The AIA contract is the benchmark of construction contracts throughout the country. As many contractors know, by default under the AIA contract it is the Owner rather than the Contractor who is responsible for purchasing builder’s risk insurance. But is that the way it should be?
Builder’s risk claims invariably arise out of work being performed by the Contractor (or one of its subcontractors), not the Owner. And in the mind of the Owner, at least, the claim is the result of the Contractor doing something wrong or letting something go wrong on its watch. The question is: Why should a claim be made on my policy? From the perspective of the Owner, it is the Owner’s policy, the Owner paid for it, and the Owner didn’t do anything wrong. While at first blush (particularly if you are an Owner) this might sound reasonable, it’s not, and it runs afoul of the entire purpose of procuring builder’s risk insurance at the outset of a project.
As designed, builder’s risk insurance is one part of a three-part deal struck between the Owner, Contractor, and Subcontractors at the outset of a given project. The deal goes like this: (1) Let’s agree to purchase insurance that will cover losses that may occur during the course of construction; (2) Let’s agree that to the extent something is covered under that insurance, we won’t make claims against one another (avoiding the infighting that can bring a project to a screeching halt); and (3) Let’s agree to waive subrogation rights so that the insurer who pays out can’t come back against the at-fault party for reimbursement. Sounds like a good deal, right?
The rub, in my experience, stems from the fact that the Owner purchased the policy, and the rub has two parts. First, because the Owner purchased the policy, the Owner views the policy as its policy rather than one part of a three-part risk transfer deal. As a result, the Owner resists claims on “its” policy, and often puts significant pressure on the Contractor not to make a claim (pressure that can be uncomfortable to say the least if there is future work to be done for that Owner).
Second, the incentives are all screwed up. When a builder’s risk claim happens, it is almost always the Contractor, not the Owner, that has to pay for the loss. So it is the Contractor, not the Owner, who has the greater incentive to buy a responsible and broad builder’s risk policy. The Owner, on the other hand, often views the purchase of builder’s risk insurance as a box checking exercise, and simply buys the cheapest possible conforming policy. Not so good for the Contractor facing a multi-million dollar hit.
These and other problems can be mitigated by simply having the Contractor purchase the builder’s risk policy and charge it back to the Owner. Somewhat remarkably, this is a built-in option in the AIA contract, but it is rarely utilized. My suggestion is that Owners and Contractors rethink builder’s risk insurance and how it is dealt with in their contracts so that the interests are realigned as they should be. Ultimately, it is the Contractor who risks the most in the event of a loss. As a result, it should be the Contractor, not the Owner, who purchases the builder’s risk insurance. And when you do, buy a policy that provides broad coverage. That will be money well spent.
Zak McIsaac is a Partner in Ashbaugh Beal’s Insurance Recovery Group. He can be reached at email@example.com.