1. In Evolution There Is Conflict

June, 2010

On January 20, 2009, President Barack Obama, in his inauguration speech said: “We will harness the sun, the winds and the soil to fuel our cars and run our factories. All this we can do! All this we will do!” Whether or not you doubt climate change — the effects of carbon dioxide emissions and the loss of atmospheric ozone — the erection of sustainable “green” buildings is a prominent focus of the Commander In Chief.

It is a great credit to the insurance industry and its members that they are supplying an insurance product to meet the needs of those who choose to erect and maintain green buildings. On this course, our understanding of humanity’s interaction with the environment is certain to expand, while the examination of expenditures furthering environmental goals is certain to become a part of first-party property loss adjustment procedures.

The insurance industry is responding to meet the needs of the environmentally conscious individuals who desire insurance coverage that encourages green construction following an insured loss. Just as the 1980s introduced loss adjusters to various environmental concerns and a new vocabulary involving the EPA and Superfund sites, the new green building forms introduce us to the USGBC, LEED Certification, and the International Energy Conservation Code and the accompanying lexicon. Green building coverage will also introduce an additional level of complexity to property loss adjustments.

The new green coverage is generally available as an endorsement to existing property policies that provide for replacement cost coverage. The green coverage is an enhancement that provides a sublimited amount of money to upgrade the replacement of damaged covered property using green materials, equipment, or techniques.

The green building enhanced coverage is limited to specific property. It does not apply to all property — excepting process and production equipment, for example. However, the new green forms may expand the property insured clause to include rainwater recovery systems with the accompanying underground piping and storage facilities. As we discuss later, there are many additional considerations that go into shaping the new green building forms including:

• The expansion of the property insured clause;
• The designation or definition of “green”;
• The determination of what is the appropriate green repair or replacement;
• The rating authority guidelines that should be employed;
• The integration of the green enhancement endorsement into the basic policy terms and sublimits;
• The scope of the recoverable loss;
• The interaction of the green endorsement with the law and ordinance exclusion or the law and ordinance extension of coverage; and
• The interaction of the green endorsement with any “pollution” exclusion within the policy. Before discussing the green coverage it is helpful to have a basic understanding of the use of the term “green” or “sustainable building.”

GREEN BUILDING BASICS

The environmental performance of a building throughout its life forms the core of the green assessment process. The various proposed or adopted standards governing “green” focus on considering the building project and its various components on a full lifecycle basis. “This “cradle-to-cradle” approach, known as ‘green’ or ‘sustainable’ building, considers a building’s total economic and environmental impact and performance, from material extraction and product manufacture to product transportation building design and construction, operations and maintenance, and building reuse or disposal.” Sustainable Building Technical Manual, Green Building Design, Construction, and Operations, U.S. Green Building Council, 1996, available at www.usgbc.org/Docs/SBTM/intro.pdf. A green building evaluation will consider such things as site planning, water management, energy performance, material usage, and indoor environmental quality (including life and air quality). In the words of the U.S. Green Building Council (USGBC):

“Successful sustainable design requires an integrated approach; green building systems and operational practices are dependent on siting, solar access and light penetration, architectural design, and product specification. Green buildings must take all of these factors into consideration on a ‘whole-building,’ integrated basis. This approach is not linear; rather it is circular and multi-dimensional.”

Id.

USGBC

The USGBC was formed in 1993 as a 501(c) (3) nonprofit organization. The mission of the USGBC is “[t]o transform the way buildings and communities are designed, built and operated, enabling an environmentally and socially responsible, healthy, and prosperous environment that improves the quality of life.” See USGBC, Who Do we Think we Are? available at www.usgbc.org/ShowFile.aspx?DocumentID=2069. The organization realized the need to define and measure a “green building.” A diverse committee was formed composed of a cross-section of people and professionals to formulate standards to measure a green building. The result was the LEED Green Building Rating System. The USGBC says, “[t]he LEED Green Building Rating System is the national benchmark for high-performance green buildings”; although, as discussed herein, LEED is not the only green rating system competing for recognition as authoritative. Id.

LEED

LEED is a registered trademark of the USGBC. It stands for Leadership in Energy and Environmental Design. As published the LEED Standards are not a building code; they are consensus-based, yet the LEED Program provides for third-party verification based upon information submitted for evaluation by an independent body, the Green Building Certification Institute (GBCI). The GBCI, established in January 2008, provides third-party project certification and professional credentials recognizing excellence in green building performance and practice. There are four levels of LEED: LEED Certified; LEED Silver; LEED Gold; and LEED Platinum, the last being the highest level of achievement.

