Ordinance or Law: The Increased Cost of a Claim You May Not Be Aware Of

By Clark Parr, Commercial Risk Manager and Insurance Advisor

It may seem straightforward to estimate the value of your property. What is the building worth? How much would it cost to rebuild? Unfortunately, additional costs that are hard to quantify can become a part of the valuation equation after your property suffers damage, and not all are covered under a replacement cost policy.

Insurance is intended to make you whole after a loss. With standard property insurance, the expectation is that if your building is damaged by a covered loss, what has been damaged will be restored to its original state before the damage occurred. But there are other factors at the time of a claim that can make this a complicated endeavor. One of the coverages most often missed that can lead to significant out-of-pocket expenses is Ordinance or Law. Ordinance or Law refers to any loss or increased costs of a loss caused by regulations or code requirements in the construction or repair of a damaged building. But how much can regulations increase the cost of construction? How often do these codes change? And how much can it affect claim coverage?

The International Code Council (ICC) releases new guidelines every three years, but it is up to state and local officials to adopt and enforce those guidelines – which can be done at any point in time (1).

Building location is a fundamental concern because it is the state, city, or county officials who are charged with implementing new codes that can affect the requirements for a rebuild or repair.

The age of your building matters, but your building doesn’t need to be very old to no longer meet new construction codes. The Americans With Disabilities Act (ADA) Standards were recently updated and put into effect nationally in 2012 (2). Texas adopted the International Building Codes (IBC) and mandates in 2015 (3). The City of Dallas Green Ordinance took effect in 2017 (4). Now consider the age of your property. If you own a building in Dallas older than five years and you had to rebuild from the ground up today – your building plans would most likely violate both state and local code requirements.

But what exactly are these codes enforcing? The most common code changes and requirements are in three key categories: accessibility & safety, fire resistance, and more recently, energy conservation.

The key lesson is that an unendorsed property policy will not cover Ordinance or Law related costs. If officials require updates after a loss that were not in the original build, those updates are coming out of your pocket, not your insurance limits.

Let’s look at a potential scenario:

You own and insure a building for $10 million. A fire destroys one half the building, and the other half was saved when the fire department responded. According to local city ordinance, if 50% of a building is damaged – the undamaged portion of the building must be torn down as well. Additionally, there are $80,000 in upgrades required upon reconstruction to bring your building up to today’s green energy standards according to a city ordinance. City officials also require that you install a sprinkler system upon rebuilding. How would a standard policy respond?

Here’s a possible outcome: The damaged half of the building is covered under your property policy. The costs to tear down the remaining half, not covered. Rebuilding the undamaged half of the building, not covered. Both the green standard upgrades and the sprinkler system are not covered by a standard policy. A breakdown of potential costs is listed below:

• Rebuild the damaged portion of the building: $ 5,000,000 — Covered
• Cost to tear down the remaining building: $ 200,000 — Not Covered
• Rebuild the undamaged half of the building:  $ 5,000,000 — Not Covered
• Green energy ordinance upgrades: $ 80,000 — Not Covered
• Required sprinkler installation: $ 50,000 — Not Covered
• Total Cost: $10,330,000
• Insurance Pays: $5,000,000
• You Pay: $5,330,000

City ordinances and building codes can have a major impact on the total cost of a claim, and also your wallet. In the scenario above, it’s possible that less than half of the claim would be covered. Given how often these city and state codes can change, it’s a frightening but realistic scenario. Let’s take the remaining $5,330,000 of this claim and explain how an Ordinance or Law coverage form could apply if put in place prior to the loss:

Coverage A: Value of the Undamaged Portion of the Building

This covers the remaining $5 million to rebuild the entire building, or the form pays the actual cash value if the undestroyed portion of a building cannot be rebuilt to previous area, height, etc. due to ordinances.

Coverage B: Demolition Costs

$200,000 to destroy the remainder of the building and the foundation.

Coverage C: Increased Cost of Construction

This will include any repair or rebuild costs that are a direct result of building regulations and codes, such as energy conservation requirements and sprinkler requirements. All $130,000 is covered under this coverage.

Local and state ordinances or construction codes often affect the cost and requirements of an insurance claim. In order to adequately manage your risk, you must understand the hazards and challenges that could be in front of you in a worst-case-scenario. You don’t need to experience a total loss to incur high claim costs. Partial losses can be just as costly. Speak to your trusted Insurance Advisor to find out if your policy includes Ordinance or Law coverage. If it does, check your limits for coverages A, B & C – make sure they are sufficient for your level of risk in the event of a claim.