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Risk Management
Construction defects coverage
Buy-back endorsements can be tricky
By Donald S. Malecki, CPCU
An increasingly frustrating situation that confronts producers is what to do about the availability of extra coverage that some insurers are providing by endorsement to deal with construction defects.
As discussed in the October column, some insurers are offering to sell back coverage that already exists under a commercial general liability policy. The coverage in question is property damage to work performed by a subcontractor on behalf of the named insured.
This coverage is customarily referred to in insurance circles as broad form property damage including completed operations coverage. Introduced in 1968, it has become a well understood and commonly requested coverage with regard to construction work.
If coverage already exists under a CGL policy for property damage to work performed for the named insured by a subcontractor, the question that producers are pondering is how they can justify selling the coverage back.
Before producers ponder that question, however, they first need to determine what it is that the insurer is willing to sell back by endorsement, because some insurers want to hedge their bets against paying too much in the event of a claim.
It is not our purpose here to analyze the available endorsements, even though some are real eye-openers. One of these endorsements, for example, will provide coverage to the extent that the allegation of defective work is limited solely to physical damage to or destruction of tangible property.
One should not forget, however, that both the standard ISO CGL policy and many independently filed policies also provide coverage for loss of use of tangible property that is not physically damaged or destroyed.Considering that many of the claims involving defective work allege loss of use of tangible property that is not physically damaged, endorsements carving out that coverage could be fostering the employment of more attorneys.
Another insurer is pushing an endorsement that provides coverage subject to a sub-limit. A potential problem here is whether everyone knows about that sub-limit. Suppose a certificate holder requires broad form property damage including completed operations for the same limit ($1 million per occurrence) as other liability coverages but the limit on this endorsement is half of the policy limit ($500,000 per occurrence).
How is that limit shown on the certificate, if at all?What impact would a sub-limit have on a large loss that triggers an umbrella or excess liability policy? What are the consequences of failing to obtain the coverage limits promised? There are too many questions and not enough answers. Also, based on custom and practice, it's fairly obvious who will be blamed for any shortfall.
A commendable approach
Fortunately, not all insurers are blaming the courts for adverse decisions (which would not have arisen had insurers not denied coverage in the first place based on the lack of an occurrence and breach of contract), and this gives some insurers a reason to offer some buy-back coverage.
One insurer is taking a commendable approach. Instead of selling back coverage that already exists, it is issuing an endorsement (without charge) clarifying that broad form property damage coverage for completed operations applies to a CGL policy.
The insurer attaches an endorsement to its CGL policy that is titled "Definition of Occurrence Amendatory Endorsement." It replaces the policy's definition of "occurrence" and inserts in its place the customary meaning of that term as found in standard forms.
This endorsement further states that an accident includes property damage arising out of the named insured's acts or omissions or those of a subcontractor that is working on behalf of the named insured in a variety of construction activities listed in the endorsement.
It may come as a surprise to some people, but the rationale behind this endorsement, in the words of the insurer, is not only to clarify how it views the application of coverage, but also to allow it to compete more effectively with insurers that take the other approach.
Parenthetically, it should be mentioned that two ISO endorsements are available to underwriters who do not wish to provide buy-back coverage. The first one is Exclusion—Damage To Work Performed By Subcontractors On Your Behalf, CG 22 94, and the second is Exclusion—Damage To Work Performed By Subcontractors On Your Behalf—Designated Sites Or Operations, CG 22 95.
What producers should do
When discussing this situation with producers, I find that most have the desire to sell these buy-back endorsements. Of course, they have certain reservations because they too know that potential problems may arise from selling coverage that already exists.
In fact, one has to wonder what a prospective insured for one of these buy-back endorsements thinks about an insurer that will not deny coverage, if the insured purchases the coverage offered.
In that vein, producers have to understand that issuance of the endorsement, regardless of the coverage provided, does not automatically guarantee that coverage will apply in every instance. The insurer can still deny coverage based on the facts and how the complaint is alleged.
Producers, therefore, need to be careful when selling these endorsements not to give prospective insureds the idea that coverage is guaranteed. Nothing is further from the truth. In fact, they need to begin building a defense because problems are likely to arise.
Producers have to explain: (1) what the endorsement being sold does, (2) why the insurer is selling this endorsement, and (3) how to make clear that there are no guarantees that coverage will apply when a claim is made or suit is brought, despite purchase of the endorsement. This is a tall order.
To reduce the chances of repercussions in selling these buy-back coverage endorsements, producers might place a statement on their letterhead or any written material accompanying this endorsement that says: "Determining whether coverage applies is a question that only a court can answer."
This statement or notice might go a long way as a defense against any dispute over coverage dealing not only with these buy-back endorsements but also with the sale of any coverage.
Summing up
To summarize, some people may be justified in thinking that the buy-back endorsements being offered by some insurers are unnecessary, given an unendorsed CGL policy.
Apart from that fact, producers who want to sell these endorsements need to be up front with their insureds on why this endorsement is necessary. What producers might do is ask that the insurers provide written brochures or documents explaining the rationale for these endorsements and how they work.
Prospective insureds also need to be warned that the purchase of these endorsements is no guarantee that coverage will apply. In the event of a dispute, the final determination will be made in the courts.
Producers must take whatever steps are necessary to build a defense in the event they are implicated in an allegation of selling worthless coverage that was not necessary in the first place.
The author
Donald S. Malecki, CPCU, has spent 50 years in the insurance and risk management consulting business. During his career, he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates LLC, an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.
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