A general contractor plans to build a new warehouse and takes out a builders risk policy with a $2 million limit and 100% coinsurance.

A year into the project, a windstorm rolls through and damages the building's unfinished roof. The contractor submits a claim of $250,000 for the cost of new materials, additional labor and a few soft costs stemming from the delayed completion.

While processing the claim, the carrier works with an independent appraiser who revalues the project at $2.5 million, determining it was underinsured by 20%. The contractor gets hit with a coinsurance penalty of $50,000.

While the specifics may differ, this is an all-too-common scenario.

Builders Risk and Coinsurance

After receiving a builders risk claim, a carrier first reappraises the project to confirm that its value aligns with the policy limit. If the appraiser determines the project's value is greater than the policy limit and the claim is for a partial loss, the coinsurance penalty comes into play.

Carriers reduce payments for penalized claims to the same degree the overall project is undervalued—and if a claim is large, the penalty can have a severe impact on the project's finances.

It's critical that you help policyholders understand the mechanics of this potential coverage gap.

Keeping Track of Changing Costs

It's equally important that policyholders don't see a project valuation—and the corresponding coverage limit—as a static variable, since costs can and often do change over the course of a build.

Changes in project scope are a common culprit. Take a project for a new home valued at $3 million at the time of policy issuance, with 90% coinsurance, written with a $2.7 million limit. During construction, the homeowner gets inspired to take the design in a new direction, adding various high-end finishes and upgrades to the home, driving up its value to $4 million.

In this scenario, not only would the insured's limit be woefully inadequate to cover a total loss, but any partial loss would be subject to a coinsurance penalty of 25%.

Significant changes to a project's scope should always trigger an update to its valuation. Policyholders should also keep an eye on materials and labor costs, as these may change over the course of construction.

Getting Valuation Right

Given the real risk of coinsurance penalties, “close enough" isn't good enough when it comes to project valuation for builders risk coverage. To minimize the risk of a coverage gap, builders should make sure they:

• Develop a proper budget and construction plan. An experienced and reputable general contractor should be able to define the full scope and cost of a project. Keep in mind that, with ongoing inflation and skill labor shortages, using outdated cost assumptions in a budget can create real problems.
• Provide the carrier with all the required information upfront. Quality submissions allow for more efficient processing and a better experience for all parties. When the agent and insured understand what a carrier needs to make accurate underwriting decisions, the project is usually regarded as a better risk.
• Get on the same page with your carriers. It's critical that agents have a strong understanding of each carrier's preferred risks before submitting new business. For in-appetite risks, carriers can bring their underwriting expertise to the table, partnering with the agent to determine proper valuation and a coverage plan that best meets the needs of the insured.