The LEED rating systems apply to specific building typologies, sectors, and building design and project scopes, including: LEED for Core & Shell; LEED for New Construction; LEED for Schools, LEED for Neighborhood Development; LEED for Retail; LEED for Healthcare; LEED for Homes; and LEED for Commercial Interiors. LEED 2009 For Existing Buildings Operations And Maintenance, Introduction, I. LEED Green Building Rating System, p. xiii, USGBC, available at www.usgbc.org/ShowFile.aspx?DocumentID=5545.

The LEED evaluation looks at a variety of buildingproperties and considerations that generally are not factors considered by a first-party property adjuster in the measurement of the cost to repair or replace damaged property under typical first-party property policies. For example, the LEED Evaluation will consider reduced site disturbance, storm water management, heat island reduction, light pollution reduction, water efficiency, water efficient landscaping, innovative waste water technologies, optimizing energy performance, ozone protection, performance measurement, toxic material source reduction, construction waste management, sustainable cleaning products, and occupant recycling.

The LEED 2009 rating system allocates points and credits based on the potential environmental impacts and human benefits with respect to a set of categories. The allocating process is called credit weighting. The LEED 2009 Standards also use the EPA’s TRACI environmental impact categories as the basis for weighting each credit. The LEED 2009 also considers the weightings developed by the National Institute of Standards and Technology (NIST). The LEED Credits are worth a minimum of one point. The 2009 LEED rating systems employ 100 base points, with 10 additional points available. The LEED 2009 rating system represents a “significant change” in allocation of points compared with previous LEED rating systems. The changes are intended to increase the relative emphasis on the reduction of energy consumption and greenhouse gas emissions associated with building systems, transportation, the embodied energy of water, the embodied energy of materials, and where applicable, solid waste. Id. at xiv. LEED v3 was launched on April 27, 2009 and the LEED 2009 Standards apply to projects submitted after June 27, 2009. See USGBC Web site: http://www.usgbc.org.

Other Approaches

There are numerous other groups that purport to rate performance of materials and equipment as well as provide guidance relating to sound environmental practices. See, Appendices, 1. Resources for Local Government, Sustainable Building Technical Manual, Green Building Design, Construction and Operations, USGBC, available at www.usgbc.org/Docs/SBTM/sbt.pdf. See also, 2009 International Energy Conservation Code; http://www.usgbc.org.

Independent of the USGBC and LEED, international code officials recognized the need for a modern energy conservation approach to the construction of buildings. The 2009 International Energy Conservation Code (IECC) was designed to meet the needs of environmentally conscious authorities. This comprehensive energy conservation code establishes minimum regulations for energy-efficient buildings using prescriptive and performance-related provisions. The 2009 edition of IECC represents a revision of the first edition of 1998, which was based on the 1995 edition of the Model Energy Code promulgated by the Council of American Building Officials (CABO). The IECC is available for adoption and use by jurisdictions internationally. See 2009 International Energy Conservation Code.

Local and national authorities can also implement green practices through laws, voluntary inducements, and other various vehicles. For example, the City of San Francisco has engaged in a series of well-publicized initiatives to foster green construction. As discussed later herein, the City of Albuquerque adopted several ordinances that are the subject of legal challenge relating to their application, including questions relating to whether federal law preempts the application of the city ordinances — specifically the Energy Policy and Conservation Act (EPCA), 42 U.S.C. §6201 et seq., as amended by the National Appliance Energy Conservation Act (NAECA), Pub. L. No. 100-12 (1987), and the Energy Policy Act of 1992 (EPACT), 42 U.S.C. §§6311-17.

Property Insurance Coverage For Non Green-Certified Buildings

To initially qualify for the green building policy endorsements many insurers impose certain basic prerequisites. The basic requirements are:

• The property policy must insure on a replacement cost coverage basis;
• The real property must be valued on a replacement cost basis, utilizing 100 percent of the values;
• The coverage may be offered on a blanket basis but values for each location must be identified at 100 percent.

The foregoing requirements are also true for personal property and time element coverage. Each insuring company may also impose its own prerequisites specific to the offered coverage.

Coverage For Non Green-Certified Buildings

Basic first-party property building replacement cost forms may be upgraded to indemnify for the additional costs to repair utilizing green materials or components following a covered loss. A monetary sub-limit is typically set for the increased incremental cost for the installation of green materials or components based on the expectation that the new green components will be more expensive than the “as was” or “like kind” replacement.

