chevron-down Created with Sketch Beta.

Probate & Property

Nov/Dec 2023

The Most Important Things to Know When Insuring Lease Work Letter Construction Projects, Part Two: Property Insurance

Jonathan Ashley Kendrick


  • A lease can require either the landlord or the tenant to carry property insurance on a building.
  • Under an ISO Property Policy, the covered property the insurer will pay to restore or replace includes items.
  • A property policy’s declarations page sets out the maximum amount that an insurer will pay in any single occurrence.
The Most Important Things to Know When Insuring Lease Work Letter Construction Projects, Part Two: Property Insurance
FooTToo via Getty Images

Jump to:

This is the second part of a two-part article on insurance for construction projects under commercial lease work letters in which either the landlord or the tenant is responsible for engaging the contractor to perform the work. This part focuses on property insurance for commercial buildings (property insurance), including tenant improvements to a tenant’s premises (leasehold improvements). Part One focused on commercial general liability (CGL) insurance.

Property Insurance for Work Letters

A lease can require either the landlord or the tenant (or both) to carry property insurance on a building (and permanent improvements or additions to that building). Multitenant office or retail leases typically require the landlord to carry property insurance on the building and often will not require the tenant to carry property insurance on anything other than its machinery, personal property, and equipment. The lease, however, will typically allow the landlord to charge the tenant for the tenant’s pro rata share of the premiums for the landlord’s insurance through pass-throughs of operating expenses (or increases in a base year amount of operating expenses) or common area maintenance expenses.

For purposes of analyzing the appropriate types of property insurance in the context of two types of work letters discussed in the companion articles (see Marie A. Moore and G. Trippe Hawthorne, Lease Work Letters, Part One: When the Landlord Performs the Work, Prob. & Prop., May/Jun 2023, at 26; Marie A. Moore and G. Trippe Hawthorne, Lease Work Letters, Part Two: When the Tenant Performs the Work, Prob. & Prop., Jul/Aug 2023, at 44), this article assumes the landlord will carry property insurance on the building with limits sufficient to include the value of the leasehold improvements upon completionthat are of the types discussed in the companion articles. This article does not discuss property insurance issues that arise for construction of new buildings or significant additions to existing buildings, nor does it cover situations in which the landlord obligates the tenant to insure the leasehold improvements after. they are constructed under a work letter. Where the tenant insures the leasehold improvements, this is typically provided under a tenant’s property insurance policy. Under an Insurance Services Office, Inc. (ISO) form property insurance policy (ISO Property Policy), coverage for leasehold improvements is called “improvements and betterments” coverage, but such coverage is beyond the scope of what is covered in this article.

Property insurance policies frequently also include coverage for loss of business income insurance that commercial leases typically require the tenant to carry or loss of rental value typically carried by landlords. This article discusses these coverages briefly in the context of “Builder’s Risk” insurance, which is a specific type of property insurance that may be appropriate to procure when constructing leasehold improvements under a work letter. This article will primarily focus on the ISO Property Policy and the ISO Builder’s Risk Coverage Form (ISO Builder’s Risk Form). There are many other types of property insurance and policy forms in addition to the ISO Property Policy and ISO Builder’s Risk Form, and insurers sometimes use manuscripted policies rather than standard forms, but space does not permit a discussion of forms other than the ISO forms.

Property insurance is considered “first party” insurance. It applies to the insured’s own property and indemnifies the owner of the insured property (i.e., the landlord), but only for those losses covered by the policy and only to the extent of the limits of the policy. It does not cover property of third parties, although “Builder’s Risk” insurance under the ISO Builder’s Risk Form (builders risk insurance), which is discussed below, typically insures the interests of certain other parties.

Evidence of property insurance coverage is typically provided using a form provided by the Association for Cooperative Operations Research and Development (ACORD) called Evidence of Commercial Property Insurance. The most current form was issued in November 2011. As discussed in Part One of this article in the context of certificates of CGL insurance, the Evidence of Commercial Property Insurance form alone will not suffice as adequate evidence that the specified insurance has been procured because the form itself states it is issued as a matter of information only and confers no rights upon the person with the additional interest identified in the form. Moreover, it is subject to all of the terms, exclusions, and conditions of the policies themselves. Instead, the party seeking evidence of insurance should request the declarations page and a list of the forms comprising the property policy, and then obtain copies of the relevant forms that are included in the property policy.

The ISO Property Policy

The ISO Property Policy comprises multiple forms, but this article discusses only the key policy forms and endorsements relevant to work letters. A typical ISO Property Policy includes a declarations page that identifies the forms and endorsement forms constituting the policy and the properties insured, as well as the limits of coverage, deductibles, and sublimits under the policy; the policy period; and other important information. The ISO form declarations page is called the “Commercial Property Coverage Part Declarations Page,” CP DS 00 10 00. As with all other ISO insurance forms, CP denotes the form is a Commercial Property form, the first two numbers designate the form number, and the last two sets of numbers indicate the month and year in which the form was adopted by ISO.

Two separate ISO base forms are then combined with the ISO declarations page to form the key provisions of the ISO Property Policy. These two base forms include (1) the Building and Personal Property Coverage Form (currently CP 00 10 10 12), which describes the categories of property that the insurer will pay to restore or replace (the covered property), and (2) one of three different ISO “Causes of Loss” forms, which define the events that will trigger the insurer’s obligation to pay for restoration or replacement of the covered property. In addition to the declarations page and the two base forms, there are many other forms or endorsements that are or can be included within a complete ISO Property Policy, some of which are discussed in the portion of this article that discusses builders risk insurance.

Covered Property

Under an ISO Property Policy, the covered property the insurer will pay to restore or replace includes items such as

  1. The real property and items related to the real property, including the building, fixtures (including outdoor fixtures), permanently installed machinery and equipment, and the materials and equipment used to maintain or service the real property, and
  2. The “business personal property,” including the insured’s furniture and fixtures, machinery and equipment, “stock,” and other personal property used in its business located in or on the building or structure described in the declarations page. A tenant’s business personal property includes its use interest in fixtures, alterations, installations, and additions made as part of a building or structure that the tenant occupies but does not own, as well as those that the tenant acquires or makes at its expense but cannot legally remove (called “improvements and betterments”), but only if the building or structure is described in the declarations page.

Covered Causes of Loss

Leases often speak in terms of “casualties” that are to be covered by the landlord’s or tenant’s property policy or property insurance called “casualty insurance.” This terminology is not consistent with the terminology used in the insurance industry. Insurance professionals use the term “casualty insurance” to mean CGL insurance. The term of art used in the insurance industry to describe a type of covered cause of loss under a property policy (or special endorsement to such a policy) is a “peril.”

