Chapter 21 Insurance and bonding.
In this chapter we discuss the types of insurance and bonds often taken out by landscape architects, designers, and contractors. We also describe the rights and obligations of insurance companies and bonding companies, of landscape architects, designers, and contractors, and of others insured and protected under the insurance policies and bonds. After studying this chapter, you should know what types of insurance and bond coverage landscape architects, designers, and contractors should have and their cost.
CONTRACTUAL NATURE OF INSURANCE
An insurance policy is a contract governed by basic contract law. An insurance contract can be analyzed just like any other contract by considering the basic who, agrees to do what, when, provisions introduced in Chapter 2.
Professional Liability Insurance
The essential terms of a professional liability insurance policy (sometimes called an "errors and omissions insurance policy") for landscape architects and designers are shown in Table 21-1.
Landscape Contractors' Insurance
The essential terms of landscape contractors' insurance policies are shown in Table 21-2.
An insurance policy is a contract by an insurance company to indemnify the insured for, or pay on its behalf, certain losses that an insured suffers.
FINANCIAL BASIS FOR INSURANCE
The financial basis for insurance is that the risk of loss is spread among all those who buy the same type of insurance from the same insurance company. For example, if 20 landscape contractors each buy a policy from the same insurance company insuring their equipment against loss or damage in the amount of $100,000, the total amount at risk for the insurance company will be 20 x $100,000, or $2,000,000. However, the insurance company, based on its experience with insurance of this nature over the years, estimates that the total amount of claims will be only $100,000. Therefore the premium charged each landscape contractor by the insurance company, in theory, will be $100,000 divided among the 20 landscape contractors, or $5,000 each for aggregate premiums of $100,000. At the end of the year, if the insurance company's estimates of loss are correct, the aggregate insurance premiums ($100,000) will equal the aggregate amount of the losses ($100,000) suffered by and paid out to those of the 20 landscape contractors who suffered the losses.
In practice the setting of premiums is more complicated. First, an insurance company issues many types of insurance policies and so must estimate the risks of loss under all of them. In addition, the insurance company must make a profit. As a rule of thumb, profits are covered by the interest and investment income the insurance company earns on the premiums it receives in advance, before it has to pay out the proceeds of the insurance to those suffering losses. This interest and investment income also is often great enough to cover some of the insurance proceeds the insurance company has to pay to insureds to indemnify them for their losses.
If the insurance company's estimates of loss are too low, it will charge higher premiums in subsequent years to make up for the losses.
Moreover, an insurance company usually reinsures part of its risks with reinsurance companies operating worldwide, who charge premiums for this reinsurance. If the reinsurers' estimates of loss are too low, the reinsurers will charge a higher premium to the insurance company the following years, who in turn will pass this higher premium on to its insureds. Thus a disaster such as a hurricane in Central America, for example, could result in increased insurance premiums in Oregon, even though the insurance company in Oregon doesn't directly insure the risks of loss in Central America.
Finally, the insurance business is competitive, so most insurance companies in fixing their premiums take into account what other insurance companies are charging for accepting similar risks.
USUAL OBLIGATIONS OF LANDSCAPE ARCHITECTS, DESIGNERS, OWNERS, AND CONTRACTORS, TO INSURE
Liabilities of Landscape Architects and Designers
At common law, landscape architects and designers are liable for the losses they cause by their professional negligence (see Chapter 2). They have a duty to perform their professional services to a standard of care, skill, and diligence normally performed by those in their profession in similar circumstances. If they do not perform to that standard, they are liable for any resulting loss. For example, if a retaining wall collapses owing to faulty design, the landscape architect will be liable for the resulting loss.
A landscape architect, by contract, could be required to work to a higher standard, (e.g., to guarantee the work) so that if a retaining wall failed owing to faulty design, the landscape architect would be liable whether negligent or not. Such a requirement is rarely inserted in a contract because the prevailing view is that landscape architects should be liable only they are negligent. Otherwise landscape architects would find it difficult to get professional liability insurance.
