Smart strategies for tough problems carried the
day at IRMI's Construction Risk Management Conference
By Elisabeth Boone, CPCU
(Left) William S. McIntyre, IV, CPCU, ARM, chairman/CEO-American Contractors Insurance Group, Inc., and (right) Jack P. Gibson, CPCU, CLU, ARM, president of IRMI, acted as co-chairmen of IRMI's recent 22nd annual Construction Risk Management Conference held in San Diego, California.
These days, you'd have to look pretty far to find an industry that's taken more hits than the construction business. Mold, terrorism, recession--and the tightest insurance and surety markets in 15 years--all add up to a bucketful of woes for beleaguered contractors in virtually all specialties.
That's the bad news. The good news is that for most of these problems there's a workable strategy, if not a solution, and such strategies abounded at the International Risk Management Institute's 22nd annual Construction Risk Management Conference held in November 2002 in San Diego. Attended by a record 1,240 contractors and owners, agents and brokers, insurer representatives, attorneys, consultants, and others, the conference offered a briskly paced agenda and an impressive roster of expert presenters and panelists. Almost every session of the three-and-a-half-day meeting was filled to capacity, and the break periods were beehives of intense networking in the mellow Southern California sunshine. Lunch wasn't just a meal; one noon repast was devoted to the popular Construction Café, where attendees could rotate among tables hosted by experts serving up an appetizing menu of topics--some 44 in all. A Technology Showcase featured hands-on demonstrations of software for certificates of insurance, cost containment, and claims, as well as construction products that are resistent to mold and mildew, moisture, and fire.
With an aptly chosen theme of "succeeding in a difficult market," the conference presented a deft blend of general sessions, seminars, and workshops that addressed virtually every issue of concern to attendees, from asbestos to zero injury management. What follow are highlights of selected presentations judged to be of greatest interest to agents and brokers, taken from the opening day seminar, "What's Hot in Construction Insurance." Each of the themes addressed in this all-day session was examined in more detail at subsequent seminars and workshops.
A record 1,240 contractors and owners, agents and brokers, insurer representatives, attorneys, consultants, and others attended the IRMI Construction Risk Management Conference.
Sharing insights at the seminar was a four-member panel drawn from the insurer, producer, and contractor ranks. Moderated by IRMI's president, Jack Gibson, the panel consisted of Michael Markman, chief executive officer of Zurich North America Construction, Edina, Minnesota; Tom McCarley, executive vice president of Palmer & Cay, Knoxville, Tennessee; David O'Haren, executive vice president of Holder Construction Company, Atlanta; and Michael O'Neill, president of ACIG Insurance Agency, Inc., Dallas. The panel was equipped to tackle a daunting array of topics, each of vital concern to attendees in the packed room.
Tight market challenges
Leading off was ACIG's O'Neill, who spearheaded a lively discussion on insurance market challenges and their effect on contractors. Calling 2001 "a year the industry would like to forget," he cited the numbers that tell the grim story: a 116% combined ratio, the industry's first-ever net loss after taxes ($15.2 billion), and a GAAP return on average net worth amounting to minus 1.4% compared with an estimated 11% for the Fortune 500. Key forces contributing to insurers' flood of red ink, O'Neill observed, are the economic recession; years of underpricing; a surge in catastrophe losses, including some $10 billion from the World Trade Center attacks; medical cost inflation; the collapse of Enron and other large corporations; and abuse of the legal system. "Restoring rate adequacy will take years," he commented, adding that he expects the hard market to continue into 2003.
Given this dismal scenario, what can contractors do to survive the hard market? O'Neill's suggestions offered guidance to agents, brokers, and risk managers as well as contractors. First, "Return to basics; cover your core activities, and deal from your strengths": reputation, conscientious corporate governance, a solid risk management program, and an excellent safety record. "Retain more risk, and balance the ingredients: your capital position, risk appetite, funding levels for retained risk, cash flow requirements, and restrictions in loan or surety covenants." Another strategy: "Avoid the risk of marginal activities: new operations or services that have a low impact on probability and a high impact on severity," he advised. Examples of such activities are blasting operations, equipment rental, and environmental cleanup.
