Direct Loss Property Adjustment Before any other step in the POR process can begin, the direct property loss must be adjusted - or be in the process of adjustment. This time drain cannot be overlooked when calculating the POR.
How long will the direct loss adjustment take? Forty-five days is the likely minimum, but this process will probably devour closer to 60 or even 90 days following the loss (sometimes longer). And if the insured and insurance carrier disagree on the values or some other aspect of the loss, the loss adjustment process time can devour many months.
Pre-Construction Period of Restoration Time Factors During the direct property loss adjustment process, the insured can initiate some of the non-building / pre-construction requirements necessary for rebuilding, including:
- Development and approval of the new building plans;
- Advertising for, interviewing, and selecting a general contractor;
- Applying for and waiting on building permits; and
- Scheduling and completing site clearance work.
Development and Approval of Building Plans: Before the building can be rebuilt, building plans must be drawn, approved by the insured, and, in many cases, approved by a governmental authority. The three parts of this process may require 60, 90, 120, or more days based on complexity and the bureaucracy to which the insured is subject. The good news is a large portion of this can be accomplished during the adjustment process.
Advertising For, Interviewing, and Choosing a General Contractor: This step, too, can begin during the adjustment process. The time required to accomplish this step is a function of current economic conditions, the quality of the general contractor pool, and the necessity of a specially trained general contractor. Once begun, the process could take as long as 45 days, but not in every case.
Applying For and Waiting on Building Permits: This process may not be as burdensome as it once was. Some jurisdictional building departments report turnaround times of 15 business days. The top-end estimate for this part is 30 days. This includes the time for the insured to acquire the form(s), complete the information and receive the building permit. However, this step cannot be accomplished in the absence of the building plans, so this is linearly dependent on the receipt of the final building plans.
Scheduling and Completing the Site Clearance Work: Rebuilding cannot begin until the site has been cleared and prepared for construction. Site clearing cannot be done until specific milestones are accomplished: 1) a demolition contractor is found; 2) the demolition is scheduled (may be 15 to 30 days before the chosen contractor can do the work); 3) the insurance carrier approves the clearance of the site; and 4) the appropriate governmental authorities approve the site clearance.
Completing all the pre-construction requirements highlighted above may add between 45 and 60 days to the already-spent adjustment process time. The insured may have already invested somewhere between three to five months in the POR before the footings of the replacement building have even been placed.
Time Required to Rebuild the Structure Too many factors directly affect the time required to rebuild a structure to hazard a guess at the total time necessary to rebuild any specific structure. The size of the building, special features, weather conditions, economic conditions, availability of skilled labor, unforeseen accidents, availability of materials, and many other issues play a part in the time necessary to rebuild a structure.
For sake of the discussion, assume four months on the short (very short) side and eight months on the average side. Again, these are just mid-point guesses.
Restocking - Two Definitions Neither manufacturing nor non-manufacturing operations can return to full operational capability until the business is restocked of all or nearly all goods and merchandise damaged and/or destroyed by the covered loss. Obviously the cost of the goods being restocked is paid by the commercial property policy (CPP) and not the business income protection; but the time it takes to restock is included as part of the period of restoration.
However, the point at which a manufacturing operation is considered restocked differs from the point at which a non-manufacturing operation is restocked. Manufacturing operations are restocked once they arrive at the same level of raw stock and goods in process existing prior to the loss (notice that the time to get to the same level of finished goods is not included). Non-manufacturing operations are not considered restocked until they are at the same level of inventory available for sale or use as existed prior to the loss.
Theoretically this step should add no time to the period of restoration for non-manufacturing operations as arrangements should have been made during all the preceding steps to have the necessary goods ready to stock the operation immediately upon receiving a certificate of occupancy (CO). However, manufacturing operations will likely see additional time added to the period of restoration because the time to restock a manufacturing operation includes the time necessary to return to the level of
goods in process existing prior to the loss. The amount of additional time is based on two factors: 1) the availability of production machinery; and 2) the length of the manufacturing process.
Hiring, Rehiring and Training Only employers that choose to exclude or limit ordinary payroll by use of the CP 15 10 should be subject to this time factor. Employers that keep all employees on the payroll during the period of restoration will have no need to hire, rehire, or train, as they still have the same group of trained employees.
However, this is in reality a
non-factor in regard to the insurable period of restoration. If the employer chooses to limit or exclude payroll of ordinary employees, extending the period of restoration to allow time to rehire or train these ordinary employees would violate the intent of the CP 15 10.
While hiring, rehiring, and training may have to be done, the employer/insured does so on its own time, not the insurance carrier's time.
Replacement of Production Machinery Returning to operational capability means that a manufacturing operation must have the machinery and equipment necessary to resume production at the same level that existed prior to the loss. This does not mean that the insured
will produce the same amount of goods, it just means the insured is
able to produce at pre-loss levels.
When estimating the period of restoration, the time required locating, purchasing, installing and testing replacement production machinery must be considered. The period of restoration does not end until each of these steps is accomplished. After all, a brand new building without production equipment is nearly as useless as a building reduced to rubble. The purpose of the building is to house the equipment that makes the goods which are sold to generate revenue/profit.
To reduce this to its simplest terms, the building makes no money for the insured; the equipment does. Until the equipment is in place and operational, no money can be made and the insured is still out of business.
Building Codes Are Bad Of the 10 factors controlling an entity's return to full operational capability, governmental involvement may have the most detrimental effect. Ordinances and laws (aka "building codes") often skew the estimated rebuilding schedule and extend the time of operational shutdown.