Obligations of Landscape Architects to Insure
Under AIA Document B141-1997, architects have no obligation to insure against professional negligence claims, although there is a provision that the expense of professional liability insurance related solely to the project, or requested by an owner in excess of the liability insurance usually carried by the architect, is a reimbursable expense. Many owners require landscape architects to carry professional liability insurance, and in any event most landscape architects do so because of the increasing number of claims and the benefits of having insurers bear the expense of defending against and paying claims. Some contracts for the provision of landscape architectural services provide that landscape architects won't be liable for amounts in excess of their liability insurance but that they will take out additional liability insurance at the specific request and expense of their client.
Liabilities of Owners and Contractors
At common law, contractors and owners are liable to each other for harm they or their employees cause to the other by their or their employees' negligence (see Chapter 2). Often contractors, by contract, also are liable to owners for any the harm their employees and subcontractors cause the owners (see AIA Document A201-1997, Paragraph 3.18). Owners and contractors usually consider it in their best interests to require the other to be insured for such liabilities so that funds will be available to pay any damages to which they are entitled. Contractual obligations to insure may vary from contract to contract, but the usual obligations of owners and contractors to insure are similar to those contained in AIA Document A201-1997.
Obligations of Owners to Insure
Under AIA Document A201-1997 General Conditions, owners are obligated to carry both liability and property insurance.
Owners' Liability Insurance. Owners are obligated to maintain their usual liability insurance. As owners rarely carry out risky operations that might cause loss to contractors during a construction project, these insuring provisions aren't onerous nor do contractors usually demand specific amounts of coverage. (see AIA Document A201-1997, Paragraph 11.2).
Property Insurance. Owners are obligated to maintain property insurance in the amount of the aggregate contract price for the project, on a builder's "all-risk" policy covering the work as construction proceeds. It covers loss from such things as fire, theft, and vandalism. The proceeds of the policy are to be held by the owner for the benefit of the owner, general contractor, and subcontractors as their interests may require. (see AIA Document A201-1997, Paragraph 11.4) For example, if an owner's fence is knocked down during the work, the insurance proceeds should be payable to the contractor for rebuilding the fence in accordance with its obligation to deliver the completed project to the owner.
It is reasonable for an owner to bear the cost of this insurance directly because, if the owner did not, the contractor would have to take out this insurance, the cost of which would be indirectly borne by the owner in the contract price. The owner would probably insure also, so there would be duplicate insurance (and premiums) for the same loss. Insurance premiums currently are approximately $0.02 per $100 per month, based on the cost of the completed project; however, insurance premiums vary widely from year to year.
Obligations of Contractors to Insure
Under AIA Document A201-1997, contractors are obligated to carry liability insurance and certain other coverage.
Contractors' Liability Insurance. Contractors are obligated under AIA Document A201-1997 to take out insurance to protect them against claims for
* workers' compensation, disability benefits, or similar benefits;
* bodily injury, sickness, or death of employees or others;
* usual personal injury liability insurance coverage;
* loss of or damage to tangible property (other than the work);
* loss arising from motor vehicle ownership or use; and
* negligence under AIA Document A201-1997, Paragraph 3.18.
Such insurance is to cover claims whether they arise from the contractors' operations or the operation of their subcontractors or their employees.
Contractors' general liability insurance premiums vary widely and could range from $20 to $50 per $1,000 annual payroll. Costs of workers' compensation insurance also varies widely, depending on the type of work and payroll. In most states private insurance companies provide workers' compensation insurance, but a few states, (e.g., Washington) provide state-run workers' compensation plans.
Contractors have some minor obligations to insure under AIA Document A201-1997. In addition, contractors should insure their equipment against loss or damage. Some owners require contractors to maintain this type of insurance so that, if equipment is destroyed or damaged, the contractors will have sufficient funds to replace it and complete their work. Contractors should consult their insurance agents when entering into AIA construction contracts or other forms of construction contracts to ensure that their insurance policies will cover all their obligations under the contracts.
INSURANCE OBLIGATIONS UNDER SUBCONTRACTS
Under AIA Document A401-1997 a general contractor has the same obligations to subcontractors as the owner has to the contractor under the prime contract. These obligations include providing all-risk insurance for the property and proof of this insurance. Subcontractors are obligated to have the same types of insurance that general contractors must have.
UTMOST GOOD FAITH
Insurance contracts are somewhat different from ordinary contracts, in that they are contracts of "utmost good faith," or as lawyers call it, uberrima fides. That is, someone applying for insurance must not mislead an insurance company by answering questions falsely. Insurance companies accept risks, fix premiums, and issue policies based on information they receive about the nature of the risk. If they are misled, they might accept risks that they would not otherwise accept, or they might charge lower premiums than actually called for.
