Current Construction Issues In Contractor’s Commercial General Liability Insurance Coverage
commercial general liability insurance coverage is currently in a crisis
mode for construction in many areas due to a number of issues.
Contractors are seeing significant premium increases for this
coverage ranging from as high as 600% to 1,000% on a year-over-year
basis in some states, such as California and Nevada.
The cost of this insurance is the second highest insurance cost
for contractors behind only worker’s compensation coverage.
Moreover, significant policy exclusions are prevalent, including
exclusions for project types, such as condominiums, apartments, and
master-planned developments that include a home owner’s association.
The increasing prevalence of construction defects lawsuits has
led to the exclusion of various exposure types of construction from
commercial general liability (CGL) policies.
Constructor education about these emerging CGL trends is
essential, since mistakes here can and, in fact, have led to the
bankruptcy of contractors
construction defects, insurance, insurance deductibles, liability
issues, risk management, premiums
management in construction is a key element in business success and survival for
contractors. This risk management
can take many forms, including subcontracting to shift risk to others, contract
modifications, avoiding extreme-risk projects, subcontractor bonding, and
insurance requirements. The last category of insurance includes numerous types of
insurance, including worker’s compensation, builder’s risk, errors and
omissions (for design-build responsibilities), and commercial general liability.
The focus of this paper will be on current construction issues in
contractors’ commercial general liability insurance coverage.
Commercial general liability (CGL) policies provide coverage for
contractors, arising out of events from their completed construction operations. Thus for a general contractor, a roof leak that damages a
two-year old office building, due to an omitted flashing detail by the roofing
subcontractor, would have the water damages covered under the CGL policy.
An individual contractor’s CGL policy will not cover their own
defective work, but instead the resultant damage.
In the case of a leaking roof, the general contractor’s insurance
carrier would look to the roofing subcontractor’s insurance carrier for
compensation for the water damages. The
roofing subcontractor would still be responsible to repair, out-of-pocket, the
omitted flashing detail. Similarly,
a patron of a restaurant who suffers an injury at the establishment, due to a
construction defect, will seek recovery from the restaurant owners, who in turn
will claim against the general contractor and subcontractor as well, if
relevant. If it was a poorly-constructed concrete step at the
restaurant by the concrete subcontractor, the ultimate responsibility will be
the sub’s CGL policy for the personal injury costs and then the sub’s own
pocket for corrections to the step itself.
Thus the standard CGL policy provides for coverage for injuries to
persons or damage to property, occurring after a construction operation is
completed but attributed to that operation.
defects, resulting in damage to persons or property, are not new.
Indeed, some of the world’s oldest building codes, such as the Code of
Hammurabi in 2200 B.C., prescribed literally “an eye for an eye” punishment
for defective construction (Carper, 1974; Kaminetzky, 1992; Poe, 1973).
Insurance vehicles, such as builder’s risk and worker’s compensation,
were developed to deal with construction defects, during the time frame of
actual construction. The commercial
general liability coverages for contractors were developed, as noted before, for
after the completion of construction.
Given that both
construction defects and commercial liability insurance for them are not new,
what are the reasons why contractors must pay close attention to significant
changes in the commercial liability insurance environment.
In general, the reason for these significant changes in the CGL
environment have arisen due to the prevalence of class-action construction
defect lawsuits. Projects, such as
condominiums, apartments, and any development with a master-plan format and a
home owners’ association, provide a significant opportunity for a
plaintiff’s attorney in a lawsuit against the project’s contractors, if
defective construction is present in the project.
Flaws in the design, construction, and/or project management on these
types of projects contributed to project problems.
As an example, trade interfaces improperly coordinated by the builder,
such as the intersection of a balcony deck with an exterior stucco wall result
in water damage to interior surfaces. Instead,
if the balcony deck-waterproofing contractor would have been scheduled before
exterior stucco installation, defect avoidance would be the result.
Plans, due to a failure to spend adequate time and funds in the design
process, may be unclear as to design requirements.
Craft personnel may be unfamiliar with a particular new construction
material or existing materials may be used in an improper application.
In both cases, missed application steps may take place.
The resultant defect may not be apparent, until long after the project
construction is completed. In a 200
or 300 unit condominium project, an investment by every condo owner of $500
results in a starting legal fund of $100,000 or $150,000, respectively.
Or an attorney may decide to take the case on a contingency basis for a
40% contingent fee of any recovery. The
successful litigation case awards can be substantial. In one recent 2002 condominium defect case in Nevada, a jury
awarded $12 million dollars on a project whose initial construction costs were
$8 million. The condominium
owners’ plaintiff’s attorneys are now seeking an additional $8.9 million in
legal fees (Hill, 2002). The legal
fees are more than the original cost of construction twelve years earlier.
