Stalwart Group Of E&S Insurers

Stay In Residential Construction Market

Defects fuel concerns, but quality construction, documentationopens doors to coverage

"Residential" is not a dreaded word in the constructionliability insurance world for a handful of players--old andnew--who say that quality building and customer service are keys toincreasing coverage grants.

Underwriters are by no means embracing the residential classwith open arms. But a determined few, mainly operating in thenon-admitted market, have constructed policies to withstand claimsleakage from prior years.

John Edack, an executive vice president for the Western regionof Arch Insurance Group in San Francisco, went so far as todescribe the current market for residential contractors andhomebuilders as "robust."

"I think it's a healthy marketplace," he said, noting thatresidential contractors and builders are now able to find coveragethat meets their requirements and those dictated by financialbackers of construction projects. Insurance prices seem to fit intotheir overall budgets as well, he added.

But the class "is not for the faint of heart," he warned, notingthat Arch entered 2002 with a qualified underwriting team, making athorough application an integral part of the process. "There ispotential for significant loss," he said.

Ten years ago, a California Supreme Court decision in MontroseChemical Corp. vs. Admiral Insurance opened the floodgates tosignificant losses from construction defect claims. Theruling--which actually involved pollution cleanups at a chemicalmaker's facilities--rejected doctrines that previously stood asbars to coverage for claims from existing defects. Together withsubsequent decisions, it put contractors' liability carriers on thehook for losses and defense costs on policies issued after theonset of continuing damage claims that took place over a number ofpolicy periods--like leaky roofs.

"It seemed to immediately turn the market" for residentialcontractors in California, said William Newton, president of Lemac& Associates in Los Angeles.

Before Montrose, most risks were placed in the standard market,he noted. After Montrose, as business flowed to the surplus linesmarket, Lemac became a major player, and the wholesaler now has 40percent of its operation in residential on the West Coast and inHawaii, Mr. Newton said.

Lemac's markets include Mt. Hawley Insurance, a unit of Peoria,Ill.-based RLI Corp., with a program for small contractors doingresidential repair work (under $1 million in sales), and seveninsurers writing subcontractors for new tract homes.

Almost all those writing contractors involved in condominiumsuse wrap-up policies--purchased by an owner, developer, or generalcontractor to cover all parties involved in a project, heexplained. "Arch took the lead in putting together a wrap-upprogram, and a few others followed them into the market," he said,noting that the wrap-up trend that started in California is movingacross the country.

According to Ken Maskell, regional vice president for Arch, onebenefit of a wrap-up from an insurer's perspective is that itreduces the possibility of cross-suits that exists when contractorsand subs are covered under multiple policies.

Like Arch, ProBuilders Specialty Insurance--a Washington,D.C.-domiciled RRG--entered the residential construction market in2002. "We capitalized on the market turmoil," said Peter Foley,president and chief executive, noting that a group ofindividuals--each with 20 years experience in construction--beganworking on the venture in 2001.

Focusing initially on the Western states, he said, marketdisarray in California caused by court rulings and a housing boomwere factors that opened a huge market opportunity. ProBuilders nowactively writes in 28 states and is registered in 49.

New York is the exception, Mr. Foley noted. "We're watching anddeciding if we want to enter," he said.

In 2005, he predicts that the RRG will write close to $100million, adding that nine homebuilders associations have endorsedthe RRG. "Our focus in working with the associations is not to bethe cheapest or the broadest in coverage, but to look for long-termrelationships," he said.

In Mr. Foley's view, contract language and breadth of coverageare not the biggest issues for contractors. "Candidly, for many,the goal is 'Give me an insurance certificate, so I can get on thatjob site,'" he said.

Responding to that need, "we don't template-underwrite," hesaid, noting that the RRG will individually "risk-underwrite" mostclasses--including foundation, excavation, framing and roofingtrades.

"If they know what they're doing, we'll look at them," he said,noting that the RRG's focus is on midsized contractors ($20-to-$25million in revenues). ProBuilders also recently entered themulti-family townhouse and condo market with a wrap-up,entertaining subcontractors doing non-structural repairs.

While the focus in on the midsized contractors, Mr. Foley said awillingness to listen--for example, when a large shock loss hits acontractor with an otherwise good track record--has allowed the RRGto gain a presence in the $25-to-$50 million range. In onesituation, he said, a big contractor wanted a large deductible,prompting a rejection from a usual market that viewed that as acredit risk.

He was located in a "homegrown community, where, if you foul up,you might as well move out of town," he said, going through some ofthe considerations that allowed the RRG to afford coverage. Thecontractor hadn't put a lot of assets in his company (to avoidbeing a target), but a look at his personal financials revealed thewherewithal to maintain a large deductible.