Insurance companies rely on the information that prospective insureds give them because making independent inquiries for all the policies they issue would be too costly. If there are losses, which happens for relatively few policies, insurance companies usually verify the information that they have been given. If they have been given false information, the courts could hold that the insurance was invalid.
Insureds are not obliged to volunteer information, but they must complete application forms correctly. If asked, they must answer questions honestly; if they don't, their insurance coverage will be at risk.
Insureds must have financial interests in the risks they insure. If they have no financial loss if events for which they insure occur, they aren't entitled to the proceeds of the policy. For example, if someone insured a neighbor's house against loss by fire and the neighbor's house burns down, unless the insured suffers some financial loss from the neighbor's house burning down, the insured couldn't recover under the policy. A contract of insurance must not be a wagering contract; rather it must be a contract of indemnity for loss. If a landscape contractor insured its pickup truck for $40,000 against loss, and the truck were lost, but its value was only $20,000, the landscape contractor could recover only $20,000 under the policy.
Many policies of insurance have a coinsurance clause. This clause provides that, if the face amount of the policy is less than a certain percentage (usually 80%) of the full insurable value of the property insured, the insured won't be able to recover the full amount of a partial loss, but only that percentage of the partial loss. For example, suppose that the current full insurable value (replacement value) of a property is $100,000. If the coinsurance provision is for 80%, the face amount of the policy should be not less than 80% of $100,000, or $80,000. If the face amount of the policy is $60,000 (75% of $80,000) and there is a partial loss of $10,000, the amount that could be recovered for the partial loss would be 75% of the $10,000 loss, or $7,500. If the face amount of the policy is $80,000, equalling the coverage required by the coinsurance clause, the full $10,000 partial loss could be recovered.
The purpose of a coinsurance clause is to prevent insureds from underinsuring (and paying lower premiums), yet still recovering up to the face amount of the insurance policy for a partial loss. Partial losses, not total losses of insured property, are frequent.
When an insurance company pays the proceeds of insurance to an insured, the insurance company is subrogated to the insured; that is, the insurer has all the rights of the insured (colloquially, "stands in the shoes of" the insured) to recover from the person who caused the loss, to the extent of the amount paid by the insurance company. For example, if a landscape contractor negligently damaged a customer's garage and the cost of repairs were $10,000, the customer could file a claim under its own insurance policy for indemnity for the repair cost of $10,000. The customer's insurance company (on payment of the $10,000 to the customer) would have a right to recover the $10,000 from the landscape contractor who caused the loss.
Under AIA Document A201-1997, owners and contractors waive rights of subrogation against each other for claims covered by the property insurance that owners take out for their benefit and the benefit of contractors and subcontractors.
INSURANCE FOR LANDSCAPE CONTRACTORS
Landscape contractors should carry these types of insurance--general liability insurance, motor vehicle insurance, all-risk insurance during the construction period, and equipment insurance--discussed for contractors in general. In addition, landscape contractors should consider life and accident insurance for their principals, property insurance on their premises, business interruption insurance, and other types of insurance that may be desirable, depending on the risks that landscape contractors face in their business operations.
When considering the amount of coverage to take out, landscape contractors should determine an acceptable risk of loss and compare the cost of insurance to the possible cost of loss.
Acceptable Risk of Loss
A landscape contractor shouldn't accept a risk of loss if the risk can be insured for a reasonable cost and the landscape contractor can't afford to bear the loss. A landscape contractor that can afford to bear the loss shouldn't take out insurance. For example, motor vehicle insurance may require a deductible of $100 or $500. If the landscape contractor can afford to pay the first $500 of any loss, taking the $500 deductible probably would be advisable because the cost of the $100 deductible would be relatively expensive. Landscape contractors should not a accept risk of loss for more than they can afford to lose.
Cost of Insurance Versus Cost of Loss
Landscape contractors should consider the cost of insurance in relation to the cost of potential loss. For example, the premium for the first $1,000,000 liability coverage for motor vehicle insurance may be $130, but the second $1,000,000 coverage may be an additional premium of only $55. Considering that damages for severe personal injury often exceed $1,000,000, it would be sensible, for $55, to get coverage for $2,000,000 instead of risking liability for amounts between $1,000,000 and $2,000,000.