The three types of ISO “cause of loss” forms the insured can choose from are:

  1. A Basic Form that covers only listed perils, including fire, lightning, vehicles, aircraft, and civil commotion (ISO Form CP 10 10 10 12).
  2. A Broad Form that provides Basic Form coverage as well as coverage for certain additional listed perils, such as structural collapse, sprinkler leakage, and losses caused by ice, sleet, or snow weight (ISO Form CP 10 20 10 12).
  3. A Special Causes of Loss Form that adds some listed perils to those covered under the Broad Form, and also covers “all risks of direct physical loss” except those perils that are specifically excluded (ISO Form CP 10 30 10 12).

In the distant past, the Special Causes of Loss Form was called an “All Risk” coverage form, although it never really covered “all risks.” A Special Causes of Loss Form provides the best coverage available today via standard form (i.e., non-manuscript policies) and is the type of property policy that landlords and tenants typically maintain for their property. Many types of perils are still excluded from Special Causes of Loss ISO Property Policies. These excluded perils include matters such as ordinance or law, earth movement (earthquake, landslide, and earth sinking other than sinkhole collapse), governmental action, nuclear hazard, utility services, war and military action, water (flood and other water-related occurrences), and fungus (mold), wet rot, dry rot, and bacteria. Many of these excluded coverages can be added by way of special endorsements to the base ISO Property Policy.

The Amount Insured

A property policy’s declarations page sets out the maximum amount that an insurer will pay in any single occurrence (the coverage limits). For insured physical property (as opposed to loss of business income and rental value), the insurer will generally be required to pay either the replacement cost or actual cash value, depending on which option is selected by the insured. The amount paid is limited, of course, by the insurance limits and perhaps by a coinsurance penalty if the limits of coverage are too far below the actual cash value or replacement cost of the property.

If replacement cost coverage is elected, the property policy will pay for the actual cost of making the repairs or replacing the damaged property with property of comparable material and quality, used for the same purpose, and at the same location (though the proceeds, once determined in this way, can be used to reconstruct at a different location). Most lenders will require their borrowers carry replacement cost coverage.

On the other hand, if actual cash value coverage is elected, the property policy will pay for the cost to replace with new property of like kind and quality (i.e., generally replacement cost) minus physical depreciation. Each component of the property may be subject to its own depreciation schedule, depending on the nature of the component, its useful life, the degree to which it was maintained, and whether it was replaced recently (e.g., a 50-year-old building with a two-year-old roof).

Even when replacement cost coverage is elected, separate sublimits are typically provided for certain coverages, such as the cost of demolition and disposition of the damaged portions of the property. Separate sublimits and the overall limits should be set high enough to cover the expected amount of the costs, with no coinsurance penalty for underinsuring. For example, when an insured purchases $10 million coverage on a building, the insured expects to be able to reconstruct the building with those proceeds. But if a significant portion of the $10 million has to be used for demolition and debris removal costs, as well as for soft costs associated with preparing plans and specifications for the restoration work and obtaining permits, there may not be enough remaining to pay for the reconstruction.

Regardless of whether replacement cost coverage is elected, if the property is not actually repaired or replaced in accordance with the policy terms, the insurer will pay only the actual cash value. Also, even if the replacement cost coverage is elected, the insurer will initially pay only the actual cash value during the reconstruction process. When the reconstruction is complete, the insurer will pay the additional amount that is required to cover the difference between the replacement cost and the actual cash value previously paid (up to the policy limits).

It is important not to understate the replacement cost because the ISO Property Policy includes a “coinsurance” provision that reduces the insured’s recovery. The starting point for the coinsurance penalty is the coinsurance percentage specified on the declarations page, generally 80 percent or 90 percent. That percentage is then applied as spelled out in the property policy in a manner that significantly reduces the recovery. For example, if the replacement cost of the insured property is $5 million, the coinsurance percentage is 80 percent, the policy limits are $3 million, the covered loss is $1 million, and the deductible is $10,000, then the coinsurance penalty will be triggered. This is because the insured owner has insured its property for less than 80 percent of its insurable value (the $5 million value that could have been insured, multiplied by the 80 percent coinsurance percentage, equals $4 million—an amount greater than the $3 million coverage limits that were purchased). Once the coinsurance penalty has been triggered, under the ISO Causes of Loss Form, the insurer will:

  1. i. Multiply the value of the property at the time of the loss ($5,000,000) by the co-insurance percentage ($5,000,000 × 0.80 = $4,000,000),
  2. ii. Divide the stated limits of the coverage ($3,000,000) by the figure in (i) ($3,000,000 ÷ $4,000,000 = 0.75),
  3. iii. Multiply the amount of the loss ($1,000,000) before the application of the deductible by the figure calculated in (ii) ($1,000,000 × 0.75 = $750,000),
  4. iv. Subtract the deductible from the figure in (iii) ($750,000 – $10,000 = $740,000), and
  5. v. Pay the result ($740,000) or the limits of the insurance, whichever is less.

The remainder of the loss amount ($260,000) will not be covered. One way for an insured to avoid the application of the coinsurance penalty is to be sure that the property is insured for its full insurable value at all times—or at least for the coinsurance percentage of this full insurable value. In the example above, if the property had been insured for its $5,000,000 replacement cost (or at least 80 percent of that amount), the amount of the loss the insurer would have paid in this example would have been $990,000 (the $1,000,000 loss minus the deductible of $10,000).

Sophisticated property owners frequently avoid a coinsurance penalty by electing agreed value as an optional coverage on the declarations page of an ISO Property Policy. If agreed value coverage applies, the insurer stipulates an agreed value for the insured property and suspends the operation of the coinsurance clause. The key is to be sure that a schedule of values for the property is agreed to by the insurer and incorporated into the policy. Often this will require periodic appraisals and corresponding adjustments to the property’s agreed value when the policy is renewed.

If the landlord has multiple properties, it probably insures those properties by means of a “blanket” policy. Under a blanket policy, the insured assumes that a fire or other peril will probably not affect more than one of the covered properties at a time, so the insured covers these properties in a bundle, which can result in a lower premium per property. Typically, insurers issuing blanket policies include at least a 90 percent coinsurance requirement. To avoid application of the coinsurance penalty in a blanket property policy, the policy should include an agreed value endorsement that incorporates a statement or schedule of values fixing an amount for each location (and ideally also deleting the coinsurance penalty).

Even if the insured obtains agreed value coverage in its policy and incorporates a statement or schedule of values, the insured should be sure that the policy does not also contain an ISO Form CP 12 32 06 07 Limitation on Loss Settlement—Blanket Insurance (Margin Clause) or its equivalent. A “margin clause” is an endorsement to a blanket policy that limits the amount of recovery for a particular property to a percentage of the stipulated value for that property, usually ranging from 1.05 percent to 1.20 percent. A margin clause effectively eliminates one of the key benefits of a blanket policy limit (allowing full amount of the policy limits to be available to pay for any one loss) and forces the insured to adequately cover the individual properties in its schedule of values.

