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The Most Valuable Document That Money Can Buy

The Reserve Funding Analysis is one of the most important documents that an insurance provider can have for a property it covers.

A Reserve Funding Analysis is a formal evaluation of the physical condition of a property and the expected future expenses that will be needed to keep the property in a viable state of repair. Having this funding statement out in the open on Day One discloses to the owner, the insurance company, financial institution and all other stakeholders the real cost of preserving the asset that everyone is vested in.

For the insurance carrier, the analysis establishes the baseline property condition, helps ensure responsible operation of the property and provides the actual numbers that support appropriate pooling of the risks and accurate pricing of the insurance product.

This is not trivial. Where there is an absence of knowledge and inadequate reserve funding, there is little incentive for the operators to mitigate major system exposures. Many times, market conditions such as “curb appeal,” trend-setting landscaping, new exterior paint or other highly visible amenity may receive disproportionately higher funding priority than the hidden major building system peril such as a potable water system rupture, building envelope failure, venting or water drainage intrusion.

This situation represents a severe moral hazard.  The insurer becomes the de facto major system reserve fund. This is especially the case when the owner can claim no knowledge of imminent failure or will attribute the failure to one or more lesser contributing factors.

While this is not quite as scandalous as TV crime dramas where the crook sets a building ablaze to collect the insurance money, owners are still making insurers unfairly responsible for more subtle perils such as catastrophic water system failures and building envelope failures such as roofs, water rot and foundation decay.

These conditions are often difficult to see until there is a major failure. Or, they may be exacerbated, but not caused, by a storm, earthquake or natural risk. Piping systems corrode from the inside, becoming weaker while showing little or no indication of a problem until water is cascading down 12 floors of luxury condominiums. Building envelope water intrusions can go unnoticed until toxic mold appears in the venting or a deck collapses. Certain concrete cracks can allow water to enter invisible places, undermining the purpose of the foundation.

Many of these perils are easily avoided with routine maintenance, assuming the owner is aware of and has budgeted for them.

The most typical Reserve Study available on the market is a common tool for condominiums. The purpose is to protect mortgage holders and shared asset community members and to help set homeowners association (HOA) dues fairly and comparably (vs. alternate properties) while avoiding the need for imposing special assessments on the owners.

Think about it. These are exactly the same business functions as the insurance carrier! Therefore, a specialized Reserve Study that meets the needs of the insurance carrier should be considered essential in any significant building, facility or property.

The Building Condition Assessment

The first step is to perform a comprehensive Property Condition Assessment by a registered professional engineer knowledgeable in the ASTM E2018-08 standard. No law exists that requires a professional engineer or architect to perform the inspection, but one is highly recommended by most attorneys in the event that the findings are legally challenged. The ASTM E2018-08 standard will provide visibility to major systems and components that are due to be replaced, that are failing or that are operationally sub-standard or outdated.

The Condition Assessment can also reveal how a building is “aging.” For example, a 10-year-old building can reveal what the next 40 years will be like much better than a new building can. A quarter inch of settling after 10 years can be re-measured after 20 years. Corrosion or rot on the north side, but not on the south side, can tell an important story for the future. A good engineer can see these trends and predict future conditions with surprising clarity.

Hiring a Consultant

It is imperative that a licensed, professional, civil or mechanical engineer perform the assessment and reserves estimate. Many engineers closely align themselves with architects and other engineers, so it is important to inquire about their professional network. There are many Certified Inspection Professionals who are qualified to perform inspections, but the science of engineering can quickly become an integral part of the process. Water chemistry, corrosion science, water vapor diffusion and hydrocarbon compatibility, electronic logic controllers, etc., are the domain of engineering. Further, only the engineer would be qualified to allocate other engineers where needed — the lineage should remain intact wherever possible because only engineers can come up with the numbers that fit the actuarial tables and can be upheld in court.

Initial Project Review

Once the responsible engineer has been retained, he will require a set of initial information about the build, property or facility. This will include:

  • As-built drawings and architectural specifications
  • The declaration and description
  • Reciprocal cost-sharing agreements
  • Previous reserve fund studies
  • The most recent audited financial statements
  • What the current annual contribution to the reserve fund is
  • Inspection of the current maintenance and repair record
  • A summary of (end-user) problems and concerns

The Process

  • The engineer is provided the above information. The as-built drawings and specifications are prior to visiting the site in order for the engineer to become familiar with the overall design and construction schemes. If they are absent or deficient, this is a red flag.
  • Site inspection is performed.  Problem areas are reviewed and documented.
  • The report is prepared. The drawings are used to “take-off” quantities such as roofing, exterior wall cladding, asphalt, hallway finishes, etc. that will assist in preparing the replacement/repair cost budgets.
  • The engineer presents a draft report to the insurer prior to its being finalized.
  • Upon receiving direction from the investors, the Reserve Fund Study is finalized and submitted.

