If You Build It, They Will Sue
Spending on new construction reached a five-year high in 2014, according to the U.S. Department of Commerce.
As the economy reboots, new projects are expected to keep increasing slowly and steadily, but there are liability hurdles facing contractors that threaten to slow the progress.
The debate over whether a builder’s commercial general liability (CGL) policy should cover damage resulting from faulty workmanship — or construction defects — has oscillated since the 1990s. Litigation yields very different results depending on which state you’re in.
In Florida, for example, property damage stemming from a construction defect constitutes an “occurrence” as long as it is “unexpected and unintended.”
Pennsylvania law, on the other hand, says that property damage caused by a construction defect is “foreseeable” and therefore should not be covered, whether performed by a lead contractor or its subcontractors. Ohio and Kentucky courts have reached similar conclusions.
Some states have flip-flopped on the issue. In 2013, a North Dakota court determined that property damage resulting from a defect, regardless of whether the damage was to the insured’s property or a third party’s, constituted an occurrence.
That ruling reversed a 2006 decision that excluded defect-related damage from the definition of “occurrence.”
West Virginia similarly reversed a 2001 decision in a recent case, deeming defective work and any resulting property damage as covered occurrences.
Alabama, Georgia and Connecticut have ruled that while defective work itself is not covered, any damage resulting from it is, regardless of where that damage occurs.
Other states further limit that scope, determining in recent cases that damage arising out of a defect is only covered if it affects a third party, not the insured.
According to Bill Sullivan, vice president, construction, at Berkshire Hathaway Specialty Insurance, the mix of states’ positions on the issue will continue to ebb and flow as the case law continues to mature.
Doug Cauti, chief underwriting officer, specialty construction, Liberty Mutual, said those inconsistent decisions “cause issues for insurance companies because you’re setting prices based on exclusionary language, and when a court overrules on that, you’re sitting here covering something that you never intended to.”
Sullivan said that variability in case law, “coupled with carrier differences in policy language and the responses from a claims handling standpoint, can create uncertainty and discontent in the construction industry. Due to this environment, contractors may be unknowingly taking on more liability.”
The result is that insurers are hesitant to provide general liability cover to contractors taking on projects in regions deemed not insurer-friendly on the issue.
That drives up prices for the policies that are available, which adds costs to projects and hinders smaller contractors and subcontractors from bidding on work.
“Over the years, a majority of courts tend to look at cases and find full coverage for allegations of faulty work,” said Paul Primavera, senior vice president and construction risk practice leader at Lockton.
“Construction defect losses are still tracking upward compared to all other losses under a GL policy in the construction industry.”
There have been legislative efforts to protect contractors from owners passing down risk and to fill in gaps created by inconsistent interpretations of an “occurrence” under a CGL policy.
The Colorado community of Lakewood, for example, passed an ordinance granting builders the right to repair defects before any litigation is brought against them and made it more difficult for residents living in multi-family units to sue over defects.
Council members who voted in the measure’s favor said it would help limit the liability carried by contractors and make it easier to start large residential projects. Now the state legislature is using the local ordinance as the catalyst for a new bill to protect contractors.
Builders Bearing More Liability
Owners have been able to pass down more of their risk to contractors largely due to evolving delivery methods. Rather than just bidding on plans that have already been established between an owner and a designer, contractors are playing a bigger role in project development, adopting more responsibility for structural or design flaws.
That introduces a relatively new exposure for builders — professional liability risk.
“Contractors traditionally have not been held responsible for professional services, so they never purchased professional liability coverage, or were not required to do so. There was always that line of demarcation between contracting services and professional design services,” said Tim Farrell, senior vice president, New Day Underwriting Managers.
“That’s been the big hurdle: having contractors consider that they do have professional exposures and getting them to buy the coverage.”
That exposure has been heightened by a tendency of contractors, as the result of a struggling economy, to take on projects outside of their comfort zone — whether the issue is size, the delivery method, or the materials and technology used — just to maintain a steady workload.