In some areas, the vast majority of projects such as condominiums, have
ended up in litigation especially in the case of San Diego County in California,
where over 90% of these projects have seen construction defect litigation (Luhr,
Due to the increasing
trends towards more construction defect litigation and the rising costs
associated with these cases, insurance organizations have been beset by claims.
Their reaction has been to substantially change their past approach to
commercial general liability policies in the construction arena.
Combined with this have been substantial premium increases in some cases
on the order of 600% to 1000% (Colvin, 2002).
commercial general liability insurance concerns for contractors, every
contracting purchasing insurance coverage must pay attention to the issue of
insurer solvency. Insurance firms
make money from both the premium income they receive and the investment income
based on the net return of those investments.
The success of an insurance company will be measured by its combined
ratio, which is the total of two ratios: the loss ratio and the expense ratio.
The loss ratio measures the ratio of adjusting costs and losses against
the amount of premiums earned. The
expense ratio measures the ratio of incurred business operations costs versus
written premiums. These two ratios
are then added together to measure the combined ratio (Mehr, 1992).
If the combined ratio exceeds 100% in any given year, the insurer has
then lost money for the year. A.M.
Best, a national rating firm, measures the financial solvency of insurers.
Six ratings of liability insurers are used, ranging from A+ and A
(excellent) to C (fair). If the
insurer does not cooperate or does not have a five-year history, the rating is
omitted from Best’s Report.
about insurance firm solvency typically place their policies only with insurance
firms that have an A+ or A excellent rating (Koehler, 1998).
With increasing losses suffered through successful construction defects
jury verdicts and out-of-court settlements, insurance firm solvency is a major
consideration. In some insurance markets hard hit by losses related to CGL
policies, a contractor may face limited options and be forced to place insurance
business with a lower-rated carrier. As
an example, in the State of Nevada, 70% of the firms previously writing CGL
policies for the construction market have exited that market (Royal, 2002).
Versus Non-Admitted Insurance Carriers
insurance carriers to conduct business within the state.
There are two basic classes of insurance carriers: admitted and
non-admitted. Admitted carriers are
considered residents within that state. Non-admitted
carriers are not considered as resident and thus not subject to the same
requirements of that state. The
common benefit of admitted insurance carriers within a state is priority in
terms of receiving insurance business. In
the State of Nevada, for example, an insurance agent must go to at least two
admitted carriers and receive denials of insurance interest before going out of
state (Royal, 2002). Once these two
denials are received, the agent can seek insurance coverage anywhere in the
In return for the
above-cited right of first refusal, admitted insurance carriers within a state
pay into an insurance risk pool fund. The
purpose of this risk pool fund is to provide compensation for claims, if a
particular insurance firm goes out of business.
Thus contractors doing business through admitted carriers can be assured
that they have a safety net in case their insurer goes bankrupt.
On the other hand, non-admitted carriers doing business within a state do
not pay into an insurance risk pool fund. Thus
a non-admitted carrier that goes out of business may leave stranded a contractor
confronting a sizeable construction claim.
markets hard hit by construction defect claims, California, Nevada, and Arizona
have seen no admitted carriers writing CGL policies in these states in the most
current three-year period (Marshburn, 2002).
Thus contractors have to figuratively “walk the plank” when placing
insurance business with a non-admitted carrier.
To protect themselves some contractors and developers are forming limited
liability companies with the life of a single project.
Every project, thus, has its own unique contracting entities, formed
solely for that project.
Versus Claims-Occurrence Policy Type Exclusions
CGL policy was in
effect. Many contractors are
unaware of the ramifications of this distinction, when purchasing insurance.
Thus contractors may sincerely believe that since they have always had
CGL insurance, they are covered from any claim.
Nothing could be further from the truth, though, and contractors must
understand this key insurance difference.
exclusions typically manifest themselves in prohibitions for coverage on
condominium projects. This is due
to the ready potential for class-action lawsuits on condominiums particularly as
it relates to common-area construction. Since
a condo project’s common areas include foundations, roof, area-separation
walls, area-separation floors and other elements, there are numerous avenues in
a class-action lawsuit. Since its
inception, condominium exclusions have been broadened to include apartments, as
well as single-family residential home owner’s association projects.
The rationale for the apartment inclusion is that these types of projects
can and are converted to condominium projects.
An apartment-condo conversion project now means that warranties with the
sale of real property start to take effect over the rented premises previous
situation. In some cases, the
exclusion may be all residential construction of any variety.
As an example, one plumbing contractor, on a mixed-use retail commercial
project with sixty apartments built above the retail shopping promenade, could
not obtain insurance because the insurer considered this to be a residential
project (Kerzetski, 2002).
