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Business Income and Ordinance or Law

Author: VU Faculty

An apartment building is located in an area where a building ordinance mandates a certain amount of parking space per unit. As a result, if the building was rebuilt at this location, it would have fewer units to allow space for more parking, thus resulting in a loss of rental income. Is there an Ordinance or Law endorsement that can solve this business income problem?


Question..."Is there a way to cover loss of income resulting from Ordinance or Law requiring the apartment building be rebuilt with fewer units following a covered loss? The reason for the building ordinance is a density issue, resulting in requiring the rebuilding on the same premises to have room for adequate parking of cars, thereby requiring fewer apartments units be built to make room for the parking area. As a result, the rental income will be less due to fewer rental units."

Answer...While ISO provides an endorsement to permit coverage for direct loss governed by an ordinance or law, there is no real complimentary endorsement for indirect losses such as the future loss of business income you cite. Below are some suggestions from the VU faculty.


Faculty Response
The CP 15 31 only extends the period of restoration. Business income coverage vanishes when the property is restored so there is no way to cover the FUTURE loss of income.

The only way I know to get what you’re looking for is to have the carrier manuscript something. I’ve never seen it done, though there are a lot of things I've never seen done.

Faculty Response
The CP 04 05 will have no bearing on a business income loss - it is for direct property losses only. The CP 15 31 - Ordinance or Law Extended Period of Restoration will provide business income coverage to the extent that the period of restoration is increased due to compliance with the new building code.  However, I do not see any way to cover the long-term reduced income which will be caused by having less rental units.

Faculty Response
The Building Ordinance Time Element endorsement is just to cover the business income loss during the extra time required due to the building ordinance demolition and rebuilding. It does not cover the loss after the property is fully rebuilt/repaired. I assume most landlords increase rents to correct this problem. The insured does not need to rebuild on the same premises. He could rebuild at a different location that allows for more units. Replacement cost coverage includes this possibility.

Faculty Response
We had a similar question in March:

Do you or any of the members of the faculty have a form of "loss of real estate market value coverage" where the insured is paid for the loss of market value of a structure after loss that cannot be built as large as it was before loss? For example, the insured is a 60 unit apartment building destroyed by fire. It can, by law, only be rebuilt to contain 30 units which produces half the income of the prior apartment and therefore loses approximately half its fair market value. If you have a sample form please let me see it ASAP.

Here was a response:

Since the problem is created by a law regarding construction, I think one logical source of recovery would be under Ordinance & Law coverage.
1.  Business Income.  After a loss to the existing 60-unit structure, it seems likely that the amount of time to rebuild will be lengthened due to the necessity of totally revising the building to a 30-unit design. The business income O&L endorsement would provide coverage for loss of income during this extended period of indemnity in my view, but that's all.
2.  Dealing with a smaller building.  With the property O&L endorsement, the insured would have additional funds to help offset the reduction in number of rental units at the original site. One approach might be to secure another site, and either build a new 60-unit apartment complex, or build a 30-unit building on the original site, and another 30-unit building at a new site.
Another VU faculty member uses a case in his seminars that is similar. As I recall, an older 2-story home had been converted to an upscale restaurant. Following major damage to the structure, the insured could only get a building permit if he installed an elevator. Engineers determined that the old structure could not support an elevator, so the insured had to install a free-standing elevator along side the restaurant.
However, his structure was too close to his property line to allow for the free-standing elevator to be installed, so he was forced to purchase a small strip of land from the owner of the adjacent property, in order to have enough room for the new elevator. O&L coverage would pay for the land, and the elevator, assuming sufficient limits.

Faculty Response
Historically this has been a tough risk to insure.

One approach is to design a special coverage that pays for the loss in real estate market value. You will have to go to find a creative underwriter and insurer willing to write the risk. Market value would include consideration for the physical property as well as the income stream.

Thus If the building would sell for $10 million before the loss and $5 million after the loss, the insurer would pay the $5 million loss of market value in addition to the replacement cost to repair or rebuild what can be rebuilt.

A second approach is to insure the building at a higher value to include the cost of building an underground garage or a couple of stories of parking on top of which will sit the new apartment building.

A third option might be a policy offered by AIG in 2006. It was written by Lexington and called the Zoning Restriction Protector Insurance – available to a limited marketplace.

Faculty Response
I am not aware of one. I think what you are describing is a true business risk for the building owner. To properly cover the potential loss of revenue for the units not being rebuilt you would have to manuscript the cover, find a carrier willing to agree, and offer a premium that is reasonable. I don't see the stars aligning to allow that placement to occur.

Faculty Response
While Business Income insurance is available for the additional time it takes to rebuild due to the enforcement of building law, insurance is not available for the loss of income that is sustained through the reduction in the number of units in the apartment if the bylaw or ordinance requires less density in the rebuild.

Faculty Response
Ordinance or Law coverage is for direct property damage, not consequential loss. I think the insured has two options. Rebuild on the site and increase rents or, if the market won’t permit that, rebuild on another site that allows more units per building. The ISO CP 00 10 allows for replacement at another location.

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