BUILDING CODE EXCLUSION - AGENT'S TRAP AND ADJUSTER'S DILEMMA?

BY RONALD J. ZAREMBA, CPCU

MAY 31, 1990

As an insurance adjuster I am bringing up several points for discussion regarding the potential conflict between the policy and consumer expectations, primarily evolving around the building codes exclusion.

I do not claim to be an expert in this area and I doubt if there are very many people who are experts in this area. I would believe that many of you are more conversant on this subject than I am.

There are three types of property, real property, personal property and intangible property. That is, unless you're getting divorced. Then, there are only two types of property, our property and your spouse's property. Discussion here is limited to part of one type of property, real property. Real property is land and permanent improvements attached there to. We are not directly concerned with land.

A problem exists not because of the codes or the policy wording but because of changing consumer expectations. The public demand, primarily through governmental action, caused the code changes. New code changes include energy requirements, earthquake requirements and upgraded electrical requirements. Most of these that did not exist even five years ago.

Our expectations have increased because of our awareness of what is going on around us has increased, primarily through the mass media. Rising expectations have been fueled by the miraculous growth of technology. As our population grows older, our rising expectations will increase at a decreasing rate. That’s because as we get older the tendency is to like things to stay the same. For now, we are nation of young people with high hopes and ideals. We want it now, no patience!

Building codes have existed since ancient times dating back to the Hammurabi Code. You remember the Hammurabi code, an eye for an eye and a tooth for a tooth. In those days if your building collapsed and you were injured, you were permitted to exact the same injuries on the architect and builder. Thus, periodically with the earthquakes that did occur, the population was purged of a number of contractors and architects.

Earlier building laws were primarily concerned with the prevention of collapse. Rome, during her rapid growth under the reigns of Julius and Augustus Caesar was afflicted with speculative building of apartment houses which projected to considerable heights, The structural failure of these buildings appeared to be frequent and laws were passed to limit the height to 70 feet and then 60 feet.

More recently came numerous regulations restricting the spread of fire. In the 14th century, the City of London required chimneys be built of stone, tile or plaster and prohibited the use of timber for this purpose. Among the first building ordinances of New York were similar provisions. Among the first legislative acts in the City of Boston was one requiring dwellings to be build of brick or stone and the roof of slate or tile. Clearly the view was toward restricting the spread of fire. Some of the old building ordinances show a certain recognition of the health problem . However, regulations on sanitation, light and ventilation are distinctly a modern development.

Building Codes page 2

The initial push for building codes in this country has been by the insurance industry, primarily for the prevention of fire. The evolution of the building codes have come from three sources, the insurance industry, the building trade unions and contractor/construction associations and the public through various governmental agencies.

The modern purpose of building codes is to provide minimum standards in safeguarding life, limb, health, property and public welfare by regulating and controlling the design, construction, quality of materials, use and occupancy, location and maintenance of all building and structures and certain equipment.

Stripped of it's legal and technical phraseology, the building codes are a set of rules to keep people from getting hurt. To meet it's purpose, building codes must concern themselves with the reasonable safety of the community, to the occupants of the building and to the building itself.

Building codes cover all facets of construction, repair, remodeling and demolition. There are separate codes for mechanical, electrical, plumbing, building, fire and zoning codes and ordinances. Electrical and mobile homes are administered through the Department of Labor and Industries. The rest of the codes are administered through the City of Yakima and/or County of Yakima. Most of the smaller cities in the county refer the code enforcement back to the county or the City of Yakima. Adoption of these codes by the City and County of Yakima has occurred in the last twenty years. There are a lot of buildings out there built before any code adoption.

Repairs and alterations can proceed without bringing the complete building up to code providing: 1) the repairs meet the existing code, 2) repairs or alterations do not cause the building to be in violation of the existing code and 3) the repairs or alterations do not create an unsafe condition.

