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Risk Management The money pit Renovation of a home can create some E&O problems if things start going wrong By Donald S. Malecki, CPCU
Every once in a while there arises an agent’s errors and omissions case (of which there are many) that is worth repeating for a number of reasons, including the fact that others are able to learn from it at the expense of those who lived it. One such case, which actually was resolved through arbitration after much time and expense, involved home owners in Indiana who not only had great plans for renovating their home, but also had much higher expectations of insurance services than producers generally provide. The cast of characters also involved an insurance company underwriter, a general contractor, and testifying experts, one of whom is a practicing insurance agent, and the other a former insurance agent, far removed from the business. A number of different events led to the dispute. First of all, the homeowners policy was inherited with the purchase of an agency. It was issued on a one-story house built in 1925, protection class 6, that was insured in the amount of $148,000. In February 2001, the owners started thinking about extensive remodeling that would involve demolishing a built-in garage, adding a second story, and adding an extension to the house that would consist of a four-car garage and an art gallery above it. More than a month after signing the contract with the builder and allowing work to commence, the home owners notified their insurance agency about what was taking place. The home owners thought that the insurance should be increased by $195,000 but instructed the agent to contact the builder to make sure about the proper amount. The builder told the agent that the work would cost $220,000. As a result, the policy amount of $148,000 was endorsed by that figure for a new amount of $368,000. Even though the dwelling insurance amount for Coverage A of the homeowners policy more than doubled, the underwriter said nothing in response to the agency’s request for an endorsement. The agency did ask the insurer to do an appraisal after the work had been completed. All downhill from here As sometimes happens in relation to construction projects, everything that could go wrong did. In this particular case, some additional work had to be done, such as strengthening the foundation, replacing the septic tank system, and adding lightning rods. These items increased costs to more than the estimate and did not set well with the home owners. From a purely fortuitous standpoint, the wind from a rainstorm blew off the protective covering from the roof that was being constructed, and the rain damaged the interior ceilings and walls. Resultant mold adversely affected the realty and home owners’ personal property. Additionally, it allegedly caused them adverse, unhealthy side effects, which forced them to live elsewhere. Although the insurers (builders and homeowners) were responding to the loss, it finally reached a point where the home owners decided to sue the builder and later their insurance agency. The allegations against the builder were that the work was inadequate and overpriced, and that the builder was negligent in its performance, resulting in exposing interior portions of the house to moisture, and leading to the growth of mold within the walls, fixtures, and structural members. The complaint also alleged negligence from the standpoint of the insurance agency for a number of absurd reasons. One was that it was the agency’s responsibility to check the builder’s insurance portfolio to see that it was adequate for the work undertaken. Another was that the agency should have recommended that the builder provide a surety (performance) bond. This allegation was prompted because the builder ceased work, leaving the project substantially uncompleted. This caused the home owners to expend substantial additional funds to have the work completed. Another allegation against the insurance agency was that the house should have been insured for something in the area of $550,000 instead of $368,000 and that the agency should have conducted an appraisal before the losses occurred. Questionable experts The home owners produced a former insurance agent, currently employed as a schoolteacher, to testify that the home owners’ insurance agency’s conduct fell below the standard of care normally exercised by insurance agents in like situations. Most of his testimony, however, was far removed from custom and practice: • It was the agency’s duty to examine the builder’s insurance policies to see that they were adequate for the work undertaken, as well as the builder’s contract. (The agency was not informed of this project until more than one month after the contract was signed by the home owners, and the agency was not the builder’s insurance representative.) • The agency should have recommended that a surety (performance) bond be furnished by the builder, considering that the agency had a bond department. (Performance bonds are generally not available for home renovations and if a bond is necessary, it should be required before the contract is signed, not after. It’s the builder’s insurance representative who has the obligation to obtain such bond, if available.) When it came time to make other accusations, the home owners also complained that the agency refused to alphabetize their fine arts floater, even though the agency could have done so with its software. The home owners also were perturbed by the frequent misspellings in the communications