An insuring provision for a basic green endorsement might provide as follows: “We will pay the increased cost to replace such damaged or destroyed property with products or construction materials of otherwise equivalent quality and function existing at the time of loss, that meet the requirement of the green rating authority.”

Some examples of the available green upgrades include the following:

• Paint, carpeting, and furniture employing green materials;
• Replacement of equipment, appliances, or fire extinguishing systems that reduce the consumption of CFCs or HCFCs or otherwise meet green standards on the basis of chemicals consumed or used;
• Installation of all types of equipment, including office, commercial cooking, laundry, and electronics that will reduce energy consumption. This could also include lighting;
• Replacement of various elements of interior (and possibly exterior) plumbing systems that improve the efficiency of water usage, including waterless urinals, sensor-activated urinals and faucets, dual-flush toilets, flow restrictors, and localized hot-water heaters; and
• Replacement of roof materials with qualifying green materials.

The terms “green” or “green materials” are typically defined in the green policy endorsement as materials, equipment, and construction that meet the USGBC, LEED, or Green Building Initiatives “Green Globes” standards. (Green Globe International, Inc. is the majority owner of Green Globe, Ltd., a British company that owns the Green Globe brand, the premier international brand for sustainable travel, tourism, and related green businesses.)

The definitions adopted by U.S. Department of Energy and the EPA may also be included by reference to the “Energy Star” program and the SNAP program (Significant New Alternatives Policy, i.e., the EPA’s program to control ozone-depleting chemicals). The policy definition section may also include the generalization “or such other similar standards.” This phrase expands the definition to include standards similar to those of the USGBC or LEED. For policy interpretation purposes the phrase (without limiting language otherwise appearing in the endorsement) may create the potential for differing views about which standard controls the rebuild, and the concomitant additional expenses involved to meet the more restrictive standard.

The basic green building enhancement coverage may also include:

• The extension of the debris removal clause to cover additional expense of recycling;
• Compensation for the purchase of power or water if the existing building had features that generated power or reduced water consumption; and
• Compensation for loss of income if the building had features that allowed it to sell power to the electric grid.

Certified Green Building Property Coverage

When coverage is sought for buildings that have already been certified as “green” before or at the time of underwriting, some insurers provide additional coverage for existing green building characteristics that might not have been covered under traditional building replacement cost property forms indemnifying on the basis of “as was” or “like kind” replacement. In contrast, the additional coverage can extend to:

• Construction practices such as vegetative roofs;
• Professional expenses to hire a LEED Accredited Professional (LEED AP) to oversee repair or reconstruction. (The LEED accreditation is acquired after passing a standardized test in conjunction with satisfying the GBCI that the individual has the knowledge and skills to steward the green building certification process);
• Additional debris removal expenses to compensate for recycling expenses;
• Expenses to purchase power and water from outside sources where the building was otherwise self sufficient;
• The loss of income for sale of power to the electric grid;
• Rebuilding costs to comply with the most current green standard required by existing law or ordinance.

The coverages may be limited to those buildings that are certified as green by the USGBC or the Green Building Initiative. Once again, insurers require that the building will be insured on a full 100 percent replacement cost basis.

Additional Green Coverages

Green construction creates some unique issues that present the opportunity for insurers to expand the scope of the offered coverage. One does not need to be a great prognosticator to see that many current “unique” features of green construction may become the norm for future generations. However, some additional areas where green coverage is currently offered include the following.

Building Commissioning Expense Coverage

This coverage provides indemnity for the costs of building commissioning to oversee the repair and reconstruction of a covered system following an insured loss. This coverage may include the costs and expenses for an engineer or architect to assure that the building will be accredited by the green rating authority.

Commissioning expense is intended to see that the building works as a single system as designed to deliver the performance the owner anticipated. Generally, commissioning ensures that all of the components of the building work together rather than against each other (the systems include building envelope, HVAC, electrical and plumbing). A typical problem is that an HVAC system is out of balance and therefore inefficient. Some aspects of commissioning include, but are not limited to:

Alternative Power Generating Equipment

Specific property can also be identified as covered under the new green building forms. In this regard, the green form may specifically recite that “alternative power generating equipment” is covered. Practicing property law traditionalists might see this as an expansion of the property form to include elements of basic boiler and machinery coverage. Alternative power generating equipment can also be defined to include:

Alternative Water Systems

Alternative water systems are also a popular description that may be included in green coverage. This additional description may include both above- and below-ground equipment, pipes, reservoirs, tanks, etc. In contrast, the basic first-party property form would likely exclude underground pipes and tanks. The water system coverage may also specifically include waste water or “brown” water recovery systems.

