Soft Costs coverage is important for all Builder’s Risk policies

What is it?
Construction projects are typically broken down into different categories of costs for the developer. The direct construction costs are the physical materials and supplies required to construct the building and labour costs to have the construction completed. These represent the hard costs of construction, implying these are the costs that do not change if the property had to be reconstructed – save for inflation or changes in contract and materials pricing.

Alternatively, soft costs are the expenses not directly incurred for the physical construction of the project. Typical soft costs include professional fees, financing costs (commitment letter fees, interest on loans, other lender fees), marketing, advertising, permits, realty taxes, workers overtime, lease renegotiation fees and accounting and legal expenses.

Why you need soft cost coverage
Traditionally, insurance is seen as repairing or replacing the physical building that is damaged. In construction projects, this reconstruction is easily identifiable in the project’s hard costs. However, soft costs represent a significant expense to the project owner in the development of the project. As such, if the project is damaged these indirect expenses represent significant costs which are not considered in the hard costs of construction, and if not explicitly insured would not be covered by insurance.

Soft cost coverage is often misunderstood
It is commonly misunderstood that insurance companies will cover soft costs. But unlike standard commercial property insurance, most builder’s risk policies do not include soft costs automatically. Thus, if any costs other than labour or materials arise during reconstruction, these costs would not be covered by the insurance policy, so the contractor, owner or developer would be required to pay out-of-pocket.

Determining soft costs
Recurring Costs – “Hard” costs versus “Soft” costs
Hard costs and soft costs are easily identifiable and included in most construction budgets. Where these costs differ is with respect to loss or damage. It is easy to understand that if the building is damaged by an insured, the peril to the materials and labour required for the reconstruction of the project will reoccur at roughly the same cost as the original price. The indirect or soft costs is a different story. The only costs in which insurance would apply are the “recurring” indirect costs.

For example, an entire shopping center is destroyed by fire near the end of construction. All of the concrete, framing, drywall, plumbing, fixtures and finishes (among many other supplies) will have to be purchased again and the labour costs of installing the various supplies will be covered by the insurance company as hard costs. But what about soft costs? The project owner will likely need to refinance the construction loan and incur additional commitment fees, other lenders fees, accounting and legal fees associated with the restructuring of the loan which are not part of the direct reconstruction of the project and thus not covered by the hard costs coverage. These additional costs or expenses represent recurring soft costs, and it is the recurring soft costs that need to be insured.

Often determining which specific indirect costs will recur can be a tedious exercise and, as a result, the construction industry has developed a general guideline of a minimum of twenty-five percent of total soft costs should be insured. Of course, this rule of thumb is not applicable in all scenarios and a more detailed analysis may be appropriate.

How to manage it
Insured should work with their insurance advisors to calculate appropriate limits of soft costs coverage on a case by case basis. “Industry standard ‘rule of thumb’ is to ensure 25 percent of total soft costs or 100 percent of recurring soft costs”. Your INTECH consultant can help identify soft costs that should be insured.[:fr]

What is it?
Construction projects are typically broken down into different categories of costs for the developer. The direct construction costs are the physical materials and supplies required to construct the building and labour costs to have the construction completed. These represent the hard costs of construction, implying these are the costs that do not change if the property had to be reconstructed – save for inflation or changes in contract and materials pricing.

Alternatively, soft costs are the expenses not directly incurred for the physical construction of the project. Typical soft costs include professional fees, financing costs (commitment letter fees, interest on loans, other lender fees), marketing, advertising, permits, realty taxes, workers overtime, lease renegotiation fees and accounting and legal expenses.

Why you need soft cost coverage
Traditionally, insurance is seen as repairing or replacing the physical building that is damaged. In construction projects, this reconstruction is easily identifiable in the project's hard costs. However, soft costs represent a significant expense to the project owner in the development of the project. As such, if the project is damaged these indirect expenses represent significant costs which are not considered in the hard costs of construction, and if not explicitly insured would not be covered by insurance.

Soft cost coverage is often misunderstood
It is commonly misunderstood that insurance companies will cover soft costs. But unlike standard commercial property insurance, most builder's risk policies do not include soft costs automatically. Thus, if any costs other than labour or materials arise during reconstruction, these costs would not be covered by the insurance policy, so the contractor, owner or developer would be required to pay out-of-pocket.

Determining soft costs
Recurring Costs – "Hard" costs versus "Soft" costs
Hard costs and soft costs are easily identifiable and included in most construction budgets. Where these costs differ is with respect to loss or damage. It is easy to understand that if the building is damaged by an insured, the peril to the materials and labour required for the reconstruction of the project will reoccur at roughly the same cost as the original price. The indirect or soft costs is a different story. The only costs in which insurance would apply are the "recurring" indirect costs.

For example, an entire shopping center is destroyed by fire near the end of construction. All of the concrete, framing, drywall, plumbing, fixtures and finishes (among many other supplies) will have to be purchased again and the labour costs of installing the various supplies will be covered by the insurance company as hard costs. But what about soft costs? The project owner will likely need to refinance the construction loan and incur additional commitment fees, other lenders fees, accounting and legal fees associated with the restructuring of the loan which are not part of the direct reconstruction of the project and thus not covered by the hard costs coverage. These additional costs or expenses represent recurring soft costs, and it is the recurring soft costs that need to be insured.

Often determining which specific indirect costs will recur can be a tedious exercise and, as a result, the construction industry has developed a general guideline of a minimum of twenty-five percent of total soft costs should be insured. Of course, this rule of thumb is not applicable in all scenarios and a more detailed analysis may be appropriate.

How to manage it
Insured should work with their insurance advisors to calculate appropriate limits of soft costs coverage on a case by case basis. "Industry standard 'rule of thumb' is to ensure 25 percent of total soft costs or 100 percent of recurring soft costs". Your INTECH consultant can help identify soft costs that should be insured.