By: Larry Rosen, Rifkin & Rosen Ultimate Property Loss Consultants
At almost every meeting, I get questions about code upgrades. Does my insurance policy include code upgrades? What are they? How are they determined? When is there coverage for them? How do I get paid for them? Do I still get paid for the work if I don’t do the code work? If I decide to purchase a building with my insurance claim money, can I still get code upgrades?
First people need to understand that “code upgrades” is the common term used for “increased cost of construction” or “ordinance and law.”
Most commercial insurance policies include a limited amount of coverage for code upgrades—generally between $5,000 and $25,000. Most landlord policies for 1–4 family homes include code upgrade coverage at 10%–20% of the building coverage, and most multifamily dwelling policies include code upgrade as either part of the total insurance limit or as an additional amount (from $10,000 to $250,000).
Code upgrade coverage is triggered if you have a covered loss to the building and the coverage is in your policy.
Before getting into the mechanism of triggering and how coverage is applied, it is important to understand the four types of code coverage: (1) coverage for the damaged area, (2) coverage for the undamaged area, (3) coverage to install an item required by code that never existed, and (4) coverage to replace an item that is not code compliant with an item that is code compliant.
Policies that include code coverage will provide coverage for the rebuilding, repair, and restoration up to current code of the damaged portion. The coverage may be limited only to the damaged portion of the property; any area not damaged but is required to be brought up to code will be excluded. For example, two units in a ten-unit building are damaged. In addition to the two damaged units, the electrical inspector requires the eight undamaged units to be brought up to current electric code. The cost for upgrading those eight units is excluded.
Some policies have language that extends the coverage to the undamaged portion of the same building that has been damaged by a covered peril. With this coverage in the previous example, the code upgrade cost for the eight undamaged units would be covered along with the cost for the two damaged units.
If there is code coverage and you are required by code to install an item that does not exist in the building, that cost is 100% covered. An example would be if you’re required to install a sprinkler system in a building that doesn’t currently have a sprinkler system. The entire cost would be covered.
If you are required to upgrade an existing damaged item, the insurance company will pay the difference between the amount allowed to replace the existing item and the increased cost. For example, you get paid to replace an existing electric outlet, and now you are required to replace it with a GFI outlet. The insurance company would be obligated to pay the difference between the cost of the allowed outlet and the GFI outlet.
Code upgrade coverage is triggered only when there is covered loss and the policy provides code upgrade coverage. If the claim is excluded from coverage code, upgrades are also excluded.
As previously explained, if it is either included in the coverage or purchased and endorsed to the policy, the standard policy form excludes code upgrade coverage or provides very limited coverage for code upgrades. It is important that you review your policy with your insurance agent to confirm there is code upgrade coverage.
When triggered by a covered peril code, upgrades are determined by the building and code inspectors, or, if necessary, by an architect for rebuilding. When the architect prepares the drawings, he will identify what code requirements are needed. When submitted to the local municipality, the inspectors will usually advise the contractor of the code requirements.
Unlike an insurance settlement, which is paid before the work is started, code upgrades are paid only if they are triggered by a covered peril; after it is determined they are required for the rebuilding, then the code work must be done. Therefore the work must be paid for out of pocket before being reimbursed by the insurance company for the incurred cost.
If the code work isn’t completed, the insurance company has no obligation to pay for the code upgrades, even if they agree they are covered.
Some policies state that code upgrades are only available for use at the described location (i.e., the location where the loss occurred). Some policies allow you to apply the code upgrades to an alternate location, if the alternate location replaces the location where the loss occurred.
For example, a building sustains a covered loss. Instead of rebuilding, the owner decides to use the funds to purchase an alternate policy. If the damaged property requires code upgrades that have been identified and agreed on, and a replacement property is purchased, then you can move the code coverage to the replacement property but only to the extent of the same code requirements. If the damaged property required GFI outlets and you are required to install GFI outlets at the replacement property, it would be covered by the insurance.
If the damaged property doesn’t require a code upgrade, but the replacement property does, the code upgrade would not be covered.
Any code requirements that were required before a covered peril but were not completed are excluded from coverage. If you’re renovating a building and bringing it to code as part of the renovation and a covered peril occurs, the code work that you had already identified and started, or were going to do, would be excluded.
It is important to review you property insurance at every renewal and ask your agent about the coverages to make sure you understand what you are purchasing.
Larry Rosen is the owner of Rifkin & Rosen Ultimate Property Loss Consultants and Immediate Past President of the POA. He has been a public adjuster for over 40 years. He currently serves on several industry committees. He can be reached via phone at (732) 431-0100 or via email at email@example.com.