Robert Trautmann | Weber Gallagher Simpson Stapleton Fires & Newby
Builder’s risk insurance is a cornerstone of effective risk management in the construction industry. It offers protection against a variety of physical and financial risks that can impede the successful and timely completion of a construction project. Among the most critical concepts within builder’s risk coverage are the definitions and implications of “hard costs” and “soft costs.” These classifications not only influence how policies are underwritten and priced but also play a decisive role in how claims are evaluated and resolved.
For insurance professionals — whether underwriters, claims adjusters, brokers, risk managers, or legal advisors — understanding the nuances of hard and soft costs is essential. This article explores these two fundamental cost categories in depth, offering a comprehensive legal and practical guide tailored specifically for professionals in the insurance industry.
I. Overview of Builder’s Risk Insurance
Builder’s risk insurance, also known as course of construction insurance, is a form of property insurance specifically designed to cover buildings and structures while they are under construction. Its primary purpose is to protect against physical loss or damage to the insured project due to various perils, which can include fire, windstorm, hail, theft, vandalism, explosion, and in some cases, earthquake and flood (depending on endorsements or exclusions).
Builder’s risk policies can be written on a completed value basis or on a reporting form basis. A completed value policy provides coverage for the full value of the project at the time of completion, while a reporting form policy allows for periodic updates of the project’s value as construction progresses.
The insured parties under a builder’s risk policy may include:
- The project owner
- The general contractor
- Subcontractors
- Construction managers
- Architects and engineers (in some cases)
- Lenders or financial institutions providing funding for the project
Common provisions in builder’s risk policies include:
- Covered Property: Specifies the types of property that are insured, such as the building under construction, temporary structures, and materials on-site or in transit
- Covered Causes of Loss: Identifies perils that the policy protects against
- Exclusions: Lists perils and situations not covered by the policy, such as faulty workmanship, wear and tear, or certain natural disasters unless otherwise endorsed
- Valuation Clauses: Determine how losses are calculated — either based on actual cash value, replacement cost, or another agreed-upon value
- Time Element Coverage: This optional coverage addresses financial losses stemming from delays caused by a covered peril
Understanding the categories of hard and soft costs within this framework is crucial for accurately assessing risk and coverage needs.
II. Definition and Scope of Hard Costs
Hard costs, also known as “brick-and-mortar” or “direct” costs, represent the tangible expenses directly associated with the physical construction of a building or structure. These costs are usually the most visible and well-documented elements of a construction budget and are often the baseline for builder’s risk policy limits.
Examples of hard costs include:
- Construction Materials: Concrete, lumber, steel, glass, roofing materials, insulation, drywall, and other physical components used to build the structure
- Labor Costs: Wages, benefits, and payroll taxes for workers involved in the construction process
- Equipment Rental and Operation: Costs associated with leasing or operating cranes, bulldozers, excavators, scaffolding, generators, and other essential machinery
- Site Work and Preparation: Grading, excavation, demolition of existing structures, and soil stabilization
- Utility Installation: Connection of water, gas, sewer, and electrical services to the site
- Contractor and Subcontractor Fees: Payments made to general contractors and trade specialists such as electricians, plumbers, and HVAC installers
- Temporary Structures and Safety Measures: Fencing, signage, scaffolding, and safety barriers required for regulatory compliance and worker safety
Hard costs are typically well-supported by invoices, receipts, construction contracts, and project budgets. Because they are more concrete and less speculative, they are less likely to be subject to dispute in claims scenarios. However, challenges can arise when determining the exact replacement value or scope of loss following a covered peril.
III. Definition and Scope of Soft Costs
Soft costs, in contrast to hard costs, are indirect or ancillary expenses that are not directly tied to physical construction work but are nonetheless essential to the successful completion and operation of a construction project. These costs are particularly relevant when a project is delayed due to a covered loss, as they often continue to accrue during periods of inactivity.
Examples of soft costs include:
- Architectural and Engineering Services: Fees for redesign, re-inspection, or additional planning due to damage or delays
- Legal and Accounting Fees: Costs for legal representation, contract reviews, audits, and compliance with regulatory requirements
- Permit, Zoning, and Inspection Fees: Government-mandated expenses that may need to be renewed or extended if delays occur
- Financing Costs: Interest payments on construction loans, additional lender fees, and refinancing expenses incurred due to delays
- Real Estate Taxes and Utilities: Property taxes, utility bills, and maintenance charges that continue during periods of delay
- Marketing and Leasing Expenses: Costs associated with re-launching marketing campaigns or renegotiating lease agreements due to project delays
- Insurance Premiums: Premiums for extending insurance coverage due to construction delays
Unlike hard costs, soft costs can be more difficult to substantiate because they are often time-dependent and require careful documentation to establish causation. Coverage for soft costs is generally not included in standard builder’s risk policies and must be added via endorsement, with specific sub-limits, deductibles, and waiting periods.