The Report Format

Every engineer may have a slightly different format, but, in general, the Reserve Funding Analysis has two main components: physical analysis and financial analysis. The analysis includes:

  • Inspection Report. Based on the results of the site inspection, the report will provide an itemized overview of the major common elements. This will include general condition, the need and timing for remedial work or replacement and any other information that the stakeholders should be aware of.
  • Information Tables. There is typically a table that summarizes the common elements in terms of current age, life expectancy, remaining service life and current and future cost budgets.
  • Expenditure Tables. The data from the information tables is summarized to show when the itemized common element repair/replacements are estimated to take place. For each year, these expenditures are summed. The annual projections must be a minimum of 30 years commencing in the year the study (and updates) is prepared.
  • Cash Flow Tables. Based on the estimated expenditures, different contribution plans can be provided. Often, one plan includes the contribution level currently being used as a form of comparison with other scenarios.

The Funding Plan

As part of the Financial Analysis, the study must have a recommended funding plan projected over 30 years from the date of the study. The plan must show:

  • The estimated cost of major repairs and replacements based on current costs.
  • The same costs adjusted to account for an assumed inflation rate. The inflation rate must be stated in the study.
  • The opening balance of the reserve fund.
  • The recommended amount of contributions to the reserve fund determined on a cash flow basis that are required to offset adequately the expected cost in the year of the expected major repair or replacement common elements and assets.
  • An estimate of the interest earned on the reserve fund contributions based on an assumed interest. The study should state the assumed interest rate.
  • The percentage increase in annual contributions to the reserve fund for each year of the 30-year study.
  • The estimated closing balance of the reserve fund for each year.

Conclusion

It may be surprising to know that much of this due diligence is already being performed by the owners, management firm, bank, attorneys, accountants, real estate brokers, etc.  However, it is the insurance carrier that must have the clearest probabilistic view of the property. The insurance carrier must be assured that due diligence has been performed by the right professionals, at the right time, and articulated in the right numerical form that serves the calculations of insurer, not just the calculations of the insured.

The Value Game™: A New Class Of Business Methods For The Condominium Reconstruction Market

Part 1: Correcting a Distorted Insurance Market

For many condominium associations, the maintenance, repair, and reconstruction industry has devolved into a minefield of distrust and dysfunction. Countless lawsuits have taken their toll on the industry to the point of near dysfunction where many contractors simply walk away from condominium projects. The worst form of “capitalism” ensues where everyone acting in their own best interest is in fact acting in the counter-interest of their community. The Value Game promises to reset this negative incentives condition while enhancing community resilience.

Here's How The Problems Start:
The board of directors of a homeowner's association is entrusted by the residents to hire a contractor to perform a complicated reconstruction project. Unfortunately, condominium board members are not very good at writing contracts or issuing requests for proposal or collecting bids. When a contractor is selected, the scope of work is often poorly established. The expectations between the community and the contractor begin to diverge. Soon, a law firm is engaged my some residents to sue the contractor for damages. After a long battle, a settlement is awarded, but it is not enough to fix the problem after expenses are paid.

A Chain Reaction:
Fortunately, the contractor in the suit was insured, but this does not cover the personal, professional, and opportunity hardship of defending against the suit. The insurance company also increases the premium for coverage for condo projects. Most good contractors say, “it's just not worth the trouble.” As the pool of available contractors dries up and the price for reconstruction increases, many condos are forced into deferring maintenance in a distorted market.

Cascading Failures:
After a while, a condominium springs a few leaks in their piping system. Each leak results in a relatively small water damage claim. When the insurance company notices several claims in the same building, they begin to fear that a mainline is about to rupture next, and threaten the condominium with cancellation of their policy unless the community replaces the entire system immediately. Now the insurance industry is in a double jeopardy: they force the contractor out of the market and they force the condo out of the market to basically avoid suing themselves.