Landscape contractors should choose good insurance agents. Some agents are more knowledgeable and make more effort than others to advise customers about proper insurance coverage. Landscape contractors should choose insurance agents with whom they feel comfortable and confident.
CONTRACTUAL NATURE OF BONDS
A bond is a contract governed by basic contract law and is similar to a contract of gurantee. A bond can be analyzed just like any other contract by considering the basic who, agrees to do what, when, as described in Chapter 2.
Bond coverage for landscape contractors is shown in Table 21-3.
FINANCIAL BASIS FOR BONDS
The financial basis for a bond is that the risk of loss is spread among all those who obtain bonds from the same bonding company. Bonding companies won't issue bonds for landscape contractors unless they consider the contractors to be reliable and unlikely to default on their contracts. Further, bonding companies require indemnity from landscape contractors for whom they issue bonds and might have to pay on default by the contractors. Bonding companies often require guarantees from the principals of the landscape contracting companies for whose benefit the bonds are issued. They may also require guarantees from the principals' spouses to minimize any losses if they must perform the obligations of the defaulting contractors. Bonding companies know from experience their anticipated losses for a year, and when adding to this the amount of their profit. They average their total cost and profit per $1,000 of bond coverage and base their fees on that. Unlike insurance premiums, which are fixed on an actuarial basis because insurance companies expect to pay for losses without indemnity from the insured, bond premiums are fixed on the basis that there should be no loss. In other words the bonding companies expect to able to recover from landscape contractors for whose benefit they issue the bond all amounts paid out.
TYPES OF BONDS
Landscape contractors often need three types of bonds: bid bonds, performance bonds, and payment bonds.
When a landscape contractor bids for a job, the bid documents are so precise that when the bid is accepted, a binding contract is formed, and the parties must execute a contract on the basis of the bid documents. If the landscape contractor refuses to sign the contract, the owner goes to another bidder, whose bid is probably higher. The landscape contractor that refused to sign the contract would be liable for the difference between the bid price in its offer and the bid price in the higher bid.
An invitation to bid often requires that the bid be accompanied by a bid bond. In issuing a bid bond the bonding company agrees to accept the landscape contractor's liability if the contractor refused to sign the contract after its bid was accepted. The bid bond is for a maximum stated face amount.
A landscape contractor that can present a bid bond probably is reliable because bonding companies won't issue a bid bond unless it believes that the landscape contractor will perform its obligation under the contract. By requiring a bid bond, owners save expense by excluding unbondable and unreliable landscape contractors from the bidding process.
Bonding companies rarely charge a fee for issuing bid bonds because the bonding business is so competitive. The bonding companies' main remuneration comes from their fees for performance bonds and payment bonds. The relationships between bonding companies and landscape contractors are continuing and relatively permanent. Bonding companies usually won't issue bid bonds unless they're also prepared to issue performance bonds and payment bonds required under contract.
Performance bonds are the covenants of bonding companies to be liable for the performance of the obligations of landscape contractors if they fail to perform under the contracts for which the performance bonds were issued. The bonds are for a stated maximum amount.
If a landscape contractor is in default, the bonding company usually has the options of
* curing the default,
* completing the work required under the contract itself, or
* finding another landscape contractor who will agree with the owner to complete the work required under the contract and paying any amount in excess of what the owner would have had to pay if the first landscape contractor hadn't defaulted.
Usually the amount of the performance bond required is 100% of the contract price. The loss would be the difference between the amount the owner would have had to pay the original landscape contractor under the contract for the work and the aggregate amount that must be paid to the original landscape contractor and the new landscape contractor for the work. The cost of a performance bond varies widely, from about $6 to $25 per $1,000 contract amount.
Payment bonds are the covenants of bonding companies to pay unpaid workers, suppliers, and subcontractors who provide labor or materials to a landscape contractor for a project.
Owners require payment bonds so that unpaid workers, suppliers, and subcontractors won't file mechanics' liens and delay project completion if contractors fail to pay them. In addition, having payment bonds in place should make it easier for landscape contractors to buy on credit.
Although a payment bond is for the prime benefit of workers, suppliers, and subcontractors, they aren't parties to the bond. But the bond is entered into for their benefit, so by statute they may recover under the bond. Usually the amount of the payment bond required is 100% of the contract price.