“In my world, when I see people doing new things that constitute the biggest project of their corporate existence, that raises a red flag,” said Josh Leavitt, principal and co-chair of the construction law practice at Chicago-based law firm Much Shelist.
Growing Design Role
One example of a “new thing” is integrated project delivery, or IPD. In its truest form, IPD joins the property owner, contractor and designer together in their own corporation, making each a shareholder so all parties have an equal stake in the project’s success.
That can help avoid legal problems; they won’t sue or file claims against each other because that damages the corporation as a whole. But that collaborative approach also presents challenges in determining the boundaries of responsibility and, ultimately, liability.
Projects developed using an IPD approach often utilize building information modeling, or BIM, in their design plans. BIM constructs three dimensional models that incorporate multiple aspects of design; for example, it can show in real time how changes to structural elements affect the HVAC system layout. Every party has access to the design.
“The problem from an insurance and risk point-of-view is there’s a blurring of the distinction between the parties,” Leavitt said. “Who’s designing the project and who’s building it? What insurance product is going to insure the project and whose insurance is it?”
“Construction defect losses are still tracking upward compared to all other losses under a GL policy in the construction industry.”— Paul Primavera, senior vice president and construction practice leader, Lockton.
Another trend complicating matters of insurance coverage is the evolving role of design firms, which find themselves in the same bucket as contractors in terms of accepting more risk than they have traditionally had to shoulder.
“More design firms now want to take the lead in design projects,” Leavitt said.
“When that happens, you could see companies assume risk that they are less able to handle.”
When there’s a claim of a defect, it will have to be determined who controlled the decision-making around the faulty work. Who devised the plan, who approved it, and who built and tested it?
“When there’s a loss or violation,” Lockton’s Primavera said, “it’s going to depend on the specific nature of the event; what the root cause of the issue is that caused the damage will determine where responsibility may lie.
“In construction more than anything else, both from a determination of liability and securing or properly evaluating coverage, understanding the mechanisms of how a building and a process to construct evolved, as well as how the damage developed, needs to be known in order to properly evaluate those points.”
Until state courts take a more uniform stance on the issue of construction defects, contractors will have to find ways to affordably transfer their potential exposure and insurers must find coverage solutions that account for the expanded scope of liability.
“There really aren’t that many carriers that provide professional liability for contractors — unlike other traditional lines of coverage,” Farrell said. “So there’s a scarcity in supply and underwriting talent that understands these exposures and shifting liabilities. The product is relatively young compared to some of the traditional lines of coverage.”
Underwriters need to see more of the risk to develop adequate and affordable coverage, and brokers specializing in construction need more education about professional liability risk and the products available to address it.
Some carriers have made changes to existing policies and are developing new ones to address new risks in the industry.
“At Lockton, we developed endorsements for our clients that would consistently apply allegations of faulty work as an occurrence across the board, so we don’t have to deal with individual adverse case law,” Primavera said.
BHSI has taken a similar approach, offering a “contractors” endorsement to provide a range of coverages.
“In my world, when I see people doing new things that constitute the biggest project of their corporate existence, that raises a red flag.” — Josh Leavitt, principal and co-chair of the construction law practice at Chicago-based law firm Much Shelist.
“Some examples include per-project aggregate limits for operations, an amendment which provides affirmative language around construction defect as an occurrence, and a carve-out for contractors’ professional liability as it relates to construction means and methods,” Sullivan of BHSI said.
He also pointed to an increased demand for wrap-up programs, which provide comprehensive coverage for all parties on a project, including most subcontractors. This ensures adequate coverage even if subs are carrying insufficient limits.
New Day Underwriting Managers offers both an owners protective professional (OPP) product as well as contractors’ professional liability (CPrL). CPrL forms are regularly re-worked with supplemental coverages for risks that accompany professional liability, including collaborative work done using BIM, disaster response plans and corporate reputation.
“A professional liability policy is triggered by a negligent act, error or omission — and the primary intention of the coverage is to provide for economic damages. So if the root cause of a problem was a negligent act, error or omission, whether or not it resulted in property damage, then that will likely trigger a response,” Farrell said.