The Dysfunction Deepens:
Banks will not make construction loans to condominiums that are not insured. Likewise, they will not make mortgage loans to buildings that are not insured. The property values plummet and the owners are sent under water. Soon they begin to default on the mortgages that the banks already hold. More maintenance is deferred as owners move out and renters move in. Buildings fall apart and become unsafe. Banks pull out of the market to avoid defaulting on themselves. The wider community suffers.

The Value Game
The Ingenesist Project is currently deploying The Value Game to the condominium reconstruction market with remarkable success. The Value Game is a new class of business methods that alters the incentive structure of a distorted market such that everyone acting in their own best interest is in fact acting in the best interest of the community. Clearly the intention is to demonstrate that asset preservation is the domain of engineering and not the legal system.

Here Is How The Value Game Is Formed:
The first thing is to identify the “shared asset” in whose best interest it is for everyone to preserve. In this case, the shared asset is the physical condominium building where preservation is the context about which a community interacts.

If we look at each of the players individually, we see some consistent patterns.

  • It is obviously in the best interest of the residents to have a safe and well-maintained home.
  • It is in the best interest of the contractors to have a successful and profitable interaction with the building.
  • It is in the best interest for the Insurance industry to reduce the risks that they underwrite.
  • It is in the interest of the financial industry to loan money into a viable, organized, and disciplined community.
  • It is in the best interest of the real estate industry to represent strong values and complete insurability of assets.
  • Finally, the broader neighborhood benefits from the presence of a viable condominium community.

In short, it is actually in everyone's best interest that the others are successful.

About The Value Game Game Board
The first rendition of the Internet was populated by static websites built for a person, or to sell a product, or to deliver entertainment, or to provide information. The next level of the Internet included social media, where users actually create the content that populates a website such as Facebook and Twitter, etc.

The next level of the Internet is taking on a form consistent with the Value Game where a social network is built about an asset that communities share.

Part 2: Case Study — High Rise Condominium Re-piping Project

The current case study is a condominium re-piping project in Portland, Oregon. The actual community consists of 200 units (400 residents) who occupy a single high-rise tower that must undergo a major reconstruction project that will impact everyone. The total value of the project is about 3 million dollars. This is real money in a real Value game.

For this project, we built a website for the physical building with its own social network where all of the different (and willing) players can interact with each other to preserve each other's best interests.

The first thing to accomplish is to reduce the likelihood of diverting incentives that can result in litigation. This may be accomplished by introducing strong community management. In this particular case, a professional engineering firm was hired to represent the best interests of the asset. The engineers represent the needs of the homeowners association to selected construction technologies, defined project scope, wrote the RFP, wrote the contracts, selected the contractors, and managed the project.

The Social Network Dynamics
The website used in this case study is a common open source WordPress platform with a Buddy Press backend to provide “Facebook-like” features (except with privacy). The engineering firm submits all reports, surveys, test results, assessments, photographs, schedules, products, accessories, and plans onto the website for members to see equally (there are some exceptions to protect financial data).

Individual residents are invited to form “groups” and start “threads” in topics for which they have an interest or a concern. People naturally migrate toward other people with similar interests and they build relationships.

Contractors are able to see all of the assessments, conditions, and work scopes directly from the website instead of paper submittals. They can ask questions and post ideas of their own for community review.

Engineering firm(s) can monitor discussions and collect frequently asked questions, which are posted in a FAQ. Everyone gets the same correct answer to their questions without rumors or speculation.

Communities: Community meetings are held. There is no bickering or infighting because everyone is educated and prepared to ask unique and relevant questions of the presenters. When a community is unified, they can easily come together to make important decisions that impact the quality, cost, and schedule of the project.

The insurance company is given limited access to the website which demonstrates that the community is acting to mitigate the risks that the insurance company underwrites — this keeps the policy in force.

With website access, the insurance industry can also see that licensed engineers professionally manage the project in a vibrant community. This reduces the likelihood of litigation against contractors. The insurance industry can now classify this project among “commercial” insurance pool instead of the litigious condominium insurance pool.

Contractors feel comfortable with this professional engineering management and insurability, which brings more contractors to market thereby increasing the talent pool and reducing costs. At the end of the project they may get 400 likes on Facebook, YELP!, and Angie's List.

The bankers will have access to the website to monitor progress. With insurance policies fully enforced, banks will lend favorably to the homeowner's association which needs to fund a major reconstruction project. Banks will also lend favorably to mortgages in this structure because it is well maintained.