Is a Property Policy Sufficient to Insure Leasehold Improvements or Do You Need Builder’s Risk Insurance?

In situations where the landlord is leasing space in an existing building for a tenant to build out its leased space under a work letter, or where the landlord of an existing building is constructing leasehold improvements for a tenant under a work letter, the landlord should evaluate its existing property policy coverages, exclusions, endorsements, and limits before construction commences. Such an evaluation is both necessary and advisable to determine whether the landlord’s existing property policy will adequately cover the leasehold improvements during construction and upon completion or whether builders risk insurance should be procured during construction.

Existing Permanent Property Insurance for Renovation of Existing Buildings

An existing property policy may not automatically cover losses from damage to leasehold improvements. It all depends on the definition of “covered property” within the landlord’s existing property policy and the exclusions and endorsements to the policy. The ISO Property Policy includes “Completed additions” in its definition of covered property but only includes additions under construction and alterations and repairs to an existing building if they are not covered by other insurance. Thus, if builder’s risk insurance is procured by the tenant or its contractor, the landlord’s property policy will not cover the leasehold improvements during construction because the builder’s risk insurance will be considered primary as long as it remains in effect.

When deciding whether the landlord’s existing property policy is sufficient to cover the leasehold improvements under construction, there are a number of things to consider. First, the landlord should confirm that the property policy will remain in effect for the duration of the construction of the leasehold improvements. If it will expire before the expected completion date, it is possible a gap in coverage will occur, particularly if the landlord switches carriers and coverages. Second, the landlord should review any “sublimit” in its existing property policy for additions under construction, alterations and repairs to the building and whether that sublimit will be sufficient to cover the anticipated cost of the leasehold improvements during construction. Finally, the landlord will need to determine that the overall limits of its property policy are high enough to cover the replacement cost of the building as improved by the leasehold improvements upon their completion. If not, the overall property policy limits may need to be increased. Failure to adequately increase the building’s replacement cost limits might result in the imposition of coinsurance penalties at the time of a loss occurring after completion.

If the landlord chooses to rely on its existing property policy, it should consider the additional “soft costs” that might be incurred if completion is delayed because of a fire or other covered cause of loss that occurs during construction of the leasehold improvements. These may include general condition costs for the extended period of construction and lost rental income if the tenant’s obligation to occupy the premises and commence payment of rent is delayed on account of a delay in completion.

Lastly, before relying on an existing property policy, the landlord should determine whether its existing property policy can be modified to include the interests of the contractor and subcontractors and whether the policy will limit or restrict the named insured status for the contractor and subcontractors to their interest in the portions of the building where the leasehold improvements are being constructed and will exclude them with respect to losses to their work caused by a covered cause of loss occurring in other portions of the building.

Builder’s Risk Insurance for Existing Buildings

If there are issues with the landlord’s existing property policy, the landlord might procure a separate builder’s risk policy or add builder’s risk coverage to its existing property policy. Most builder’s risk insurance policies prohibit occupancy of the project or provide that coverage will terminate upon occupancy. This can be an issue if the premises in the building in which the leasehold improvements are being constructed is occupied during the work (e.g., because the work letter calls for construction in an existing tenant’s premises). Careful coordination between the landlord’s permanent property policy and the builder’s risk insurance policy is required to avoid such problems. In addition, the landlord needs to understand what the insurer considers occupancy under the builder’s risk coverage. This can be more difficult if the tenant or the contractor performing the work under a work letter procures the builder’s risk insurance rather than the landlord.

Builder’s Risk Insurance

Builder’s risk is a subset of first-party property insurance that provides coverage for all types of property under construction, including leasehold improvements. As its name suggests, it is designed specifically for construction projects. The typical builder’s risk policy often will exclude coverage for existing buildings and for the tools and machinery for the contractor and subcontractors performing the work. See Am. Bar Ass’n, Construction Insurance: A Guide for Attorneys and Other Professionals 252 (2011) (Construction Insurance Guide). Unlike, however, traditional property insurance policies, builder’s risk coverage “is, by its nature, temporary insurance. . . Coverage typically ceases upon completion of the project (or some short time afterward), even if that occurs before the policy’s stated term has run.” Id. at 270.

Builder’s risk insurance, like property insurance on completed buildings, is considered “first party” coverage, meaning it provides coverage for the landlord. Unlike property insurance for a completed building, which typically covers only the owner of the building, builder’s risk insurance also provides coverage for other parties with an insurable interest in the insured building or leasehold improvements under construction.

Why Obtain Builder’s Risk Insurance?

Construction projects, by the very nature of what is occurring at the insured site, have a very different risk profile from that of completed buildings. For example, material and equipment are being delivered to the site, and other materials are being delivered that need to be stored before they are installed. The work is being performed by many different subcontractors at the site—many of whom are performing their portion of the work at the same time and in confined quarters. Flammable processes (e.g., welding) are often conducted in areas where flammable materials are stored. This different risk profile means the premiums for builder’s risk insurance are determined based on different criteria than permanent property policies.

Also, during the work associated with the construction project, the value of the property insured is changing. Contractors and material suppliers perform work but aren’t paid immediately. If a fire occurs, not only are the contractors entitled to be paid for the work performed before the damage, but they will have to be paid to reconstruct the portion of the work that was damaged. Debris will have to be removed and disposed of before the reconstruction work can begin, and delays in completion of the project are likely to occur as a result of the damage.

Builder’s risk insurance is intended to transfer the risk of physical damage to the work caused by a covered cause of loss during construction from the owner, contractors, subcontractors, and sub-subcontractors to the builder’s risk insurer. By providing the funding for necessary repairs or restoration, the work can move forward. The alternative would be to stop the work and litigate responsibility for the loss between the parties, which is neither desirable nor practical.

What Does Builder’s Risk Insurance Cover?

Policy Forms for Builder’s Risk Insurance

Builder’s risk insurance historically was written on an inland marine coverage policy form. Inland marine insurance originally was developed to provide coverage for goods lost or damaged while in transit over the oceans (today, this coverage is typically called ocean marine insurance). It later evolved to provides coverage for goods lost or damaged while in transit across inland waterways, and later still, overland by train, truck, or plane. In this way, inland marine coverage follows the goods as they move rather than insuring property in a fixed location on a particular parcel of real estate. By following inland marine policy coverages, builder’s risk insurance can provide broader coverage for losses occurring during construction than most permanent property policies. For example, builder’s risk insurance typically provides coverage on property that is destined to be included in the project, while in storage at the construction site, while in offsite storage, and while in transit.

Most insurers who underwrite builder’s risk coverage elect to draft and use their own policy forms, although ISO does have a builder’s risk coverage form (see, e.g., ISO CP 00 20 10 12) (ISO Builder’s Risk Form). Space does not permit a discussion of the differences between the myriad of forms for builder’s risk insurance, and the precise forms available may vary by insurer and by state, so this article focuses on the ISO Builder’s Risk Form.

