Big Money Losses and the 50% Rule. Law & Ordinance Explained
by Charles R. Tutwiler on 7/17/2017
Almost two months into the 2017 hurricane season, most of the pundits have upgraded the likely number of tropical storms we can expect in the Atlantic basin this year. Of course, these experts can never tell us when and where the storms will impact a particular geographic area, but what we all can do is prepare as best we can based on the location of the property at risk. Just as the mantra for successful real estate investment is location, location, location the same applies in a disaster recovery plan. Know your location, the risk you are exposed to and understand the exposure you are facing.
A recent engagement our firm received last month helps to highlight an issue that is not given a lot of publicity. So I’d like to share information on what could become a very large financial loss for property owners who may not be insured for it. A commercial client who owns a hotel on the beach had the misfortune of experiencing a very bad fire. While working this loss it reminded me of the exposure property owners with older properties are facing. In addition to the lost business income and facing a lengthy restoration process, the property owner is also facing what many will see as cruel repair and restoration regulations; namely the 50% rule.
The reason for this is that if your property (be it commercial or residential) suffers a loss where the cost of repairs is greater than 50% of the pre-loss value of the real property, your repairs must incorporate current building code upgrades. For properties in flood zones (as is the case with our new client) the code upgrades will include among many other building items, elevating the property to current FEMA height requirements. These regulations are adopted by communities who want their citizens to be able to buy flood insurance. By raising properties to a higher evaluation, the Federal government hopes to reduce or eliminate future flood claims.
To accomplish this code requirement, the building has to be raised up on pilings or torn down and rebuilt to current height requirements. While the peril(s) that caused this code requirement i.e. wind, fire, or water may be covered by a property insurance policy, the cost to elevate the property will not be covered, nor will the cost to rebuild to current code UNLESS you had the foresight to buy what is called LAW & ORDINANCE (L&O) coverage. Note that there is very limited law & ordinance coverage in a standard flood policy which folks in Super Storm Sandy found out. Coverage for the law & ordinance exposure is extremly valuable for property owners who hope to rebuild at their current location. Without it, any difference in cost will have to be paid out-of-pocket by the property owner. Unfortunately for Super Strom Sandy victims this was a very unpleasant surprise when they got their “settlement checks” from insurance companies which proved to be woefully inadequate when faced with code compliance issues. The bad news came from the building officials when property owners took their estimates from the adjusters down to apply for building permits.
How big is this problem in Florida? My guess given all the buildings built along beaches and channels that pre-date the FEMA flood program (NFIP- vintinage1968) will be huge. Just take a drive around beach and waterfronts along any coastal area of Florida and note all the properties built on-grade with ground useable space being lived in or businesses occupying store fronts on ground levels.
So, what’s the solution? In the residential market, if you have an admitted carrier you likely will have an additional 25% of Coverage A (Building) for L&O coverage built into the policy. Additional L&O coverage can be purchased. So homeowners need to have a conversation with their agents regarding this very important additional insurance coverage. For commercial properties this coverage is expensive and if older buildings are in the hazard zone it may not be available. Whatever your situation, now is the time to discuss exposure with your insurance agent or broker. Another source is your financial adviser, banker, CPA, etc. as a plan may need to be in place to budget for expected costs to comply with current codes should you lose your grandfather status due to a casualty event.
As to our client on the beach, well they had a very good broker and it did not hurt that they have hundreds of properties scattered across the county. The result was that this broker secured an umbrella policy full of outstanding property insurance coverage, which included Law & Ordinance coverage for this fire location. While this loss is still under the adjustment process we anticipate good results for this policyholder given the coverage the broker put in place before the loss.
Finally, the tragic London high rise fire where 80 plus people lost their lives struck a note in Florida on the law & ordinance issue. As you can read, Scott sides with safety following London fire, Florida has been kicking the can down the road for years on a requirement that condos needed to retro fit their buildings with sprinkler systems. Governor Scott selectively pushed that issue to the forefront as he is now requiring older buildings to comply with building code requirements for sprinkler systems. Good move!
Make no mistake about it; this will be a very costly endeavor especially if condominiums are damaged from a hurricane this season. They will bear the financial brunt of this bill. The long and short of this is that building officials will require sprinkler systems to be installed during the repair process. While insurance may cover the cost of repairs for wind damage, it will not pay for code upgrades such as a new sprinkler system unless there is Law and Ordinance coverage in the policy “for the peril” that caused the loss. No doubt this will be a big issue if the State is hit with a big hurricane. Policyholders should be on-guard of some bad apples in the representative business making promises that if you just sign their contract they will get you money to cover this expense.
Let us know what you think.