It is in the best interest of the community to be civil and thoughtful in their discussions knowing that they are being observed by some of the other stakeholders. This eliminates the incentive to be disruptive and increases the incentive to be engaged and productive in the project.

Over time, the website becomes a forensic record of all matters associated with the project. Everyone knows who said what, when, where, and why with an electronic time stamp. There is little to be disputed.

Interaction With The Wider Community:
Real estate agents always describe property in poetic hyperbole — they rarely tout the improvements that a community works so hard for. The website could be a place where a real estate agent can advertise their services in exchange for a promise to mention the re-piping project. The market will respond to a well-maintained building by an engaged community, which will drive real estate valuations up.

Hotels, restaurants, theaters, art galleries, service groups and civic organizations benefit from prosperity and resilience in their community.

In the end, the shared asset is preserved and everyone is profitable.

Update: Important Observations

In deploying the Value Game, we need to be careful of how much collaborative innovation we are able to introduce to a system that is normally adversarial. A general distrust of new ideas and the technological platforms that they depend on is still fairly high. For this reason, we estimate a 40% adoption level of the principles discussed here.

What The Insurance Industry Needs To Know About Epoxy Water Pipe Liner

Epoxy is a magnificent substance used in many important applications where strength, hardness, moisture protection and strong adhesion are a requirement. Epoxy coatings are used to protect industrial applications from factory floors to reinforcement bar embedded in concrete. When applied correctly to a strong surface, few coatings are as tough as epoxy.

Recently, epoxy manufacturers have developed a lining process to coat the inside of an old potable water system with epoxy. This method is touted as a fast, 60 year, non-invasive, and inexpensive alternative to re-piping a whole building. However, when applied incorrectly, epoxy coatings can create a dangerous sense of false security especially where hidden from view such as the internal surface of a pipe.

Many epoxy failures are appearing in the field where litigation is often protected by gag orders thereby never reaching the public domain. This document identifies a wrinkle in the market that supports the rapid liner industry as well as the consequences of an unseen failure, should they occur.

This article arrives at the following conclusions:

  • The potential for epoxy liner failures may be high in galvanized steel potable water systems.
  • There is no reliable way to inspect the adhesion of epoxy inside a pipe.
  • If an adhesion failure is found, there is no practical way to repair it except re-pipe — so, why not just re-pipe?
  • Epoxy liner failures may typically occur at the precise location where the galvanized steel pipe is already at its weakest.

These observations are very important for the insurance underwriter who would otherwise classify a water system that has been repaired with epoxy liner as a “new” system. These observations are important for the forensic analyst that may determine the cause of a major water system failure on a condition other than being weakened by the epoxy coating. These observations are very important to the insurance broker who may inadvertently force a condominium community into an epoxy liner “solution” as a condition for maintaining coverage on their property.

Recommendation
Insurers should allow their condominium clients to perform a condition assessment without threat of cancellation. A small leak does not necessarily mean that the big rupture is imminent. In any case, epoxy does very little to eliminate the risk of a large rupture and possibly increases the likelihood. Then the insurance industry should work with the community to save enough money to perform a superior re-pipe with new materials such as polypropylene or copper. Together, a strong case can be made for the reserves or lending process. In the long run, a superior re-pipe may cost several times less than an epoxy “solution.”

The Vicious Circle
Something as simple as a pinhole leak can generate thousands of dollars of water damage claims. Imagine what a fracture in a main riser cascading down 10 floors of luxury condos can cost? Unfortunately, many insurance underwriters believe that after a few small water claims, the big one is imminent. This may not necessarily be the case. Yet, many a condo is put on notice that they will lose their coverage unless the whole system is immediately replaced.

Long before the first pinhole leak, insurance companies stipulate in their policies that they are not responsible for a pipe failure if the condominium board is aware of the problem and fails to take corrective action. This condition essentially removes the incentive for the condo board to perform a quantitative piping condition assessment — if they don't know that there is a problem, they are insured. If they do know that there is a problem, they are not insured. This creates a compound moral hazard because they have no basis for saving reserve funds for a replacement.

After awhile, a few small leaks may appear leading to some minor insurance claims — this can trigger the threat of insurance cancellation for the condo. But this is the least of their worries; the condominium construction market is renowned for litigation, and many insurance companies make it very difficult or impossible for a contractor to be insured for condominium work. Condominium homeowners associations quickly learn that many contractors are simply unable or unwilling to work on condominiums.