IV. Legal Interpretation and Policy Drafting Considerations
Legal interpretation of hard and soft cost provisions in builder’s risk policies often hinges on the language of the policy and the factual context surrounding the claim. In cases of ambiguity, courts may interpret policy language in favor of the insured, following the principle of contra proferentem.
Key legal and drafting considerations include:
- Clear and Precise Definitions: Policies should explicitly define what constitutes hard and soft costs. Vague or undefined terms are fertile ground for disputes.
- Detailed Schedule of Values: Insureds should be required to provide a comprehensive breakdown of project costs, with clear distinctions between hard and soft components.
- Sub-limits and Conditions for Soft Costs: These provisions must specify applicable sub-limits, waiting periods (e.g., 30 days before coverage begins), and documentation requirements.
- Interplay with Delay in Completion Coverage: Some soft costs may fall under delay in completion or business income coverage. Coordination between these provisions helps avoid gaps or overlaps in coverage.
- Causation Requirements: Many policies require that soft costs be the direct result of a covered physical loss. Therefore, language addressing proximate causation is critical.
- Exclusions and Carve-Outs: Be wary of exclusions for consequential losses, which may inadvertently limit soft cost coverage.
Effective policy drafting demands collaboration between underwriters, brokers, legal counsel, and insureds to ensure that the policy accurately reflects the risk profile and intentions of the parties.
V. Claims Handling and Adjustment of Hard and Soft Costs
Handling claims involving hard and soft costs requires a nuanced approach. The process involves not only determining the scope of the physical damage (hard costs) but also assessing the financial ripple effects (soft costs) that follow a covered event.
Steps for claims adjusters include:
- Loss Assessment and Segmentation: Separately identify and assess hard and soft costs. For hard costs, conduct a site inspection and compare actual damage to the schedule of values. For soft costs, analyze the impact of delays and supporting documentation.
- Establishing Causation: Demonstrate a direct connection between the covered peril and the incurred soft cost. For example, show that additional interest expense resulted from a delay caused by fire damage.
- Waiting Periods and Sub-Limits: Ensure compliance with applicable waiting periods (often 30 days for soft costs) and verify that claimed amounts fall within policy sub-limits.
- Documentation Review: Request and analyze contracts, project budgets, loan agreements, financial statements, and revised project timelines.
- Engagement of Forensic Accountants: In complex cases, insurers may employ forensic accountants to calculate time-element losses and validate soft cost claims.
Soft costs require a higher burden of proof and may involve subjective assessments, which is why detailed recordkeeping and expert analysis are essential.
VI. Litigation Trends and Case Law Examples
Insurance claims involving hard and soft costs in builders risk policies often center on the interpretation of policy language, particularly regarding coverage for soft costs such as interest, taxes, and other financial losses. Courts frequently address whether soft costs are explicitly included or excluded, the scope of ensuing loss clauses, and the application of exclusions for consequential damages. Ambiguities in policy language often lead to disputes, with courts applying rules of construction to resolve them. These cases highlight the importance of clear policy drafting and the challenges in determining coverage for financial losses beyond physical damage.
- In Vision One, LLC v. Phila. Indem. Ins. Co., 174 Wn.2d 501, the Washington Supreme Court held that while the builder’s risk policy was an all-risk policy, it only covered physical losses to covered property. Soft costs, such as financial losses, were not covered unless explicitly included. The court affirmed that collapse damages were a covered resulting loss but rejected the insured’s claim for soft costs, as the policy did not extend coverage to financial losses.
- In RLI Ins. Co. v. Highlands on Ponce, LLC, 280 Ga. App. 798 on Ponce, LLC, the Georgia Court of Appeals found the policy provisions regarding soft costs and business income ambiguous. The court ruled that the ambiguity could not be resolved through rules of construction, requiring a jury to determine the scope of coverage. The case involved a fire at an apartment construction project, with the insurer disputing the extent of coverage for soft costs and business income beyond $100,000.
- In Seabury Housing Associates v. Home Ins. Co., 695 F. Supp. 1244, the U.S. District Court for Maine addressed a builder’s risk policy that did not expressly include or exclude soft costs coverage. The court found genuine ambiguity in the policy language and denied summary judgment on the issue of soft costs. The case also involved disputes over bad faith claims under Maine law, which the court partially resolved.