To help offset the costs of higher retained risk and insurance premiums, O'Neill said, contractors may need to reprice their products and services. He urged contractors to foster a corporate culture in which everyone in the organization is responsible for managing risk, and to protect their assets: physical, human, and intangible (reputation).
Consultant Mark W. Bridgers of the FMI Corp., Raleigh, North Carolina, spoke at the general session about the general impact of current insurance conditions on the financial performance of contractors, and on owners' 2003 construction costs.
In preparing for renewal, he added, contractors should start 80 to 120 days in advance. "Provide an accurate underwriting submission with details on both current and past operations," he advised. "Detail large losses and steps implemented to prevent them from recurring." Finally, he said, "You need to tell your story to underwriters. Your broker doesn't know your business as well as you do, and no one can tell your story better than you can."
Bonding blues
Contractors' woes go beyond the headaches of dealing with constriction in the property/casualty market and extend into the contract surety bonding arena. Like P-C insurers, surety companies have seen the red ink on the wall and are responding by restricting capacity, increasing rates, and imposing new requirements on contractors. In this "new era" of bonding, said Tom McCarley of Palmer & Cay, a 30-year veteran of the surety business, terms and prices will be influenced significantly by how a contractor has been conducting its operations. "Contractors who have stuck to the basics, maintained financial integrity, built relationships with other sureties, and avoided high-risk situations will have no real problems with surety and should find somewhat reduced competition," McCarley observed. "Those who have not done these things will find that bonds are no longer available at the same levels they enjoyed in the past, and perhaps not at all, even though their situation has not materially changed."
Ben R. Turner, president of Phillips & Jordan, Inc., Zephyrhills, Florida, assessed the issues surrounding cleanup efforts from Ground Zero. His statement that only one site injury report was filed drew a general "WOW" from the audience.
Sureties are back in the underwriting business again, McCarley comments. "Underwriters will again be questioning more aggressively the contractor's job selection, scrutinizing bond forms, confirming financing, reviewing subcontractors, insisting on interim financials, and ideally helping their clients avoid missteps."
In today's market, communication among contractor, broker, and surety is "absolutely imperative," McCarley asserted. "The best relationships are built on complete understanding: the surety knows the contractor's financial picture, understands its plans (job and program desired), and is comfortable supporting them. Consistency, credibility, and predictability are major components of the foundation for surety 'stretching.' Surprise, especially negative surprise, is bad," he continued. "Bad news needs to travel fast. Few things will sour a relationship faster than an underwriter believing all is well and communicating that up the line, only to get a year-end statement reflecting a big loss, or a buyout or distribution. Somehow, knowing the year-end will not be good before (and I don't mean a phone call the day or week before) receiving the statement softens the blow. It also gives an opportunity for corrective measures."
A thorny issue in today's constricted bonding market is personal indemnity. "From the perspective of the surety, requiring personal indemnity is perfectly reasonable; but from the contractor's perspective, it defeats the whole purpose of setting up a corporation or limited liability company in the first place," McCarley remarked. "If the contractor is not a large entity that clearly will outlive existing management and ownership, the surety is probably not off base in requiring personal indemnity. Would you want to guarantee someone's obligation if you knew that, sensing a problem, he could distribute most of the worth to himself and not be responsible for the consequences?" In McCarley's view, "requiring personal indemnity will become more common in the future."
For agents and brokers, McCarley offered some commonsense advice. "The old days of simply delivering the bonds are gone with high-topped shoes," he declared. "We must be proactive and partner with our clients in what, for some of us, are new ways." Among these are: "Working to help clients aggressively assess, manage, and/or transfer objectionable language flowing downhill toward them; evaluating the risks and remedies associated with the early recognition and handling of subcontractor nonperformance, both bonded and unbonded; understanding the frailties of the lien waiver process; determining amounts retained to maintain bond capacity; preparing appropriate financial presentations; and continuity planning."
What's the bottom line? "The losses suffered by our industry required immediate action, and it's a rare visionary who knows exactly how to respond," McCarley commented. "In all likelihood sureties, like insurers, will push the pendulum a bit too far in the other direction before swinging back close to equilibrium. As strange as it may sound," he concluded, "these tougher times allow each of us the opportunity to be more relevant to our clients and prospective clients. It's actually reassuring, in spite of the pain, when there is some correlation between how a contractor is doing and the bonding credit available."