Key Elements of the ISO Builder’s Risk Form

The ISO Builder’s Risk Form must be paired with additional forms to have a complete policy. To complete the policy and to know what types of losses are covered by the ISO Builder’s Risk Form, it must be paired with an ISO Causes of Loss Form (e.g., Basic, Broad, or Special). It can also be appended to an existing ISO Property Policy.

The other items that must be negotiated are the overall limit of insurance (i.e., the maximum amount of the insurance coverage) and any special sublimits (i.e., reduced amounts) for specific types of losses, such as expediting expenses, expenses to re-erect scaffolding, fire department service charges, pollutant cleanup and removal, and coverage for personal property at temporary storage locations or in transit. The amounts of any deductibles and self-insured retentions are also important to understand because the work letter or contract with the contractor should specify the deductibles allowed and who bears the risk of any deductible or self-insured retention. Finally, it is important to know whether the policy contains a coinsurance provision that will apply if the overall limit on the amount of insurance is not equal to the estimated value of the project upon completion. Some of this information is included in the declarations page or schedule of coverages portions of the policy, but sometimes sublimits and co-insurance provisions are included within the policy itself (or both).

Typical Builder’s Risk Policy Coverages

The ISO Builder’s Risk Form covers direct physical loss of or damage to “covered property” caused by or resulting from “covered causes of loss.” What covered causes of loss are excluded will depend on which causes of loss form is part of the policy (Basic, Broad, or Special).

Covered property under the ISO Builder’s Risk Form includes structures under construction. Damage to existing structures is typically excluded, but if the landlord carries an ISO Property Policy on the completed building and adds the ISO Builder’s Risk Form to that policy, both would be covered for the same covered causes of loss. The ISO Builder’s Risk Form also excludes, among other things, the contractor’s and subcontractors’ machinery, tools, equipment, and similar property that will not become a part of the permanent structure; property in transit (but coverage for this can be added); and property either left in the open and not stored inside the structure or stored offsite (but coverage for this should be added if the landlord or tenant and contractor contemplate significant amounts of materials and equipment to be installed as part of the leasehold improvements will need to be stored offsite).

Additional and Supplemental Coverages

The ISO Builder’s Risk Form contains certain “Additional Coverages.” One such coverage is for debris removal, but only for the insured’s property that is covered by the policy. If the tenant, rather than the landlord, procures the builder’s risk policy, the debris removal coverage will not apply to property owned by the landlord, unless the tenant is obligated to insure the landlord’s property and that property is considered covered property (i.e., part of the leasehold improvements) under the builder’s risk policy. It will not cover removal of debris from damage to portions of the building leased to other tenants or part of the existing structure owned by the landlord. This is because removal coverage for these other types of property should be covered by the landlord’s permanent property policy or possibly by the other tenants’ property insurance.

The ISO Builder’s Risk Form contains a complicated sublimit for debris removal. It is limited to (i) 25 percent of the deductible under the policy, plus (ii) the amount paid for the direct physical loss for the covered property, but (iii) if no covered property has sustained direct physical loss or damage, the most the insurer will pay for covered debris removal is $5,000. The ISO Builder’s Risk Form, however, will pay an additional $25,000 for debris removal costs where either (a) the debris removal costs plus the amount paid for the direct physical loss for the covered property exceeds the limit of insurance on the covered property or (b) the actual debris removal expense exceeds 25 percent of the deductible plus the amount paid for direct physical loss or damage to the covered property that sustained the loss or damage. Whether the amounts potentially available under these limits will be sufficient needs to be evaluated for each work letter.

Completed Value Form or Reporting Form

Builder’s risk insurance can be written to cover a single project or multiple projects. If written for a single leasehold improvements project, the completed value for the leasehold improvements will be used as the amount of the insurance. This type of coverage is usually what is procured by landlords because they more frequently are involved in constructing only one project at a time. But some landlords have multiple projects under construction at a given time, and if the contractor procures the builder’s risk insurance for the leasehold improvements, the contractor may have multiple projects under construction at one time. If so, a “reporting form” policy may be used.

If the builder’s risk insurance is written on a completed value basis, the premium is calculated and paid at the beginning of the policy period. If the expected completed value of the leasehold improvements increases during construction due to change orders, it is important to increase the coverage limits (and pay the corresponding increase in premiums) in order to remain fully insured and avoid a potential reduction in coverage by reason of the coinsurance penalty.

If the builder’s risk insurance is written on a reporting form basis, the insured must submit periodic reports (usually monthly or quarterly) of the values in place at the end of the reporting period. The amount of the premium for each reporting period is then determined by multiplying the rate specified in the reporting form by the value of the work completed as reported for that reporting period.

The advantage of a reporting form basis is that the premium is lower initially than it is for the completed value policy because the premium is paid over time based on the values reported during the progress of construction and will increase with each report. The disadvantage of the reporting form is that if the amounts reported are inaccurate or late and a loss will not be covered occurs, it is likely a portion of the loss because the insurer will not pay more than the value stated in the last report filed before the loss. Moreover, the insurer will not pay more for any loss than the proportion the values last reported before the loss bears to the actual cash value of the covered property on the effective date of the report. Finally, the insurer will not pay more than the total limit of coverage even if the reported values exceed the limit.

Coverage for Stored Materials or Materials in Transit

Ideally, all significant materials, whether stored onsite or offsite, should be covered. Otherwise, the parties will have to bear the risk of loss to those items before they are incorporated into the leasehold improvements. But the limits available for materials under the ISO Builder’s Risk Form are rather limited. The ISO Builder’s Risk Form covers only the insured’s building materials and supplies used for construction and only if they are intended to be permanently located in the building or within 100 feet of the property.

The ISO Builder’s Risk Form does not cover materials, equipment, or supplies in transit. In order to properly cover these items, whether they stored offsite or are in transit, a special type of endorsement or additional coverage must be obtained. For smaller projects, as long as the construction contract does not obligate the landlord or tenant to pay for materials, equipment, or supplies until they are incorporated into the structure, the lower limits available in the ISO Builder’s Risk Form might be sufficient. If the leasehold improvements to be constructed under the work letter call for using long-lead-time items that are ordered and paid for in advance, additional coverage will likely be needed, especially if the items need to be stored offsite until they are needed.