Unendorsed time element forms specifically exclude from the POR any increase in shutdown time directly attributable to government intervention via building codes. ISO's exclusion reads as follows:
"Period of restoration" does not include any increased period required due to the enforcement of any ordinance or law that: (1) Regulates the construction, use or repair, or requires the tearing down, of any property; or
(2) 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."
Throughout this article, a worst-case-scenario loss has been assumed; the same assumption applies to ordinance or law losses. The structure's failure to meet a jurisdiction's building codes could turn what is only a partial loss into a worst-case-scenario total loss simply due to the existence of building codes. Understanding this
increase-in-loss scenario necessitates an awareness of all issues surrounding the building codes to which the building is subject.
Source of Building Codes Building codes, though enforced by local jurisdictions, are promulgated by an assortment of contributors. Local jurisdictions, state governments, and the federal government each add something to jurisdictionally-enforced building codes.
The vast majority of building and building-products-related codes are promulgated by advisory organizations, such as the International Building Code Council (IBC) and the National Fire Protection Association (NFPA). A 1996 study conducted by the National Institute of Standards and Technology (NIST) found that more than 93,000 codes established by more than 700 advisory organizations apply to construction products and methods. Luckily only a relatively small number of these codes actually apply to the structure itself (most of these codes relate to the materials used in construction).
When Governments Get Involved Specific legal requirements stipulate the point at which a structure must be brought into compliance with local building codes. Existing structures are usually "grandfathered" and are not required to comply with current building codes unless certain statutorily-specified events occur. "Major structural damage" is one of those qualifying events.
Major structural damage (major damage) does not offer a universal definition; each jurisdiction establishes and applies its own interpretation of this concept. There are, however, two broad major damage categories into which most state and local building codes fall:
- The Jurisdictional Authority Rule: States using this as the measure of major damage allow the authority having jurisdiction (the local government) to decide when a damaged building must be brought into compliance with current building codes; and
- The Percentage Rule: States and jurisdictions applying this rule require a building damaged beyond a certain percentage of its "value" or square footage (the rarer option) be brought, in its entirety, into compliance with local building codes.
Both rules present unique problems. The
jurisdictional authority rule is
subjective in its application; and the definition of "value" differs among the states that apply
percentage rule. Knowing which major damage rule applies is of utmost importance when planning for the "building code" contingency in the period of restoration.
How This Extends the Period of Restoration Regardless of which rule is subscribed to by a particular jurisdiction, building code violations have the potential to turn a partial loss into a functional
total loss - greatly extending the POR. The additional work and time required to bring a damaged building into compliance with current building codes is a function of:
- The building codes to which the structure is subject;
- The "rule," as discussed above, to which the building is subject;
- How far "out of compliance" the building is;
- The political climate and speed of action (how quickly can or will a decision be rendered); and
- Any special or unusual regulations or laws to which the entity is subject (i.e., the EPA, historical societies, etc.).
Estimating the additional time required to return the business to operational capability because of the adverse application of building codes is impossible. The only good news is that the insured does not have to know or delineate the building codes to which the structure is subject.
Ordinance or Law - Increased Period of Restoration (CP 15 31) To redefine the POR to include the increased period of operational suspension caused by or resulting from the enforcement of
any building code in force at the time of the loss requires attachment of the Ordinance or Law - Increased Period of Restoration (CP 15 31) endorsement to the policy. No time limit applies to the endorsement. Any additional loss of income directly related to the application of the jurisdiction's building codes is paid by the insurance carrier,
provided adequate limits have been purchased.
Attaching the CP 15 31 requires the insured to adjust the POR, the coinsurance percentage, and the limit of coverage to account for the additional time period covered by the endorsed policy. The coinsurance penalty is not altered by the attachment of the endorsement, so all limits and amounts must reflect the estimated increase in time.
A highlight of the endorsement is that there is no limitation regarding which building codes are covered by the endorsement. The form specifically covers "any" ordinance or law affecting the structure.
Importance of the CP 15 31 If business income is the most important coverage the insured can have, the CP 15 31 is one of the most important business income endorsements. Most buildings fail to meet current building codes. Age has a lot to do with that, but so, too, does the number and breadth of building code changes since the building was constructed and/or renovated. Any building more than five years old should have the CP 15 31 endorsement, and it is almost a requirement on any building more than 10 years old.
How much time will the application of the building codes add to the POR? There is no way to know. But without this endorsement, any additional loss of income resulting from the enforcement of building codes would come out of the insured's own financial resources.
The Effect of a "CAT" on the Period of Restoration Properties damaged by a "general"
catastrophe (rather than an individual one) can logically expect an increase in the POR. The POR for a "traditional," non-cat loss is likely to be a minimum of 12 months (now that we are aware of the realities). Following a "cat," the POR might as much as double. It will almost certainly increase by a minimum of 50 percent.
Planning for the POR necessitates consideration of the "worst-case-scenario." A "cat" is a worst-case-scenario. Always consider this possibility, especially in "cat-prone" areas, and adjust the POR, the coinsurance percentage, and the limit of coverage to account for this possibility.
Information used in this article is taken from, "
Business Income Insurance Demystified."
I would love to hear your feedback, please send me an email
cboggs@ijacademy.com.
Until next time,
Christopher J. Boggs, CPCU, ARM, ALCM, LPCS, AAI, APA, CWCA, CRIS, AINS
Director of Education
Academy of Insurance
cboggs@ijacademy.com 
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