Sometimes landscape contractors find it more convenient to have their banks issue letters of credit to owners to give owners the protection that they would otherwise have under a bond.
RELEASE OF BONDING COMPANY OBLIGATIONS RESULTING FROM CONTRACT AMENDMENT
Bonds are issued for specific contracts, which are examined by bonding companies. If these contracts are amended, the risks could be different from the risks the bonding company originally accepted. The bonding company could be released from its obligations if it doesn't consent to the amendment because an amendment could be detrimental to the bonding company. For example, if the amendment provided for early payment of the contract price, the landscape contractor might dissipate the funds and, as a result, not have enough working capital to complete the contract. The bonding company could be prejudiced by the amendment for early payment because, as a result of the dissipation of the funds by the contractor, it would have to pay out more to complete the work. In these circumstances a court might hold that a bonding company was not liable for payment under the bond.
If a contract has a provision permitting an owner to make changes to the work under a contract, these changes won't be an amendment to the contract releasing the bonding company, so long as the provisions in the contract for changes to the work are complied with.
If owners fail to give prompt notice to bonding companies of defaults by landscape contractors under contracts, or waive defaults under contracts, bonding companies could be prejudiced. If bonding companies are notified promptly of defaults, they can take prompt action to reduce their costs of completing the contracts; if they are not notified, they won't know that they should take these steps.
Owners usually won't agree to amendments to contract or permit defaults to continue under contracts unless they have the consent of bonding companies. Otherwise their bond protection could be in jeopardy.
An insurance policy is a contract governed by basic contract law and can be analyzed in the manner described in Chapter 2.
The financial basis of insurance is the sharing of risk. The aggregate amount of premiums paid to an insurance company each year will be approximately the same amount payable to all insureds that suffer a loss. The risk is shared by all insureds, so that each pays a small amount as a premium, and those who suffer a loss are compensated out of the premiums paid by all insureds.
Landscape contractors who work under the AIA standard form of construction contracts, either as prime contractors or subcontractors, are obligated to take out contractors' liability insurance to cover the risks of
* workers' compensation, disability benefits, or similar claims;
* bodily injury, sickness, or death of employees or others;
* usual personal injury liability insurance coverage;
* loss of or damage to tangible property (other than the work);
* loss arising from motor vehicle ownership or use; and
* claims arising from their contractual liability for negligence under AIA Document A201-1997, Paragraph 3.18.
Subcontractors are obliged to take out the same types of insurance as prime contractors. They have the same benefits as prime contractors under all-risk coverage for the period of the work taken out by owners.
Insurance contracts are contracts of utmost good faith. If insureds don't complete insurance applications honestly insurance companies can deny coverage if there is a loss and the dishonesty in the applications is discovered.
Insurance contracts are not wagering contracts. Insureds must have an "insurable interest" in the risk for which they take out insurance.
Coinsurance clauses require insureds to insure property for a high percentage (usually 80%) of the replacement cost if they are to recover the full amount of a partial loss--that is, a loss of or damage to part of the property insured. When an insurance company pays an insured for a loss, the insurer is subrogated to the rights, or "stands in the shoes of" the insured for claims against those who caused the loss.
When considering the appropriate types and amounts of insurance, landscape contractors should consider the risk of loss and how much they can afford to risk. Usually the higher the deductible amount from the loss indemnity amount, the lower is the premium. Landscape contractors should deal with knowledgeable and reliable insurance agents.
Bonds also are contracts covered by basic contract law and can be analyzed in the manner described in Chapter 2.
The financial basis of bonds is that bonding companies estimate their total losses on the bonds they issue and divide those among all that take out bonds. If there is a high risk of having to pay out on bonds issued on behalf of a landscape contractor, the bonding company will not issue the bonds. The bonding companies may require guarantees of the principals of the landscape contracting companies and perhaps their spouses before issuing bonds.
Landscape contracting companies commonly need three types of bonds:
1. bid bonds, which protect owners from loss if successful bidders refuse to execute contracts in accordance with their bids;
2. performance bonds, which protect owners from loss if landscape contractors fail to perform their obligations under a contract; and
3. payment bonds, which protect workers, suppliers, and subcontractors from loss if landscape contractors fail to pay them and which also protect owners because the unpaid workers, suppliers, and subcontractors will probably file claims under bonds instead of filing mechanics' liens.