Wrap it up
As the property/casualty market hardens, an approach that's gaining popularity is the so-called wrap-up, an insurance program that covers the on-site risk of the project owner, general contractor, and subcontractors. The components and benefits of wrap-ups were described by David O'Haren, executive vice president and head of the risk management department for Holder Construction Company in Atlanta.
Wrap-up programs are of two main types: owner controlled (OCIP) and contractor controlled (CCIP). Asked who is better able to manage the wrap-up, the owner or the contractor, O'Haren responded, "Whoever holds the contracts."
Coverages available under a wrap-up are on-site workers compensation, on-site general liability, employers liability, and excess liability. Excluded are automobile liability, builders risk, professional liability, pollution liability, and off-site workers comp and general liability. Builders risk, although not included in a wrap-up, is typically purchased in connection with the program. A wrap-up can be designed to cover one project or can be set up as a "rolling" program, with multiple projects, usually worth up to $1 million, consolidated into an ongoing program.
In between sessions, Alan J. Bressler, senior vice president of Marsh Environmental Practice, Inc., Atlanta, Georgia, discusses with a conference attendee how insurers are expanding and contracting environmental coverage.
A wrap-up offers advantages not available in a traditional insurance program, O'Haren noted. "A wrap-up provides higher limits and broader coverage, with fewer coverage gaps," he said. "It allows for one consolidated safety program, with a single source for insurance, safety, and risk management." Other benefits he cited are increased buying power in the market, reduced duplication of effort, and enhanced opportunities for minority participation.
Up-front costs are about the same for wrap-up and traditional insurance programs, O'Haren explained; but historically, loss ratios for wrap-ups are between 30% and 40% better than for traditional programs.
Wrap-up programs clearly benefit owners and general contractors, but subcontractors, O'Haren observed, aren't always enthusiastic about the approach. They have two key concerns, he said: first, a perception that all the good jobs are taken out of corporate programs; and second, loss of control over insurance exposures, safety, and claims. These concerns, he said, can be addressed by clear statement of "the rules of the game," timely communication, and fair treatment.
The mold mess
Anyone who's familiar with 1950s-era schlock horror movies ("The Blob," "I Was a Teenage Werewolf") will appreciate the parallels between these titles and some recent headlines cited by Michael O'Neill of ACIG: "We've Got Killer Mold" (New York Daily News), "Lurking, Choking, Toxic Mold" (New York Times Magazine), and "Haunted by Mold" (New York Times Magazine). In addition to ordinary citizens finding slimy black stuff in their basements, the media are hyping the woes of celebrity mold "victims" like Ed McMahon and Erin Brockovich.
Last June a Texas home owner received a jury award of $32 million against Farmers Insurance--not for mold damage but because the carrier was found to have acted in bad faith. In Texas alone, O'Neill noted, mold costs in 2001 were a staggering $845 million. "Farmers nonrenewed 700,000 homeowners policies in Texas, and State Farm and Allstate don't want the business," he said. The result: "There's a growing excess-surplus homeowners market in Texas."
Homeowners loss frequency and severity are up 1,300% to 1,800%, O'Neill continued, and insurers are now excluding mold claims from coverage. Builders of single- and multi-family homes are hardest hit by the mold situation, and it's also affecting real estate sales.
On the commercial and industrial side, O'Neill observed, underwriters are now asking: Is mold the next environmental peril? As with asbestos, claims for damage or injury from mold develop slowly over time. Another concern is that media attention will exacerbate employees' fears of mold-related health problems.
To illustrate the potential danger of commercial mold claims, O'Neill cited a high-profile California case, Krant vs. Tulare County, in which the lead plaintiff is a state district court judge. Over 100 employees of Tulare County allege that defects in the HVAC system and curtain wall systems permitted the growth of stachybotrys chartarum (black mold) and resulted in serious bodily injury. Allegations against the county also include fraud and concealment. Among other defendants are the construction manager, general contractor, various subcontractors, and designers; allegations against these defendants include construction defects and negligent construction and design. The building involved in the suit was built in 1988, and claim was first alleged in 1998--a perfect example of the ominous long tail associated with mold claims.
