Author: Chris Boggs
Let's cut to the situation at hand - your homeowners' clients have an ordinance or law exposure that must be addressed. Commercial clients' ordinance and law exposures have historically been the focus of VU articles and webinars, but it seems we have failed to call attention to the ordinance or law exposure faced by homeowners'.
The Homeowners' Coverage/Limitation
Five Insurance Services Office (ISO) homeowners' policies provide a limited amount of ordinance or law coverage, only the HO-8 lacks the ordinance or law additional coverage. Ordinance or law coverage pays the increased costs associated with the enforcement of any building codes following a major homeowners' property loss – subject to the limits available.
Unendorsed, ISO's HO-2, HO-3, HO-5 and HO-6 policies automatically provide 10 percent of Coverage A (Dwelling) to cover the costs of ordinance or law losses. The HO-4 bases its 10 percent ordinance or law limits on the Building Additions and Alterations coverage provided.
Regardless which form is considered, this additional 10 percent is all that is granted by the unendorsed policy to pay:
- The cost to tear down and remove the debris of the undamaged part of the structure;
- The cost to rebuild or repair the undamaged part of the structure in compliance with current building code; and
- The increased cost necessary to bring the damaged part of the house up to current code.
"Undamaged" is obviously a key term in ordinance or law coverage grant. Remember, Coverage A of the homeowners' policy pays only the cost to tear down, remove the debris of and rebuild or repair the damaged part of the house. Coverage A does not provide coverage for undamaged property. If undamaged property must be torn down, removed and replaced, all coverage for these costs must be paid from the available ordinance or law coverage.
Is the automatic 10 percent enough to cover a building code-related homeowners' loss? The following "fictitious" loss scenario exemplifies how ordinance or law additional coverage responds and answers the sufficiency of limits question:
- 100 percent Insurance Value of House:
- "Automatic" Ordinance or Law Coverage:
- Jurisdictional Building Code Rule
|60% of Square Footage|
|2,450 square feet (75 percent)|
Because this loss surpasses the jurisdiction's "major damage" threshold, the building code official mandates that the undamaged part of the structure be torn down. Further, the replacement structure must be built in compliance with all building codes at the time the structure is rebuilt.
Before calculating the additional costs of compliance with the ordinances or laws, the amount of loss paid by the HO policy's Coverage A must be calculated (assuming full insurance-to-value and ignoring deductibles):
- Amount paid by HO policy for damaged portion of the house:
|$ 264,000 (value of damaged portion)|
- Estimated cost to remove debris of damaged portion:
|Total Paid by Coverage A for Damaged Property: ||$ 276,500|
Prior to the loss, the cost to rebuild the structure "as it stood" (out of code) was $107.69 per square foot. To bring the dwelling into compliance with current building code requires $120 per square foot. Remember, the HO policy pays to replace what was damaged with like kind and quality – not including the updates and improvements necessary to meet current building code.
To tear down and remove the debris of the undamaged part of the structure, and to rebuild the entire structure in compliance with current building codes following this fictitious loss costs:
- Estimated cost to tear down and remove undamaged part of structure (800 sq. ft. * $5 per sq. ft.):
- Cost to rebuild undamaged part of structure (800 sq. ft. * $120 per sq. ft.):
- Additional cost to bring damaged part of structure into compliance with current building code (2450 * $12.31):
|TOTAL COST of Building Code Compliance:||$130,159.50|
Compare the $130,159.50 "cost" required to comply with the building codes in this example to the amount available in the unendorsed HO policy - $35,000 (10 percent of Coverage A) – and the insured has an out-of-pocket deficit of $95,159.50. Ultimately, the total cost of this loss (real property only) is $406,659.50.
Essentially, building code enforcement resulted in a total loss in this example - even though the house was not totally destroyed. But remember, Coverage A pays only for the damaged property. Funds required to pay the additional costs resulting from the enforcement of the building codes can only be paid from the Additional Coverage—Ordinance or Law. If the basic 10 percent of Coverage A limit isn't enough, ordinance or law limits must be increased by endorsement. In this example, the insured is greatly underinsured if all they have is the automatic 10 percent.
Not Necessarily an Example of Reality
Costs associated with the undamaged portion of the house are generally the most expensive ordinance or law-related costs. In the above example, the cost to tear down and rebuild the undamaged sections of the house in compliance with current building code was $100,000. However, a house damaged to 75 or 80 percent of its replacement cost would most likely be declared a total loss by the carrier, or at least a constructive total loss; thus, the exampled ordinance or law limits gap probably wouldn't result. Massive ordinance or law-related costs and limit gaps like the above are most common when the structure suffers just enough damage to trigger the local building code official to take such an action.
But even if the structure is declared a total loss allowing, Coverage A to respond to the entire structure, this does not mean the unendorsed HO policy provides ordinance or law coverage sufficient to bring the entire house into compliance with current building codes. Discounting the high costs associated with the undamaged portion of the house, the cost to rebuild the entire structure in compliance with the current building code could, itself, use up and exceed the limited ordinance or law coverage limit provided by the unendorsed HO policy. Using the above example, the additional cost required to bring the entire house into compliance with current code is $40,007.50 (3,250 square feet x $12.31 per square foot). This requires the homeowner to pay $5,007.50 out of pocket.
