By STEVE YAHN, who has written for and edited national trade magazines for more than 30 years
The American landscape, especially on the coasts, is littered with partially completed construction projects--particularly in the residential sector.
That's the bad news. The good news, according to several experts, is that the nation's construction locomotive is revving up again thanks in part to the Obama administration's stimulus plan. Carriers are interested in insuring some of these partially completed projects and the market is warming, says Sandi Sikora, director of the construction and property management division at D.L.D. Insurance Brokerage Inc. in Irvine, Calif.
"The carriers have gotten a little bit more comfortable with what they're looking at and don't view it as a completely unknown exposure," she says.
Underwriters, she says, are starting to get a handle on the kind of detailed information they need: Is the general contractor experienced in the field, along with safety and quality control? Are the customer service procedures the owner has in place likely to minimize claims?
"We're seeing more and more transactions to which property or real estate is being sold," says Stacy Pocrass, vice president at the Denver construction business services unit of Lockton Cos. and manager of its project specific (wrap-up) business. "The credit markets and the economic uncertainty of the buying marketplace have slowed new projects from starting and have prompted us to see more transactions where distressed projects are being taken back by the lenders or are being taken over by new ownership interests."
That's hardly a guarantee, however, that carriers will come knocking on the door to underwrite a partially completed development project, says Scott Jensen, a broker specializing in tough-to-place construction risk accounts.
"Up until last year, we were in a more forgiving marketplace," notes Jensen, vice president in the Birmingham, Ala., office of AmWINS. "The carriers realized the insureds were no longer able to meet the initial (insurance) demands given to them. The carriers were therefore willing to allow the insureds infinite time to extend the policy term, in order to get the projects completed."
But no longer. The market has turned and the mood is unforgiving. Premiums on carriers' overall construction books have plummeted. "In turn, they are not wanting to extend the policy for free, getting less premium for this year, as well as increasing exposure for claims."
"We have seen, and expect to continue to see, partially completed projects become dormant and then the mad rush to figure out how to insure them properly taking place thereafter," notes Tom Grandmaison, senior vice president, product line manager for construction liability, at Boston-based Lexington Insurance Co., which last year launched Lex Idle Asset Liability Protector, a product designed to insure partially constructed properties.
So, how long will the dormant period last?
"That's the million-dollar question," says Grandmaison. "I still have no idea. I would expect it will correlate with the state and future improvement of the economy and real estate market. Some experts believe we've bottomed out, while others see it bottoming out later this year. Some experts believe things will improve next year or perhaps 2011 or 2012."
Most of what Lexington has seen in terms of adversely affected regions runs along the western, southern and eastern edges of the country, with California, Nevada, Arizona and Florida being the "big four," notes Grandmaison, whose name in French--perhaps ironically--means "big house."
For the time being, developers are having a hard time getting loans to complete unfinished projects. In turn, carriers are skittish about extending coverage. Why commit to partially completed construction projects because of their uncertainty about the economic future?
To increase a carrier's comfort with taking on the coverage for a partially completed construction project, the new owner and its lender want coverage for both the work performed before the new buyer took title and for the work the new owner or their contractors perform, say Bruce Ring and Ken Miller, attorneys at Walnut Creek, Calif.-based Morgan Miller Blair, a law firm handling real estate throughout the country.
"The big stumbling block is when the big carriers like ACE, Lexington and Zurich are asked to come in and what they run into is the merchant builder saying, 'Look, we're building this project and there's partially completed improvements, will you cover the entire work?' " note Ring and Miller. "And the carriers say, 'No.' That's killed a number of deals and the people say, 'We just can't get insurance for it.' "
Miller cites hypothetical situations not uncommon in today's market: A partially completed project in which the builder has run out of money and the lender is in the process of foreclosing or may foreclose and take the project back, for example.
"Or that the builder is trying to get some kind of recovery by selling to a vulture fund. These are people who are in there picking at the bones and who have the kind of cash value to do that. A lot of these vulture funds are just money funds with no appetite and no skills for what would be involved in completing a project," says Miller.
"But if they thought they could pick up an unfinished project that has insurance available that would cover their liability for the project when it's ultimately sold, it would stimulate more interest by funds with money to invest in the troubled assets," adds Miller.