Meanwhile, O'Neill pointed out, considerable confusion exists with respect to the pollution exclusion in the contractors commercial general liability policy. In the 1973 standard pollution exclusion, pollution is excluded unless it is sudden and accidental--but "pollutants" are not defined. The 1986 form contains an "absolute pollution exclusion" that, O'Neill remarked, "is not a total exclusion but does define pollution." Adding to the confusion is the wording of the CGL's nonstandard pollution exclusions, as well as the fact that case law with respect to mold as a pollutant is "currently very thin," O'Neill said.
For contractors who face exposure to mold claims, O'Neill noted, completed operations coverage in the CGL is critical because it provides protection for bodily injury and property damage arising out of the work once it has been completed. "The 1986 pollution exclusion is regarded by ISO and other insurance industry experts as not applying to completed operations exposures of contractors," he said.
How will the insurance industry respond to the mold situation? "The increase in mold-related litigation may have a similar result as the asbestos litigation," O'Neill commented. Mold exclusions are being drafted and filed, although as yet no standard ISO mold exclusions have been developed. "Leading underwriters are focusing on mold exposures," he said. For insurers, "it's easier to exclude mold than to take the risk." On a more positive note, "Specialty underwriters will have the flexibility to develop an insurance product that addresses mold claims."
For contractors, O'Neill said, two steps are critical: implementing mold prevention procedures and instituting a strict quality assurance program, with the overall goal of constructing a high-quality, watertight building.
Terrorism risk and insurance
In the aftermath of the 9/11 terrorist attacks on the World Trade Center, insurers, legislators, risk managers, and contractors have struggled mightily with the frightening issues raised by the reality of massive death and destruction on American soil. Examining these issues and their implications for contractors was Michael Markman, CEO of Zurich North America Construction and a former Minnesota insurance commissioner.
A key concern is insurers' perception of the terrorism exposure, Markman said. "As time passes since the attacks, companies are taking a more balanced view of what they can and should do," he commented. The terrorism bill (now law) that was awaiting action in the post-election lame duck session of Congress will provide a vital backstop in the form of government reinsurance, but carriers still face a daunting array of challenges with respect to property, liability, and workers compensation exposures, Markman said. "Each company must look carefully at its potential exposures, the premium it can collect, and its appetite for risk. The terrorism law will make it illegal not to provide terrorism coverage--and there are no policy limits on workers compensation."
Equally critical are legal issues, product design, and reinsurance. "Some companies are now willing to provide stand-alone terrorism coverage," Markham noted, "but it's more commonly available as a limited buyback of the terrorism exclusion." Pricing for stand-alone coverage will depend on the cost of reinsurance and insurers' assessment of potential liability. "It's mostly a judgment call with little hard information available," he said. "Companies need to find a balance between getting enough premium for the risk and charging so much that no one can afford coverage."
Under primary workers compensation policies, Jack Gibson of IRMI pointed out, state law prohibits the exclusion of terrorism. "How has the lack of reinsurance affected workers comp and other coverages?" he asked. "Zurich paid a king's ransom for workers comp reinsurance with terrorism coverage," Markman responded.
A question from the audience concerned the scope of the terrorism law: "Is it domestic only? How will the insurance industry distinguish between terrorism and acts of war with respect to the invasion of Iraq?" The law applies only to domestic terrorism, initiated only by non-U.S. citizens, Markman replied. "It wouldn't have covered the Oklahoma City bombing by Timothy McVeigh," he explained. Under the law, he added, the Secretary of the Treasury determines what is war and what is terrorism.
Outside of insurance, an attendee asked, what can contractors do to control terrorism exposures from a risk management standpoint? "Follow the contractual risk management process; look at your policies," advised David O'Haren of Holder Construction. "Evaluate each project," O'Neill said. "The government has a list of high-profile industries, like petrochemicals."
Putting it all together
Given the array of subjects addressed, the careful selection of presenters, and the range of perspectives offered, it's not surprising that the IRMI Construction Risk Conference speakers bureau consistently wins excellent ratings from attendees. The conference is widely recognized as the leading forum for learning and networking, and its flexible structure allows attendees to choose the sessions most relevant to their needs and concerns. Not many conferences offer a money-back guarantee--but IRMI does so with confidence, and justifiably so. *