While there is no shortage of demand for new homes in a hot housing market, construction and engineering firms are having a tough time finding shelter when it comes to obtaining insurance coverage for residential and mixed-use projects.
Affordable coverage for construction defects that can emerge years after a housing project is built has become a scarce commodity due to a surge in lawsuits and some adverse court rulings that have hit both insurers and general contractors.
For their part, the small group of insurers willing to provide coverage for "habitational" projects, which account for more than half of U.S. building activity, are laying down plenty of restrictions.
"The whole residential issue related to construction defect is huge, and it's spreading," says Mark Boyle, general manager of Turner Casualty & Surety, which manages insurance and surety programs for the nation's leading general builder, Dallas-based Turner Corp.
"It was more localized as an ugly risk in California, but it has now clearly spread to Florida, Texas, Nevada and Washington state. That's a big one that's costing owners a lot of money," says Boyle, who is based in New Jersey.
The problem is being driven by a wave of construction-defect lawsuits that has swept across the nation from California, says Karen Reutter, senior vice president in the national construction practice for brokers Willis Inc.
"What we've seen, particularly in the last year and clearly in '05, is still angst and worry from the carriers and the underwriters around construction defect," says Reutter, who is based in Minneapolis.
Insurers also have made it more difficult for subcontractors to extend their coverage to general contractors, cutting down on a traditional means of risk transfer in the industry and forcing general contractors to develop alternative risk management strategies.
Behind the growth in litigation for housing projects lies the trend toward condominium and mixed-use developments, particularly for urban redevelopment. That stands in contrast to the 1980s and 1990s, when development focused on commercial projects such as office buildings and stadiums.
As building trends shifted toward condominium projects, however, a key California court ruling in the 1990s spawned a host of lawsuits in residential construction defect cases, often as pre-emptive moves by homeowners associations to keep the statute of limitations, or repose, from running out.
"It's extremely common now for those associations to file suits even if it's to toll the statute of repose," Reutter says. "They're all scared to death that if something does go wrong in seven years--the windows leak, or there's a sound issue from floor to floor ... they're just afraid that the unit owners themselves will sue the (condominium) board."
The California state court ruling involved a Los Angeles-area company, Montrose Chemical, which made DDT from 1947 until 1982 and was sued by the state and federal government for dumping chemical waste. The court ruled that because the dumping occurred over a period of time, all of the carriers that had insured Montrose over that period of time had a duty to defend the company as long as there was some potential that its claims for coverage might be valid.
That theory of continuous loss was soon extended to construction defect lawsuits, and had the effect of triggering all insurance policies in effect at any time from a project's inception. On top of that, plaintiffs' lawyers often went after every contractor and subcontractor that had worked on a project to trigger all of their insurance policies. The ruling and the lawsuits that followed led insurance carriers to put in place so-called "Montrose" exclusions to limit their exposures to losses from prior years.
The effect of the California ruling and lawsuits has spread to other states.
"Insurance legal trends and case law originate out of California ... and that sets a precedent for other states," Reutter says. "Carriers usually look to the West to see what's coming, and that's where this construction defect started. It's national now: You can look at Texas; you can look at Florida."
The restrictions put in place to deal with states such as California affect the whole country because the limitations that carriers set on coverage are determined to a large extent by their reinsurers.
"From an insurance company standpoint, their restrictions are usually driven by the reinsurance treaties, which are national," Reutter says.
While Montrose hit insurance companies, a 1997 Florida court ruling that involved defects in the construction of a school roof has had the effect of limiting coverage that general contractors can claim under general liability policies for work performed by subcontractors.
Another legal issue that has made obtaining insurance more problematic is the so-called "Scaffold Law" in New York State that places absolute liability on owners and general contractors for injuries due to falls on work sites.
"It's really putting a crimp on getting insurance in the state of New York for all projects, regardless if it's residential or standard commercial construction," Boyle says.
While insurance companies historically issued standard general liability policies to subcontractors and extended coverage to general contractors as additional insureds, carriers have become increasingly unwilling to do so.
"Given really broad court interpretations, those policies have been interpreted in many geographic regions as covering losses around construction defect that insurance companies really say they never intended to cover," Reutter says.
Insurers have become particularly cautious about extending subcontractors' policies to general contractors for residential, or "habitational," projects.
