Agony Aunt: Who's covering you?

If you are building a new home in an earthquake-prone area (listen up, Cantabrians and Wellingtonians), building insurance might seem like a dry old topic.

Don't tune out though, because it may well save your bacon. And what will save your bacon even more is paying close attention to the policy and making sure you know exactly what it does and does not cover.

These policies come under several names: "Contract Works", "Contract Risk" or "Builders Insurance". Ignore the terminology. The key thing to remember is that you must check your builder or contractor has a policy to cover you. It gives your builder protection from all sorts of things - floods, fires on site or theft of materials.

Most importantly for those living in quake-prone areas, these policies give cover for that much-dreaded new event. If an earthquake strikes in the middle of your building project, damaging your foundations and framing, who pays? The builder, you hope, with their specialist policy.

In the past, very few of us paid much attention to these dull little documents and left it to those holding the hammer. But as a client of the builder, have you had a close look at their policy and the fine print? Did you get a copy of the full policy document and show it to your lawyer alongside your building contract? Do you know what the excess is? And do you know who is paying that excess - you or your builder? If it is your builder, do you know if they have the financial strength to sustain multiple claims on all their projects? Do you have the financial strength or the ability to borrow more if your builder can't cover it?

In the current environment of heightened risks, policy costs are rising across the country and there has been a seismic shift in the size of the excess for earthquake cover.

Traditionally, the amount not covered by the insurer was about 2.5 per cent of the build-cost, with a minimum excess of a few thousand dollars.

If you had incurred $300,000 in build costs when an earthquake hit, 2.5 per cent would mean the builder paid the first $7500 of the claim.

At these levels it seemed like small bucks, and no-one really considered if their building firm could take the hit.

With the size of earthquake excesses sky-rocketing to as much as 10 per cent of the build cost, homeowners should be asking more questions.

Imagine if an $800,000 home was nearly complete and disaster struck, causing a total loss.

A 10 per cent excess would mean the first $80,000 was not covered. Would a building firm survive that, across multiple projects in the same area?

On some policies I've seen offered in Canterbury, the minimum excess was as high as $50,000. It is completely understandable that smaller firms will have to be honest with their clients and pass that liability back to them as a contingency in the building contract.

Homeowners rebuilding in the Garden City will need to discuss with their insurer who will pay the excess if there is claim in this case. If your insurer is handling your rebuild, get it in writing that they, or their contractors, are covering the excess.

Wherever you are building in the country, always look at the worst-case scenario. If your builder puts the liability for the excess back into your contract, weigh up the consequences. If an earthquake hit at the worst possible time - near completion, when most of the project cost was spent - what would your liability be?

For most people, risking 10 per cent of their equity would be pure madness and other options need to be considered.

Reinsuring the excess

One of the wonders of the modern world of insurance is that almost anything can be insured - even the "excess" that one insurer won't cover can be insured by someone else. The second insurer simply charges you a premium, and the two policies put together give far less risk. The downside is the cost. It feels expensive.

As an example, I got a quote recently to cover a $30,000 excess on a building policy and the premium was about $5400. Yes, you pay out $5400 to avoid the risk on $30,000. It's expensive, but for a lot of people losing $30,000 might be all the equity in their home, or it might mean they cannot put in the kitchen and bathrooms for their new house, making it unliveable.

Builders need to consider if it is prudent to take out this "excess-insurance" themselves, pass it to their client or cost-share with their client.

It would be an all-round mess if one party could not withstand the size of the excess on the claim. One company that can issue policies like this is Auckland-based broker Apex General.

It is part of an Australian insurance group and the policy is written through Lloyds of London.

In post-earthquake Canterbury, most home owners are still only dreaming of their homes being rebuilt. Insurers using the big project management companies are arranging building insurance via the likes of Arrow, Hawkins and Mainzeal. These organisations are getting their excess sizes down to five per cent of the build cost with a $5000 minimum. They will not start building until they can get cover at these levels. Homeowners will still need to have a clear conversation with their insurers and make sure they know where the liability for the excess sits.

Contract works insurance

~ When building a new home, the Earthquake Commission (EQC) does not provide any cover. It only covers completed homes.

~ If a home is undergoing an extensive repair or renovation and cannot be lived in, you need a Contract Works policy as EQC provide no cover. If the home remains self-contained and could be lived in, EQC cover does apply to the Contract Works policy.

~ As soon as your new home is considered inhabitable by your insurer, make sure the usual home policy is put back in place. This will mean you have EQC cover on your home and your land. Remember, there is no land cover until a completed dwelling sits on it.

~ Always show a copy of your builder's Contract Works insurance to your lawyer and ensure you are noted on the policy as an interested party.

Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.