Crush Of Defect Claims Persists In Construction Insurance Market

Over the past several years, construction defect claims have become increasingly difficult to manage for a number of reasons.

Geography

Construction defect claims have spread from predictably litigious states into virtually all states. Even traditionally non-litigious states in the Midwest and Plains states are seeing the emergence of construction defect issues.

Deep pockets

Plaintiffs attorneys have perfected the art of going after the limits of multiple policies covering multiple insureds, including general contractors, construction managers and various subcontractors.

Plaintiffs profile

Until recently, the vast majority of plaintiffs were associated with multi-unit housing developments. Now plaintiffs attorneys are also recruiting individual homeowners.

We have reached the point where the ultimate costs of insuring residential construction risks are virtually impossible to quantify. As long as judicial decisions and state laws create a favorable climate for construction defect litigation, we foresee continued difficulty for homebuilders and their subcontractors in obtaining insurance protection.

For instance, the Montrose case in California in 1995 (Montrose Chemical Corp. v. Admiral Ins. Co.) and similar decisions in other states tremendously expanded the pool of insurance dollars that can be tapped in a construction defect case. Citing Montrose, California courts have since held that when the bodily injury or property damage continues throughout successive policy periods, all of the insureds policies in effect during those periods are triggered.

Although Montrose concerned pollution, it set down a coverage theory–the continuous trigger–that has been routinely applied to construction defect cases in California and other states.

In another key California case in 2001, Presley Homes v. American States Insurance, the Court of Appeal of California (Fourth Appellate District, Division Three) held that when a subcontractor owes a defense obligation to an additional insured listed on the subcontractors policy, the obligation is 100 percent regardless of the subcontractors legal exposure to the claim. In essence, this means that the doorknob installer with a $1,000 sub-contract is obligated to provide a complete defense to a named additional insured developer once the developer tenders the obligation to the subcontractor.

The court held that the subcontractors carriers are free to pursue other potentially responsible parties and their carriers for contribution, but the scope of the defense obligation is not limited by the mere existence of other potentially liable parties or carriers.

Presley has contributed in a major way to the deterioration of the subcontractor insurance market in California and other states that look to California as the leader in the construction defect arena.

Also, a significant number of the larger carriers in the construction defect field have gone into liquidation (including Reliance and Legion) leaving the viable carriers in the position of having to fill in the gap years under the Montrose decision. Thus ABC Insurance Company, which wrote one policy for XYZ Painting Contractor, may face years of coverage exposure when liquidation and factors such as exhaustion of other policy limits are considered.

In addition to adverse legal decisions, construction defect-friendly state legislation has taken many forms. A Nevada statute, Chapter 40, makes construction defect defendants potentially liable for the plaintiffs legal costs and attorney fees if the plaintiff prevails. The Colorado Consumer Protection Act, which awards treble damages under certain circumstances, has been used by plaintiffs counsel to extract large settlements from construction defect defendants. In other states, legislatures have extended statutes of repose to accommodate certain types of construction defect claims.

While state legislatures have begun to address some of the issues discussed above, attempts such as Californias SB 800 (Builders Right to Repair Bill) and reforms to the Colorado Consumer Protection Act will do little to stop the hemorrhaging within the industry for some time to come. The backlog of claims filed before the reforms continue to generate losses, and it is too soon to know what impact the reforms will have on construction defect costs going forward.

The second major driver of the construction insurance marketplace is complexity of risk–an issue that impacts residential and commercial construction alike.

The complex chain of contractual liability that connects the owner, the general contractor, the design professional and the subcontractors is unparalleled in any other industry.

In response to this complexity, insurance contracts must incorporate an intricate set of additional insured and other indemnification provisions. As a result, its not unusual nowadays for construction underwriters to spend hours making sure the policy and endorsements accurately reflect the nature of the exposure.

The complexity of construction risk is adding impetus to a number of alternative approaches. While not a brand new idea, wrap-up master insurance policies that cover all parties to a construction project are becoming the right solution in more and more situations.

In addition, complexity of risk has caused many insurance companies to treat the construction business as a specialty line, with dedicated underwriting, claims and risk control professionals. Dedicated construction claims adjusters, for example, have a deep knowledge of the construction industry and the various contracts, safety rules and other considerations that add to the complexity of construction claims.

Another way to approach the complexity of risk is through specialized insurance programs targeted at specific construction segments, e.g., electrical and utility contractors. Focus on a particular construction specialty enables insurance professionals–and the firms being insured–to develop more effective strategies for managing risk.

Even with needed rate increases over the past two years, many construction insurers are barely breaking even. To achieve acceptable results, both insurers and construction firms must have a laser-like focus on controlling losses.

Construction losses are being driven by a number of systemic issues. For one thing, salaries are relatively high compared to other industries, and injuries tend to be more severe. These factors translate to higher workers compensation indemnity and medical costs. Compounding this issue is the entry of less experienced workers into the construction trades due to fewer jobs elsewhere. In addition, contractors are dealing with communication issues as more non-English speaking workers join the industry.

The insurance industry is responding to these issues with enhanced safety, ergonomic and return-to-work capabilities. Companies are producing multilingual safety materials. In addition, by partnering with construction industry associations, insurers are able to develop best practices that can be shared broadly with association members.

For all its challenges, we continue to see opportunities in the construction insurance marketplace, and we continue to believe that superior risk management represents a competitive advantage for contractors and owners.

From the perspective of insurance providers, a strategy for success combines prudent risk assumption, risk-based pricing, specialization and painstaking attention to loss control.

For construction firms, safety and loss control combined with strong management accountability are the keys to improving productivity and reducing insurance costs.

And for agents and brokers, in-depth knowledge of the clients risks, along with full-disclosure submissions to underwriters, will add value to agent/broker services and expedite the most favorable quotes from their carriers.

The bottom line is that in construction insurance, carriers, clients and agents succeed by working together. Regardless of market conditions, we prosper to the degree that our interests are aligned around understanding, managing and financing risk.

Antonio Z. De Padua is senior vice president of CNA Construction, a part of the U.S. Insurance Operations of Chicago-based CNA. Mr. De Padua is responsible for CNAs $1.3 billion U.S. construction business.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, January 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.