"Those subcontractor (general liability) policies were being tapped for defense, and in many cases for indemnity payments, and the underwriters never priced for that," Reutter says. The reluctance to provide coverage for habitational projects and to offer additional insured endorsements has created a huge risk management problem for general contractors that had normally relied on subcontractors' policies.
"One of the things that we used to be able to do routinely was get additional insured endorsement certificates naming us as an additional insured for completed operations on the subcontractor's policy," says Ted Mullinix, chief financial officer of The Haskell Co., a Florida-based design-build firm with more than $600 million in annual revenues.
"It's becoming more difficult. Some carriers are giving it freely. Others are charging their clients for it. Others are saying, 'We don't have it.' Others are providing endorsements that are not standard," Mullinix says. "It's becoming a real mess."
In addition, underwriters are defining habitational projects in a variety of ways. Some define it narrowly as apartments and condominiums, while others use it to include anywhere a person sleeps or spends a lot of time. The more expansive definitions could take in hospitals, retirement communities and even schools.
"You're seeing more and more of the traditional underwriters who would normally write business for the construction industry be much more difficult in their underwriting of habitational work," Mullinix says. "It's making it more difficult for contractors that do habitational work to get coverage at an affordable price."
In some cases, subcontractors may be willing to agree to extend the coverage even though their policies don't support it.
But Turner's Boyle says that getting the additional insurance and enforcing it from subcontractors has become difficult. "The problem is that subcontractors don't even realize that they don't always have the right to give that, even though they sign contracts saying they will give us additional insured status," he says.
The inability to transfer risk to subcontractors has led general contractors to take a different approach through contractor-controlled insurance programs or general liability wrap-up programs.
"That's why we went ahead and started writing our contractor-controlled insurance program, because then we control the limits and what the terms and conditions are," Boyle says. We don't have to rely on anybody else.
"What we do now is we place the insurance for our construction sites all together. We try not to buy insurance from our subcontractors. We'll place the insurance for the whole job," Boyle says, adding that last year the company had about $3.5 billion of exposure in its contractor-controlled program.
In a wrap-up program, the project owner or the general contractor obtains a policy for a specific project that provides general liability coverage for the general contractor, the owner and the subcontractor.
The benefits are that contractors get a dedicated set of limits, one retention and one deductible; and coverage for 10 years or for a given state's statute of limitations or repose. That statute of limitations for construction defect varies from six years in Colorado to 10 years in California and Minnesota, Reutter says.
Then if a construction defect claim comes in seven years later, there is one set of attorneys for one insurer representing all the parties.
"The underwriters like it because they can put one limit. They know what price they have. They can reserve for potential losses and move on," Reutter says. "They know that there's reduced litigation potential."
COVERAGE AVAILABLE ONLY FROM A HANDFUL OF CARRIERS
Besides coverage restrictions and a reluctance by carriers to offer coverage for residential projects, construction and engineering firms have only a few insurers to turn to for coverage in the market.
"You could count them on one hand on any given day, and in many cases there may only be two or three markets willing to underwrite that type of exposure," Reutter says.
Another issue is that of mergers and acquisitions among insurers that offer coverage for construction and engineering work.
"One thing we see right now in the construction marketplace is the effects of mergers and acquisitions, most recently St. Paul and Travelers. Both were significant construction players, but both had very, very different market appetites, and to see those two carriers come together has created a little bit of havoc for everyone," Reutter says.
Right now the market is fairly stable in terms of pricing, she says.
"The market overall for engineers and contractors, just the construction insurance marketplace is pretty stable. We don't see a lot of decrease in pricing," Reutter says. "We see some decrease in excess or umbrella pricing, but otherwise for casualty, meaning workers' comp, general liability, those types of lines, the pricing is pretty stable, maybe 5 percent here or there. We're seeing reductions in price on the excess or umbrella coverage, maybe anywhere from zero to 10 percent. Property is stable."
Boyle says while the property market showed some significant softening in 2004, the hurricanes that hit Florida this year would probably halt any further declines.
"We saw a big softening in the property market last year," Boyle says. "My gut tells me after the hurricanes in Florida and some of the other disasters out in California this past winter, that the property is probably going to level off."
At Haskell, Mullinix says he has seen little evidence of price declines.
"Unlike a lot of other industries that are seeing a softening market, we're certainly not," Mullinix says.
a former journalist and editor with Reuters, writes frequently on technology issues for Risk & Insurance® magazine.
April 15, 2005
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