Related to contractor
and project-type exclusions are policy exclusions, based on the use of certain
high-risk building materials. Certain
building materials exclusions, such as asbestos exclusions have been common for
a number of years. However, other
building materials are seeing increasing reference as sources of exclusions in
policies. Some of these examples
include EFIS (exterior finish and insulation systems) and polybutyl piping.
Materials, such as polybutyl piping are no longer being used, but a
contractor who installed it on a past project may not have coverage, since it
has been written as an exclusion to the claims-made coverages described earlier.
As one of this writer’s late instructors once stated, “There are no
bad materials just bad materials applications” (Poe, 1973).
In some cases, the problem is not with the material, but with the
application of that particular material. Contractors
should be cognizant of repeated materials problems in similar applications.
In the case of building material exclusions, written definitions should
be sought from the insurer explaining the scope of the relevant exclusion.
For example, what exactly is an EFIS application?
Does the EFIS application mean any exterior system that utilizes foam
insulation? These issues can be
have been common exceptions to coverage in CGL policies for a number of years.
An increasing problem in construction has been the prevalence of mold
litigation. In Houston, there are
currently over 25,000 cases pending related to mold damage (Nazoff, 2001).
Insurers have been unsuccessful in their attempts to avoid mold damage
coverage under the pollution exclusion. What
has taken place is that newly-issued CGL coverages are specifically excluding
mold as a covered issue. One
insurer had so few mold claims and in such minor amounts in 1999 that mold cases
were not even tracked separately. Now
the value of their mold claims exceeds claim values from all other causes (Dolnick,
2002). The other side of the
insurance market for most mold cases is coverage through the owner’s property
insurance policy. However, property
insurance carriers have also seen mold claims skyrocket over the last few years
and as a result have been steadily adding this as an exclusion to new policies
and coverage renewals going forward.
trades, such as exterior stucco, roofing, and plumbing, are having difficulty
thus being covered for the key damage area of mold problems related to their
work. Insurance carriers still
providing mold coverage for contractors are doing so only if the contractor can
demonstrate that an aggressive risk management program is in place.
Risk management is covered in more detail in due course.
Given that any
litigation is expensive, many CGL carriers, in an effort to control their
exposure, are excluding defense costs from policies.
On a 200-unit condominium project, subcontractors being sued can expect
to spend anywhere from $3,000 to $5,000 per month defending themselves over the
18-month to 24-month time frame of active litigation on this case (Rasmussen,
2002). Thus defense costs are
subject to a number of exclusions. An
insurer may state in the policy that they have “the right, but not the
obligation to defend” the contractor. Or
it may simply state that the contractor will bear all defense costs for the
insurer’s attorneys in defending a CGL claim.
A third type of defense costs exclusion is where a successful judgment is
obtained against the CGL carrier that may exceed coverage limits.
The CGL policy may state that defense costs are within the policy limits
and thereby act as a deductible on the amount of the award.
In another effort to
control claims costs, CGL carriers are rapidly increasing deductible limits on
new policies. CGL deductibles have
moved from relatively minor sums of $5,000 to $10,000 to current levels seen in
some instances of $25,000 to $75,000. One
Arizona-based residential roofing contractor, with multi-state operations, has a
current deductible of $75,000 in one state and is paying CGL premiums of
$1,000,000 per year (Colvin, 2002). Another
Nevada-based residential concrete slab foundation and exterior flatwork
contractor pays $1,000,000 in CGL premiums, with a $25,000 deductible limit.
In both cases for the Nevada and Arizona contractors, the deductible is
on a per occurrence basis. Thus a
200- unit condominium project that results in a successful damage claim against
a roofing contractor of $5,000 per unit average or $1,000,000 total.
Given the previously-cited $75,000 per occurrence deductible, none of
these costs would be covered. With
a 5% net margin before taxes, the roofing contractor would have to do
$20,000,000 in additional work to make up for this single claim.
Deductibles in some instances have reached as high as $100,000 per house
limits considered an entire project as one claim.
As aforementioned, deductibles have increased greatly.
The same can apply to defense costs, which may also be subject to a per
unit or per occurrence basis applied above in the case of standard coverage
deductibles. Deductibles may cover
defense costs, but only after a $25,000 or more deductible limit is reached.
A contractor sued on 5 separate projects or five units in an industrial
park may end up paying $125,000 in defense costs, rather than just a $25,000
that subcontractors in certain specialty areas cannot obtain insurance at any
cost, some developers are migrating towards owner-controlled insurance programs
(OCIP), to handle insurance requirements. The
original goal of OCIPs was to lower the overall insurance costs on a project.
Instead of every contractor purchasing separate liability, equipment,
worker’s compensation and other project policies; substituted is one master or
“wrap-up” policy. This
“wrap-up” policy would be purchased to cover all construction activities
during the project or subsequent to construction in the case of CGL coverage
issues. On a large project, the economies of scale in purchasing a
significant amount of insurance become substantial. Therefore, large owners and large managing/prime contractors
were able to effect significant savings. In
the case of large manufacturers, their pickup of construction contractors
worker’s compensation costs was taken and blended into the manufacturer’s
own experience modification rating (EMR) (Stoddart, 1993).
