Ordinance or law coverage: paying for code upgrades after a loss

Ordinance or law coverage pays the extra cost of complying with building codes and zoning rules when you repair or rebuild after a covered loss. Without it, a standard commercial property policy pays to put back what was damaged and does not pay for the sprinklers, the accessibility work, the structural upgrades, or the demolition of an undamaged part that the city requires before it will issue a permit. In older buildings, that gap can rival the claim itself.

Why the standard policy leaves a gap

The ISO special form, CP 10 30, excludes loss caused by the enforcement of or compliance with any ordinance or law that regulates the construction, use or repair of property, or that requires tearing down property, including the cost of removing its debris. In other words, the exclusion is aimed at exactly the costs that a building department imposes after a fire or storm.

The base building form, CP 00 10, gives back a small piece. Its Increased Cost of Construction additional coverage applies to buildings insured on a replacement cost basis, requires that the work actually be done, and is capped at the lesser of $10,000 or 5% of the building limit. It does not cover the undamaged part of the building or the cost of demolishing it. Commentary on the form describes the same cap; verify the amounts in your own policy. (Policy language varies, and businessowners policies and carrier forms carry different built-in amounts.)

Three problems follow after a loss in a building that predates current codes:

• The city may require the damaged section be rebuilt to today's code, which can mean sprinklers, fire separations, accessibility features, energy provisions, wind or seismic upgrades.
• A local rule may require demolishing the undamaged remainder once damage passes a threshold. Many jurisdictions apply a percentage-of-value rule, but the threshold and its details differ by locality, so ask your building department.
• A zoning change since construction can mean the building cannot be rebuilt as it stood, or only with a smaller footprint or a different use.

The three coverages in CP 04 05

ISO's Ordinance or Law Coverage endorsement, CP 04 05, adds three coverages. The schedule on the declarations sets how much applies to each.

Coverages B and C can be bought as separate limits or as a single combined limit, which gives flexibility if the cost splits unpredictably between demolition and upgrades. Coverage A is the quiet one. It matters most when the building is a total loss for legal reasons even though much of it is physically fine.

Four conditions run through the endorsement:

1. The loss must come from a peril the policy covers. If an ordinance is triggered only by damage from a cause not covered, there is no coverage.
2. The enforcement must be a direct result of the covered loss.
3. The ordinance must have been in force when the loss occurred.
4. The building must not already have been out of compliance with an ordinance that required compliance. Deferred code violations do not become insured losses.

Increased cost of construction is generally paid only once the work is completed, and the policy sets a deadline for starting and finishing, so you cannot collect and walk away. Costs tied to testing for or cleaning up pollutants and to fungus or rot are not part of the grant.

A hypothetical example

Say a 1968 office building is insured for $4 million on replacement cost. A fire damages 55% of it. The city enforces a rule that when damage exceeds 50% of the building's value, the whole structure must be brought into compliance and the undamaged portion cannot stay as it is.

Without the endorsement, the owner receives the $2.2 million for damaged property, and the standard Increased Cost of Construction coverage adds no more than $10,000 of the $600,000. The $1.8 million of undamaged value is not a loss under the standard form because it was not damaged, so it is not paid. With the endorsement, Coverage A pays for the undamaged portion within the building limit, and the B and C limits pay the demolition and the upgrades, provided the limits are large enough. All figures here are invented to show how the pieces fit, not typical costs.

Business income and the extra months

Code compliance adds time. The standard business income form, CP 00 30, ends the period of restoration when the property should be rebuilt with reasonable speed and similar quality, and it excludes any increased period caused by enforcement of an ordinance. An endorsement, CP 15 31, Ordinance or Law – Increased Period of Restoration, extends the period for that extra time. If you have a larger building or an older one, ask for both: Coverage C pays the construction cost, and the extension keeps the income coverage alive while the permit and the extra work run. See business interruption insurance: how business income coverage works for how the period of restoration works.

Setting the limits

The correct limit is a building-specific question, and there is no good rule of thumb. Work through it with these questions:

• Age and construction. Pre-code buildings, unreinforced masonry, buildings without sprinklers and buildings with historic designation carry more exposure.
• Jurisdiction. Ask your building department or an architect what a rebuild would trigger: the damage threshold, accessibility, sprinkler requirements, setbacks and parking.
• Zoning. Check whether the use or the footprint is legal non-conforming.
• Replacement cost basis. The coverage depends on the building being insured to value; insurance to value: setting the right building limit and replacement cost vs actual cash value for business property explain why an undervalued building makes everything else smaller.
• Coinsurance. Ask whether the coinsurance condition applies to each of A, B and C in the form your carrier uses; see the the coinsurance clause and how underinsurance is penalized guide.

Mortgage lenders on older buildings often ask for the coverage and for the limits to be specified. The building owner, often a landlord, is the buyer; a tenant's obligations come from its lease. insurance requirements in commercial leases shows how leases allocate the obligation.

Where it interacts with other perils

The endorsement follows the peril. An earthquake rebuild brings seismic code upgrades, but the earthquake coverage is a separate purchase and the ordinance or law exclusion still has to be addressed; see earthquake insurance for businesses: coverage, deductibles, limits. A wildfire rebuild in a wildland-urban interface zone can bring fire-resistant construction rules; wildfire and commercial property insurance: cover, cost and mitigation covers it. The commercial property exclusions: what the standard policy won't pay guide lists the other exclusions that sit next to this one.

Making a claim

• Ask the building department for the code requirement in writing; the carrier will want proof that enforcement is real.
• Keep estimates that separate the like-kind repair from the code upgrade, because the carrier pays them from different coverages.
• Do not demolish or start rebuilding before the carrier has seen the property and agreed on scope.
• Track the policy's deadlines for starting and finishing work.

Key takeaways

• The ISO special form excludes the costs of complying with building codes and zoning after a loss; the endorsement gives the coverage back.
• CP 04 05 has three parts: the undamaged portion (A), demolition (B) and increased cost of construction (C), with A inside the building limit and B and C needing their own limits.
• The built-in increased cost coverage in the base building form is small and does not cover the undamaged portion.
• Add the income extension for the extra months that code compliance creates.
• Set limits from the actual code and zoning picture for the building, not from a percentage.