Ultimately though, determination of liability comes down to the contractual language between owner, designer, contractor and subcontractor. In addition to placing professional liability policies, contractors can mitigate risk of losses from defects by making sure their contract does not promise the highest standard of work, and that it shares risk fairly with the owner, designer and even subcontractors.
“There’s an increased need on the part of contractors to put more emphasis on quality control and assurance and validation of work to make sure something doesn’t give rise to a later discovery,” said Jack Probolus, manager, construction wraps, Liberty Mutual.
“Be aware of both the contract language and jurisdiction’s statutes where you’re doing work.”
“For underwriters and brokers to best serve their clients, they need to stay informed, current with industry trends and abreast of the ever-changing claims and legal environment,” Sullivan said.
Blurry Boundary of Work vs. Personal Duties
As mobile technology becomes faster and more connected, fewer workers can say they’ve never dashed off an email from home or made a business call from a personal cell phone. Working from home – or telecommuting – has grown in popularity as it offers convenience and flexibility for the workers while saving his employer overhead costs.
According to Global Workplace Analytics, “telework” has risen by a minimum of 3 percent year-over-year every year since 2006. And the definition of telework is a blurry one. Some telecommuters work exclusively from home, while others do so only part-time, or do the majority of their work from the road. And few employers have set rules to differentiate those circumstances.
Thus, the space where office and home collide is filled with gray area for workers’ compensation claims. What spaces qualify as work spaces? Was the employee truly performing a work-related task at the time of injury, or was it personal? Employers may not be as aware of the liability risk as they should be, and are not taking steps to mitigate it.
“So far, employers haven’t had to take it very seriously,” said Paul Hooper, owner of The Flying Pig Consulting Group, an occupational injury and workers’ compensation consultancy. “OSHA has left it to the court systems to decide, but that’s so variable from state to state.”
“I don’t know if everyone really is aware of the issue, and how it’s becoming bigger every day with the advancement of mobile technology and the ability to bring work home with you,” said Jeffrey Costolnick, senior associate in the workers’ compensation practice at Drew Eckl & Farnham, LLP.
“In the near future, there’s going to have to be some decisions by employers that if you’re going to have telecommuters, these are the guidelines. The clearer those guidelines are, the more protection there is for the employer.” — Paul Hooper, owner, The Flying Pig Consulting Group
OSHA guidelines for Home-Based Worksites, introduced in 2000, state that employers will be held responsible for the safety of employees in home work spaces, but won’t be expected to conduct inspections of those spaces and are not liable for injuries that occur during non-work activities. That puts the onus on the employer to take initiative and devise policies to govern how and when telecommuting employees should be working from home.
“In the near future, there’s going to have to be some decisions by employers that if you’re going to have telecommuters, these are the guidelines. The clearer those guidelines are, the more protection there is for the employer,” said Hooper.
As in all questions of compensability, the matter boils down to whether the injury “arose out of and in the course of employment,” and whether the employee’s ability to work from home presented some benefit to the employer and not just a convenience to the worker, Costolnick said.
To determine benefit to the employer, courts have looked at the extent and regularity of the employee’s work from home, which establishes whether the employee’s home qualifies as a secondary workplace.
“Having work equipment at home used to be a deciding factor. If you had a fax machine or computer at home, you could establish a home office,” Costolnick said. And any supplies that the employer reimburses an employee for – such as a cell phone plan or tablet – are considered. “But today everything is becoming more and more mobile. Everybody has laptops and cell phones and they can work from anywhere.”
Courts have tended to rule in favor of the injured workers when there are doubts about compensability.
In 2007, a Nashville woman filed an injury claim when a neighbor attacked her while she was working at home (Wait v. Travelers Indemnity Company of Illinois). Although the injury did not stem directly from her work duties, the court found that because her employer did not specify work hours for its telecommuters to have a policy restricting personal activities, she could not be ruled ineligible for compensation.
In another 2004 case, a 24-hour on call nurse fell while walking from her car to front door, carrying both a pizza and some work papers (Amedisys Home Health, Inc. v. Howard). Because she was on-call and carrying work-related materials when she fell, her injury was linked to her job and found to be compensable.
