Inside Third & Bond: Week 120

This week the Third & Bond bloggers from developer The Hudson Companies tackle the exciting subject of insurance.
Philippe Petit, the Frenchman who walked on a tightrope stretched between the two World Trade Center towers in 1974 said, No, I was not taking my life in my hands. I was very careful with the rigging of the wire and careful to use all my knowledge of wire-walking, which, in retrospect, was limited at the time. But I would never have risked my life. Developers, too, give the appearance of taking huge risks but in reality we carefully calculate and protect ourselves against disaster. Purchasing insurance is a key component of risk mitigation, and the subject of this week’s blog.

Developers are subject to many different kinds of risk, from building damage or destruction, to bodily harm of workers or visitors. To protect ourselves, we take on several different insurance policies and demand evidence of insurance from our contractor and subcontractors as well.

Let’s start with builder’s risk insurance….

…This type indemnifies us against damage to buildings while they are under construction. Pretty much any improvement to a parcel of land becomes property of the title holder—that’s us. If there’s a fire or an act of God (force majeure), then the insurance pays out for our losses.

If we had a general contractor agreement with Kiska instead of a construction management agreement, then we would make them get the builder’s risk policy—which would still pay us in case of a claim. But we take on more control with the CM arrangement as well as risk which means carrying the builder’s risk policy. For Third + Bond, the builder’s risk runs about $15,000/year. We are covered up to the construction cost of the project. We also add on earthquake, flood, and model furnishings coverage. Each of these comes with its own deductible. A typical range for deductibles is $5,000 to $500,000.

The second type of insurance we purchase is owner’s liability. This policy is separate and in addition to the liability policies we require of the contractor and subcontractors. Its purpose is to protect us against claims by third parties. Unlike builder’s risk, the insurance company pays the third party and not us if it pays at all. The insurance company can also opt to mount a defense on our behalf, which usually means that lawyers retained by the insurance company sit down with lawyers retained by the complainant to argue over the claim, sometimes in a court of law. The insurance company has an incentive to fight against fraudulent claims and that’s fine by us.

Our liability insurance runs us considerably more than the builder’s risk: about $4/$1,000 each year. In other words, take the total of our construction costs and divide it by 1,000 and multiple by $4 and that’s a good rule of thumb for how much the policy will cost. For Third + Bond, our liability insurance costs alone are nearly $200,000 to date. With these kind of numbers what does the coverage look like?

We have general liability that is covers us per occurrence. Some of our policies are held at the corporate level and specify per location as well as per occurrence. We also have umbrella liability and auto insurance per occurrence. Typical ranges for coverage are $1 million to $10 million for each type of liability insurance. Each occurrence is crucial. Say we had a claim of $1 million on Tuesday and then another $1 million disaster on Thursday. We need to be able to claim $2 million. Of course, we have to prove there were two separate occurrences.

That was difficult for Larry Silverstein to prove after 9/11. He had the various WTC structures insured up to $3.55B and then tried to claim $7.1B for a total of two occurrences (two planes). The insurers did not agree. In the end, the insurers agreed to pay out $4.55B for a claim against the property insurance.

Aside from the obvious practicality of having insurance to protect from catastrophe or simple accidents, the construction lender requires us to have coverage. They and we require our contractor to carry liability insurance. If someone sues after an injury caused by an unsafe condition on the site, the contractor’s insurance needs to step up. The contractor is the one who has responsibility for day-to-day management of the site. (The owner has ultimate responsibility.) There is a common exception to this arrangement and that is the scaffolding carve-out. According to NY Labor Law 240, commonly referred to as the Scaffold Law, building owners are liable for any workers’ injury that occurs on their property at or due to gravity-related accidents. The statute imposes a non-delegable duty upon owners, meaning we can’t just say that the contractor has to indemnify us. This law applies even if the building owner did not authorize the construction activity. Yikes!

In a typical worker injury suit, the contractor’s liability insurance will immediately take over the claim and either pay it or mount a defense. If the Scaffold Law is invoked, the contractor will push for the owner’s liability to deal with the claim as will the complainant. That doesn’t always end up happening but it is definitely more complicated than a non-gravity related injury suit.

We haven’t received any claims for Third + Bond, which might come as a surprise if you thought all of the Stop Work Orders were actually related to safety issues. Kiska received a property damage claim from a neighbor who experienced flooding from a fire hydrant the Fire Department turned on so Kiska could utilize the water. That claim was paid out-of-pocket because it was below the deductible. (Kiska will want us to say that they think it was the Department of Environmental Protection’s fault that the hydrant leaked underground and not Kiska’s shut-off procedure.)

But claims have a way of materializing. On another of our projects a couple of years ago, two men were electrocuted (fully recovered now) when a concrete truck lowered its boom over an electrical line instead of below it. Neither of those men made any claims against us or the contractor. On the same job we have two claims being fought by our insurance company by men who claim they were injured by a small but heavy object falling on their head. Funny thing is that there is no record of these men being on site or employed for the job, not in the construction manager’s records nor in the subcontractor’s records. One of these claims just came to us a month or so ago for a 2007 event.

So, let’s review our risks: fire, earthquake, high winds, flooding, terrorism; people: slipping, falling, smashing, or just plain thinking that we have deep pockets. Is our situation more or less frightening than walking 1,368 feet above the ground without a net?

Inside Third & Bond: Weeks 1-119 [Brownstoner]
Our legal fine print: The complete offering terms are in an Offering Plan available from Sponsor. File No. CD080490. Sponsor: Hudson Third LLC, 826 Broadway, New York, NY 10003.