Calculation of the deductible under a builder’s risk insurance policy. McDonnel Group, LLC v. Starr Surplus Lines Insurance Company, United States District Court for the Eastern District of Louisiana (2020), by Hugh Anderson

Summary: The McDonnel Group was the general contractor for the renovation of the historic Jung Hotel in New Orleans. McDonnel purchased a builder’s risk policy, expressly including flood insurance. Two years into the project, on August 5, 2017, a heavy rain caused $3.2 million in damage to the work in progress. McDonnel made a claim under the builder’s risk policy.

The policy had a total insured value of $86 million. However, flood damage under the policy was subject to a sublimit of $10 million. Several different deductibles applied to the policy, depending on the nature of the loss. For example, losses due to “Land Movement” were subject to a deductible of $100,000. “Water Damage” other than flood was subject to a $50,000 deductible. Both “Named Windstorm”—hurricanes—and “Flood” had deductibles of “5% of the total insured values at the time and place of loss subject to a $500,000 minimum deduction.”

At the time of the flooding the project was 80% complete. Based on that percentage, the insurance company (actually two insurance companies, each taking on 50% of the risk) calculated that the “total insured value at the time and place of loss” was $68.8 million: 80% of the total project value of $86 million. Continuing the arithmetic, the insurance company calculated that the deductible for flood damage was $3.4 million: 5% of $68.8 million. Because the deductible exceeded the damage amount ($3.4 million > $3.2 million), the insurance company denied the claim.

McDonnel argued that the calculation of the deductible should have been based on the $10 million sublimit available for flood damage, since as a practical matter this was the total insured value for the specific peril at issue. Under this analysis the deductible would have been $500,000, resulting in entitlement to $2.7 million in insurance proceeds, after application of the deductible.

Decision: The contractor took the dispute regarding the builder’s risk deductible to federal court. In a short decision, the court held that “the language of the Policies is clear and unambiguous.” The deductible was to be based on “total insured values” and that term as used in the builder’s risk policy was $86 million. The decision does not discuss the equities of the situation, or the reasonable expectations of the insured, because of the holding that the terms of the policy are unambiguous.

Comment: The general contractor has appealed the adverse district court decision to the U.S. Court of Appeals. According to reports, the contractor’s legal team, and the insurance broker that sold the policy, are taking the position that the impact of a sublimit on a percentage-based deductible is a novel issue of law that should be decided in favor of a comparably limited deductible.
The EJCDC builder’s risk provisions (see EJCDC® C-700 2018, Standard General Conditions of the Construction Contract, Paragraphs 6.04 and 6.05; and EJCDC® C-800 2018, Supplementary Conditions of the Construction Contract, SC-6.04) contemplate the possibility of sublimits for certain categories of loss (C-800, SC-6.04, Guidance Notes—Builder’s Risk Insurance Requirements, and SC-6.04.F.13).
The Guidance Notes also anticipate that there may be specific deductibles for specified categories of loss, and that some deductibles may be on a percentage basis:
The builder’s risk policies available for projects in coastal and
other high-risk areas may have special deductible provisions for
wind and flood damage (hurricanes), earthquakes, and other
specific risks. Such deductibles are determined based on a
percentage of the property value at the time of loss, rather than
being stated as a specific dollar amount. SC-6.04.H should be
revised to reflect coastal or other local conditions that change the
approach to deductibles. C-800, SC-6.04, Guidance Notes—
Builder’s Risk Deductibles.

EJCDC also advises in the same Guidance Note that it is common to leave the “establishment of deductible amounts to the discretion of the purchasing party, which is responsible for payment of the deductibles.” On the Hotel Jung project, the contractor purchased the builder’s risk insurance. The district court decision does not indicate whether the deductible amounts were specified by the owner, or negotiated by the contractor and the insurance company (via an insurance broker), or whether the implications of a 5% deductible for a high-value project were discussed or recognized.