loss and what particular events are excluded from that definition? Exclusions are an incredibly important part of any coverage and should therefore be addressed with care. Often, because of a lack of understanding, knowledge or time on the part of the owner or insurance broker, they are not, and that could make a huge difference in the event of a loss.

Carriers involved-Obviously the owner will want to make sure to understand something about the insurance carrier that will ultimately be providing the protection desired. How long have they been in the biofuel business? How many similar plants do they write? What is their long-term commitment to the industry? What support will they provide through the process? What lines of insurance will they carry and what lines will they not? Will there have to be layers of coverage or are they able to handle the full total insured value? All of these are important questions that should be answered before any coverage is bound.

Finally, how testing coverage works and how fire protection is designed must be addressed during this coverage phase. Testing coverage is important because every insurance carrier views it differently and each has a different definition as to how and when that coverage starts and stops. It will be critical for an owner to understand this within the scope of the project and to make sure there are no gaps in coverage at any time.

Fire protection is also critical because the ultimate design of the fire protection program could have a significant impact on the availability and or pricing of the insurance coverage down the road. Today, while the insurance markets are soft, it is easy to find a carrier that will cover a project as long as some fire protection is in place. However, when the insurance markets tighten up, it will be critical that the fire protection design will be able to stand up to the scrutiny of those carriers still interested in writing biofuel facilities. A tighter market means tighter requirements. For that reason, it is imperative for an owner not to cut corners.

Who Will Provide Assistance?
Finally, maybe the most important decision an owner can make, even before the builder's risk coverage is placed, is that of selecting an insurance broker to help navigate the minefield of issues. Many times this decision is made based on who an owner knows or who happens to be an investor in the project. Unfortunately however, that choice is often not in the best interest of the project. Insuring a biofuel facility is very different than insuring a retail building, business or even another manufacturing operation. A number of issues must be managed, including, but certainly not limited to those mentioned earlier. Selecting a broker without significant experience in this field means that someone else has to pick up the slack and often times that simply does not occur. The inexperienced broker does not have the knowledge, owners and boards of directors don't have the time, contractors, engineers and technology providers each have a different set of issues to worry about, and even insurance companies have a singularity of focus. Ultimately, it is important to select a broker that has the experience and ability to assist and coordinate through all aspects of the project and to make sure that there are no surprises at a time when they are needed least.

As mentioned earlier, the builder's risk phase and the placement of builder's risk coverage is one of the most important phases of the entire project. The key for any project owner is to make an early, proactive decision as to how each of those items will be addressed and who might be chosen to assist in that process. In the end, those owners that pay heed to the phrase, "an ounce of prevention is worth a pound of cure," will be well on their way to success both in the present and the future.

David Weaver is with the biofuels practice group of The IMA Financial Group Inc. in Wichita, Kan. Reach him at or (316) 266-6203.
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