Soft cost, or delay in the project completion coverage has been a hot topic of discussion and concern recently due to the unique claims scenarios that occur during a construction phase of a project. At first glance, the term “soft costs” seems easy to explain. But it's actually a more complex subject.
Many Builder’s Risk policies do not clearly define hard costs and leave it up to the insurer or loss adjustor to interpret. As a result, expenses that should be classified as soft costs are incorrectly treated as hard costs at the time of a claim. This misclassification may result in lower claim payments or denials of coverage. Determining the items to be included in the soft cost category should be done prior to insurance placement.
Soft cost coverage includes loss of rental income, as well as costs incurred from a delay in completion of a construction project. The coverage provides indemnification from when construction should have been completed (had no loss occurred) to the date the project is completed.
Examples of soft costs that arise from a delay in project completion include:
- Loss of rent
- Architectural, engineering, legal, accounting, and financing fees
- Additional interest charges
- Marketing expenses
Simply put, soft costs are costs incurred as a result of the covered losses that are not labor and materials. If a standard Builder’s Risk policy does not have the soft costs coverage, these types of losses will not be paid to the insured.
Previously, policies did not provide a distinction between “additional construction expenses” and “additional soft costs.” This fact can result in confusion at the time of compensation to the insured. It is critical that the insured of the Builder’s Risk policy be aware if the policy has this distinction.
In the policy, the “additional construction expenses” include extra advertising, promotional expenses, inspecting fees and costs to renegotiate leases, just to name a few. These costs are incurred in a lump sum and are not directly related to the length of the project delay. Also, there is a “per occurrence” limit that is subject to the policies’ dollar deductible.
However, the “additional soft costs” are not incurred in a lump sum, and these costs increase with the delay in project completion. The occurrence limit is subject to a time deductible of 14 or 30 days.
Splitting up the coverage for soft costs into these two categories allows insurers to manage their exposure by tailoring coverage for the different group of risks. This strategy takes into account the complexities of trying to define “delay in completion coverage” and provides the insured confidence in the coverage. It also gives the insurer the ability to manage exposure by treating risks in ways other than a lump sum of soft costs.
The following items are critical in determining the amount of soft costs coverage:
- Establishing the anticipated delay in completion (post loss)
- Analysis of the policy terms and conditions
- Thorough review of underlying contracts
- Making a reasonable estimate of the repair time and cost post an insured property damage
If both parties (insured and insurer) come to agreement on items that should be covered under the soft costs heading and the policy captures this intent, the result is a smoother claims settlement, should such a scenario arise.
For more information on this topic please read our most recent post "While Constructing a Builder’s Risk Policy, Consider Soft Costs & Hard Costs".
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