Nearly every estimate submitted on behalf of a Texas building owner for the replacement of a commercial roof includes the same last two line items:
Overhead: 10 percent
Profit: 10 percent
These two line items for overhead and profit (O&P) are causing considerable debate in the Texas insurance claims process. The same questions are asked in almost every claim:
Who will receive it?
Are the line items duplicative of O&P already built into other line items?
Must it be incurred to be paid?
Is it owed under the insurance policy?
Neither Texas law nor the Texas Department of Insurance has provided determinative guidance on these issues. As a result, the debate over whether and when O&P is appropriate continues.
The initial question to be asked is who will receive the O&P? Is it the roofing contractor that submitted the estimate? Is it a general contractor that has yet to surface on the project (and likely never will)? Will it be used to pay a public adjuster’s fee? Or is it simply intended to help cover the insured’s deductible?
No one would dispute a roofing contractor’s right to earn a reasonable profit for its work. Assuming the line items at issue represent actual O&P for the roofing contractor, and all other line items are unquestionably stated and detailed as actual costs (material, labor, equipment rental, etc.), inclusion of a reasonable percentage for the cost of operating the business and making a reasonable profit should be acceptable.
But that’s usually not the case. The O&P line items at the conclusion of an estimate, especially when added by software estimating programs such as Xactimate, were always intended to be “general contractor overhead and profit.”
However, O&P is frequently added to roofing contractor estimates that already include a healthy profit margin in the line item amounts they are charging for material, labor, equipment rental, etc. The O&P is added despite the fact that no general contractor is involved in the project, nor is one necessary.
Therefore, the typical dispute now is whether O&P is payable on a Texas insurance claim that: (1) only involves a roof replacement; and (2) will not require the involvement of a general contractor.
A general contractor is “one who contracts for the completion of an entire project, including purchasing all materials, hiring and paying subcontractors and coordinating all the work.” General contractors generally include line items for overhead and profit in their estimates, as they are often necessary for coordinating multiple trades to complete jobs. This is how they get paid.
The overhead charged represents indirect costs incurred to operate a general contractor’s business. Examples could include office rent, insurance, staff, licenses, and marketing and advertising costs. Profit is “the excess of revenue over expenditures in a business transaction” and is used to pay the general contractor.
The “three trades rule” is often quoted as a benchmark in determining whether it is appropriate to involve a general contractor, and therefore, whether to include general contractor O&P. The “rule” presumes a general contractor is required once it is determined that three trades or more are necessary and must be coordinated to repair or replace the claimed damage.
The origin of this “rule”, however, is unknown. Whether it is legally correct under Texas law or properly reflective of policy coverage is uncertain. There is no binding authority in Texas for the application of the “three trades rule.”
When determining replacement cost estimates under Texas law, an insurance carrier must include “any cost that an insured is likely to incur in repairing or replacing a covered loss.” It is also settled in Texas that if general contractor O&P is likely to be incurred, the insurer may not deduct or withhold the entire general contractor O&P from an actual cash value payment. The Texas Department of Insurance has provided further commentary on this issue as follows:
The department has learned that one or more insurers have interpreted language in the Texas Standard Homeowner’s Policy – Form B to permit the deduction of contractor’s overhead and profit, in addition to depreciation, from replacement cost in calculating actual cash value. This interpretation has generated two class action lawsuits and inquiries to the department regarding the department’s position on this matter. The insurers are interpreting the following Loss Settlement provision of the Texas Homeowner’s Policy – Form B:
We will pay only the actual cash value of the damaged building structure(s) until repair or replacement is completed.
The purpose of this bulletin is to state the department’s position that actual cash value under a replacement cost policy, when the insurer does not repair or replace the structure, is the replacement cost with proper deduction for depreciation. The deduction of prospective contractor’s overhead and profit and sales tax in determining the actual cash value under a replacement cost policy is improper, is not a reasonable interpretation of the policy language, and is unfair to insureds.
The scope of this bulletin is limited to the calculation of actual cash value for dwelling coverage in replacement value policies by use of the practice described herein. The bulletin is not intended to, and does not, express any opinion of the department as to the calculation of actual cash value in other contexts, such as personal property, or measures of the actual value of such property to the owners of such property.
The department has concluded that an insurer providing property coverage under replacement cost residential policies that allow for the adjustment of covered losses to structures on an actual cash value basis may not calculate actual cash on the basis of replacement cost with proper deduction for depreciation, less contractor’s overhead and profit, nor may the insurer deduct sales tax on building materials. Any insurer that determines actual cash value on this basis may be subject to disciplinary action for violations of the Texas Insurance Code …
TDI bulletins are not law, but rather advisory opinions subject to judicial review. In fact, courts only look to TDI bulletins upon a finding that a policy or policy term is ambiguous on any given issue. Moreover, this bulletin only applies, if at all, to homeowners’ policies. It does not apply to commercial policies.
Nevertheless, if general contractor O&P is a “cost that an insured is likely to incur in repairing or replacing a covered loss” under an applicable policy, the calculation should look like this:
Replacement cost value of damaged property: $100,000
Plus overhead and profit, and tax (assume 20 percent): $ 20,000
Total replacement cost value of damaged property: $120,000
Less depreciation (assume 30 percent): $ 36,000
ACV (actual cash value) amount to be paid (subject to applicable $ 84,000
What the case law and the TDI have not addressed is whether O&P is “a cost that an insured is likely to incur in repairing or replacing a covered loss” when the claim involves only the repair or replacement of a commercial roof.
