Soft Costs: A Moving Target
Bill Wall, Director
Crawford & Company Technical Services
When Adjusters are asked to define costs in construction, the usual response is land, materials, labor, and equipment. Everyone recognizes these are all required elements to build a home or commercial project. Sounds like a great response. In the world of adjusting we refer to the aforementioned as “Hard Costs”. These costs are easily measured and are directly assignable to the job.
When the project is completed, you can visually see the building with all of the “Hard Costs”. However, there are costs that don’t really transfer once the project is completed. Where have these costs gone? Have they disappeared?
The term “Soft Costs” has been described by the insurance industry as a moving target. Of all of the elements of a Builders Risk loss, Delay in Completion and Soft Costs provide the most uncertainty for all parties.
As mentioned above, you can see the “Hard Costs”, as the building is comprised of the “Hard Costs”.
The Builders Risk Book[1] includes the following definitions from the Appraisal Institute as a starting point:
Direct Costs: Expenditures for the labor and material used in the construction of improvements; also called hard costs.
Included in this category are building permits; materials, products, and equipment; labor security and equipment used in construction; temporary fencing; material storage facilities, power line installation and utility costs; contractor’s profit and overhead, including supervision; insurance and performance bonds.
Indirect Costs: Expenditures or allowances for items other than labor and materials that are necessary for construction but are not typically part of the construction contract.
Included in this category are administrative costs; professional fees; financing costs and the interest paid on construction loans; taxes and builder’s or developer’s all risks insurance during construction; and marketing, sales, and lease up costs incurred to achieve occupancy or sale. These costs can vary by property type: also called soft costs.
The definition of Soft Costs (Indirect Costs) includes examples of Soft Costs; the list is not exhaustive. The description of potential Soft Costs is limited only by the types of costs actually incurred. Most, if not all, policies list many of the types of expenses in the policy or endorsement.
Soft Costs can include tangible items; however, most soft costs are intangible in nature. Tangible costs include equipment usage and management teams.
The key to defining Softs Costs is understanding these costs are not directly assignable to the project or job.
We have described above both Direct Costs and Indirect Costs. Most of the Indirect Costs are generally intangible in nature and thus Indirect Costs are referred to as “Soft”. The key is these costs are difficult to assign to a particular job because they are used across many jobs over long periods of time. The construction industry uses two types of cost to build a project.
(Policies require a direct physical loss resulting in a Delay in completion or direct physical loss of or damage to “covered property” before incurred Soft Costs are considered and paid.)
The line between what is considered Hard versus Soft Costs is gray, and different insurers may draw the lines in different places.
For instance, one Insurer has as Additional Coverage, Delay in Completion Expenses which includes four Soft Costs. Additional Interest, Additional Realty Taxes and other assessments, Necessary Additional Advertising and Promotional Expenses, and Additional Costs, such as additional license and permit fees, additional commission and legal fees resulting from the renegotiations, but not including rental discounts and rebates. Many Insurers have Delay in Completion Expenses Endorsements, which broaden the Soft Costs covered by the policy.
Another insurer requires a Delay in Completion Endorsement before any of the Soft Costs are covered under the policy. The Soft Costs are specified and include Interim Interest Expense, Realty Taxes/Ground Rents, Advertising Expense, Commission Expense, Architect/Engineer Fees, Project Administration Expense, Legal/Accounting Fees, Insurance Premiums and Project Administration.
Most builders risk policies will insure only those soft costs that (1) are specifically described, (2) are actually expended, (3) are deemed “necessary” (sometimes this term is also accompanied by “reasonable” or other selected language), and (4) would not have been incurred except for the delay.
Policies which have Delay in Completion and Soft Costs language embedded in the main policy form will have a minimum amount of coverage shown in the Declaration. A Delay in Completion Endorsement will generally show the limit and the deductible. Often the “Deductible Period” in the Delay in Completion Endorsement is 30 days, so none of the liabilities under the policy exist unless any one delay exceeds this period and exists only for each Delay that is in excess of this period, usually 30 days. Of course, the Deductible Period can be amended to less or more than 30 days.
When a construction project is delayed, overall project costs will increase. Reasons for the increase vary as project efficiencies diminish. The potential Soft Costs which can be included are myriad. There are many variations in the definition of “Soft Costs” coverage throughout the Insurance Industry.
While this article barely scratches the surface of Soft Costs, the adjuster should understand this coverage requires detailed investigation, review of documentation and communication with the Insured as this coverage has potential for conflict with the Insured(s), impacting the handling of the overall loss.
[1] Authors: Steven A Coombs, CPCU, ARM and Donald S. Malecki, CPCU
Bill Walls began his career as a Claims Adjuster in 1974 and has, throughout his 45 years of experience, handled Property and Liability losses around the Globe, managed Claims teams, and founded his own Adjusting Firm. Mr. Walls is now an International Executive General Adjuster and Director of Excellence with Crawford Global Technical Services. Should you have any questions about this article or would like more information about this topic, please contact Mr. Walls at e-mail William_Walls@us.crawco.com or call him at (303) 882-9907 .