Builders risk insurance provides valuable protection in the event of a direct property loss experienced by a contractor, project owner or other insured party during the construction process. However, when a catastrophic loss delays a project, indirect costs, such as soft costs and lost business income, can create substantial financial exposures for the businesses involved. Complicating matters further, many builders risk policies do not include coverage for soft costs or lost income related to construction delays.
Thankfully, firms can close this insurance gap with the addition of a soft costs endorsement to their builders risk insurance policy.
What are Soft Costs?
Construction projects are typically broken down into different categories of costs. The direct construction costs are the physical materials and supplies required to complete the structure. Labour costs are also included as a direct cost. These direct costs are referred to as the hard costs of construction.
On the other hand, soft costs are expenses not directly incurred for the physical construction of the project. Examples of soft costs that could be incurred include, but are not limited to: interest, real estate taxes, accounting and legal fees, developer’s fees, contractor’s general conditions, inspection fees, consulting and marketing fees, and additional insurance costs.
In the event that a loss occurs and the completion of a construction project is delayed, soft costs can represent significant expenses to the project owner and other parties working on the project.
To demonstrate how quickly expenses from soft costs can add up, consider an example of a project to build a new apartment complex. In the event of a catastrophe, the architects and engineers may charge a fee to redraw changes to plans. Legal fees may continue as well during this time, and new permits may need to be pulled. The site may need to be resurveyed, and insurance costs will increase if the term needs to be extended as a result of delay from a loss. Additionally, the apartment complex may lose potential renters when construction is delayed from the loss.
How Are Soft Costs Insured?
Insurance coverage for soft costs is most commonly obtained by adding an endorsement to a builders risk policy. The endorsement will specify which soft costs will be covered if a loss occurs. In the event of a loss that results in additional soft costs for the insured party, there are four requirements that typically must be met for coverage to apply:
- The delay must result solely from covered physical damage.
- The types of soft costs must be set forth in the policy endorsement.
- Proof that the soft costs were necessary and reasonable must be provided.
- Proof that the costs would not have been incurred but for the delay must be provided.
Under a builders risk policy, soft costs are covered during the delay period. The delay period is typically defined as a period of time that commences with the anticipated completion date and ends when the project is actually completed.
Business Income Coverage
Another consideration for businesses purchasing builders risk insurance, especially project owners and developers, is whether their policies cover lost rental income or lost business income. This coverage, which can be added to a builders risk policy through an endorsement, replaces lost revenue or profits that would have been earned by the policyholder had the project been completed on time.
How Much Cover Do I Need?
When it comes to coverage for soft costs, a good understanding of project economics is key. Firms will need to account for potential delays based on worst-case scenarios. Potential exposures to soft costs can be assessed by reviewing the operational budgets that were established for the project.
In general, organizations seeking soft costs coverage should answer the follow question when assessing their coverage needs: If the worst possible loss occurred at the most inopportune time, how many and what type of extra expenses would be incurred?