The manufacturer’s EMR was significantly lower than the typical
construction firm EMR and in combination with risk management, contractor
oversight produced significant overall project savings.
to handle CGL issues are a relatively new development on the construction
insurance scene. They have been
implemented on certain construction projects, such as condominium developments.
This is because contractors in high-litigation prone areas, such as
earthwork/grading, framing, and stucco, could not obtain insurance coverage at
any price for the project. Thus the
project developer is faced with canceling the project and building something
else or having contractors “going bare,” without insurance in those
particular subtrades. The
alternative of building something else, on the part of the developer, may not be
practical because high land costs dictate multi-family developments, and zoning
precludes retail or office uses. The
risk of having subtrades going bare without insurance is equally unpalatable.
The solution to this insurance problem is for one, unified CGL OCIP
policy that covers the entire project.
Both the insurance
firm and the developer benefit from an OCIP policy.
The unified OCIP means that high-risk and low-risk subtrades will be
covered by one blanket policy. Thus
the insurance firm obtains a blended risk exposure, as opposed to sole coverage
of a high-risk subtrade. If the
project does end up in litigation, there will be one set of experts and one set
of attorneys representing all contractors on the project for the defense.
The unified group of construction experts and attorneys has obvious
benefits from an avoidance-of-duplication effort perspective.
Perhaps a more important but more subtle distinction is that the
insurance company will not have to contend with contractors’ experts
contradicting each other and pointing fingers at each other to deflect blame,
depending on what contractor these experts represent.
CGL OCIP costs for a wrap-up policy, on a recent 100-unit condominium
project, were $250,000 or $2500 per unit (Legarza, 2002).
advantages of an OCIP, there is one major disadvantage.
If the insurance carrier for the OCIP goes out of business and is not an
admitted carrier in that state, now the entire project is without insurance
coverage. Without viable insurance
coverage in place, aggressive plaintiff’s lawyers for a condominium
development or home owner’s association-type project may decide to seek
compensation out of the business and personal assets of the contractors.
Last in this paper,
but of perhaps most significance in the CGL arena, is risk management for the
contractor. CGL carriers are
increasingly looking to only cover contractors who are taking a professional
approach to their construction site activities. Part of this professional approach includes a strong
While there are many
facets to risk management, insurers are examining contractors for CGL coverage
based on the following key characteristics:
1.) Quality detailed
plans and specifications are necessary to communicate design intent to
construction personnel in the field. Sometimes,
these failure-avoidance steps involve extra steps or modified construction
methods and materials to avoid future problems with value engineering in the
design stage. As an example, one
condominium developer, due to window/flashing water intrusion issues went to a
substantially more expensive primary flashing material.
geotechnical site investigations should take place to pinpoint and to address
soils problems, such as chemically “hot” soils, collapsible soils, expansive
clays, and other soils issues that can affect construction performance.
3.) Does the
contractor build quality construction? Building
quality in the completed construction product is the first step towards avoiding
losses on a CGL exposure. While few
contractors would admit to poor quality construction, what the contractor does
to ensure quality construction must be able to be demonstrated.
Since many developers do not self-perform any work themselves, the
efforts for quality construction will come from their field project management
and the quality of subcontractors whom they select.
Are subcontractors selected merely on the basis of lowest bid or do
quality considerations enter the equation as a key element?
Does the contractor require training and education and do the contractor
actually do this or merely pay lip service to it?
inspections, during critical construction procedures such as earthwork/grading,
framing and roofing, can provide assurance that quality construction practices
are indeed taking place and that design intent is not subverted.
documentation practices must be implemented, including photographs and bar
coding key construction assemblies. Some
contractors in residential construction are going so far as to bar code and
photograph all critical construction assemblies, such as shear walls (McConnell,
customer service programs that actually fix construction problems in a timely
manner rather than ignoring consumer complaints can cut down on defects
liability insurance is a protective measure to reduce a contractor’s exposure
to losses from completed construction projects.
Construction projects are beset in many areas by ever-increasing amounts
of construction litigation. Often,
this construction litigation has involved contractor coverages under their
commercial general liability policies. As
a result of costly litigation and substantial claim settlements, insurance
carriers have enacted substantial changes in their CGL coverages.
At its most extreme, contractors may not be able to obtain coverages for
some types of projects at all. Besides
project exclusions, other evolving exclusions prohibit coverage for certain
materials, and damages or deductible exclusions are significantly higher,
ranging as high as $100,000 per house. Constructors
must be aware of these issues and changes in CGL coverages, to avoid financial
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