Restoration Contractor Revenue and Profit Is Important If Policyholders Are Going To Get Quality Work

Chip Merlin | Property Insurance Coverage Law Blog | September 10, 2019

Steve Patrick is a guru for those estimating property insurance losses. He made a suggestion on Level The Playing Field, for a construction book, Markup & Profit: A Contractor’s Guide, Revisited. His suggestion caught my eye since Merlin Law Group keeps this work in our reference library. This book is an excellent reference which contractors, property loss estimators, and property loss adjusters can use to help when considering reasonable construction pricing.

Without proper pricing, many contractors will be tempted to skimp on skilled labor, quality materials or the time of labor to properly do the job. Yet, many insurance companies seem a lot more concerned about paying as little as possible rather than providing a sufficient amount of time or money to do a quality restoration.

From what we see in the field where insurance company and independent adjusters are evaluating the amount of the loss, insurers provide little time for their own adjusters to do a quality adjustment job. From what little they pay their front-line adjusters, insurance companies are being run by bean counters rather than servicing the product they sell. No wonder there is a war going on between restoration contractors and the insurance industry.

Another book which I purchased this Spring—and strongly suggest all owners of small roofing and construction companies should thoroughly read—is Profit First For Contractors. The book notes that the insurance industry’s insistence on 20% overhead and profit is a ridiculous standard and explains why from a purely economic analysis:

What are some of the commonly accepted industry standards that will drive your business into the ground?

A contractor is not supposed to charge more than 20% for overhead and profit.

Wrong. A 20% markup yields a 16.7% margin. If you have expenses of 20%, then you are making a-3.3% net profit, otherwise known as going out of business. Some healthy construction businesses could have expenses as high as 23% of total revenue. And in order to thrive, most construction businesses should be earning a 10% net profit. That’s a 33% margin (23% plus 10%). A markup of 50% produces a 33% margin. Imagine telling customers your markup is 50%. They would have a conniption.

If we the lawyers are studying these construction reference materials, I would suggest that it is probably a lot more important for roofers and contractors to do the same.

I have discussed the pricing issues in Restoration Contractors Providing Great Quality Workmanship Are Policyholder Friends But Many Insurance Companies Refuse To Pay For Quality. One problem is the suspect pricing which Xacitmate is using. Contractors, estimators, and public adjusters should be double-checking the pricing Xactimate is using against local and reasonable pricing. I would suggest those involved with property loss estimating also consider Getting the Xactimate Construction Price Right!

Entitlement to Overhead and Profit on an Actual Cash Value Estimate

Jason Cleri | Property Insurance Coverage Law Blog | December 10, 2017

In the New York class action suit, Mazzocki v. State Farm, 1 A.D.3d 9 (N.Y. 3rd Dept. 2003), the Appellate Court for the Third Department finally clarified the question regarding overhead and profit in actual cash value and replacement cost value claims.

Plaintiffs in the class action sustained storm damage to buildings on their respective properties and filed claims for the actual cash value of the damage under homeowner’s insurance policies issued by State Farm. State Farm then excluded overhead and profit expenses of a general contractor in calculating the actual cash value. Plaintiffs cited the loss settlement provision in the policy which read:

We will pay the cost to repair or replace buildings…subject to the following: (1) until actual repair or replacement is complete, we will pay the actual cash value of the damage to the buildings, up to the policy limits, not to exceed the replacement cost of the damaged part of the building. . . . Any additional payment is limited to that amount you actually and necessarily spend to repair or replace the damaged buildings. . . .

The issue raised by the Plaintiffs was whether State Farm’s refusal to include overhead and profit in its estimate of replacement cost in the first instance constitutes a breach of the terms of its policies. The court stated:

Actual cash value is payable regardless of whether the property is eventually repaired or replaced. Under New York law, “[t]he determination of actual cash value is made under a broad rule of evidence which allows the trier of fact to consider ‘every fact and circumstance which would logically tend to the formation of a correct estimate of the loss’” (Cass v. Finger Lakes Coop. Ins. Co., 107 A.D.2d 904, 905, 483 N.Y.S.2d (1985), quoting McAnarney v. Newark Fire Ins. Co., 247 N.Y. 176, 184, 159 N.E. 902 (1982).

The court determined that in applying the same logic as in Salesin v. State Farm Fire & Cas. Co., 229 Mich.App. 346, 367, 581 N.W.2d 781, 790 (1998), the term “replacement cost” – as opposed to “actual replacement cost” – in State Farm’s policies can reasonably be interpreted to include profit and overhead whenever it is reasonably likely that a general contractor will be needed to repair or replace the damage. Therefore, the court confirmed that Plaintiffs may bring a breach of contract action when overhead and profit is excluded from an estimate upon proof of the likely necessity of a general contractor’s services in the repair or replacement of their damaged property.

Is a Dispute Over General Contractor Overhead and Profit Appropriate for Appraisal?

