ENCON Group Inc.

500-1400 Blair Place

Ottawa, Ontario K1J 9B8
Telephone 613-786-2000
Facsimile 613-786-2001
Toll Free 800-267-6684
www.encon.ca







Builders Risk
Insurance
Rationale for Premium Adjustment Clauses
and the Importance of Insuring to Full Value

Many projects experience an increase in construction values during construction. The original limit shown on a
builders risk policy rarely equates with the actual value of the project at completion. Several factors may contribute
to an escalation in the contract value, for example change orders (in methods or materials), inflation (in costs of
labour and materials) and unforeseen challenges with the project.

The Premium Adjustment Clause

Most builders risk policies contain a premium adjustment clause which stipulates that once the construction project
is completed, the insured must report the final completed contract cost upon which the insurer will adjust the final
premium.

For example, if the builders risk insurance application indicates an estimated project value of $10 million, the policy
is issued with a limit of $10 million at a premium of, say, $10,000. The final contract cost reported on the Premium
Adjustment Report at completion is $11 million; therefore, an additional adjustment premium of $1,000 will be
charged.

Contractors may ask: If the project had experienced a total loss a few days prior to completion, would the insurer
have indemnified me $11 million in damages, or will it limit the payout to the policy limit of $10 million?

Typical Insurers Answer

According to most builders risk policy contracts, the insurer would only be required to indemnify the insured for the
maximum limit of the policy, which in our example would be $10 million. The insured would be left with a
significant shortfall of $1 million. This is certainly cause for ensuring that the limit of insurance on the builders risk
policy is adequate. The situation can be aggravated when debris removal costs following a large loss further inflate
the total loss amount. Yet, contractors rarely increase the limit of their builders risk policy to take into account
potential debris removal costs, or to keep up with increases in project costs during construction.

This answer may generate additional questions from contractors and project owners:
Well, why does a builders risk policy have a premium adjustment clause if the insurer refuses to pay for a loss
beyond my policy limit?
If I never had the additional $1 million in coverage, why should I have to pay for it?

The premium adjustment clause is rationalized as follows:

(a) In the event the project is completed for less than the limit shown on your policy, the insured will realize a
return premium (subject to any applicable minimum retained premium). In such cases, the Premium Adjustment
clause works to the insureds benefit.

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(b) The appearance that the contractor does not have coverage for the additional $1 million in construction values is
to some extent a misconception. This is because most builders risk policies do not contain a co-insurance
provision. In our example, while the policy limit available for indemnity is limited to $10 million, the value of
property exposed to loss or damage is really $11 million and same is fully insured against partial losses without
requirement for reinstatement. In reality, total losses are very rare. For instance, in the case of a minor fire
occurring near the end of construction, the insurer would fully indemnify the insured (subject to the deductible)
for each such loss, without application of a co-insurance provision. If the premium is charged on only the
estimated project value of $10 million, when the total values exposed are really $11 million, the insurer would
fail to obtain a premium commensurate with the values at risk. It would be akin to insuring a larger project for
the same price.

Few owners and contractors are in a financial position to (or would choose to) co-insure projects, in effect paying
potentially significant parts of claims out of pocket. Hence, the premium adjustment clause is the most viable
alternative to ensure the contractor maintains a builders risk policy limit commensurate with the actual exposure.

ENCONs Answer

ENCONs Builders Risk policy protects insureds in the event an escalation of values on the construction
project exceeds the policy limit by up to 10 per cent.

Realizing that construction values frequently escalate during a project, ENCON has added to its Builders Risk policy
a 10 per cent automatic limit increase clause. The project hard cost limits made available under the policy will
automatically be increased by a maximum of 10 per cent of the limit shown in the Declarations, despite the premium
being based on the original estimated value.

This is done by means of the following clause contained in ENCONs Builders Risk wording:

If during the policy period, the actual value of the insured project increases, without material change in the scope of
the work, then the Limit of Insurance at the site indicated in Item 7 (a) of the Declarations of this policy, excluding
the value of any property insured under this policy not included in the contract price, shall be increased
accordingly, but in no event to exceed 110% of the original Estimated Insured Value. This clause does not apply to
any insurance for Soft Costs or Delayed Opening endorsed hereon.

This clause notably puts the ENCON policy in compliance with the new CCDC 2 standard construction contract
which requires that the limit of insurance for the project be equivalent to 1.1 times the contract price.

It is possible that construction values could escalate beyond the 10 per cent automatic limit increase clause.
Therefore, when asked to extend the policy period of projects that require an extension, ENCON prompts the broker
and the insured to scrutinize and update limits of insurance if the project value has increased. ENCON does this by
requiring a Term Extension Questionnaire that inquires about changes in the scope and value of the project.

Summary

Not all builders risk policies are created equal and provisions addressing how limits of insurance may apply to
value increases during construction should be taken into account when placing the insurance.
The status of the project, including potentially escalating values, should be reviewed on a regular basis
throughout construction to identify if increases in the limits of insurance are appropriate to fully protect the
insured parties interests.







This document is for illustrative purposes only and is not a contract. It is intended to provide a general overview of
the program described. Please remember only the insurance policy can give actual terms, coverage, amounts,
conditions and exclusions. Program availability and coverage are subject to individual underwriting criteria.
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