Historic buildings may be repaired without conformance to the building codes when authorized by the building official provided 1) building has been designated officially as a historic structure, 2) any unsafe conditions are corrected and 3) the restored structure is no more dangerous than the existing building. Unsafe conditions include: 1) structural over loading, 2) inadequate egress, 3)fire hazards. Nonstructural repairs or alterations can usually be made with original quality of materials if fire resistance is not adversely changed.

While the building codes and the insurance policy's are in black and white, the interpretation of the building codes and the policy is in various shades of gray. These shades of gray are constantly changing. Perspective alone can cause different interpretations of the policy whether you're the agent, adjuster, claims examiner or the policy holder. The interpretation of the building codes and zoning ordinance will depend on whether you. The interpretations of the building codes are more political than are interpretations of insurance policies.

Disputes in the interpretation or resolution of the building codes can be referred to the board of appeals at the city of Yakima and from there it can be appealed to the city council.

Both the City of Yakima and the County of Yakima have zoning ordinances which restrict the use and occupancy of the property . The zoning codes and building ordinances also restrict the location of the improvements on the property in relationship to the perimeter of the property (set backs). Existing structures which do not conform to the current zoning of that property will require a Certificate of Noncompliance from the city or county in order to rebuild (a variance). Thus, rebuilding a single family residential structure in a multiple family zone area probably will not be too difficult to get a variance; however, to rebuild the same structure in a light industrial or manufacturing zone may be much more difficult. The initial decision that you will have to live with will either be made by the building inspectors in regard to building codes or by the zoning adjuster in regard to application of zoning laws and ordinances.

Yakima is located in seismic zone 2 B. This zone requires that a masonry building (brick or block) to have continuous horizontal reinforcement. Nearly all masonry building built over ten years ago probably will not conform to the current code.

Insulation requirements for residential are now set at R 19 for the walls, R 30 for the ceiling and R 19 for the floors, except for electrical heat, then 38 is required for the ceiling. Very few houses built before 1985 meet these criteria. Other changes in code such as double pane glass versus single pane glass, differences in lumber dimensions and quality, roofing materials and electrical service are normally minor.

For a building that is substantially damaged by fire or other peril and the owner wants to rebuild, the question becomes whether the owner has to bring up the entire structure up to current building codes. According to local building codes, if the structure is nonconforming, (does not meet current codes) they will require that the entire building be brought up to current codes if the cost of repairs equals 75% of the total value of the structure. If they are left to their own devices, they will usually use the assessed value from the assessor's office to determine the total value of the structure. However, they are willing to listen to arguments by the owner. The owner is free to submit copies of his estimates of repair and appraisal of the value of the property. What you are up against then is trying to keep the replacement cost (repair cost) less than 75% of the market value of the structure. The repair cost can be higher than the replacement cost.

Traditionally, replacement costs means replacing the structure with materials of like kind and quality. Whereas reproduction costs means replacing it with the same kind of materials and the same construction techniques as was originally used. The distinction between replacement costs and reproduction costs is blurred in part, thanks to advertising from the insurance industry. Thus, today's consumer of replacement cost policies expects reproduction cost coverage.

A good example of the distinction between replacement cost and reproduction cost is Yakima's Capital Theater. When the City of Yakima acquired the property, they had it appraised for replacement cost and insured for that value ( less than two million dollars). When the structure ultimately burned and was rebuilt, the reproduction cost was actually over five million dollars. The appraisal firm was then sued by the City of Yakima >and in the end, contributed an additional one million dollars> toward the reproduction costs.

Until 1967, Washington was a value policy state. Thus, if the structure was totally destroyed, the policy limits were paid. Regardless of the actual cash value, market value, replacement cost value, depreciated value etc., policy limits were paid. Valued policy laws are to encourage the underwriters to write the amount of insurance more closely to the value of the property insured.

