Risk Management More bad news for contractors Class underwriting, increased use of claims-made policies appear to be developing trends By Donald S. Malecki, CPCU A growing number of construction contractors/subcontractors (contractors), particularly those involved in habitational risks, are learning painfully that their liability costs are rising and their coverages are dwindling. Unfortunately, it does not matter how loss control-conscious these contractors may be. Many insurers are viewing them on a class underwriting basis. This means they are now being grouped together, regardless of their loss history, as opposed to having their exposures considered on an individual basis. Thus, despite the fact that some regions in the United States have more construction defect claims than others, no underwriting distinction is being made. A steady increase in construction defect claims, not necessarily limited to habitational risks, is the underlying cause of this problem. Many of the coverage restrictions are being dictated by reinsurance companies, from which insurance companies purchase some of the coverages they provide to insureds, so as to further spread the risks assumed by the insurers. Effect of class underwriting A review of commercial general liability policy provisions will reveal whether a contractor is within a class established by underwriters. The tell-tale signs are many and varied. Exclusions will likely be issued for mold, residential defects, exterior insulation and finish systems (somewhat similar to stucco work). There also may be a completed operation exclusion, meaning that liability coverage will be provided only for ongoing operations. There also may be an exclusion for work performed on behalf of contractors by subcontractors. This is a major exclusion recently introduced on a large-scale basis by insurers to eliminate having to pay for construction defects on behalf of (1) project owners by contractors, (2) general contractors by subcon-tractors, and (3) subcontractors by subsubcontractors. Since it is quite common for contractors to agree to hold harmless and indemnify project owners, developers, or general contractors for bodily injury and property damage, CGL policies are structured to include contractual liability coverage to cover that exposure. Unfortunately, there are exclusions that greatly reduce this coverage. Space limitations prohibit a description of all the possible exclusions that insurers can issue on a construction contractor’s CGL policy. Suffice it to say, a construction contractor that can obtain a CGL policy without all or most of the kinds of exclusions being issued today should be considered the exception. As a general rule, when the services of a construction contractor are sought, one of the requirements is that its CGL policy be written on an occurrence basis. This means that the trigger, or what activates the policy’s coverage, is injury or damage during the policy period. Although the occurrence and injury or damage often are simultaneous, there are times when there is a delay between the occurrence and injury or damage. In these cases, it is the policy that is in force at the time of injury or damage that applies to a given claim. It does not matter when the occurrence giving rise to injury or damage actually occurs. The fact that there can be a long delay between the time of an occurrence (e.g., faulty workmanship) and when injury or damage becomes manifest presents a long-tail exposure for insurers that are trying to establish the appropriate price for contractors liability insurance. What insurers charge for a given exposure may turn out to be grossly inadequate by the time claim payouts are made. Those who hire the services of contractors favor liability coverage on an occurrence basis because of this long-tail coverage, which is why contractors are usually obligated to maintain an occurrence policy for as many years as necessary to cover the appropriate statute of limitations. Coverage on a claims-made basis A growing number of insurers are requiring CGL policies for construction contractors to be written on a claims-made basis in order to avoid the long tail inherent in the occurrence form. The criterion for this coverage is that the claim alleging bodily injury or property damage be made during the current policy period. The occurrence that gave rise to such injury or damage can take place sometime earlier, but on or after a retroactive date, usually the first inception date of the policy—injury or damage that occurs before that date is not covered. This retroactive date should remain fixed, as of the first date coverage was issued; otherwise, when a claims-made policy is renewed or replaced, there may be a gap. If a claim is not made or reported to the insurer by the time a CGL policy expires, the insurer knows with more certainty how to establish the price of future coverage and knows better how to establish reserves, since no further claims will be made. For some contractors, there may be no correlation between experience and price. It all hinges on what the insurer may believe is an appropriate charge, particularly if the contractor has to obtain its insurance through the excess and surplus lines market. Those who employ the services of construction contractors do not favor liability insurance on a claims-made basis. In fact, insurance specifications commonly require that the insurance not be provided on a claims-made basis. The reason is that those who are covered by a claims-made policy sometimes do not purchase tail coverage, an optional feature of a claims-made policy. Once the project is