If the homeowners association fails to save for a re-piping project, they are forced into an expensive bank loan from lenders who are equally wary of litigation … this can become a huge mess far beyond the knowledge and capability of a condo board to manage effectively. The inability to manage a project in a litigious environment leads invariably to more litigation!

Herein lies the wrinkle in the market caused largely by the insurance industry betting against itself thereby creating a vicious circle that has very little to do with actual plumbing. In the midst of this condo / contractor / insurance / banking madness arises the epoxy liner salesman who is quick to provide everyone with exactly what they need — a cheap, fast fix.

The Epoxy Liner Process
The epoxy liner process involves isolation of sections of the existing pipe, drying the pipes with hot air and then sandblasting the inside walls with pressurized air and an abrasive mineral that is supposed to remove all corrosion, leaving bare metal in order to prepare the pipe walls to accept adhesion of the epoxy liner. Once prepared, the paint-like epoxy is blown through the pipes in a liquid state using pressurized air. The epoxy is then “cured in place” either by the application of heat and/or the passage of time (pot life).

A Case Study
A reputable plumbing contractor in the Seattle Area provided samples of epoxy liner sections that were removed from at least three properties and which failed within 4-7 years of entering service.

Failure Modes
The following video demonstrates common epoxy liner failure modes correlated to available literature on epoxy liner vulnerability. The most common vulnerabilities of the epoxy lining system are associated with the planning and quality of the preparation as well as training of the applicator personnel.

 

The Anatomy of an Epoxy Failure: The following photographs demonstrate the progression of an epoxy failure where the surface has been improperly prepared.

Single Crack Allows Water To Enter

Multiple Cracks Form Due To Underlying Corrosion

Cross Section of Coating Breach, Pitting Continues

When an epoxy failure does happen, it is likely to occur at the location where the pipe is already at it's weakest — pitted areas and threads.

Pipe threads are especially vulnerable: The photo below shows corrosion in steel pipe near pipe threads. Sandblasting with epoxy would weaken the threaded area further. A crack in the epoxy at this location would allow the corrosion to continue unknown to the residents. In many cases the existing pipe is better off left alone until a full re-pipe can take place.

Corrosion In Steel Pipe Near Pipe Threads

Literature Review
Epoxy coating of steel is a widespread practice in construction and mainline water service2 3 4. While epoxy is tested safe to drinking quality standards by independent studies1 and national water quality standards6, any such “certification” is dependent upon actual adhesion to the surface of the pipe. The failure modes and vulnerabilities of epoxy are widely known and highly consistent in the progression7 of adhesion failure. It is also widely recognized that the project planning, surface preparation, and precise measurement and application of the ingredients to the substrate are the most significant variables in determining the probability of a successful epoxy coating assignment.

These factors are addressed in significant detail by the U.S. Army Corp of Engineers3, The American Water Works Association9, the American Society of Testing and Materials10, the Society of Protective Coatings, etc., who have all developed standards for the planning, preparation, measurement, and application of epoxy coatings. It can be assumed that if, and only if, these standards are followed and documented, then failures in epoxy coatings will not occur.

A comprehensive collection of tests and inspection criteria has been developed for epoxy coatings in any number of applications including internal water pipe coatings.3 Such tests as the knife blade test or those tests specified in ASTM F2831 are simple, fast and conclusive.10

The Epoxy Paradox
Epoxy coating is extremely strong and adherent if, and only if, applied correctly.7 The question arises that if an application should fail a test, inspection, or in service, what is the contingency plan to remediate the flaw? How will the epoxy be removed and how will the re-coating be applied? If re-pipe is the answer, why wasn't re-pipe considered in lieu of epoxy in the first place? If a single failure is found, what test sampling strategy must be applied to give a high likelihood that no other flaws exist in the system? Under what warranty claim would a failure be covered and to what extent will total coverage be warranted? These questions would be imminent in any litigation related to epoxy failures.5

Double Jeopardy: When an epoxy failure does happen, it is likely to occur at the location where the pipe is already at its weakest; i.e., pitted areas and threads. As such, a poorly applied epoxy liner could weaken a pipe considerably.6 The result could be a catastrophic high-volume pipe failure requiring a high insurance payout, which would not otherwise be attributed to epoxy coating.

