ORDINANCE OR LAW COVERAGE

(June 2019)

BACKGROUND

Grandfathering is an important tool in passing laws to improve the quality of new construction. It is needed because it exempts existing structures and does not require their owners to comply with new laws and ordinances. Revolts and chaos would prevail if existing buildings had to be upgraded each time a new code or ordinance was introduced.

Laws that permit grandfathering also specify when and the circumstances under which an exemption ends. In many cases, an existing building must comply with new codes and ordinances after a significant property loss or when it undergoes a major renovation. A typical provision may require that the entire structure that does not currently comply with the code be brought up to code if 50% or more of it must be repaired or rebuilt. The rationale is that upgrades can more easily be made when other major repairs are taking place.

Insurance policies are contracts of indemnity. This means they return the insured to the condition that existed before the loss occurred and nothing more. They are not intended to improve the insured's situation. Complying with codes and ordinances creates a betterment for the insured which is why most insurance coverage forms and policies do not cover the cost of such improvements. Even replacement cost valuation provisions state that any changes required due to an existing ordinance or laws are excluded.

Example: F & J Slaughtering was built outside the original city limits. Over the years, the city limits expanded and
F & J is now inside the city limits and violates the ordinance that prohibits livestock within the city limits. F & J was grandfathered when the zoning laws were enacted. A severe tornado destroys 75% of F & J's property. When it contacts the city and attempts to obtain building permits, it is informed that the slaughterhouse cannot be re-built at its current location because it violates current zoning requirements. F & J's only option is to rebuild elsewhere. The insurance company pays only the cost of rebuilding 75% of the slaughterhouse at the current location because of the ordinance or law exclusion. It does not pay for the expense to demolish the undamaged portion of the building. It also does not pay any additional costs associated with rebuilding at a new site.

In light of this dilemma, what can be done to protect against the issue of complying with ordinances or laws?

Related Court Cases:

Building Code Compliance Held Compensable By "Reasonable Expectations" of Insured

Does Policy Cover Code-Mandated Repairs?

AVAILABLE ORDINANCE OR LAW COVERAGE

1. CP 00 10–Building and Personal Property Coverage Form

Additional Coverage–Increased Cost of Construction provides a limited amount of coverage to bring a damaged building up to code. It applies automatically to any building that uses the optional replacement cost valuation. The amount of coverage is very low. It is the lesser of $10,000 or 5% of the limit of insurance. But the coverage is similar to the coverage provided by Coverage C of CP 04 05–Ordinance or Law Coverage. It does not cover the value of the undamaged part of the building nor the cost to demolish that undamaged part.

Related Article: CP 00 10–Building and Personal Property Coverage Form Analysis

2. CP 04 05–Ordinance or Law Coverage

This endorsement includes three separate coverages. Each is treated separately and apart from the others.

• Coverage A insures against loss to the undamaged portion of the building. This coverage is unusual because it pays for the value of property that must be intentionally destroyed. However, coverage applies only to that portion of the building that must be destroyed in order to comply with a building code or ordinance that was previously grandfathered but is being imposed following a covered loss.
• Coverage B insures against the cost to demolish and remove the undamaged portions of the building. This coverage is even more unusual than Coverage A because these are the costs to destroy undamaged property. As with Coverage A, it applies to only the costs to demolish and remove the portion of the building that must be removed in order to comply with a building code or ordinance that was previously grandfathered that is imposed following a covered loss.
• Coverage C insures against the increased costs to repair or rebuild the property to comply with current building, zoning, or land use ordinances or laws. The increased costs must be incurred in order to comply with building codes or ordinances that were previously grandfathered that are being imposed following a covered loss.

3. CP 04 26–Ordinance of Law Coverage Form Tenant’s Interest in Improvements and Betterments (Tenant’s Policy)

The three coverages described under CP 04 05 are covered under this newly introduced endorsement in a very similar manner but modified because improvements and betterments are not the same as buildings. Those differences are described and analyzed after the CP 04 05 analysis.

CP 04 05–ORDINANCE OR LAW COVERAGE ANALYSIS

A. Schedule

The first part of the endorsement is a schedule that allows the insured to select the type of coverage desired. A limit of insurance must be entered if Coverage B and/or Coverage C is selected. There is an option to combine Coverage B and Coverage C into a single combined limit of insurance.

A limit of insurance is not entered for Coverage A because it depends on the building limit on the declarations. The insured cannot establish a value on a possible undamaged portion of the building that may have to be demolished. Rating for Coverage A is based on a rate surcharge applied to the total building limit.

Yes or No must be selected for the Post-Loss Ordinance or Law Option.

B. Application of Coverage(s)

Certain conditions must be met in order for any of the coverages selected to apply. Coverage does not apply without these conditions.