completed, so, too, is the insurance. Tail coverage actually is a misnomer, since it does not provide coverage. A more exact term is an extended reporting period (ERP). If a CGL policy is canceled or nonrenewed, the insured may be able to purchase an ERP. When purchased, it extends the period for which claims can be made, after expiration of the policy, to (1) those made during the extended reporting period, and (2) for bodily injury or property damage that occurred before the policy’s termination, but after the retroactive date. An example is a claims-made policy that expires on February 28, 2006. If the insured purchases a three-year tail or ERP, the period during which a claim under that policy can be made is extended until February 28, 2009. If, however, a claim were to be made during this three-year period, it would have to be the result of injury or damage occurring after the retroactive date and during the policy period, no later than February 28, 2006. Many insurance specifications specifically rule out contractors liability coverage on a claims-made basis because the extended reporting period is not long enough to encompass the statute of limitations or the period of time the contractor remains accountable for its work. Another important caveat of claims-made forms is that if a contractor replaces a claims-made policy with an occurrence policy, or a claims-made policy with a later retroactive date, there will be a gap in coverage. To avoid gaps, the expiring claims-made policy needs to be renewed each year it expires, subject to a retroactive date fixed at the policy’s first inception date (if a retroactive date is required) that remains unchanged with each renewal. A double whammy obstacle While contractors may feel a bit of relief if not subjected to a claims-made policy, they may be surprised to learn that their CGL policy contains a provision that functions just like a claims-made policy. This provision is commonly referred to as a “prior loss or loss in progress” exclusion. The genesis of such exclusions is the 1995 court decision of Montrose Chemical Corp. v. Admiral Insurance Company, 10 Cal. 4th 645, which involved a chemical company and resulted in coverage insurers thought should not have been granted. This provision of ISO standard CGL provisions appears within the insuring agreement of both occurrence and claims-made forms. Briefly, this provision states that if an insured or an authorized employee knows, prior to the policy period, that bodily injury or property damage had occurred, any continuation, change or resumption of that bodily injury or property damage will be considered to have occurred prior to the policy period. Thus, only injury or damage first beginning during the policy period will be covered. Injury or damage that first began before the policy period will be viewed as covered only by the policy in effect when such injury or damage first happened. This exclusion could preclude coverage whether the policy is a claims-made or occurrence form. Coverage may also be in jeopardy if the aggregate limits of the policy period have been reduced or exhausted. The wording of some of these exclusions is very restrictive in comparison to ISO’s. For example, knowledge by anyone can rule out coverage. Also, the fact that any injury or damage that is unknown to the insured that can be traced or argued to have been in existence prior to the issuance of the policy could also rule out coverage. The variations of these provisions are such that all cannot be pointed out here. Suffice it to say that these provisions can nullify coverage insureds seek when purchasing liability insurance on an occurrence or claims-made basis. To be quite blunt about them, they can virtually wipe out any hope for coverage in time of need. These provisions, in conjunction with a claims-made or occurrence CGL policy, therefore, can truly serve as a double whammy. Conclusion Some commercial construction contractors who continue to have a long-standing relationship with insurers, have good loss history, are willing to implement safety precautions, and show a possibility of insurance company profit, may enjoy liability coverage on an occurrence basis with some coverage concessions not commonly granted to other contractors. When it comes to habitational risks, the better-than-average construction contractor may still be written on an occurrence basis, even in the standard insurance market. It is rather unlikely, however, that such contractors will escape the use of exclusions for mold, residential defect, and EIFS. They also will be subject to prior loss or loss in progress exclusions, which are commonly built into CGL policies today. The less-fortunate contractors may have no other takers for their liability insurance than insurers in the excess and surplus lines market where coverage on a claims-made basis is virtually guaranteed, and only the beginning as far as exclusions go. The question is whether there is any light at the end of the tunnel. For some contractors, there may be. In all likelihood, however, it is going to take the whole class to buckle down and improve the quality of workmanship to the level that was once in vogue following World War II. One obstacle that will have to be overcome is to resist cutting corners. Project owners and general contractors are under constant pressure to perform quality work quickly and at reduced costs. Failing to overcome this obstacle adversely affects everyone within the chain, including contractors who need work, if they are to survive in this line of work. * The author |
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