Contrary to popular opinion, actual cash value is not replacement cost less depreciation. Since 1980, Washington state has followed what is known as the "Jefferson rule". This rule, adapted from California law states that actual cash value is synonymous with market value. Before 1980, Washington was one of the majority of states which followed the " Broad evidence" rule in determining actual cash value. The broad evidence rule means that any evidence will be considered that reflects on the value of the property. Thus the actual cash value can be in whole or part, the market value, the replacement value, the depreciated value, intrinsic value, the historical value , the utility value, etc. The majority of the states still follow the broad evidence rule.

Why do the insurers claim that actual cash value is replacement cost less depreciation when the courts have not followed this criteria? Replacement cost less depreciation persists in the insurance industry because of the simplicity of it's application. For older structures, the application can cause the risk to be over insured.

Some question exists whether the insurers support the principle of indemnity. The purpose of the exclusion for code enforcement is to bring the policy in line with the principle of indemnity. The principle of indemnity states that the insured is entitled to be reimbursed for the amount of his loss. Corollaries to the principle of indemnity include: actual cash value, insurable interest and subrogation. The point is to pay the policy holder the amount of his loss, no less, no more.

Replacement cost coverage does not conform with the principle of indemnity. Nearly all the homeowners provide replacement cost coverage and a good share of the dwelling forms, farm owners forms and commercial forms provide replacement cost coverage. Most policies and companies however require that the property be replaced before replacement cost is paid.

If you sell a "full replacement cost policy" to a policy holder, the growing expectation is the policy will replace the old items with new items. Now, the trend in both expectations and marketing is replacement cost is reproduction cost. The exclusion for cost arising from code enforcement conflicts with these expectations. Like any other obstacle, regardless of how well founded, it will create turmoil and misunderstanding and litigation. Thus it is important to recognize that code enforcement provisions in the policies (which are universal) may create a problem for the insured, the agent and the insurer. The agent is in position to avoid the problem when he surveys the risk. After the loss, dealing with the policy and the expectations of the policy holder are the adjusters' dilemma.

In most property insurance forms there is a general exclusion that states "we will not cover loss resulting directly or indirectly from ordinance or law, meaning enforcement of any ordinance or law regulating the construction, repair, or demolition of the building or other structure, unless specifically provided under this policy. In commercial policy forms, the exclusion refers to the enforcement of any ordinance or law: 1) regulating the construction, use or repair of any property, or 2)requiring the tearing down of any property, including the cost of removing it's debris. Note in the personal dwelling forms there is no exclusion for "use". The endorsement to pick up the building ordinance or law coverage for the homeowner's policy is very simple. It states that for the additional premium, loss or damage by a peril insured against the dwelling on the coverage A shall be settled on the basis of any ordinance or law regulating the construction or repair of demolition of dwelling. In other words, general exclusion: 1) does not apply to coverage A if you pay the additional coverage premium. Normally the premium is around 10% of the allocated premium to the dwelling. Is this a good idea on homes over 10 years old?

Probably but consider this argument. The amount of insurance on the dwelling is usually calculated from current replacement cost provided by the insurer. The agent determines the size of the building and the features it has and calculates the replacement. These current replacement costs are for building a new structure with current construction techniques and materials. The strong inference is that these current costs incorporate current codes. Thus, if the amount of insurance purchased is based on current costs using current codes, why are code improvements costs not covered?

The digression from the principle on the indemnity for replacement cost coverage is not comparable with the ordinance exclusion. Actual cash value policies do not create this conflict.

Commercial ISO form for ordinance or law coverage is more involved.

Paragraph A of form CPO4050788 finds coverage for: 1) that part of the building not damaged by the fire that must be removed because of enforcement of ordinance 2) increased cost of construction caused by enforcement of codes and 3) the cost to demolish and clear the site of any undamaged parts of property caused by the enforcement of codes.

Paragraph B states that the insurance company does not want to pay for the clean up of any pollutant. However, if the pollutants arise from the peril causing the loss, the removal may be covered under the main policy form. Debris removal is rarely defined or limited.