The ordinance or law must regulate building construction, repair, demolition, or zoning and land use requirements. Coverage is subject to the following:

1. The ordinance or law must be in force at the time of the loss.

Example: The Merrilltown city council fought for years to require that only buildings of masonry non-combustible or better construction be permitted in the downtown area. The ordinance was passed on 02/01/19. Merrilltown Furniture occupied a large frame building downtown that a large fire damaged on 01/28/19. It was forced to comply with the new ordinance when it applied for a building permit. Merrilltown Furniture requested coverage under
CP 04 05 but its request was denied because the law was enacted after the loss had occurred.

If the “post-loss ordinance or law option” in the schedule on this endorsement is marked as yes item B. 2 applies instead of item B.1 above.

2. The ordinance or law must be in force at the time of the loss. However, this coverage will continue to apply if the ordinance or law was put into place or revised after the loss but before the rebuilding commenced. The ordinance or law must require compliance in order for a building permit or certificate of occupancy to be issued.

Example: Merrilltown Furniture was not pleased when its request was denied. It asked the claims adjuster to review its form because it had requested that the “post-loss ordinance or law” option be marked Yes. The adjuster reviewed the form and coverage was granted because the law had gone into effect after the loss but before building had started.

3. This coverage does not apply to all actions the insured takes in order to comply. It covers only the cost to meet the minimum standards. Any costs that are taken to exceed those minimums must be paid for by the insured.

4. and 5. A covered cause of loss must cause the damage to the building that results in forced compliance with building ordinances or laws.

• There will be times when part of a loss is covered, and part is not. The policy will respond as follows:
  When the uncovered part of the loss is the reason the ordinance or law compliance is required, no coverage is provided.
• When the covered part of the loss is the reason the ordinance or law compliance is required, the entire compliance is covered under this endorsement.
• When the combination of covered and uncovered loss is the reason the ordinance or law compliance is required, this endorsement will respond in the proportion that the covered loss bears to the total loss.

Example: Fair Weather Hotel does not have wind coverage on its commercial property coverage form but it does include CP 04 05–Ordinance Or Law Coverage. A Wind Pool policy provides wind coverage. A hurricane causes direct wind damage to the building and also downs a power line that starts a fire in the building.

Scenario 1: The reason the ordinance or law is being imposed is due to the wind loss. No coverage under this endorsement.

Scenario 2: The reason the ordinance or law is being imposed is due to the fire loss. This endorsement responds to the total ordinance or law loss.

Scenario 3: The reason the ordinance or law is being imposed is due to the combined loss. The covered direct loss is $150,000 and the total direct loss is $300,000 so this endorsement pays 50% of the cost to comply with the ordinance or law.

6. It is not unusual for an insured to seek pollution coverage in every insurance coverage form or policy. The coverage this endorsement provides does not include any coverage for pollution, fungus, or mold, even if an ordinance or law requires cleaning up a contaminated or affected building. In addition, there is no coverage for the costs associated with any testing or response to pollutants at any site.

7. No coverage applies for the cost to comply with any ordinance or law that was in effect at the time of loss and which had NOT been grandfathered such that the insured was responsible for compliance but elected not to do so.

Example: Farley’s Restaurant was told it had to install two additional drains in the kitchen to comply with current health department requirements, but it ignored the order. When rioting occurred and the restaurant was damaged, Farley’s added the cost of the drains to the increased cost of construction. However, the claims representative refused to pay for the drains when he discovered the outstanding orders to install them.

C. Coverage

1. Coverage A–Coverage for Loss to the Undamaged Portion of the Building

Property insurance usually applies to only damaged property. This coverage does just the opposite and covers undamaged property. The Building and Personal Property Coverage Form covers the damaged property. This coverage applies to the undamaged portions of the building that must be demolished because of a law or ordinance that controls construction.

Example: McKinley Department Store is a five-story, joisted masonry building in the downtown area. A city ordinance requires that all buildings two stories or higher be of masonry noncombustible or better construction. Grandfathered buildings must conform to this ordinance if more than 30% of a building is destroyed. A fire destroys 40% of the building. McKinley is informed of the ordinance and told that it cannot rebuild the structure as is. In addition, it must demolish and remove the remaining 60% because it does not meet current construction requirements. Coverage A applies to the undamaged 60% of the building. CP 00 10–Building And Personal Property Coverage Form applies to the damaged 40% portion.

2. Coverage B–Demolition Cost Coverage

Providing coverage on the undamaged portion of a building is not enough. In order to rebuild the structure, the undamaged portion must be removed, and the site cleared to allow for new construction. This coverage allows the insured to anticipate the expense to demolish an older structure and requires a separate limit of insurance. This limit should be selected carefully and after much thought and review because of the high costs of demolition. The actual costs of demolition and site clearance are covered up to the limit of insurance on the endorsement schedule.

