Ordinance or law endorsements exist to fill coverage gaps in unendorsed commercial property policies and business income forms. These coverage gaps involve the additional costs and time associated with enforcement of changes in local building codes.

ISO uses two primary ordinance or law endorsements for commercial property policies: Ordinance or Law Coverage (CP 04 05), and Ordinance or Law – Increased Period of Restoration (CP 15 31). There’s also an endorsement for the business owners policy, the BP 04 06, which essentially combines the two commercial property forms. Proprietary forms also exist in the marketplace.

Ordinance or Law Coverage (CP 04 05)

This option involves three distinct coverages:

Coverage A: Loss to the Undamaged Portion of the Building

Coverage A responds when a major loss triggers the application of local ordinance or law, yet part of the building is undamaged. Essentially, the actual loss in such a claim is not just the value of the damaged part of the structure, but the value of the entire structure, since the remaining structure has been rendered unusable by application of the local building code.

Coverage A's payment following a "major" damage loss relates directly to the limits in the underlying property policy. In essence, the maximum the insured can receive is the total limit of coverage listed in the commercial property policy. Coverage A is a function of the jurisdiction's rule of major damage, the actual amount of damage and the insured value of the building.

Coverage B: Demolition Cost

Coverage B fills the gap between the commercial property policy and Ordinance or Law Coverage endorsement’s Coverages A and C. Specifically, Coverage B pays the cost to demolish the undamaged portion of the partially damaged structure and remove it from the premises.

When a "major" loss occurs, the commercial property policy and Coverages A and B of the Ordinance or Law Coverage endorsement apply concurrently as illustrated below to ready the site for the replacement structure.

The commercial property policy pays:

• The value of the actual damage to the insured structure.
• The cost to remove the debris of the damaged structure.

Ordinance or Law – Coverage A pays:

• The value of the undamaged part of the structure rendered unusable and valueless by the application of any ordinance or law.

Ordinance or Law – Coverage B pays:

• The cost to tear down the undamaged part of the structure.
• The cost to clear the site of the debris resulting from demolition of the undamaged part.

Once the site is clear, construction on the new structure can begin.

Coverage C: Increased Cost of Construction

This third leg of the Ordinance or Law Coverage endorsement provides the funds necessary to pay the difference between the replacement cost as defined in the insurance policy, and the insured's understanding of its meaning. In short, Coverage C pays costs in excess of the amount paid by the underlying commercial property policy necessary to bring the damaged structure into compliance with the building code in effect at the time of loss. Without Coverage C, the insured would have to pay these additional building costs out of pocket.

Coverage C also extends protection for some classes of real property that are specifically excluded in the commercial property policy, including the cost of excavations, grading, backfilling and filling, building foundations, pilings and underground pipes, flues and drains.

Note that it’s possible to find payment for an ordinance or law claim under Coverage C alone, without resorting to payouts under Coverages A or B. Coverage C responds to three types of losses:

• The cost to repair or reconstruct the damaged portion of the building
• The cost to reconstruct the undamaged portion of the building if demolition is required
• The cost to remodel the undamaged portion of the building if demolition is not required

But Coverage C applies only when all three of the following criteria are met:

1. The rebuilt or remodeled property is intended for similar occupancy, unless such occupancy is no longer permitted.
2. The building is rebuilt or remodeled.
3. Repairs or replacement are made as soon as reasonably possible. They must be completed within two years of the loss. If they expect to require more than two years, the insured can request an extension.

Also note: While the insured can choose to rebuild anywhere, the most Coverage C pays—subject to the limit of insurance purchased—is the increased amount necessary to replace the building at the insured premises. If, however, the local ordinance or law requires relocation of the building, this coverage part will pay the lesser of the increased cost at the new premises or the limit of coverage.

Since the goal of Coverage C is to replace the damaged building with an improved one, the underlying property coverage must be written on a replacement cost basis, preferably insured at or near 100% of insurance to value. Doing so removes most limit gaps and coinsurance problems. Notice, however, that the coinsurance condition does not apply to Coverage C.

Ordinance or Law – Increased Period of Restoration (CP 15 31)

This endorsement revises the business income policy's definition of "period of restoration" to include any increase in such a period resulting from the application of any ordinance or law. Simply stated, if the building code lengthens the "period of restoration," the definition of "business income" includes the income an insured loses during the extended period.

Both the CP 04 05 and CP 15 31 respond only if all three of the following conditions are met:

1. The loss is caused by a covered peril, regardless of the form used.
2. The loss breaches the "major" damage threshold as defined and applied by the subject jurisdiction.
3. The damaged structure is lacking in some aspect of the local building code in effect at the time of the loss.

Any loss that satisfies all three conditions activates coverage. However, note that the endorsements pay only to the point necessary to meet the minimum code requirements that apply to the structure, meaning the insured must bear any costs associated with going beyond the minimum code. The insured must also bear any costs associated with meeting codes they were required to meet prior to the loss, but didn’t. For example, if the jurisdiction directed the insured to install a sprinkler system before the loss, but the insured didn't do so, the policy would not pay for its installation after the loss.

Want more information on ordinance or law coverage? Join the Big “I” Virtual University (VU) on Wednesday, Aug. 23 for a two-hour webinar, When (and Why) Partial Losses become Total Losses. The session will tackle:

• Ordinance or law-related coverage gaps in property policies.
• Who promulgates and enforces building codes.
• What constitutes "major" damage.
• The details of various ordinance or law endorsements.
• How to develop coverage limits for each coverage part.

Continuing education is available in several states. Remember, every registrant receives a link to the recording as well as the class transcript.

Check out Part 1 of this article: How Building Codes Turn Partial Property Losses into Total Losses.

Chris Boggs is executive director of the VU.