Vegetative Roofs

For a wide variety of reasons, vegetation on top of a roof has received particular study, including but not limited to issues relating to: the additional weight of the soil; the potential for water seepage and/or collapse owing to clogged drains; and fire spread issues relating to dead foliage. Coverage for vegetative roofs also presents unique issues relating to the particular configuration of the roof, the type of foliage planted, and the location of the building within its environs. When vegetative roofs are specifically covered, the policy is also likely to include specific exclusions for loss caused by or resulting from disease, dampness and dryness, changes in temperatures, insects, rodents, birds, animals, rain, snow, frost, sleet, sand, or dusts.

Green Fees

The USGBC now requires that projects be registered and certified through the GBCI. Registration and certification fees may be covered by the new green enhancement coverage to the extent that registration and certification are required by the related green rating authority. The GBCI charges both project registration fees and certification fees, which are dependent on a variety of factors.

Recycling Expenses

Recycling expenses can include the costs to deliver the debris to a recycling center as well as the recycling costs for the debris. Costs to separate materials during the course of demolition at the site may also be covered.

Flush Out Coverage

Flush out coverage is also available to pay for reasonable and necessary expenses incurred to flush out the reconstructed space with 100 percent outside air through new filtration media following the reconstruction in a manner consistent with the procedure specified by the green rating authority.

Green Financial Incentive Loss

Green financial incentive coverage is available to pay for loss of specific financial incentives that accrued to the insured as a direct result of green upgrades made by the insured to the subject property. The financial incentives may include tax discounts or favorable tax rates provided by a government body, utility discounts or favorable utility rates, and loan discounts or favorable loan financing rates accorded by lending institutions.

Business Income Indemnity Period

When business income or business interruption coverage is provided, the new green building forms extend the period of indemnity for the additional length of time necessary to restore the damaged property utilizing otherwise covered green materials or equipment. Some forms recite that the period of indemnity will be extended to include such time as is necessary to obtain recertification of the property as green. At present LEED does not require recertification of property owing to a casualty loss, including any otherwise insured first-party property loss. The entire process of recertification is being studied by the USGBC.

GREEN BUILDING COVERAGE IN PERSPECTIVE

A good way to understand green coverages is to analyze them in light of historic first-party property issues.

Replacement Cost Is More Than Actual Cash Value Indemnity

The Indiana Supreme Court in Travelers Indemnity Co. v. Armstrong, 442 N.E.2d 349 (Ind. 1982), provided in its own words an admittedly overly simplified explanation of property insurance coverage saying:

“The insurance industry provides two distinct types of casualty protection for dwellings. One insures to the extent of the ‘actual cash value,’ i.e., the diminution in value; and the other insures to the extent of ‘the full cost of repair or replacement without deduction for depreciation,’ i.e., without regard to whether or not the restoration results in an enhanced value to the premises.”

Id. at 352.

The Court later noted that the difference between “actual cash value” coverage and coverage for “the full cost of repair or replacement without deduction for depreciation” is not only linguistic, but also that each provides a different practical result. While confirming that an actual cash value policy is a pure indemnity contract, the court noted that the cost of repair may exceed the fair market value of the building, and in the case of a very old or obsolescent building, the difference may be very substantial. The Court observed that: “When the insurance industry adopted a standard extension of coverage endorsement to provide replacement cost, it took into account the one great hazard in providing this kind of coverage: the possibility for the insured to reap a substantial profit, if fire occurs.” Id. at 353 (citations omitted). In recognition of this hazard, the insurance companies included language that limits recovery to actual cash value loss until the insured actually replaces the property before the insured can obtain recovery for the full extent of replacement cost coverage. The insurance industry as a whole accepted that the replacement cost coverage would result in the betterment as outlined above by the Travelers court.

Presumably each insurer offering the upgraded green coverage has taken into account the potential hazard that an insured will benefit by the green upgrades. Affording green building upgrade coverage is a socially acceptable and commendable direction for the insurance market. Unlike the analysis between replacement cost coverage and actual cash value coverage that focused on the “as was” physical damage repair of the damaged property, the new upgrade coverage expands recovery predicated on that which is green and desirable under goals established by authorities (either code authorities or consensus groups) as opposed to focusing solely on replacement of the specific property that was lost or damaged. The focus of the enhanced coverage is to permit compensation for a desirable green end product. The new green endorsements address the “profit hazard” by requiring that the green replacement occur before payment for the enhanced coverage loss.