- In Hall Arts Ctr. Office, LLC v. Hanover Ins. Co., 327 F. Supp. 3d 979, the Northern District of Texas considered a builder’s risk policy covering soft costs such as interest payments, realty taxes, and insurance premiums. The court granted partial summary judgment to the insurer, finding that the policy’s definition of soft costs limited coverage to specific categories and excluded other financial losses. The case arose from water damage during the construction of an office building.
- In The Bartram, LLC v. Landmark Am. Ins. Co., 864 F. Supp. 2d 1229, the Northern District of Florida ruled that ensuing losses resulting from faulty workmanship were covered under the policy, while the cost to repair the faulty workmanship itself was excluded. The court also addressed exclusions for consequential losses, such as lost rents and loan expenses, and found that the soft cost endorsement provided limited coverage for additional expenses caused by delays.
- In Diamond Beach, VP, L.P. v. Lexington Ins. Co., 748 F. Supp. 2d 648, the Southern District of Texas held that supplemental soft costs sought by the insured were consequential damages explicitly excluded by the policy. The court granted summary judgment to the insurer, finding that the claimed costs were not caused by direct physical loss or damage to the insured property and fell outside the agreed period of indemnity.
- In Seattle Tunnel Partners v. Great Lakes Reinsurance (UK), PLC, the Washington Court of Appeals referenced Vision One in holding that delay costs were not covered under a general builder’s risk policy unless explicitly included. The court emphasized that soft costs, such as financial losses, were not covered unless specifically provided for in the policy
These cases collectively demonstrate the critical importance of precise policy language in builder’s risk insurance, especially concerning soft cost coverage. Insurance professionals must ensure that policies clearly define covered soft costs and that all parties seeking such coverage are appropriately named in the policy. Proper documentation and a clear understanding of policy terms are essential to mitigate disputes and ensure that claims for soft costs are appropriately addressed.
VII. Best Practices for Insurance Professionals
To mitigate disputes and ensure accurate coverage, insurance professionals should adopt the following best practices:
- Comprehensive Underwriting: During underwriting, require detailed project budgets that distinguish between hard and soft costs. Evaluate the project’s schedule, financing arrangements, and potential delay exposures.
- Tailored Policy Language: Use policy forms and endorsements specifically designed for the insured’s industry and project type. Avoid generic language that may create ambiguity.
- Soft Cost Endorsements: Where soft costs represent a significant exposure, include dedicated endorsements with clearly defined terms, covered items, and sub-limits.
- Educational Outreach: Inform clients and brokers about the distinction between hard and soft costs and the documentation needed to substantiate claims. Offer training sessions and written guidelines.
- Claims Preparation Protocols: Encourage insureds to maintain ongoing records, including updated project schedules, cost logs, and correspondence related to delays or damage.
- Early Legal Involvement: Engage legal counsel in complex claims early to ensure compliance with policy terms and preserve the insurer’s position in the event of litigation.
- Expert Involvement: Utilize forensic accountants, cost consultants, and construction experts to assist in quantifying damages and substantiating claims.
VIII. Emerging Issues and Future Considerations
The construction and insurance industries are undergoing rapid transformation, introducing new complexities into builder’s risk coverage.
- Green Building and Sustainability Costs: Costs associated with LEED certification, sustainable materials, and green technologies often fall outside traditional definitions. Insurers must consider how to address these in policy language.
- Smart Building Technologies: The installation of IoT systems, energy management software, and other digital infrastructure adds new categories of costs that may blur the hard/soft cost distinction.
- Force Majeure and Pandemic-Related Delays: The COVID-19 pandemic raised new questions about the scope of delay coverage and the insurability of pandemic-related soft costs. Insurers must review their policy language in light of ongoing public health and economic uncertainties.
- Data-Driven Claims Analysis: Increasing use of construction management software, AI-powered risk tools, and digital recordkeeping allows for more precise loss tracking—but may also create data privacy and cyber liability concerns.
- Climate Change and Natural Catastrophes: Increased frequency of catastrophic events necessitates reevaluation of risk assessments, especially regarding delay-related costs and time element exposures.
Conclusion
The distinction between hard and soft costs in builder’s risk insurance is fundamental to effective policy design, underwriting, and claims handling. For insurance professionals, fluency in these concepts enables better client service, reduced claims disputes, and improved legal defensibility.
By employing clear definitions, robust documentation practices, and proactive legal and underwriting strategies, insurers can provide comprehensive protection that reflects the evolving needs of modern construction projects. As the construction and insurance landscapes continue to change, a commitment to continuous learning and adaptation will ensure builder’s risk insurance remains a vital tool in managing project risk and supporting successful development outcomes.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.