The difference between the cost to rebuild the structure as it stood and the cost to bring it into compliance with current building code is largely a function of the house's age combined with the rapidity and breadth of building code changes in the relevant jurisdiction. The more "out-of-code" the house, the greater the difference between the cost to rebuild "as is" and the cost to rebuild in compliance with current building code.
Ultimately, then, the older the home, the more ordinance or law coverage is needed – even if you are not considering the cost of the undamaged portion of the dwelling. The 10 percent provided by the unendorsed HO policy may be sufficient for newer homes (less than five or possibly 10 years old). But homes built 10 or more years ago likely need more than the basic 10 percent. Homes 20 years old or older almost certainly need more ordinance or law coverage; maybe up to 50 percent of Coverage A.
The above "age-limit guidelines" don't apply if the structure suffers just enough damage to cross the major damage threshold requiring the building code official to respond with a "rebuild requirement." In such instances, every home needs additional ordinance or law coverage. (NOTE: For an in-depth discussion of the meaning and application of "major damage," check out the VU's article, webinar or webinar transcript on ordinance or law.)
Luckily, the needed additional coverage is readily available by endorsement – at least in the ISO world.
Filling the Ordinance or Law Coverage Gap
ISO's HO 04 77 - Ordinance or Law Increased Amount of Coverage endorsement allows the insured homeowner to increase the available ordinance or law coverage amount. The endorsement does not change the breadth of the coverage provided in the unendorsed HO form, only the limit.
Ordinance or law limits can be increased to 25, 50, 75 or even 100 percent of the Coverage A limit. Rule 303 even allows ordinance or law limits greater than 100 percent of Coverage A - in 25 percent increments. Each increase comes with a corresponding additional premium, but the additional coverage is relatively inexpensive compared to the protection provided.
Applying ISO's countrywide rating factors found in Rule 303, increasing the ordinance or law limit to 25 percent of Coverage A adds approximately 3 percent to the HO policy base premium. Increasing the ordinance or law limit to 100 percent of Coverage A adds only 15 percent to the base premium. Be aware, though, actual premium increases can vary by state.
Using the previous example, the insured needed 37 percent of Coverage A to cover all costs associated with the enforcement of the ordinance or law loss. Thirty-seven percent is not an option, but 50 percent is. If countrywide rating factors are used, increasing the ordinance or law limit to 50 percent of Coverage A increases the base premium only 7 percent (in some states, this increase could be higher). That's $70 on a $1,000 premium.
Ordinance or law exposures and the available coverages are more commonly discussed and highlighted in commercial property conversations; rarely is such a discussion carried on with personal lines clients. As presented, failure to address and provide the proper ordinance or law protection can be very expensive for your homeowner clients (and potentially the agency from an errors and omissions (E&O) perspective).
Not to be overly dramatic, but ordinance or law is a very real personal lines exposure - often overlooked during the personal lines risk management and insurance planning process. Agents must explain the exposure, the coverage limits and the options.
Notifying Your Clients
One way to raise homeowner client awareness of the ordinance or law exposure, introduce the options and strengthen your E&O protection is to write your HO clients a letter, provided below. This sample letter can be used to notify your clients that they have a potential ordinance or law issue and that a "fix" is available.
Feel free to use this as a template or you can create your own. Note the parenthetical, underlined locations where you input specific information for and about the client. As a disclaimer, there is no guarantee this letter addresses every issue or will produce the desired result. Again, your job as an agent is to notify your insureds of limitations and gaps and offer options. This duty is not limited to ordinance or law. The sample letter follows:
Building codes constantly change and are regularly updated. Your home may have been in total compliance with the building codes just a few years ago, but now, it may no longer meet your community's current building codes. In fact, it is reasonable to assume that houses built more than 10 years ago likely don't comply with today's ordinances or laws.
This is a problem because any lack of compliance, although unintentional and even unknown, could result in a major out-of-pocket expense following a major loss to your home. Your homeowners' policy provides only a limited amount of coverage to pay any additional building or rebuilding costs caused by the building inspector's insistence that your entire home be brought into full compliance with local building codes following a loss. Yes, the building inspector has this power.
Your homeowners' policy provides (amount of coverage) coverage on your home; an additional (use 10% of the previous amount) is available to cover the expense necessary to comply with local building codes. That (10% amount above) is all that is available to pay:
- The cost to tear down the undamaged portion of the house (so the entire house can be rebuilt to code); and
- The cost to rebuild the entire house to current building code (the damaged and undamaged parts).
By itself, (the 10% amount) may not give you enough coverage to accomplish both requirements. Any amount above (the 10% amount) will have to be paid by you.
You do have the option to increase your protection and save yourself from this out-of-pocket expense. The Ordinance or Law Increased Amount of Coverage endorsement (HO 04 77 (or whatever carrier or state specific endorsement is used)) can be attached to plug this potentially expensive hole. Several levels of protection are available to meet your needs.
We feel you need to be aware of current coverage limitations common to homeowners' policies. You also need to know that there is a way to fill this gap to protect yourself from a potentially devastating out-of-pocket expense. Please call us to discuss your options.
Agent's Name (Signature)
Last Updated: November 10, 2017