The one discussion that is currently taking the insurance industry by storm is that concerning general contractor overhead and profit, and where it comes in in the property insurance claim. Whereas the terms “repair cost” or “replacement cost” are not clearly defined in the typical property insurance policy, it goes with saying that labor and materials are elements that amount to repair or replacement cost. Similarly, general contractor overhead and profit also remains an unexplored topic in the world of property insurance.
A general contractor is the overall overseer of the entire construction project. This role encompasses, among other responsibilities, sourcing the required trades (masonry, carpentry, electrical, plumbing, etc.) and ordering and supervising their daily work; researching zoning requirements along with obtaining any permits due. The contractor will incur several operational costs meanwhile (called overhead expenses) to keep things moving, with examples like: salaries and benefits for office personnel; general and administrative expenses; licences and duties; rent and utilities; depreciation on office equipment, etc.
Every general contractor is entitled to a profit, defined as the difference between the cost of (producing or acquiring) goods and the price they are sold at. Overhead and profit, in the construction industry, is basically a percentage of the total construction cost, mostly 20% of estimated repair/ replacement cost. In as much as a good number of property insurers provide replacement cost coverage, the amount they are contractually obligated rarely goes beyond the actual cash value (“ACV”) as at the time of the loss unless and after repair or replacement of the damaged or destroyed structure.
With this prevalence, courts have developed three primary rules to measure ACV: market value rule; broad evidence rule; and replacement cost less depreciation rule. In the “market value” rule, they apply the criterion of what a willing buyer would pay and what a willing seller would accept for the property on a cash sale in a free and open market. Courts that apply a “broad evidence” rule give consideration to every fact and circumstance that logically establishes a correct estimate of the value of the property, including original cost; current market value; replacement/repair or reproduction cost; income derived from its use; its age and condition; its obsolescence, both structural and functional; depreciation and deterioration; and the opinion of value given by qualified expert valuation witnesses.
Due to several courts rejecting both the “market value” and the “broad evidence” rules, a third metric, “replacement cost less depreciation rule” was brought in. Under this rule, the difference of depreciation and the estimated cost to repair/ replace damaged or destroyed property is obtained as the final measure of its ACV. Despite this fact regarding depreciation, some insurers withhold, exclude or deduct the costs of GCO&P in their calculation of the repair/ replacement cost when finding an ACV estimate and settlement of a claim based on the replacement cost less depreciation rule. Although there is no express provision in the typical property insurance policy authorizing them to do so, these insurers argue that the overhead and profit costs of a general contractor are not actually part of repair or replacement cost unless and until they are actually incurred.
Towards this debate, recent case law and two separate state insurance commissioner bulletins, along with long-accepted customs and practices in the insurance industry, conclusively establish that GCO&P should be included in the cost of repair or replacement in order to arrive at an ACV estimate and settlement.
Majority View: Payment Required if Use is Likely
The majority of courts have concluded that payment of GCO&P is required where the use of a general contractor is reasonably likely in repairing or replacing a covered loss, whether it actually ends up happening or not. This decision is guided by the nature and extent of the damage and the number of trades needed to make the repairs informing the use of a general contractor along with some consideration of the degree to which coordination and supervision of trades are required.
Several cases went before the courts involving replacement cost policies, but the policies expressly provided that until the damaged or destroyed property was actually repaired or replaced, the insurer’s obligation was limited to an ACV payment. This basically means that the insurer was also obligated to make an ACV payment to policyholders irrespective of whether they actually repaired or replaced the damaged or destroyed property.
Ideally, the issue in those cases was the amount the insurer agreed to pay to its insured prior to actual repair or replacement (the ACV), which the courts in those cases decided meant “repair or replacement cost less depreciation.
Minority View: Payment Not Required Unless Incurred
A minority of courts have come to the conclusion that overhead and profit are “non-damage” factors that have no relation to the value of the damage, apparently representing only the cost or expense that would be incurred if repair or replacement were involved. Seemingly, an insured who opts not to repair or to replace the damaged property would not incur any expenses, including the cost of building materials, collecting nothing under an ACV settlement. This means there is no need to cover that cost in the beginning.
Why GCO&P Always Should Be Included
Arguably, there is no basis for an insurer to exclude costs of GCO&P from the replacement cost calculation used in getting an ACV estimate and settlement using the replacement cost less depreciation rule, even if the insured is not reasonably likely to incur such costs. However, the jury is still out on all the factors supporting or against this.
The decision whether to include GCO&P in ACV payments remains pervasive and traditional to the insurance industry. All parties involved recognize the need to include all expenses especially where the insured is reasonably likely to incur such costs in repairing or replacement. At the very least, insureds should receive some compensation for the all expenses incurred in event a general contractor was not engaged.