If a loss occurs, there may be a dispute as to whether the property lost was actually “in transit” under the provisions of the applicable policy. In Waldan General Contractors, Inc. v. Michigan Mutual Insurance Co., a fire destroyed construction materials, worth almost $15,000, that had been packaged at the contractor’s warehouse and were awaiting shipment to various job sites around the country. 577 N.W.2d 139, 140 (Mich. Ct. App. 1998). Because the damage exceeded the limits under the contractor’s primary property policy on the warehouse, the contractor sought recovery under the inland marine builder’s risk/installation section of its property policy. The insurance company denied coverage under this section of the policy because the property was not in transit when it was destroyed. Ultimately, the appellate court found that the inland marine builder’s risk policy covered the property, holding it did not matter whether those materials were in storage following shipment or in transit.

The lesson to be learned from the Waldan case is if the project involves significant materials stored offsite (or even if building components are being fabricated at another location), an appropriate endorsement to the landlord’s or tenant’s property policy or builder’s risk insurance should be purchased to cover the expected cost of materials stored offsite regardless of whether they are in transit to the location, at the original location prior to shipment to the temporary location, or at the landlord’s building where the work is being conducted. Alternatively, an installation floater procured by the contractor or subcontractor to insure that specific item might be more appropriate and cost effective. Installation floaters are discussed in more detail below.

Duration of Builder’s Risk Policies

Under the ISO Builder’s Risk Form, coverage will end on the earlier of the date that is 90 days after the work is complete or 60 days after the work is occupied in whole or in part or is put to its intended use. If the leasehold improvements work is being done in an occupied building or an existing tenant’s premises while they are occupied, it will be important to address this with the insurance company to be sure this provision is not being violated.

If the work is in space not previously occupied by the tenant, care must be taken that the tenant does not take occupancy until the work has been completed unless the insurer has been notified and agrees to an extension of the time for completion of construction, including punch list items. The language of the policy does not define when “construction is complete,” which makes it even more important to discuss the issue with the insurer in advance. Also, if the landlord has agreed in the work letter to allow the tenant access to the premises to install its own property (e.g., furniture, cabling, phones and other equipment) before the contractor’s work is complete, the work letter needs to make it clear this is not “occupancy” or “putting the space to its intended use,” and the builder’s risk insurance insurer needs to concur.

Whom Does Builder’s Risk Insurance Cover?

Named Insured vs. Additional Insured

Typically, the persons named as insureds in a builder’s risk policy will include the owner (i.e., landlord), the contractor, and its subcontractors. The party or parties insured (both the first named insured and any other insureds named in the policy) must have an insurable interest in order to be covered. An insurable interest under a property policy means the person included in the coverage has a financial interest in the covered property (e.g., the building or the leasehold improvements) and will suffer some degree of financial loss if that property is damaged or destroyed.

Naming everyone involved in the work as an insured gives each insured the right to make a claim directly with the insurance company if the landlord (or other policy holder) fails to do so. If the landlord contracts for the leasehold improvements work under the work letter or the lease provides title to the leasehold improvements vest in the landlord during the work, the landlord will have an insurable interest throughout construction for direct physical loss or damage to the covered property (equal to funds expended for its own labor and supplies, as well as payments to the contractor and subcontractors and possibly material suppliers). Regardless of whether the landlord or the tenant contracts for the work, the tenant has an insurable interest to the extent it makes payments to the landlord or contractor for some portion of the work. This frequently occurs in work letter construction if the tenant is responsible for costs in excess of the allowance provided by the landlord. The contractor has an insurable interest from commencement of construction to final acceptance and payment; its claim is for direct physical loss of or damages to the work incorporated into the leasehold improvements (including its labor costs, materials, and supplies) but not yet paid for by the landlord or tenant. Likewise, subcontractors have insurable interest from the start of their portion of the work through final acceptance and payment.

Another reason for naming the contractors and subcontractors as insureds is to provide them with immunity from subrogation if their negligence is alleged to have been the cause of a covered cause of loss. Why is this? Because of the general principle that an insurer cannot subrogate against its insured. Using the phrase “and contractors and subcontractors of every tier” can also protect the party procuring the insurance from inadvertently omitting one of the persons who should be included in coverage, particularly a subcontractor that might not be engaged until after the business risk insurance has been procured. Finally, naming the landlord, contractor, and all subcontractors as insureds will typically satisfy the requirements in many standard form construction contracts that obligate the party carrying builder’s risk insurance for the benefit of all parties involved in constructing the leasehold improvements.

One concern sometimes voiced with a landlord naming the contractor and subcontractors as insureds is that if the policy is not divisible or severable, then coverage for all of the insureds could be invalidated if one of the insureds violates a condition or intentionally causes a loss or otherwise breaches the policy provisions. For example, the ISO Form Commercial Property Conditions (CP 00 90 07 88) excludes or voids coverage for misrepresentation, concealment, or fraud by the insured.

These concerns are why landlords or tenants procuring builders’ risk insurance often elect to name the contractor and subcontractor as additional insureds rather than as named insureds. Another way to avoid this problem is to be sure the policy has a “severability of interests,” “multiple insureds,” or “divisible contract” clause. With these clauses, the policy is clarified so that each insured will remain covered no matter what “bad acts” might be performed by any of the other insureds.

Landlord’s Mortgagees

In the ISO Builder’s Risk Form, the insurance company agrees to pay for covered losses or damages to each mortgage holder (including a trustee) “shown in the Declarations in their order of precedence, as interests may appear.” As a result, the landlord’s mortgage holder may be entitled to receive the proceeds under any builder’s risk insurance procured by the landlord. The policy also provides for payments to mortgage holders even if the insurance company denies the insured’s claim and the insurance company has the right to step into the shoes of the mortgage holder once it pays the loss. Mortgage holders are generally also named as loss payees. If so, the landlord may not control the use of the policy proceeds unless it negotiated this right in its loan documents. This issue also exists with respect to the landlord’s permanent property policy for the building.

What Is Not Covered by Builder’s Risk Insurance?

Exclusions from Covered Property

The ISO Builder’s Risk Form does not include coverage for existing buildings, which means that without further modification, there will not be any coverage for damage to the landlord’s existing building when builder’s risk insurance is procured with respect to major renovations or additions. The decision in Gerald H. Phipps, Inc. v. Travelers Property Casualty Co. of America, 2017 WL 631637 at *1, 2 (10th Cir. Feb. 16, 2017), is consistent with this interpretation. In the Phipps case, the court held the contractor’s builder’s risk policy, which expressly excluded “[b]uildings or structures that existed at the ‘job site’ prior to the inception of th[e] policy,” did not provide coverage for $804,661.76 in added costs the contractor incurred for environmental testing, asbestos removal, removal and replacement of drywall, and installation of new fireproofing materials due to damage to the elevator shafts and stairwells from water from melting snow leaking into the building before the contractor could perform its intended construction work in those areas. The Phipps opinion is silent as to whether the owner’s property policy would cover the costs the contractor’s builder’s risk policy did not cover.

