Many of the questions coming to FC&S deal with whether ornot overhead and profit (O&P) should be paid on a loss whenless than three trades are involved. Others deal with whetherO&P should be deleted in its entirety from an actual cash valuesettlement under a replacement cost policy. Still others havedifferent twists, but all of them focus on insurer guidelines forhow O&P should be treated when adjusting claims.

For example, a Wisconsin subscriber phrases it this way:

I have studied case law until I am blue. This is a questionabout the present view of the courts regarding overhead and profitdue a general contractor. Is a true GC entitled to O&P if morethan three trades are involved? I have a number of adjuster scopesthat include it in the homeowner's scope of damages and I have manythat do not include it in the same situation, maybe homes on thesame street.

Another subscriber zeroed in on the question a bitdifferently:

To receive overhead and profit, must the homeowner hire only aCGC and not a CC? If the homeowner hires a contractor that only hasa county license, is he entitled to overhead and profit?

And yet a third, from an adjuster with an independent adjustingcompany, added another spin on the question of overhead and profit,this time asking whether a general contractor who also was theowner should receive overhead and profit payments under a builder'srisk policy:

A fire loss occurred under a builder's risk policy. The insuredconstructed the dwelling as a general contractor, but he also isthe owner. Is the insured entitled to overhead and profit if hereconstructs the dwelling post loss?

Before discussing this issue, let's take a moment to outlinejust what O&P entails. According to the glossary in the book,Insuring to Value, 2nd Edition, which was written by MSB presidentPeter M. Wells, there are two types of overhead: general overheadand job-related overhead.

General overhead relates to a broad variety of costs typicallyinvolved in doing business, such as office staff, office rent,office supplies and equipment, sales, marketing and advertisingcosts, and finance charges. Job-related overhead refers to costsother than labor and material costs that are directly related to aspecific project, such as building permits, fees and inspections,utility hook-up charges, construction drawings (blueprints),surveys, erosion control (silt fences, etc.), constructiondriveway, culvert or curb cut, interior cleaning of the buildingprior to occupancy, and site security.

Profit is defined by Mr. Wells as a positive return oninvestment. In building construction, remodeling, orreconstruction, it is the fee charged by a general contractor forconstruction services provided.

The FC&S editors generally have taken the stance thatO&P is a part of replacement cost and, thus, should be includedin the replacement cost calculation, which then is depreciated toan actual cash value amount.

Particularly in cases in which the insured owner is acontractor, we don't believe it should be automatically subtractedin a settlement. In responding to the inquiry from the independentadjuster about a contractor who rebuilt his own building, wesaid:

It is our opinion that overhead and profit should be included inthe replacement cost payment to a general contractor who rebuilds astructure he owns after it is destroyed by a covered cause of loss.After all, the contractor in such a situation loses the opportunityto earn overhead and profit on another job, which must be foregonein order to rebuild this structure.

A 2006 case from the Pennsylvania superior court, Mee v. SafecoIns. Co. of America, analyzes a similar question of whether aninsured was entitled O&P when the insured repaired the damagehimself. In that case, the insured owner was not a contractor, butthe court still felt he should be able to recover O&P.

The court emphasized that the insured had paid a higher premiumfor replacement cost coverage, which entitled him to O&P whenuse of a general contractor would be reasonably likely, even if nocontractor was used or no repairs made.

The following class-action suit for breach of contract and badfaith involved a replacement cost policy covering the dwelling ofJames Mee. The policy defined actual cash value as “the cost ofrepairing the damage, less reasonable deduction for wear and tear,deterioration, and obsolescence.”

The insurer deducted 20 percent for O&P from its initialpayment, and Mee subsequently presented a claim for this 20percent. The insurer requested the name of the general contractorwho would be doing the repairs, indicating that the information wasneeded as a basis for the payment. Mee sued, and the trial courtgranted summary judgment in favor of the insurer. Mee thenappealed, arguing that general contractor O&P should be paid“automatically and unconditionally” whenever more than oneconstruction trade would reasonably be required.

The Mee court referenced another case from the PennsylvaniaSuperior Court, Gilderman v. State Farm Insurance Co. As referencedin the Mee case, the court explained that the issue in Gildermanwas “whether an insurer, which has agreed to pay repair orreplacement costs less depreciation in advance of actual repair orreplacement of a covered loss, may automatically withhold bothdepreciation and a flat 20 percent” for contract O&P in itsadvance payment.

The court said the answer to this question rested on whether useof a general contractor was “reasonably likely,” which was aquestion of fact for a jury to decide. The Gilderman courtestablished an objective standard by which an insurer coulddetermine, “on a case-by-case basis,” whether to pay O&P.

Using this logic, the Mee court said the operative issue was thereasonable likelihood of a general contract being used, not whetheror not the homeowner did the work himself. As a practical matter,adjusters tell us that several software programs use theconstruction standard of three trades as a rule of thumb on thepayment of O&P. But nowhere in any insurance policy have weever seen these specific words.

The three-trades threshold is a reasonable constructionstandard, but we don't think it can be used exclusively to decidewhether O&P should be paid. The individual facts of a case maydictate otherwise, especially when an insured has paid additionalpremium for a replacement cost policy.

Diana Reitz, CPCU, is editorial director of Fire, Casualty& Surety Bulletins. She may be reached [email protected].