Therefore, engineering and construction management representation and oversight can help assure that the epoxy liner material and contractors are aware of the expectation that industry standards will be applied. Independent testing should be applied as a condition of the contract bidding and warranty claims so that they may adjust their pricing to meet customer expectations. Again, epoxy is an amazing substance when applied correctly. But what if it is not?

References

1 Impact of an Epoxy Pipe Lining Material on Distribution System Water Quality by Ryan Price and supervised by Andrea M. Dietrich, PhD., Chair, Environmental Engineering, Virginia Polytechnic Institute.

2 Epoxy Adhesison Testing Sponsored by the Texas Department of Transportation.

3 PUBLIC WORKS TECHNICAL BULLETIN 420-49-35 15 June 2001 IN-SITU EPOXY COATING FOR METALLIC PIPE; Department of The Army; U.S. Army Corp or Engineers.

4 INVESTIGATION REPORT ON THE FAILURE OF MAKKAH-TAIF WATER TR.

5 Canadian law suit brought against the epoxy applicators.

6 Potable Water Pipe Condition Assessment For A High Rise Structure In The Pacific Northwest.

7 Layman's Guide to Epoxy Paint / Coating Failures.

8 NSF/ANSI Standard 61 Drinking Water System Components.

9 AWWS C210-3; Liquid-Epoxy Coating Systems for the Interior and Exterior of Steel Water Pipelines.

10 ASTM F2831 – 12: Standard Practice for Internal Non Structural Epoxy Barrier Coating Material Used In Rehabilitation of Metallic Pressurized Piping Systems.

Disclaimer
Engineering opinions rendered by any author are solely for the purpose of education and are not engineering advice. If you use any opinion presented in this document or on the website in any way whatsoever, you agree to hold The Engineer and the website harmless of your use of those opinions.

Addressing Condominium Water Failures Before They Happen

In the heyday of the real estate bubble, developers flipped tens of thousands of apartment structures into condominiums — with little regard for the condition of the potable water system. Many of these galvanized steel or early copper systems are rapidly approaching the end of their service life. Unseen, a small leak can cause thousands of dollars of damage and a ruptured main riser can amount to millions of dollars in claims and severe hardship for the community of homeowners.

While it may be tempting to react to failure statistics, not all water systems are equal. Water chemistry varies substantially across the country, as do workmanship and materials quality — these variables may have a greater influence on mode and consequences of the failure than the age of the system itself. The least appropriate action may be for the insurer to put the community in an emergency situation. Poor or rushed Homeowners Association (HOA) decisions can end up costing everyone far more than a properly replaced system that is well planned.

Insurers must first help the community to resolve to replace their potable water system. Then, they must encourage the community to have a comprehensive piping condition assessment overseen by a qualified engineering representative. It is essential to determine the stability of the existing system without the threat of policy cancellation. Small leaks may be tolerable as long as the possibility of a large rupture is fairly remote — they are not necessarily related conditions. Once these probabilities are known, then good decisions regarding a replacement system can be made.

Unfortunately, the Homeowners Association board is often left with a daunting task of selecting the right technology that both heals the pain and fits the budget. All pipe renewal solutions have different risks and vulnerabilities and many Homeowners Associations can fall for a slick contractor peddling inferior products. Potable water is a matter than requires rational analysis.

Piping Materials:
The three main classifications of piping renewal materials on the market include epoxy liner, copper re-pipe, or a variety of plastic products. All have vulnerabilities and limitations so it is important for the insurer to take a deep hard look at the risks while the Homeowners Association can focus on the costs.

Epoxy Pipe Liner
Epoxy pipe liner is a continuous paint-like coating that is blown through an existing pipe system that has been cleaned by an abrasive sandblasting. Epoxy has the advantage of being relatively fast and minimally invasive. The problem with epoxy is there is no certain way to know the pipe is clean on the inside and no certain way to know if the cleaning process compromises the strength of the pipe. Finally, if we were to test the epoxy, and adhesion is shown to be poor — then what? There is no way to remove the epoxy and breaking the continuity of the coating breaks the protection. Our research has found that an epoxy failure can very likely happen at the exact place where the pipe is already at its weakest. This does little to mitigate the peril of the multi-million dollar rupture claim. While we are confident that epoxy may be applied correctly, we are not confident the epoxy would be risk/cost competitive over a far superior re-pipe.