Defining The Scope Of Replacement Cost Coverage

Despite the rather clear statements of the Indiana Supreme Court in the Travelers case and other similar decisions, numerous cases have been litigated by insurers to protect the parameters of replacement cost coverage. See, Leo John Jordan, What Price Rebuilding? A Look At Replacement Cost Policies, 19 The Brief 17 (Spring 1990); Johnny Parker, Replacement Cost Coverage: A Legal Primer, 34 Wake Forest L. Rev. 295 (1999); Randy R. Koenders, Construction And Effect of Property Insurance Provision Permitting Recovery of Replacement Cost of Property, 1 A.L.R. 5th 817 (1992); J. A. Tyler, Test or Criterion of “Actual Cash Value” Under Insurance Policy Insuring To Extent of Actual Cash Value at Time of Loss, 61 A.L.R.2d 711.

One of the more publicized replacement cost coverage decisions in recent years is that of District Court Judge Harold Baer, Jr. in the Southern District of New York in the 9/11 case of SR International Business Insurance Company, Ltd. v. World Trade Center Properties, LLC, 2006 WL 3073220 (S.D.N.Y. Oct. 31, 2006). The decision by Judge Baer is helpful because it addresses the frequently encountered arguments relating to the interpretation of the parameters of replacement cost coverage and the inherent limitation of the language employed. Furthermore, a review of the common attacks on the extent of replacement cost coverage is useful to understand the backdrop of decisional authority against which the new green forms will be interpreted by the courts.

In SR International, the insured/owner of the World Trade Center attempted to recover expenses “required to address life safety, security, public policy and pragmatic imperatives” under the replacement cost coverage provision. The court characterized the insured’s assertions as follows:

“Boiled down to its essence, the logic of the insureds’ claim is that the WTC was considered safe, modern and politically acceptable when it was built; therefore, the measure of replacement cost is the amount that would be required to erect safe, modern, and politically acceptable buildings today. This is incorrect. Insurance against technological change and shifts in the political winds may very well exist in the marketplace. But no court has ever found that such coverage is included in a replacement cost policy.”

Id. at *10.

Judge Baer may have been a bit prophetic when referring to the availability of insurance against technological change and shifts in the political winds, although he did not specifically mention the development of green building forms. In an accompanying footnote, Judge Baer more specifically addressed the argument that replacement cost coverage should include public policy and safety imperatives, saying:

“One case does not explicitly foreclose the possibility that physical necessity, even at the time of rebuilding, might justify the inclusion of design changes in ‘replacement.’ See, Roberts v. Allied Group Insurance Company, 901 P.2d 317, 326 (even if engineer recommended structural changes ‘would be required by current codes prior to rebuilding the house, they are not physically required for reconstruction’). To the extent, if at all, that this case might be applicable here, the insureds’ arguments, e.g., that their claimed costs owing to ‘advances in construction,’ ‘public policy imperatives,’ and ‘safety imperatives,’ may, as the Roberts court put it, be ‘advisable,’ they are nonetheless not ‘physically required for reconstruction.’”

Id. at *10 n.36.

Therefore, we can say that courts, or at least Judge Baer, have specifically rejected the idea that societal concerns and public policy concerns are relevant considerations to expand the scope of the basic replacement cost coverage.

Fast forward to present day and we can see that in the new green forms compensation is specifically provided to take advantage of technological advances in green construction. Moreover, the green endorsements certainly fall within the subject matter of the political winds. Notwithstanding the laudable attributes of the new green endorsements, there will be issues concerning where the upgrade to green ends, particularly when authorities differ concerning the application of green standards.

In the SR International case, the insured also argued that since the replacement cost provision provided for replacement of the lost, damaged, or destroyed property with other property of comparable size, material, and quality, the insured, therefore, had some flexibility to improve the replaced property, so long as it remained comparable to the original structure. The court concluded that the insured’s argument relied on a fundamental misconception that these words expanded rather than limited recovery under the contract. The court concluded: “The only rational reading of this provision is that, while an insured may be able to recover its ‘replacement costs,’ he will not recover more than the cost of reproducing the building at the same site with materials that are substantially equivalent to those used in the destroyed property.” See, Tenley, 1986 U.S. Dist. Lexis 19275, at *4-5; Id. at *12.

Addressing further the replacement based upon comparable size

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