The rationale for excluding existing buildings from builder’s risk insurance policies is that the existing building will theoretically be covered for damage under the landlord’s permanent property policy. If the existing building is covered under an ISO Property Policy, the definition of “Covered Property” includes (a) additions under construction, alterations, and repairs to the building and (b) materials, equipment, supplies, and temporary structures, on or within 100 feet of the building, that are used for making additions, alterations, or repairs to the building, but only if they are not covered by other insurance. It also specifically excludes property that is covered under another coverage form within the policy or any other policy if that coverage form or policy describes the property more specifically, although it will cover the excess of the amount due under that other insurance (regardless of whether the insured can collect it).

This means if a contractor or tenant carries builder’s risk insurance for significant leasehold improvements to a landlord’s existing building, the landlord’s property policy insurer will look first to see if the contractor’s or tenant’s builder’s risk policy includes damage to the existing building, and if so, the insurer will expect the contractor’s or tenant’s policy to respond first to cover the loss. But, as noted above, if the contractor’s or tenant’s builder’s risk policy is the ISO Form, it is unlikely to cover damage to the landlord’s existing building unless the policy has been modified. If damage to the existing building is not covered by the contractor’s or tenant’s builder’s risk policy, the landlord’s property policy should respond, assuming the cause of the loss is a covered cause of loss under the landlord’s property policy. If the landlord procures the builder’s risk coverage for leasehold improvements being constructed under a work letter, the same issue would exist, but if the builder’s risk coverage is on the same ISO form as the landlord’s property policy with the same insurer, the landlord may be in a better position to minimize the likelihood of any gaps in coverage.

Exclusions from Coverage

The exclusions from coverage in the ISO Causes of Loss Forms are not easy to summarize because they are found in multiple places within the policy forms. There are fewer exclusions in the Basic Form and Broad Form policies because the coverage itself is narrower. Space does not permit a discussion of all the specific exclusions in this article. However, a few that are particularly relevant to work letter construction projects are discussed below.

Despite the standard exclusions in the various ISO Causes of Loss Forms, coverage for many of the exclusions can be added to the policy by endorsement. Two of the more common additional coverages added that are not discussed in this paper are earthquake (subject to high deductibles) and flood (generally excess over National Flood Insurance Program insurance) coverages.

Ordinance or Laws Exclusion

A covered cause of loss often triggers the need to upgrade or modify portions of an existing building that were not damaged because of code change occurring after the building was constructed. Not all of these added costs will be covered because the various forms of ISO Property Policies typically contain some sort of an exclusion for “ordinance or law.” The ISO Builder’s Risk Form does not cover the added cost to comply with the laws and ordinances, but the ISO Building and Personal Property Coverage Form (CP 00 10 10 12) does include some very limited coverage for increased costs of construction and specifically provides that this coverage is not subject to the ordinance or law exclusion in the ISO Causes of Loss Form that is made a part of the ISO Builder’s Risk Form policy. This seemingly conflicting provision between the ISO forms makes the coverage under an ISO Builder’s Risk Form policy very confusing. It is very likely the landlord and tenant will find some gaps in coverage, particularly for leasehold improvements work contracted for by the tenant in a partially occupied, existing building where other parts of the building outside the tenant’s premises are damaged by a fire that starts in the premises or in another portion of the building during construction. The parties should work closely with a risk manager or insurance professional to review the coverage limits and policy language carefully to minimize the risk of gaps in coverage.

For example, neither the ISO Property Policy or the ISO Builder’s Risk Form covers the cost of (1) complete demolition of a damaged building when demolition is required by governmental authorities, as is often the case where the building is damaged to the extent of more than 50 percent of its value (often where the building is “non-conforming”—meaning it no longer complies with the current zoning code requirements with respect to setbacks, size, height, etc.); (2) demolition of the undamaged portion of the building; or (3) adding features to a damaged building, sometimes including undamaged portions (for example, adding a sprinkler system, upgrades to electrical systems due to new code requirements, or new energy use reduction components) when the building was not previously required to contain these features (perhaps because it was grandfathered).

It is possible, however, to avoid the risk of these types of otherwise uninsured losses by adding ordinance or law coverage to the ISO Property Policy. This coverage can be added through an ISO CP 04 05 10 12 Ordinance or Law Coverage endorsement (ISO Ordinance or Law Endorsement). With this endorsement, the following will be covered if caused by the enforcement of any law regulating the demolition, construction, or repair of a building or zoning or land use requirements: (1) loss in value to the undamaged part of the covered property as a result of an ordinance or law requiring demolition of undamaged portions of a building that has sustained covered direct physical damage, (2) the cost of demolition and clearing the site of the undamaged parts, and (3) the increased cost of construction to repair or reconstruct damaged portions and to reconstruct or remodel undamaged portions as long as the building is actually repaired, reconstructed, or remodeled.

The ISO Ordinance or Law Endorsement contains three types of ordinance or law coverage. Coverage A covers the loss in value of the undamaged portion of a building if the ordinance or law requires the demolition of the undamaged portion as well as the damaged portion. Coverage B covers the cost of demolishing and clearing the site if the ordinance or law requires the demolition of the undamaged portion as well as the damaged portion. Coverage C covers the increased cost of construction necessary to comply with current laws and ordinances (for example, by the addition of a sprinkler system). All three types of coverage are valuable. Coverages A and B are important to a landlord that must demolish all or part of the building to satisfy local codes. Coverage C is important when the landlord elects to rebuild and must include new improvements (such as a sprinkler system or upgraded electrical work) required by laws that were not in effect when the building was originally constructed.

Coverage under the ISO Ordinance or Law Endorsement is limited, however, to “the minimum requirements of the ordinance or law.” Losses and costs incurred in complying with recommended actions or standards that exceed actual requirements are not covered. This means, for example, if a landlord is required to install a fire sprinkler system in the entire building after a fire in a portion of the building, that cost would be covered, but not the cost to add a dry fire suppression system to an area of the building the landlord wants protected from water damage from a traditional sprinkler system if the applicable fire code does not require a dry fire suppression system for that area. Also, if the applicable law required the landlord to install a fire sprinkler system throughout the building prior to the fire, but the landlord had not yet complied with that requirement, the cost to install sprinklers throughout the building will not be covered under the ISO Ordinance or Law Endorsement.

Exclusion for Damages Due to Failure to Take Reasonable Steps to Preserve the Property After a Loss

All of the ISO Causes of Loss Forms exclude coverage caused by the “[n]eglect of an insured to use all reasonable means to save and preserve property from further damage at and after the time of loss.” Thus, it is very important to immediately take action after the occurrence of a loss to prevent further deterioration or damage to the leasehold improvements under construction.

