ORDINANCE OR LAW COVERAGE

Over my twelve years in the insurance industry, one of the coverages that is often overlooked and misunderstood, is ordinance or law coverage. It is a coverage form commonly found in first-party coverage policies and in particular, commercial property insurance policies. There are a number of parts to this coverage and each policy needs to be reviewed independently as there is no uniform manner in which this coverage is provided and applied.

Ordinance or law coverage is not uncommon and in matter of fact, every insured that is insuring buildings on their property policy should include ordinance or law coverage on their policy. An insured who has a building that incurred a partial loss, usually more than 50%, may encounter a hurdle when local governmental authorities require it to be completely demolished and rebuilt new rather than repaired. Since part of the building was undamaged, the standard property coverage will not cover the cost to demolish and replace the undamaged portion of a building. This can create a nightmare situation for an insured and this is where ordinance or law coverage can be triggered. In such situations, ordinance or law coverage provides the insurance coverage needed to cover the undamaged portion of the building as well as the costs to demolish and rebuild the building.

Ordinance or law is typically broken down into three elements on a standard property policy form: Coverages A, B and C. Coverage A refers to coverage for the undamaged portion of the building, Coverage B refers to the cost to demolish the undamaged portion of the building and Coverage C refers to the increased cost of construction to meet current building codes. Policies vary on what limits are provided for each coverage and at times, may combine two, or all three of the coverages, under a single limit of insurance. Ideally, as an insured, you would want each coverage to have its own dedicated limit and in particular, Coverage A should be “included in the building limit.” In other words, the limit of insurance on the policy for that particular building should apply as the limit under Coverage A of ordinance or law. This is often included as part of the standard policy form, but not always. Thus, an informed consumer and/or his broker, should ensure that the limit for Coverage A is “included in the building limit.” With respects to Coverages B & C, there is no definitive formula to determine the proper limits to utilize and although I have seen people postulate some formulas, I recommend to my clients to use a limit for each of the two coverages that reflects 25% – 33% percent of the value of the building in question. When a policy is insuring multiple buildings of various values, the highest valued building should be utilized to determine the limits, according to this formula. This is not a surefire formula, but one that I learned as a consultant and has generally worked well when applied. Thus, for example, an insured that has a building with a replacement cost value of $1m, should, at a minimum, have a $250k limit for Coverages B and C, respectively.

There are two additional elements of coverage afforded under ordinance or law coverage that are not typical and more often than not, are not included in coverage. Nevertheless, it is worthy to be aware of them as they can be important elements of coverage depending on the exposure you are insuring. There are no universal terms for these two elements as there are for Coverages A, B & C, but I am going to use the terms I learned as a consultant for ease of understanding. “Coverage D” refers to business interruption coverage as a result of an ordinance or law claim. Thus, an insured that incurs loss of income due to a delay in rebuilding the damaged property as a result of an ordinance or loss claim, that loss of income can be covered under “Coverage D.” “Coverage E” refers to the loss of value to a damaged building that cannot be rebuilt to the same size and value it was prior to the loss. For example, a seven-story building that new code only permits a five-story building to be built in its stead, “Coverage E” will provide the loss of value for that building and is usually conditioned on the recovered money being reinvested into the operations of the named insured. Some refer to “Coverage E” as “governmental limitations coverage.” Note these are not dispositive terms and carriers may differ, sometimes dramatically, in how they refer to each of these two coverage elements. The important thing is to be aware of them and request them if it is a coverage important to you to have. In the insurance industry, as is generally the case, it is best to be an informed consumer.