3. Coverage C–Increased Cost of Construction

a. This coverage is important for any company subject to the Americans with Disabilities Act (ADA) or any of a number of similar or related local, state, and federal ordinances that affect construction, reconstruction, repairs, remodeling, and renovations after a loss. Many of these ordinances and codes are helpful and the cost to comply is relatively inexpensive and easily accommodated in new construction. However, similar compliance in existing buildings or structures following a loss is considerably more expensive and difficult to accomplish. In addition, most insurance coverage forms and policies do not cover these costs.

Example: Golden Years Nursing Home has served the needs of the aged in the community for decades. The building is masonry construction with plaster walls. The hallways in certain areas are rather narrow but lead to spacious open areas. A fire that starts in the kitchen damages the kitchen and dining hall. When building permits are obtained to repair the damage, Golden Years is told that the hallways must be widened to meet ADA standards.

b. This coverage pays the increased repair costs that must be incurred to bring the damaged portions of the building up to the minimum requirements of the ordinances or laws. It also pays the costs to remodel or even rebuild the undamaged portions of the building in order for them to comply with the ordinance or law’s minimum requirements. The buildings do not have to be demolished before this is implemented.

Example: Golden Years meets these requirements because covered property is damaged by fire. Golden Years incurs increased costs to repair, rebuild, or replace the damaged part of the covered property in order to comply with enforcing an ordinance or law.

This coverage applies only if the building is actually repaired, remodeled, or rebuilt for the same or a similar occupancy. The occupancy cannot be changed unless the law or ordinance requires a change in occupancy due to current land use or zoning restrictions.

Example: Golden Years looks at its options after the loss. One is to change from a home for the aged to a restaurant. After a review of its policy and this coverage form, Golden Years realizes that the coverage available under this endorsement does not apply if it decides to rebuild as a restaurant because that is not the same or a similar occupancy.

One unusual feature of this coverage is that certain types of property usually excluded may be covered. If any of the property listed below must be altered because of a building ordinance or law’s requirements, the increased costs for the alteration are covered:

• Costs of excavations, grading, backfilling, or filling
• Building foundations
• Pilings
• Underground pipes, flues, and drains

Example: The building inspector from the local health department visited Golden Years after the loss and informed it that the kitchen needed an additional drain to comply with health department requirements. The cost of the additional drain is covered because this requirement was in effect before the loss and is a minimum requirement to obtain health department approval.

D. Loss Payment

1. Proportional Loss Settlements

When a combination of covered loss and uncovered loss triggers coverage under this endorsement, any settlement is paid based on the percentage the covered loss bears to the total loss.

Example: Jamey’s Garage is destroyed. 50% of the damage was from a covered loss and 50% was not covered. Jamey requests his Coverage A, B, and C settlement but he receives only 50% of any settlement calculated in this section.

2. Coverage A

Loss payments vary depending on the valuation selected. They are based on whether the valuation basis is actual cash value or replacement cost.

When replacement cost valuation applies and the building is repaired or replaced, the loss payment is based on the least expensive of the following options:

• The actual amount to repair, rebuild, or reconstruct the building on the same premises, with the same height, floor area, style, and comparable quality
• The limit of insurance on the declarations for the covered property. If flood or earthquake coverage has been added by endorsement with a lower limit of insurance and flood or earthquake is the cause of loss, the limit on the applicable endorsement is used instead of the declarations limit.

This coverage does not apply to the increased cost to upgrade the type of construction to meet current codes. For example, if the building construction must be changed from frame to masonry non-combustible, Coverage C–Increased Cost of Construction provides the additional cost to do so.

When replacement cost valuation applies and the building is not repaired or replaced, or when actual cash value valuation applies, the loss payment is based on the least expensive of the following options:

• The building’s actual cash value at the time of loss
• The limit of insurance on the declarations for the covered property. If flood or earthquake has been added by endorsement with a lower limit of insurance, if flood or earthquake is the cause of loss, the limit on the applicable endorsement is used instead of the declarations limit.

Example: The Finway Pianos plant sustains flood damage to 60% of its building. Finway purchased Coverage A and its limit on a replacement cost basis is $2,500,000. The Finway family considers rebuilding but they no longer have the heart or will to continue the business. Finway decides to demolish the building and sell the land to the city. The amount paid in this case should be the building’s $1,000,000 actual cash value but Finway had purchased only a limit of $750,000 for flood damage so only $750,000 is paid.