American International Group, with offerings of primary, excessand environmental policies, never left the residential contractorsand builders market. "Obviously, there have been some issuesassociated with the insurability of these exposures," said ToddGermano, senior vice president of the Construction Specialty ExcessDivision. "I think AIG should get credit for having remained."

Noting that the excess unit writes in all states and entertainsall classes, he said one change that allowed it to continueoffering coverage for very large homebuilders was the developmentof a specialized coverage, referred to in the market as a"close-of-escrow policy." Coverage under the policy is granted onlyfor homes that close within the succeeding 12 months.

At the time it was created, in 1999, the continuous triggerdecision meant that homes built in prior years would be coveredunder previous occurrence-based policies. "If we didn't somehowstop the claims [from multiple-housing units built in prior years]from continuing into the next year, we would pick them up again. Wewere trying to avoid covering them twice," he said.

Heading up AIG's primary construction operation, Dan Conway,president of AIG Construction Risk Management, also said AIGresponded to contractors' needs as the market tightened. But "weneeded to protect ourselves--to keep ourselves out of the warrantybusiness," he added, explaining that AIG imposed uncapped per-unitself-insured retentions to accomplish this.

AIG has begun to ease up on this recently. "As we progressed,and the quality of homes and documentation of homes improved, webecame more comfortable with some--not all--who were in thisbusiness," he said, noting that this led AIG to start capping someself-insured retentions. He explained, for example, that a $25,000per-dwelling SIR might now be capped at $500,000, as opposed tohaving no limit on the aggregate amount an insured retains.

At Zurich North America, getting closer to the warranty businesswas part of the carrier's strategy to participate in the "volumehomebuilders market," according to Karen Schwartzkopf, senior vicepresident of the construction business unit in Minneapolis.

Zurich's sole product for the residential market--targetinghomebuilders with annual revenues above $100 million and availablewith limits up to $25 million--came out in 1999, and is a blend ofthe homebuilders warranty and a liability policy.

The policy differs from an ordinary liability policy, accordingto Ms. Schwartzkopf, in that it includes coverage for "damage toyour work" caused by construction defects under a warranty coveragepart, and residual defect coverage available under the liabilitypart. The warranty coverage is subject to arbitration.

With an average policy retention of roughly $1.2 million, thecost of maintenance-type repairs are usually "well within theinsured's retention," she said. While "the intent is never to pickup the operation risk from a warranty standpoint," she stressedthat understanding the warranty--and the customer service behindit--are key underwriting factors.

"We look at the upfront piece," she explained. "How well doesthat builder build a building? What is the quality-assurance,quality-control process? How do they document that? Then we look atthe back-end--customer service. How well does the builder respondto warranty claims and service issues...so that those warrantyclaims don't eventually become defect claims."

The questions outlined by Ms. Schwartzkopf were repeated byevery underwriter interviewed by NU.

At AIG, Mr. Conway said SIRs on primary policies will only becapped for contractors that "have very stringent quality-assuranceprograms [and who] are just as adamant about documenting." AIGunderwriters get comfortable with this through face-to-faceinterviews, he noted.

"We like to visit the job sites," where contractors demonstrate"water penetration avoidance techniques [and] otherquality-assurance issues--whether it's the drying of lumber orflashing around windows, the tagging process, or the documentationof the tagging in the different stages of completion of the home,"he said, explaining that tags on construction details are initialedand dated to indicated they were inspected.

They "prove to us [that] it's not just an off-the-shelf-typeprogram in a nice binder. We witness the program in action," hesaid.

Citing AIG statistics through 2004, he said that for every $1 ofindemnity, there was $1.25 paid for legal expenses--underscoringthe need for strong assurance programs, the benefit of a specialAIG construction defect claims litigation unit, and the importancefor contractors to aggressively monitor warranty processes.

"With a regimented process" that specifies timing of follow-upcalls to homeowners and documents them, he said, "if a lossemanates six months later, there is evidence that you had calledand there was nothing wrong."

"That's what it comes down to in many cases. It has nothing todo with the quality of the home, but it has a lot to do with theability to defend one's home," he said.

Art caption:

Underwriters participating in the residential constructionsector take an active stance in reviewing exposures--going out tojob site to witness quality-control programs for themselves.

Caption, with Conway pix (if needed):

Dan Conway, president of AIG Construction Risk Management, saiddefense is critical for residential contractors and homebuilders."In many cases, it has nothing to do with the quality of the home.But it has a lot to do with the ability to defend one's home," hesaid.