Sometimes landscape contractors have their banks issue letters of credit to owners instead of providing bonds to the owners.
Bonding companies issue bonds for specific contracts. If the contracts are amended without the consent of the bonding companies, the bonding companies could be released from their obligations under the bonds. Bonding companies could also be released from their obligations if owners waive defaults by landscape contractors under the contracts for which the bonds were issued or if the owners fail to give the bonding companies prompt notice of default.
CHAPTER REVIEW QUESTIONS
1. What is an insurance policy? What is the financial basis for insurance?
2. What types of insurance policies are required of owners, architects, contractors, and subcontractors under the AIA forms of construction contracts? Describe the coverage provided by each type of insurance policy.
3. What does utmost good faith mean in relation to insurance contracts?
4. What is an insurable interest in a risk? Why is an insurable interest necessary for an insured to recover a loss?
5. What is the effect of a coinsurance clause in an insurance policy?
6. What does subrogation mean with respect to the rights of an insurer against a person causing a loss for which the insurance company indemnifies the insured?
7. What types of insurance and in what amounts should a landscape contractor have?
8. What is a bond issued by a bonding company? What is the financial basis on which bonds are issued?
9. What three types of bonds do landscape contractors often require? What protections do each of these bonds provide and to whom?
10. Why might a bonding company be released from its obligations under a bond if the underlying contract is amended?
11. Why might a bonding company be released from its obligations under a bond if the owner waives a default under a contract or delays in giving notice of default to a bonding company of a default under the contract?
Table 21-1 Professional Liability Insurance Coverage For Insurance Companies Who An insurance company Agrees to do The insurance company agrees to defend the what landscape architect, or designer against claims for professional negligence and to pay the claims on its behalf when and if payable up to the maximum amount of the policy. When The insurance company agrees to settle or defend claims when the landscape architect or designer is sued and to pay valid claims when settled or when liability is determined. For Landscape Architects and Designers Who A landscape architect or designer Agrees to do The landscape architect or designer agrees to pay what premiums to the insurance company as consideration for the insurance company's agreeing to defend and to pay claims against the landscape architect or designer for professional negligence. When The landscape architect or designer usually pays premiums once a year but can arrange to pay them in installments during the contract year. Table 21-2 Contractors' Liability Insurance Coverage For Insurance Companies Who An insurance company Agrees to do The insurance company agrees to indemnify the what landscape contractor for losses as described in the insurance policies and suffered by the landscape contractor up to the maximum amount of the policy. When The insurance company indemnifies and pays the landscape contractors after the landscape contractor suffers a loss. For Landscape Contractors Who A landscape contractor Agrees to do The landscape contractor agrees to pay premiums to what the insurance company as consideration for the insurance company's agreeing to indemnify the landscape contractor for losses it suffered. When The landscape contractor usually pays premiums once a year but can arrange to pay them in installments during the contract year. Table 21-3 Bond Coverage For Bonding Companies Who A bonding company Agrees to do The bonding company agrees to be liable for the what obligations of the landscape contractor to those (beneficiaries) having dealings with the landscape contractor if the landscape contractor defaults in the performance of its obligations. The bonding company completes the obligations of the landscape contractor under the defaulted contract or pays the beneficiaries the amount of the loss suffered as a result of the default, up to the face amount of the bond When The bonding company take on the obligations of the landscape contractor when the landscape contractor is in default and when the beneficiaries give the bonding company notice of default and require the bonding company to perform those obligations. For Landscape Contractors Who A landscape contractor Agrees to do The landscape contractor agrees to pay fees to the what bonding company as consideration for the bonding company's agreeing to indemnify beneficiaries for the loss suffered as a result of default by the landscape contractor under the contract. When The landscape contractor usually pays premiums at the beginning of jobs on a job-specific basis.
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|Title Annotation:||PART 4 JOB ADMINISTRATION|
|Publication:||Landscape Estimating and Contract Administration|
|Article Type:||Professional standards|
|Date:||Jan 1, 2002|
|Previous Article:||Chapter 20 Mechanics' liens.|
|Next Article:||Chapter 22 Management of landscape contracting businesses and preparation of the business plan.|