of the agent handling the account. The other person who offered to testify against the agency was a practicing, long-standing agent residing in a nearby city not far from where this case was filed in Indiana. His testimony included that: • A Marshall Swift/Boeckh (MSB) residential valuation should have been done, and that it was the insurance agency’s responsibility to do it. • One cannot accept at face value the contractor’s estimate of work to be performed, and it was not proper for the agency to do so. • If an MSB residential valuation had been calculated by the home owners’ agency, based on his limited knowledge of the input, the replacement value at time of completion of work was more in the area of $750,000. • He did not know whether some type of effort should have been expended to see if the builder had some type of performance bond, because of his limited knowledge of bonding. (That is a poor excuse.) Analysis It is difficult to understand why the insurance company underwriter did not request an MSB residential valuation at the time of the request to double the insurance amount of a house that was constructed in 1925. The fact that the insurance agency did not conduct one, however, would not be considered conduct falling below the standard of care, contrary to what the practicing insurance agent said. It turned out that this particular agent represented only one insurer for personal lines and that insurer always requires that MSB valuations be done. By representing one insurer, this agent does not know what the custom and practice is in the insurance business for these types of conduct. To counteract the opinion of this practicing insurance agent that failure to perform an MSB valuation was considered to be conduct falling below the standard, one of the other experts testifying conducted a survey of some Indiana insurance agents. Although it is difficult to find agents willing to give opinions in surveys, three were willing to do so. The question posed to them was: Unless an underwriter requests an MSB valuation on renovation work of a home owner, what are the alternatives? The following were the responses: 1. If the work is substantial, the underwriter may require an MSB valuation. But most of the time, underwriters will accept the contractor’s figures. 2. When work is completed, insurers generally have the property re-evaluated. When there is a loss before the work is completed, the insured’s or contractor’s valuations are commonly relied on. Also, the MSB valuation is not as accurate as some insurers think it is. 3. The contractor’s estimate is what is relied on, unless the underwriter wants to re-evaluate the cost. The conclusion here is that, while some agents may conduct an MSB valuation even when they are not requested to do so by underwriters, there is nothing wrong with relying on a contractor’s or home owner’s own estimates, until the work is completed. Some years ago this column warned that insurance agents should not testify against other agents. One reason is that the legal profession will likely push the testifying agent into saying something that the agent may one day regret, particularly since giving testimony creates a long paper trail. In this particular case, for example, the testifying agent stated that someone—perhaps the home owners’ insurance agency—should have notified or counseled the home owners to have the builder’s insurance policies or certificates reviewed. It is difficult to comprehend why this should be done. This appears to be the responsibility of the builder’s insurance agent, and not the agent of the party hiring the builder. What is even more puzzling is how this could be done after the contract between the builder and the home owners was signed. It is common sense for people not to ask questions about whether a contract addresses certain subjects, such as insurance and bonding, after it is signed! The testifying agent is now in a precarious situation. As a precaution against his being sued in the future, he will have to caution every one of his insureds who undertakes construction renovations, new work, or remodeling that someone should review the contractor’s insurance portfolio. It would be in this agent’s best interest to suggest that such review be undertaken by the contractor’s insurance representative or some other third party, such as an attorney. Conclusion It is probably wise for agents to perform an MSB valuation at the time of substantial renovation work, even though a company underwriter does not require one. Having said that, however, there is nothing wrong with relying on a contractor’s estimates as an alternative to an MSB, until the work has been completed. It is absolutely not necessary for an insurance agent to review the insurance portfolio of those performing work for their insureds. It is purely gratuitous, time consuming, and could generate more problems for an agent than is worth the effort. As agents and brokers know, many insurance buyers are nice people until a loss adversely affects them. No matter what the reason may be for an insurer’s denial of coverage, it always appears to be the agent’s or broker’s fault. No matter how long the business relationship and how personal it gets, insureds should be treated strictly on a business-relationship basis. In January 1996 we wrote about the new morality. The column was titled “What are legitimate, clear-cut errors and omissions? The new fictitious standard of conduct.” Even with the passage of time, that column’s message still applies. * The author |
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