Edward Eshoo | Property Insurance Coverage Law Blog | February 22, 2017

In Windridge of Naperville Condominium Association v. Philadelphia Indemnity Insurance Company,1 a federal district court in Illinois recently addressed the issue whether appraisal is appropriate to resolve a dispute over the need for a general contractor to perform repairs following a covered loss. There, hail damaged townhome buildings, requiring repairs. Philadelphia paid for losses it conceded were within the scope of the insurance policy’s coverage for hail damage. Philadelphia though declined to reimburse the Association for the overhead and profit charged by its general contractor in making the repairs. Philadelphia then refused to participate in an appraisal to resolve this dispute, prompting the Association to sue. The Association subsequently moved to compel appraisal, which the district court granted.

In seeking to avoid appraisal, Philadelphia argued that whether it must reimburse the Association for the overhead and profit charged by its general contractor in making the repairs is a coverage question not subject to appraisal. The district court disagreed. The Philadelphia insurance policy provided for appraisal if the parties disagreed as to the “amount of loss.” The district court reasoned that in calculating repair or replacement cost, it is necessary to assess what must be replaced or repaired, who is qualified to perform that work, and how much that work costs. That inquiry requires determining whether a general contractor is needed, in which case overhead and profit is part of the loss, or whether a single tradesman can do the work. The district court concluded that such determination is a question appropriate for appraisal.2

Insurers like Philadelphia routinely decline to appraise a dispute over general contractor overhead and profit, asserting in conclusory fashion that it involves a “coverage” question. Ten years ago, I wrote an article titled “Overhead & Profit: Its Place in a Property Insurance Claim,” which was published in Adjusting Today.3 As discussed in the article, the majority of courts have concluded that general contractor overhead and profit should be included in the cost of repair or replacement to arrive at an actual cash value estimate and settlement where the use of a general contractor is reasonably likely in repairing or replacing a covered loss, even if no general contractor is used or no repair or replacement is made.4

This is still the majority view today.5 Indeed, the district court in Windridge of Naperville implicitly recognized the majority view in its ruling. The district court noted that the policy’s “Loss Payment” and “Valuation” provisions obligated Philadelphia under certain circumstances to pay the cost of repairing or replacing the damaged property. The district court stated that if repairing or replacing the property requires a general contractor, then the cost of repair or replacement includes the industry-standard overhead and profit.6 No policy language suggested that if a general contractor is required, Philadelphia may decline to pay the overhead and profit component of a general contractor’s charges. According to the district court, the coverage question was clear: If a general contractor is required to repair or replace the damaged property, then Philadelphia must pay the overhead and profit components of the general contractor’s charges. The only disputed question is whether a general contractor is necessary to perform the repairs, or whether a single tradesman would suffice, which the district court concluded was a question appropriate for appraisal.7

So, when an insurer refuses to appraise a dispute over general contractor overhead and profit, know the reason for its refusal. On the one hand, if the insurer asserts that the insurance policy does not cover the cost of a general contractor’s overhead and profit, then that would be a coverage dispute for the court. On the other hand, if the insurer asserts that a general contractor is not needed to perform the repairs, which is the typical basis for declining appraisal, then that factual determination is appropriate for resolution by appraisal for the reasons stated by the district court in Windridge of Naperville. The nature and extent of the damage and the number of trades needed to make the repairs are key factors in determining whether use of a general contractor is reasonably likely.8 This requires consideration of the degree to which coordination and supervision of trades is required.9

Besides appraising the dispute over general contractor overhead and profit, the Association in the Windridge of Naperville suit also sought to compel appraisal to resolve a dispute over the cost of repairing physically undamaged sides of townhome buildings to remedy a mismatch with repaired damaged sides. The district court’s ruling on that issue will be addressed in my next blog post.
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1 Windridge of Naperville Condominium Association v. Philadelphia Indem. Ins. Co., No. 16-3860, 2017 WL 372308 (N.D. Ill. Jan 26, 2017).
2 Windridge, 2017 WL 372308, at **2-3.
3 Adjusting Today is a newsletter published by Adjusters International, Inc.
4 The minority view is that the cost of a general contractor’s overhead and profit is compensable only if it is incurred in repairing or replacing damaged or destroyed property. Even when incurred, insurers routinely deny payment for general contractor overhead and profit, contending that the repairs were not complex enough to warrant the use of a general contractor.
5 See, e.g., Trinidad v. Florida Peninsula Ins. Co., 121 So.3d 433 (Fla. 2013).
6 At the hearing on the motion to compel appraisal, the parties’ counsel explained that it is industry custom for a general contractor making repairs to charge “10 and 10,” or 10% for profit and 10% for overhead, on top of the amounts the general contractor pays to the subcontractors.
7 Windridge, 2017 WL 372308, at **2-3.
8 Many insurance companies’ claim handling practice is to include general contractor overhead and profit in the cost of repair or replacement in order to arrive at an actual cash value estimate and settlement when three or more trades are involved in the repair.
9 See, e.g., Mt. Bethel No. 1 Baptist Church v. Church Mut. Ins. Co., 2015 WL 12591682 (W.D. La.).