New Copper Re-pipe
Copper is very familiar to most people from its use in the penny. The tarnish that forms on copper actually protects it from corrosion. Under the right conditions, a 50-year service life is a reasonable expectation if that tarnish coat is not disrupted. Copper plumbing has been extensively studied and many professional codes and standards apply to its use. Consequently, many copper failures can be traced directly back as failures to apply these standards: improper design, poor workmanship, aggressive water chemistry, or inferior materials, etc. All are known perils, which may be avoided or mitigated with the assistance of a good technical advisor representing the best interest of the owners.

Cross Linked Polyethylene (PEX)
PEX is a white or colored plastic that is fairly stiff but also quite flexible. A slightly weaker form is commonly used in plastic milk jugs. PEX has been used in the US for 20-25 years, and has demonstrated an excellent track record in millions of installations. PEX is easy to install, relatively low cost, and enjoys broad market acceptance. PEX has two main problems — both of which are avoidable. Lawsuits have been filed over failures due to “dezincification” of low cost brass fittings. It is extremely important to avoid some sources of fittings with high zinc composition in alloy. Lawsuits have also been filed over the leaching of chemical compounds from types A and C PEX — the use of Type B PEX largely eliminates this problem. Again, a good owner's representative can help navigate this landscape. Many other plastic piping materials exist, but not without similar controversies.

New Polypropylene Pipe
A newcomer to the pipe materials selection is polypropylene — polypropylene is a common recyclable material with important uses in medical and food grade applications. Polypropylene is a very simple molecule of carbon and hydrogen — nothing bad goes in so nothing bad can leach out. While new to the US, we have traced its use in Europe to at least 30 years back with a very low failure incident rate. Polypropylene has excellent thermal and acoustic properties and is widely considered the most environmentally friendly piping material available. Some disadvantages are that special fusing irons and specially trained installers are required.

Water system renewal can be a confusing process — and certainly not a hands-off affair for the insurer. A qualified owner's representative is needed to help navigate the landscape of technologies and contractors who sell them. When the project is complete, the representative can help petition the underwriter, the financial industry, and the real estate market for adjustments that reflect the value of your renewed new system. The technical representative can help eliminate engineering and construction risks without interfering with the normal dynamics of a wise and proactive homeowners association.

Arbitration Decision Can Make Condominium Developers More Insurable

Effective Underwriting Requires Review of CC&R's
Every insurer that insures developers of condominium projects in California for their liability for claims of construction defects should carefully review the decision of the California Supreme Court in Pinnacle Museum Tower v. Pinnacle Market Development, No. S186149 (Cal. 08/16/2012). The holding of the California Supreme Court should be kept in mind during the underwriting process before agreeing to insure the developer against the risk of loss by claims of construction defects. The prudent insurer might insist that an effective arbitration agreement be included in the covenants, conditions and restrictions (“CC&R's”) before selling any units to a buyer.

The Supreme Court resolved a dispute between an owners association and the original developer over an arbitration agreement made part of the CC&R's  before the owners association came into existence. The association filed a construction defect action against a condominium developer, seeking recovery for damage to its property and damage to the separate interests of the condominium owners who compose its membership. In response, the developer filed a motion to compel arbitration, based on a clause in the recorded declaration of CC&R's that provided that the association and the individual owners agreed to resolve any construction dispute with the developer through binding arbitration in accordance with the Federal Arbitration Act (“FAA”).

Factual And Procedural Background
Pinnacle Market Development (US), LLC, and others (collectively Pinnacle) developed a mixed use residential and commercial common interest community in San Diego known as the Pinnacle Museum Tower Condominium (the Project). Pinnacle, as the owner and developer of the Project property, drafted and recorded a “Declaration of Restrictions” to govern its use and operation (the Project CC&R's). The Project CC&R's contain a number of easements, restrictions and covenants.

The individual owners bought condominium units in the Project pursuant to a standard purchase agreement. The Association filed the instant action against Pinnacle, alleging that construction defects caused damage to the Project. As the sole plaintiff, the Association seeks recovery not only for damage to its own property, but also for damage to the interests held by its individual members.

Pinnacle filed a motion to compel arbitration, contending the FAA mandates enforcement of article XVIII's arbitration provisions. The trial court determined that the FAA is applicable and that article XVIII embodies an agreement to arbitrate between Pinnacle and the Association. Nonetheless, the court invalidated the agreement upon finding it marked by slight substantive unconscionability and a high degree of procedural unconscionability.