In any instance of insuring a partially completed construction project, "the line in the sand" between the original builder and the new builder that takes over the project remains the crucial issue.
"Say, we have a partially completed project," says AmWINS' Jensen.
"The carrier will no longer extend that policy but you still plan on finishing the project." Builders are finding themselves scrambling to search for another carrier willing to cover the remaining construction and the new carrier has to determine exposure versus the original carrier's exposure.
"With regard to what has already been completed," adds Jensen, "our new carrier only wants the construction exposure going forward."
WORKING THRU EXTENSIONS
When new carriers come aboard, builders need an engineering firm to review the project. "They basically say, 'Here is a very finite report on what has been constructed. Here is what is going to be insured under the original insurance company's policy,' " says Jensen. "Going forward, since the insured is being forced to switch carriers, everything else that is completed will be under the second insurance company's policy."
"The analysis should focus on the type of transaction, prior insurance that was in place, the needs of the purchasing institution and the long-term risk exposure that the transaction presents," says Pocrass. Firms cited for the engineering expertise in this area were Paramus, N.J.-based DiGeronimo PC; Irvine, Calif.-based La Jolla Pacific Ltd.; and Quality Built in San Diego.
Spelling out exactly what a buyer is paying for--an asset or a liability--is essential, says Pocrass. "And then within that, how is indemnification or subrogation being handled. Is the old owner saying, 'I want to be indemnified for any and all things that were ever done in the past, which is very typical that they'll (the new owners or carrier) ask for.' "
Also, underwriters will look closely at security measures that are in place to prevent theft from partially completed construction projects. Appliances in model homes, copper wire and even kitchen cabinets--when stolen--make for valuable commodities, notes Sikora. Additionally, landscaping losses, especially involving mature trees, can run into the thousands of dollars.
Property owners or prospective sellers should be prepared to provide details of what they've done to the partially completed project, adds Sikora. "The more information provided, the better."
"The big question in terms of information requests is, if these properties are going to be dormant for a period of time, what's the plan in terms of how long they expect them to be dormant and what they are doing in terms of protecting and securing those assets," says Grandmaison.
With carriers showing more interest in insuring partially completed construction projects, Sikora says she's seeing more placements in which the policy terms are applicable to the estimated build out of the project, say two to three years. "The term would reflect the amount of time needed to build the units and sell them," she says.
Lenders are also being added to the policy as a named insured. "This would allow the lender to still have access to this policy if for some reason the builder went under," she says. "This may be important to a lender so that they are not left taking over a project without the proper insurance in place."
Barring that, carriers can add an endorsement to the policy to allow the lender to satisfy the self-insured retention so that the insurance coverage would then kick in and handle the claim, she says.
Jensen sees another development on the horizon.
"If there's an extension on a policy, we're going to do something completely different for the next part of the project," he says. "Most likely, we will reunderwrite the project or charge the appropriate premium, take on the additional exposure."
"The cleanest way to insure continuing insurance coverage associated with the risk of prior work, as well as moving forward with new construction, is to put a project-specific policy in place, including completed operations for a project, whether insured through the owner or the general contractor," says Pocrass.
Where the prior owner of a partially completed construction project wants indemnification from past work and liability, Lockton, the Kansas City-based broker, has been able to put into effect policies that cover the completed operations exposure associated with the prior work.
"This is a more complicated issue than just naming the prior owner as an insured on new policies," says Pocrass. "Policies are structured around the performance of work."
Where work has been performed by contractors on behalf of a prior owner, insuring the completed operations has to include coverage of provisions that not only name the prior owner's interest but the interest of the prior general contractor and subcontractors for work performed on the project
"We also have seen a number of developer and investment customers that are buying up partially completed projects and in some cases, rather than looking to keep them dormant, they are looking to finish them out," says Grandmaison, of Lexington.
The Lex Idle Asset Liability Protector product, designed for real estate developers, private-equity firms, pension funds and venture capital firms that invest specifically in real estate, offers primary general liability coverage up to $2 million per occurrence plus excess liability up to $10 million per occurrence.
The plan can also be tailored to provide premises operations coverage by itself or in combination with products or completed operations coverage, says Grandmaison.
July 1, 2009
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