Exclusions for Defective or Faulty Design, Workmanship, or Materials

Relevant to the construction of leasehold improvements, under the ISO Causes of Loss Forms (one of which will be a part of coverage under ISO Builder’s Risk Insurance), the insurer will not pay for loss or damage to the covered property caused by or resulting from faulty or inadequate or defective design, specifications, workmanship, repair, construction, renovation, or remodeling. The policy will, however, pay for the loss or damage caused by a covered cause of loss. Under the policy language, if an excluded cause of loss for faulty workmanship leads to a covered cause of loss (e.g., a leaking pipe leads to a collapse of the ceiling in the space below or a defect in a new electrical system causes a fire), the resulting loss or damage will be covered (e.g., repair of the collapsed ceiling or damage to the existing building due to the fire will be covered). But repair of the defect in the pipe that caused the leak itself or the cost to correctly reinstall the electrical system will not be covered.

Additional Coverages to Consider

Soft Costs Coverage and Limitations

Landlords, tenants, and contractors all want to complete leasehold improvements construction projects on time. Tenants need to occupy the project upon completion or landlords need to deliver the completed leasehold improvements to tenants who will occupy the space and commence paying rent to the landlord as soon as possible. If the leasehold improvements are damaged during construction, landlords (or tenants, to the extent the landlord’s allowance does not cover all of the cost of the leasehold improvements) will incur costs or repair the damage. But additional expenses beyond those needed to repair the damage to the leasehold improvements might be incurred by the landlord or the tenant.

Many reasons exist for added costs after a loss. Subcontractors may have to rebid their contracts, and they may have to adjust their schedules for completing the work because of other projects. Some may no longer be available because of commitments made for other jobs. There may be additional design costs, particularly if codes or ordinances have changed and the leasehold improvements must now comply with them. The landlord may incur additional financing costs, and there may be increased costs for materials, particularly during periods of high inflation and rising construction costs, and the parties may even be unable to obtain required materials. Those involved in the construction and real estate industries are used to taking these added costs into account in budgeting the costs for their construction projects, but during 2021 and 2022, cost increases due to material and labor shortages meant much higher costs than would have been predicted based on trends during the past 40 years. Insurance companies may not consider these increases when it comes time to compensate an owner or contractor for its loss due to a fire or other peril covered by builder’s risk insurance even if the builder’s risk insurance is written on a replacement cost basis because the coverage under a property insurance policy is always limited by the limits of the policy.

The ISO Builder’s Risk Form does not specifically address these types of additional costs, which are typically called “soft costs” in the construction industry, that may be incurred in connection with a reconstruction or repair after a covered cause of loss under the policy. Likewise, none of the ISO Causes of Loss Forms specifically delineate what might be included in the amount that can be recovered under the policy in the event of a covered cause of loss. The ISO Builder’s Risk Form merely states the insurer “will pay for direct physical loss of or damage to Covered Property at the premises . . . caused by or resulting from any ‘Covered Cause of Loss.’” The line between what is considered a hard cost (or direct physical loss) versus a soft cost is often gray, and different insurers may take different positions. Likewise, insurers and loss adjusters may also disagree. Thus, it is dangerous to assume all insurance companies will interpret their policy language (which differs from company to company) in the same way when it comes to allowing “soft costs” to be included in the amount of the covered cause of loss.

At one time, ISO had developed a form of “soft costs” endorsement (IH 99 15 07 99) that could be appended to the ISO Builder’s Risk Form. Today, however, most insurers use their own manuscript forms when agreeing to cover soft costs of construction after a covered cause of loss. The landlord or tenant, depending on which one is contracting for the work, should carefully review the actual language to determine what is and is not covered and to make sure the soft cost coverage limits are adequate.

Business Income, Extra Expense, and Rental Value Loss Claims

If the landlord is responsible for completing the leasehold improvements under the terms of the work letter, the landlord might suffer from a loss of rents because of a rent abatement to which the tenant might be entitled as a result of a delay in completion of the leasehold improvements and its inability to occupy the premises (although the landlord often simply extends the commencement and expiration dates for the lease term). Similarly, the tenant might not earn the anticipated business income from operations it plans to conduct in the premises because of its inability to occupy the premises. Also, other tenants in the building whose premises may become uninhabitable due to damage to other portions of the building might be entitled to a rent abatement under their leases. These losses can be covered if the landlord and the tenant carry insurance covering “business income” or “rental value.” There are two ISO forms providing coverage for business income and rental value losses (ISO BI Forms). ISO Form CP 00 32 10 12 is used for lost business income (without extra expense), and ISO Form CP 00 30 10 12 is used for lost business income (with extra expense) (ISO BI EE Form). Both ISO BI Forms will cover loss of rental value if that coverage is specifically selected in the declarations page, but the ISO BI EE Form contains broader coverage for necessary expenses incurred by the insured that “would not have been incurred if there had been no direct physical loss of or damage to the insured’s property caused by or resulting from a Covered Cause of Loss.”

Loss of business income and loss of rental value coverage not only has a maximum insured amount as a coverage limit, but the recovery will also be limited to the loss suffered during a maximum period of time. Generally, this period is the “period of restoration.” Under the ISO BI Forms, the period of restoration begins 72 hours after the time the loss caused by a covered cause of loss to the insured premises occurs and ends on the earlier of the date on which the property “should be repaired, rebuilt or replaced with reasonable speed and similar quality” or the “date when business is resumed at a new permanent location.” If the damage is to buildings under construction or undergoing alterations or additions and delays the start of operations, the “period of restoration” begins on the date operations would have begun had the damage not occurred.

Sixty days is the maximum additional time allowed under the two ISO BI Forms (unless the policy is endorsed to provide for a longer period of time) for loss of business income, but this 60-day extended period will end at the date the insured could have restored operations “with reasonable speed, to the level that would generate the business income amount that would have existed if no direct physical loss or damage had occurred.” A similar provision applies to loss of rental value (as defined in the ISO BI Forms). Neither of the ISO BI Forms provides coverage if the loss of business income or rental value occurs due to “unfavorable business conditions caused by the impact of the Covered Cause of Loss in the area where the described premises are located.” The parties should consider obtaining an additional coverage period of up to 90 to 120 days or longer, but this additional period must be elected, paid for, and shown in the declarations page.

As in the case of loss of or damage to covered property, an insured that underinsures its loss of business income or rental value by too great a percentage may find that its recovery under the ISO BI Form is reduced due to a coinsurance penalty. The insured can avoid this penalty by obtaining agreed value coverage, but obtaining this coverage usually requires submission of a business income worksheet estimating the business income or rental value and requires that the insurer make this estimate an agreed part of the policy. Regardless of whether the landlord or the tenant is procuring the builder’s risk insurance for the leasehold improvements to be constructed under a work letter, each of them needs to obtain business income coverage as part of its own insurance policies—ideally under a form that covers extra expenses. The most difficult part of procuring such insurance is estimating the amount of insurance that will be needed because the insurance company will never pay more than the limit of insurance procured no matter how long the actual delay lasts or how long the extended period of loss is extended by endorsement.

