Code-Ordered Demolition With No Ordinance or Law Coverage
Lakeview Office Partners owns a 1962 three-story office building insured under the Building and Personal Property Coverage Form with a $4,500,000 Limit of Insurance, an 80% coinsurance percentage, replacement cost valuation, Special Form causes of loss, a $25,000 deductible, and no ordinance or law endorsement. The building's replacement cost today is $6,000,000. A high-wind event tears off a roof section and rain damages ceilings and two floors; the repair estimate is $700,000. After inspecting, the city building official determines that the repairs exceed 50% of the building's assessed value and orders the entire building brought into compliance with the current code before a certificate of occupancy will be issued. Compliance requires a full sprinkler system, ADA restrooms and reconfigured stairwells - $900,000. The code also requires demolition of undamaged portions to build the new stairwells ($250,000) and permanently destroys the value of undamaged space on one floor ($400,000).
1. Ignore the code requirements for a moment and calculate what the policy pays for the $700,000 physical damage alone.
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Step 1 - Requirement. 80% x $6,000,000 replacement cost = $4,800,000.
Step 2 - Ratio. $4,500,000 / $4,800,000 = 0.9375.
Step 3 - Apply. 0.9375 x $700,000 = $656,250.
Step 4 - Deductible. $656,250 - $25,000 = $631,250.
The insured is $300,000 short of the coinsurance requirement, which costs about 6.25% of every covered loss. Note that the coinsurance base is the replacement cost of the whole building as it stood before the loss, including the undamaged floors - a point the insured will likely contest (see the third task). This figure covers only direct physical damage from the wind and rain; it does not include demolition, code upgrades, or the destroyed value of undamaged space.
2. Explain what the policy pays for the $900,000 code compliance cost, the $250,000 demolition, and the $400,000 lost value of undamaged space, and identify the endorsement that would have addressed the gap.
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All three items are excluded as written. The Special Form excludes loss caused by enforcement of any ordinance or law regulating construction, repair, demolition or use, and the resulting increased costs. The carrier pays to repair or replace with like kind and quality - a 1962 code-compliant configuration - not to build to today's code. So the payment stays at $631,250.
The gap is filled by an Ordinance or Law Coverage endorsement, which has three parts working together:
- Coverage A - Loss to the Undamaged Portion of the Building: pays the value of the portion destroyed by code-ordered demolition even though no physical damage occurred there ($400,000 here). It sits inside the building limit, which is why the building limit must include the full value of the undamaged structure.
- Coverage B - Demolition Cost: pays to tear down the undamaged remnants ($250,000 here), subject to its own scheduled limit.
- Coverage C - Increased Cost of Construction: pays the code-required upgrade differential ($900,000 here), subject to its own scheduled limit.
The lesson for the file: buying Coverage C alone is a common error. Without Coverage A, the insured has no payment for the destroyed value of the undamaged floor, and without an adequate building limit, Coverage A has nothing to attach to.
3. The insured argues that because one floor is being demolished for code reasons, the undamaged portion should not count toward the coinsurance base. Evaluate that argument and state how the analysis would change under actual cash value valuation.
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The argument fails. Coinsurance is measured at the time of loss, before the loss, against the replacement cost of all covered property. The undamaged floors existed and had value when the windstorm struck, and they form part of the exposure the insured was supposed to insure. A post-loss event - the building official's order, the demolition, the rebuild - cannot retroactively shrink the base. Accepting the argument would allow every insured to escape coinsurance whenever a code order followed a partial loss, which would defeat the purpose of the condition.
There is a separate reason the argument is unattractive for the insured: if the undamaged portion is excluded from the base, the required amount falls to 80% x roughly $5,600,000 (the building excluding the destroyed floor's $400,000) = $4,480,000, which would technically satisfy coinsurance and increase this payment - but the insured would then have no Coverage A payment for the $400,000 in lost value, a much worse trade.
If the policy had been written on an actual cash value basis, the coinsurance base would be depreciated ACV rather than $6,000,000, and the insured would likely clear coinsurance - but the loss payment itself would also be reduced by depreciation on a 1962 building.