It’s up to the employer to draw the line between what counts as a designated work space and time, and what does not. Employee “acts of comfort,” such as using the restroom or getting a drink or snack, typically qualify as activities arising out of and in the course of employment. Accidents that happen during a scheduled break or designated off-work hours, however, do not.
In addition to setting fixed work hours, employers can specify what areas of the home are designated work areas. A separate room for a home office, or a desk in the employee’s living room, for example, would be considered work spaces. The laundry room, the garage or the backyard would not.
Employers can request to inspect the telecommuting employee’s home work space to ensure it meets both work and safety requirements. While few are currently taking that step, it’s one that’s worth considering.
Broker Success in the 21st Century
The need for niche expertise and a technical understanding of client exposures are two of the key themes that emerged during a recent panel discussion hosted by A.M. Best.
Panelists on the “Succeeding in the 21st Century Insurance Sales Environment” webinar said brokers need such skills along with a deep understanding of their clients’ businesses to stay competitive.
“It’s really about developing a specialty or expertise, because the sale is so much more technical today,” said Marya J. Propis, head of distribution management, Lexington.
Advances in technology have increased the speed of business and enhanced analytics and reporting capabilities, which allow companies to more closely track trends and predict the severity of their exposures.
“Clients today are buying solutions from organizations. It’s not as much of a linear relationship.” — Kevin Kenny, executive VP, head of growth and business development, Wells Fargo Insurance Services
“Clients expect us to have done our research,” said Kevin Kenny, executive VP, head of growth and business development, Wells Fargo Insurance Services “They’re not telling us what they want us to know about them. That’s 60 percent of the work.”
Technology has also changed the nature of relationship-building in the business, but panelists still stressed the need to personalize interactions with clients to distinguish themselves within a wider scheme of industry consolidation.
“Clients today are buying solutions from organizations,” said Kenney. “It’s not as much of a linear relationship.”
Still a “People Business”
“Data allows us to better react to our customers’ needs,” said Patrick Kennedy, regional executive vice president, insurance & risk management, Arthur J. Gallagher & Co. “It’s impacting the speed and nature of our interactions, but we’re still a people business.”
According to Stephen Jalkut, chief marketing officer, North America commercial lines, AIG, “you have to be more personal in your interactions” in an era when it’s easier than ever to avoid face-to-face meetings.
“You have to embrace technology in how you communicate with clients and manage your daily sales process.” — Joe Gunn, national partner, Northeast region, Willis
“You have to embrace technology in how you communicate with clients and manage your daily sales process,” said Joe Gunn, national partner, Northeast region, Willis.
Propis seconded that sentiment.
While “no form of automation closes deals,” she said, brokers and salespeople could harness their firm’s analytical platforms to help gain a foothold in the industry, building on the expertise and relationships that their predecessors developed before them.
Panelists also discussed the need for the industry to get better at recruiting new talent from a variety of sources.
Propis stressed that part of those efforts should be aimed at college students already pursuing risk management degrees because so many of them slip through the cracks.
These students can easily choose to go in a different direction — particularly the finance sector — when they graduate, she said. Insurers and brokers need to reach them before they reach that point and provide them with entrée into the industry, and show them what their career progression could look like.
“The industry needs to band together,” said Kennedy. “We need to do a better job talking about what a great industry we’re in.”
“We have to explain how insurance makes the gears of the global economy turn.” — Stephen Jalkut, chief marketing officer, North America commercial lines, AIG
“We have to explain how insurance makes the gears of the global economy turn,” said Jalkut.
Additionally, Gunn said, liberal arts students and professionals in other sectors, such as technology in particular, should be recruited as well. They are “sources of innovation” who can envision new problem-solving approaches.
He also stressed the need for veterans of the business to serve as mentors.
New brokers should not be left alone and checked in on after a year or more to evaluate their progress. Those with more experience should be guiding them every step of the way.
Kenny pointed out how industry leaders can attract young people entering the workforce by meeting their primary career goal: to make a difference. He said it will be vital to “allow new people to have an impact on our business.”