What Should the Work Letter or Construction Contract Say About Builders Risk?

Neither the landlord nor the tenant, depending on which one is contracting for the construction of the leasehold improvements, should rely on a contractor (performing work under a work letter) or a trade contractor (performing a more specialized scope of work that is less than a complete build-out of a tenant’s space, such as an HVAC contractor retrofitting a new heating/cooling or plumbing system) to procure sufficient builder’s risk insurance without specific contractual provisions. Specific requirements should be included in the work letter regarding what the policy and related endorsements must include, whom the policy must cover as additional insureds, the required limits of the policy, what must be provided as evidence that the required coverages have been procured, and the repercussions for failing to procure the required coverages. Replacement cost coverage is a necessity.

When the contractor must procure the insurance, the construction contract must include the same requirements and must specify what will be provided as evidence that the required coverage has been procured and what happens if the contractor fails to provide the required evidence.

Another insurance-related issue to be addressed in the work letter and construction contract is whether the parties will waive their respective insurers’ rights of subrogation. Generally, a party can waive only its own rights, so, of course, the insurer can waive its own right to make claims against another party. Today, however, an insurer’s rights of subrogation are customarily waived by its insured’s express waiver of claims in the lease, the work letter, or a construction contract, and this waiver is generally binding on the insurer.

If the parties conclude waivers of subrogation are appropriate, the work letter or construction contract language should contain two elements: (i) a waiver by each party of claims against the other party for all property damage that is insured by the specified form of property insurance policy and (ii) a waiver of each party’s insurer’s rights of subrogation against the other party. Waiving the insurer’s rights of subrogation is a bit of a shorthand way of describing a means by which the insured can cause the insurer to be bound by a waiver by the insured of its right to recover from another person who causes the loss or damage insured by an insurance policy, which, in turn, means the insured will be unable to exercise its contractual right to seek recovery from that other person.

Even the ISO Special Form Causes of Loss policies do not automatically include coverage for all types of property loss or damage. For example, without a special endorsement or policy, neither the ISO Builders Risk Form nor the ISO Property Policy cover damage from flood and water backup from a sewer or drain or loss of business income or rental loss. This means the landlord and the tenant need to consider whether the waiver of claims includes both covered causes of losses and other types of losses that are not covered by the builder’s risk insurance. The conservative approach for the landlord and tenant is to have the waiver of claims apply only to the extent the loss or damage is covered by insurance, and if builder’s risk insurance is being procured, only to the extent of the insurance proceeds made available. This preserves the right of the party whose property has been damaged to recover amounts in excess of those covered by insurance from the party causing the loss. The parties can also consider whether the waiver of claims should apply against the party obligated to procure the coverage if it fails to procure the required insurance. Such a provision is intended to give an incentive to the party obligated to procure the required insurance coverage to actually obtain it.

Who Should Carry Builder’s Risk Insurance?

The building owner (the landlord in the case of leasehold improvements) typically procures the builder’s risk policy for the work. But, before determining who should procure the policy and serve as the first-named insured, the parties should understand the repercussions of allowing another party to procure the policy as the first-named insured. The first-named insured will control knowledge of notice of cancellation of the policy, renewal and nonrenewal issues, changes to the policy, return of premiums, deductibles, the total cost of the insurance, and the claims-handling procedures. As noted above, builder’s risk insurance typically includes all persons with an insurable interest in the construction project. If the landlord wants to control all of these issues, it would be better served by naming the others with an insurable interest as additional named insureds (if this is a possibility) or somehow distinguishing via endorsement which insured does control all of these aspects of the builder’s risk insurance.

On the other hand, for smaller projects, it may be appropriate for the contractor to carry the builder’s risk insurance. Also, where the tenant is contracting and paying for the bulk of the work, it may be appropriate for the tenant to procure the builder’s risk insurance for the leasehold improvements.

Installation Floaters

As an alternative to relying on the landlord’s existing property insurance policy or a separate builder’s risk policy, the landlord and tenant might consider insuring some of the risks of the work letter construction through the use of an “installation floater” procured by the contractor or one of its subcontractors. Typically, installation floaters are best used to insure the work of specialty subcontractors such as electricians, HVAC contractors, or others who can more easily separately insure their exposures outside of a landlord-, tenant-, or contractor-provided builder’s risk policy.

Some situations do call for reasonable and logical use of installation floaters. They can be useful when a landlord or building owner undertakes renovation of specific specialty systems without use of a contractor and the existing property policy does not adequately cover the work, through the definition of “property” and “building,” or does not include the work required (often electrical, HVAC, fire suppression, etc.). The types of specialty subcontractors who do this type of work often have an annual “installation floater” policy with limits set on average or maximum installation exposures at any one site to cover their exposures until final completion of the work (typically defined by the landlord’s acceptance of the work) and final payment to the specialty subcontractor. In addition, if the builder’s risk coverage or existing property policy being relied upon to insure the leasehold improvements work does not cover property in transit and the construction contract calls for payment for material or equipment before installation, an installation floater may be appropriate because it typically covers property while in transit, while awaiting installation at the job site, and while being installed (although the coverage while in transit may be subject to a sublimit). Coverage under an installation floater will end when the work is considered to be complete by the terms of the floater. At this point in time, the landlord’s existing property policy would cover the installed equipment or material.

The landlord requiring the installation floater, and the contractor or specialty subcontractor procuring the installation floater, should review the language very carefully. Like any property policy, the parties must ensure that coverage terms, the definition of property, and the covered perils insured under the installation floater are appropriate and adequate. For example, if the permanent property policy is written on a special causes of loss basis, the installation floater should cover those same perils and should include the other coverages added by endorsement to the landlord’s permanent property policy, such as flood and earthquake. They must also ensure that the limits of the insurance are sufficient for the actual exposure at the installation site. In addition, the parties should make sure the installation floater complies with the requirements of the work letter or construction contract with the contractor and contains a reasonable deductible that is not so high it nullifies the benefits of the floater.


Understanding the appropriate types of insurance that should be procured and maintained during the construction of leasehold improvements under a work letter to a lease is no easy task. CGL insurance and permanent property insurance or builder’s risk insurance are not the only types of insurance that may be required, but those other types are beyond the scope of this two-part article. As noted in this part, the first decision to be made by a landlord (in consultation with its insurance broker or consultant) should be whether its existing property policy will be sufficient to cover potential damage to the existing building and the leasehold improvements while they are under construction or can be sufficient if the coverage limits are increased. If not, the second decision will be the amount of builder’s risk coverage that should be procured and who should best procure that coverage. The answer will depend on the nature and extent of the leasehold improvements and, as between the landlord and tenant, who will be contracting for the construction of the leasehold improvements; coordination between a landlord’s existing property policy and builder’s risk coverage; and what coverage the contractor or a specialty subcontractor might be able to provide.