Oftentimes, after a storm event, only the insured’s roof is damaged and no other trades are necessary to complete the repair or replacement. In those situations, an insured simply retains the services of a roofing contractor to replace the roof; the involvement of a general contractor is not necessary and O&P is not “likely to be incurred.”
Traditionally, a typical roofing contractor bid (as opposed to a software-generated estimate), provided to either a general contractor or directly to an insured, would look much like this:
Remove existing roofing
Install new insulation to decking
Install two new turbines, two new heater stacks
Install 5-2” and 3-5” lead jacks
Install new base sheet and three-ply gravel ballasted built up roofing
Install new base flashings to walls 272lf
Install new 15” stretch metal cap to walls 272lf
Install new pipe boots as needed
Install new cap metal on walls
Clean up and haul off all trash
Manufacturers guarantee on material
Two-year guarantee on labor
Total $37,080.00 plus tax and permit
Notably, line items for O&P are not listed in such a bid. This is because the roofing contractor, whether working as a subcontractor for a general contractor or directly for an insured, includes overhead costs and a reasonable profit in the various line items of its bid amount. The roofing contractor is already making an acceptable profit on the bid as submitted. If it wasn’t, the contractor would not bid on the job.
The problem that exists today is the inclusion of the O&P line items in roofing contractor estimates that are prepared in response to a covered event. These estimates are often generated using software programs such as Xactimate, which are subject to manipulation to achieve a desired price (either high or low).
Roofing contractors are using the TDI bulletin referenced above to argue that O&P must be added to these estimates, regardless of whether a general contractor is involved with the project. In fact, in some cases, a copy of the TDI bulletin itself is attached to their estimate in an effort to somehow justify including the O&P line items.
There is no legitimate basis, either under applicable Texas law or typical policy language, for adding general contractor O&P to a roof repair or replacement estimate when a general contractor is not required to be involved with the project.
Property insurance policies are personal contracts intended solely to indemnify an insured for its actual monetary loss by the occurrence of a covered disaster or loss. In other words, property insurance policies are meant to put the insured back in the position it was in before the loss, and are not meant to provide the insured with a “windfall” for costs it is unlikely “to incur in repairing or replacing a covered loss.”
Contrary to the intent of the insurance policy — to indemnify for the actual loss incurred — the O&P line items are being included in software-generated estimates simply to inflate the amount of a claim and ultimately increase profits for those involved with the claim process.
In some cases, the intent may also involve what the Better Business Bureau of Metropolitan Dallas has called a “scheme.” The “scheme” calls for the roofing contractor to pay or rebate deductibles as part of an agreement with an insured.
In this context, the additional 20 percent O&P on top of the claim measure is not paid to any general contractor and often goes toward the insured’s deductible and/or the fees of its public adjuster. This practice is frowned upon by the Better Business Bureau and has been characterized as insurance fraud under Texas law.
So what is the solution to the problem? It’s quite simple actually — use competitive roof replacement bids submitted by reputable roofing contractors, rather than estimates generated by computer software, to determine the appropriate claim measure.
Actual prices from reputable roofing contractors ready and able to complete the job are the best indicator of the actual cost to repair or replace the physical loss or damage. All of the roofing contractor’s costs — including a reasonable profit — are included in its bid. There is no ambiguity. The bids serve only to establish an accurate claim measure, while the choice of which contractor to use remains with the insured.
As long as software-generated estimates susceptible to manipulation continue to be used in the Texas claims process, the debate over O&P will continue. As the law exists today, insurance carriers are not required to include line items for general contractor O&P in the typical commercial roof repair or replacement claim estimate. In such circumstances, general contractor O&P are not “costs that an insured is likely to incur in repairing or replacing a covered loss.”
Don’t let a roofing contractor tell you otherwise.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 Xactware - Overhead and Profit, Xactware Solutions (2009).
 Black’s Law Dictionary 327 (7th ed. 1999).
 Id. at 1227.
 Burgess v. Farmers Ins. Co., Inc., 151 P.3d 92, 96 n.8 (Okla. 2006).
 Tolar v. Allstate Texas Lloyds Co., 772 F. Supp. 2d 825, 831 (N.D. Tex. 2011) (citing Ghoman v. New Hampshire Ins. Co., 159 F. Supp. 2d 928, 936 (N.D. Texas 2001).
 Tolar, 772 F. Supp. 2d 825 at 831.
 Emphasis added.
 Texas Department of Insurance Bulletin B-0045 (June 12, 1998). See also Texas Department of Insurance Bulletin B-0068 (Sept. 29, 2008).
 Tolar, 772 F. Supp. 2d 825 at 831.
 This calculation has been independently verified with the TDI, which advises that it complies with the TDI’s expectations.
 Tellepsen Builders, LP v. Kendall/Heaton Associates, Inc., 325 S.W.3d 692, 697 (Tex. App.—Houston [1st Dist.] 2010, review denied).
 Roofing Deductible Assistance Program: Diagram of a Scheme, Better Business Bureau of Metropolitan Dallas – BBB Investigation Summary (August 2012).
 Tex. Ins. Code § 27.02.
 Of course, if the services of a general contractor are reasonably necessary given other damage and the cost of a general contractor actually is incurred, the standard general contractor invoices can be submitted.