Discussion
To ensure that arbitration agreements are enforced according to their terms, the FAA preempts state laws which require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration. The FAA also precludes a court from construing an arbitration agreement in a manner different from that in which it otherwise construes nonarbitration agreements under state law. Nor may a court rely on the uniqueness of an agreement to arbitrate as a basis for a state-law holding that enforcement would be unconscionable, for this would enable the court to effect what the state legislature cannot.

The party seeking arbitration bears the burden of proving the existence of an arbitration agreement, and the party opposing arbitration bears the burden of proving any defense, such as unconscionability.

Settled principles of condominium law establish that an owners association, like its constituent members, must act in conformity with the terms of a recorded declaration.

That a developer and condominium owners may bind an association to an arbitration covenant via a recorded declaration is not unreasonable; indeed, such a result appears particularly important because (1) the Davis-Stirling Act confers standing upon an association to prosecute claims for construction damage in its own name without joining the individual condominium owners and (2) as between an association and its members, it is the members who pay the assessments that cover the expenses of resolving construction disputes. Given these circumstances, an association should not be allowed to frustrate the expectations of the owners (and the developer) by shunning their choice of a speedy and relatively inexpensive means of dispute resolution. Likewise, condominium owners should not be permitted to thwart the expectations of a developer by using an owners association as a shell to avoid an arbitration covenant in a duly recorded declaration.

In sum, even though the Association did not bargain with Pinnacle over the terms of the Project CC&R's or participate in their drafting, it is settled under the statutory and decisional law pertaining to common interest developments that the covenants and terms in the recorded declaration, including those in article XVIII, reflect written promises and agreements that are subject to enforcement against the Association.

The Doctrine of Unconscionability
As indicated, procedural unconscionability requires oppression or surprise. Here, the trial court found no evidence of surprise. Nonetheless, the court perceived a high degree of procedural unconscionability, because the Project CC&R's were drafted and recorded by Pinnacle before any unit was purchased and before the Association was formed. Noting the Association had no opportunity to participate in the drafting of the recorded declaration, the court determined it was oppressive.

By providing for Pinnacle's capacity to record a declaration that, when accepted by the first purchaser binds all others who accept deeds to its condominium properties, the Act ensures that the terms reflected in the declaration — i.e., the covenants, conditions, and restrictions governing the development's character and operation — will be respected in accordance with the expectations of all property owners and enforced unless proven unreasonable. Far from evidencing substantive unconscionability, the consent provision reflects a restrictive term that the Legislature, for policy reasons, has determined is reasonably and properly included in a recorded declaration.

Conclusion
Article XVIII of the Project CC&R's is consistent with the provisions of the Davis-Stirling Act and is not procedurally or substantively unconscionable. Its terms requiring binding arbitration of construction disputes are therefore enforceable.

Writing for the majority, Justice Baxter stated the following:

Even when strict privity of contract is lacking, the Davis-Stirling Act ensures that the covenants, conditions, and restrictions of a recorded declaration — which manifest the intent and expectations of the developer and those who take title to property in a community interest development — will be honored and enforced unless proven unreasonable. Here, the expectation of all concerned is that construction disputes involving the developer must be resolved by the expeditious and judicially favored method of binding arbitration.

We hold that article XVIII's covenant to arbitrate is not unconscionable and is properly enforced against the Association. Accordingly, we reverse the judgment of the Court of Appeal and remand the matter for further proceedings consistent with the views herein.

Justice Kennard, in dissent, stated that the evidence lacked a showing that the owners association's consented to an arbitration provision in the CC&R's drafted and recorded by the developer before the association's independent existence. In compelling arbitration, which offers no right to a jury, the majority deprives the owners association of its constitutional right to have its construction defect dispute decided by a jury. In the words of our state Constitution: “Trial by jury is an inviolate right and shall be secured to all …” (Cal. Const., art. I, § 16.)

Although this case never mentioned the word insurance, it is an important decision for insurers and may, if properly underwritten, make it possible to insure condominium developers for lower premium because they can effectively avoid litigation and trial and compel the resolution of construction defects by binding arbitration. Since arbitration is usually less expensive and much quicker than litigation and since arbitration does not put the parties at the risk of confusing a jury of 12 who know nothing about construction or construction defects, an actuary can more accurately calculate the potential losses and charge a competitive and fair premium to the developer.