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

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

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

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

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

Profit is defined by Mr. Wells as a positive return on investment. In building construction, remodeling, or reconstruction, it is the fee charged by a general contractor for construction services provided.

The FC&S editors generally have taken the stance that O&P is a part of replacement cost and, thus, should be included in the replacement cost calculation, which then is depreciated to an actual cash value amount.

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

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

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

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

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

The insurer deducted 20 percent for O&P from its initial payment, and Mee subsequently presented a claim for this 20 percent. The insurer requested the name of the general contractor who would be doing the repairs, indicating that the information was needed as a basis for the payment. Mee sued, and the trial court granted summary judgment in favor of the insurer. Mee then appealed, arguing that general contractor O&P should be paid “automatically and unconditionally” whenever more than one construction trade would reasonably be required.

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

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

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

The three-trades threshold is a reasonable construction standard, but we don't think it can be used exclusively to decide whether O&P should be paid. The individual facts of a case may dictate otherwise, especially when an insured has paid additional premium for a replacement cost policy.

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