Paragraph C states that the increased construction costs will not be paid unless the premises are repaired and replaced. Then they provide an time extension up to two years to do the repairs.

Paragraph D states that they aren't going to pay more than what you spent to demolish and clear the site or repair or rebuild the structure. Also they will not pay more than policy limits.

In summary the building codes exclusion can create a problem when you are writing replacement cost coverage on structures older then 10 years old. It is important to watch for masonry buildings over 10 years old. A major fire which renders the structure a total loss probably will not destroy the masonry walls to the extent that they have to be replaced. However, conformance to the current code will require that the walls be removed. The removal and reconstruction of the walls to meet the code would be the policy holders expense.

The use of the property, the construction of the property and the location on the property itself are all important considerations. The greater the variance (nonconformance), the more likely there additional loss and expense from building ordinances.

The best way to avoid a problem created by the conflict between the building ordinance exclusion and replacement cost coverage is to recognize the problem when the policy is being written. While the problem is more likely to occur on replacement cost coverage, you should consider the ramifications of this exclusion even when writing actual cash value policies on older property.

It is important to know the position of the underwriters and the claims department. Some companies do not concern themselves either from an underwriting standpoint or with claims standpoint with additional costs required by code enforcement. However, a growing number of companies are following up both with underwriting and from a claim standpoint on code enforcement costs. The problem arises rarely, but it is usually on the larger losses. Don't wait for the problem to hit you along side of the head. Find out before the loss occurs so that you can recognize the problem and correct it before a loss becomes a problem.

ORDINANCE OR LAW COVERAGE CP 04 05 07 88

COMMERCIAL PROPERTY

This endorsement modifies insurance provided under the following:

BUILDING AND PERSONAL PROPERTY COVERAGE FORM

CONDOMINIUM ASSOCIATION COVERAGE FORM

A. If a Covered Cause of Loss occurs to covered Building property, we will pay:

1. For loss or damage caused by enforcement of any ordinance or law that:

a. Requires the demolition of parts of the same property not damaged by a Covered Cause of Loss;

b. Regulates the construction or repair of buildings, or establishes zoning or land use requirements at the described premises; and

c. Is in force at the time of loss.

2. The increased cost to repair, rebuild or construct the property caused by enforcement of building, zoning or land use ordinance or law. If the property is repaired or rebuilt, it must be intended for similar occupancy as the current property, unless otherwise required by zoning or land use ordinance or law.

3. The cost to demolish and clear the site of undamaged parts of the property caused by enforcement of the building, zoning or land use ordinance or law.

B. However, we will not pay under this endorsement for the costs associated with the enforcement of any ordinance or law which requires any insured or others to test for, monitor, clean up, remove, contain, treat, detoxify or neutralize, or in any way respond to, or assess the effects of "pollutants".

C. We will not pay for increased construction costs under this endorsement:

1. Until the property is actually repaired or replaced, at the same premises or elsewhere, and

2.Unless the repairs or replacement are made as soon as reasonably possible after the loss or damage, not to exceed 2 years. We may extend this period in writing during the 2 years.

(Sample endorsement continued)

D. We will not pay more:

1. If the property is repaired or replaced on the same premises, than the amount you actually spend to:

a. Demolish and clear the site; and

b. Repair, rebuild or construct the property but not for more than property of the same height, floor area and style on the same premises.

2. If the property is not repaired or replaced on the same premises, than:

a. The amount you actually spend to demolish and clear the site of the described premises; and

b. The cost to replace, on the same premises, the damaged or destroyed property with other property:

(1) Of comparable material and quality;

(2) Of the same height, floor area and style; and

(3) Used for the same purpose.

3. For all loss or damage in any occurrence than the Limit of Insurance applicable to the covered Building property.

The terms of this endorsement apply separately to each building to which the endorsement applies.

Copyright, ISO Commercial Risk Services, Inc., 1983, 1987 Page 1