3. Coverage B Specific Limit (not a combined limit)

If there is a limit for Coverage B on the endorsement schedule, the loss payment is based on the least expensive of the following options:

• The insured's actual cost to demolish and clear the site at the covered premises
• The limit of insurance on this endorsement’s schedule

Example: Continuing the example above, Finway Pianos has a $150,000 Coverage B limit. The actual cost to demolish the remaining portion of the building is $100,000. The cost to clear the site is apportioned with the debris removal limit in CP 00 10–Building and Personal Property Coverage Form. As a result, the total cost of demolition and debris removal is completely covered.

4. Coverage C Specific Limit (not a combined limit)

If there is a limit for Coverage C on the endorsement schedule, the insurance company pays for the increased cost of construction. However, it does not pay:

• Until the building is actually repaired or replaced at the same premises or at another location
• Unless the repair or replacement is made as soon as reasonably possible after the loss or damage. This is subject to a two-year maximum time period following the loss. The insurance company may extend this period in writing during the two-year period.

If the building is repaired or replaced at the same location, or if the insured decides to rebuild at another location, the most paid under Coverage C is the least expensive of the following options:

• The increased cost of construction that would have been incurred at the same location
• The increased cost of construction limit of insurance on the endorsement schedule

If the ordinance or law requires that the insured relocate its operations to a different location, the most Coverage C pays is the lesser of either the increased cost of construction at the new location or the increased cost of construction limit of insurance on the schedule.

Note: There is no payment under this coverage if construction does not take place.

Example: Finway Pianos had an increased cost of construction limit of $500,000 because it planned to rebuild with a different kind of construction if a loss occurred. In this case, Finway does not rebuild. It asks for the $500,000 in the settlement but the insurance company denies the request because it does not rebuild.

5. Coverage B and Coverage C Combined Limit

If the insured requests a combined limit to apply to both Coverage B and Coverage C, that limit is the most paid in any one occurrence. However, certain limitations apply. For example, with respect to demolition, the insurance company does not pay more than the insured's actual costs to demolish and clear the debris from the site after a loss.

If increased costs are incurred during construction, the insurance company does not pay:

• Until the property is actually repaired or replaced at the same location or at a different one

• Unless the repair or replacement is made as soon as reasonably possible after the loss or damage. This is subject to a two-year maximum time period following the loss. The insurance company may extend this period in writing during the two-year period.

If the building is repaired or replaced at the same location, or if the insured decides to rebuild at a different location, the most the insurance company pays under Coverage C is the least expensive of the following:

• The increased cost of construction that would have been incurred at the same location
• The increased cost of construction limit of insurance on the endorsement schedule

If the ordinance or law requires that the insured relocate, the most the insurance company pays is the least expensive of the following options:

• The increased cost of construction at the new location
• The increased cost of construction limit of insurance on the endorsement schedule

E. Endorsement Terms

Each building listed on the endorsement schedule is treated individually. All terms apply separately to each listed building.

F. Examples of Proportionate Loss Payment

This endorsement provides an example of how coverage applies when a loss is only partially covered.

G. Definition

Fungus is defined. It is the same definition as the one used when the term fungus is used in other forms.

CP 04 26–ORDINANCE OR LAW COVERAGE FOR TENANTS INTEREST IN IMPROVEMENTS AND BETTERMENTS (TENANT’S POLICY) ANALYSIS

This analysis will describe only the differences between the CP 04 05 and the CP 04 26.

Schedule

A section is added to the schedule called “Description of Tenant’s Improvements and Betterments. A description of the actual improvements and betterments must be provided for each of the building number/premises numbers provided in the coverage selection section.

The coverage applies to only those improvements and betterments that are described in the schedule. This replaces the reference to buildings in the CP 04 05.

B. Application of Coverage

Only item B.4. is changed. Instead of referring to direct physical damage it refers to property damage caused by a cause of loss that is covered under the policy. That property damage must result in an ordinance or law requirement being enforced. This difference is needed because it will not be the improvements or betterments that result in the ordinance or law requirements to be enforced but will instead be due to property damage to the building to which those improvements or betterments are attached.

C. Coverage

Only items 1. and 2. are changed because these are the coverages for undamaged improvements and betterments being destroyed and the cost of its demolition. In most cases the reason for the improvements and betterments being destroyed is because the entire building, which is owned by others, is being destroyed.

1. Coverage A. applies for the value of the undamaged improvements and betterments that are destroyed because the building must be destroyed due to a law or ordinance. However, there is an important condition that applies. IF, prior to the demolition, those undamaged improvements and betterments can be removed without damage to them, no coverage is provided.

2. Coverage B pays only the amount of demolition cost that is separate and distinct from the cost to demolish the rest of the building and only for the amount for which the named insured is responsible. No payment is made if the undamaged improvements and betterments could be removed with damage to them.

D. Loss Payment

The only difference throughout this section is that the term improvements and betterments is used in place of the term building.