By Pat Curry. Well, at least we're not alone. Lest builders think this industry is the only one getting hammered in the liability insurance crisis (and it is officially a crisis now), premiums, retentions (or deductibles), and exclusions are up, and limits are down, regardless of the field.

"Try insuring a sawmill," says Karla Swanson-Murphy, vice president of Hancock Lumber in Casco, Maine. Her company owns three of them. Its new policy has less coverage at a price that's up 120 percent "and we shopped it hard," she says.

Doctors, school districts, trucking companies, innkeepers, banks ? you name the profession, and members are paying more for less insurance, says Rob Hoyt, professor and head of the Risk Management and Insurance Program at the University of Georgia's Terry College of Business.

"Absolutely, it's across the board," Hoyt says. "If I'm insuring secretaries, [premiums] are still relatively attractive, but their prices are going up too."

California builder Mick Pattinson can relate. "It's a huge issue for builders," he says. At his own company, Barratt American, in Carlsbad, coverage limits are much lower than in years past and his self-insured retention has tripled. Even with that, he says, "we consider ourselves lucky."

Plenty of builders have it worse, says Pattinson, who is also president of the California Building Industry Association. Builders in the Golden State are paying "massive increases in premiums," and trade contractors are operating with gaps in their policies because they can't get full coverage. Pattinson met with a roofing contractor recently who was charging an additional $1,500 a house to cover his insurance premium. "If we were to look at what we're paying and what every trade contractor is paying, it's very significant," says Pattinson, whose coverage costs at least $4,000 per house. Trade contractors arefeeling the most pain, he says, followed by small home builders, then large and national builders. One framing contractor he knows pays an $8,900 premium in New Mexico; in California, the same coverage costs $300,000. "Trade contractors are seeing such enormous increases, the choice is to work for nothing or go out of business. ... Without legislative reform, I don't see a lot of hope."

How Did We Get into This Mess?

It was tempting for insurers to blame the September 11 terrorist attack, with its catastrophic financial losses, for the recent spike in prices. In truth, that had little to do with the hardening of the insurance market, Hoyt says. The root cause goes back more than a decade, when aggressive insurers underpriced policies to win business. Even so, the carriers made money because the investment market was so strong. That sank with the dot-com nose dive.

Photo: Courtesy Zurich North America Construction

"I can't define the traditional market right now...Last summer, I would have said cut your limits in half and add zero to your premium. Now, I can't even guess." ?Michael Hopson, Zurich North America Construction Then, for the construction industry, came the mold claims, first in a trickle and then in a flood. Multimillion-dollar judgments fueled a construction-defect claims and litigation frenzy that continues unabated. Describing the insurance industry as decidedly cyclical, Hoyt says it's typical for soft markets to last much longer than hard ones. Since the fall of 2001, he says that $25 billion has come into the market in alternative financing arrangements, but that the capital is fairly transient.

"If we knew the capital was being developed internally, I'd say the likelihood was quite good the market would ease from where it is right now," he says. "When you've got transient capital and marginal investors, if it doesn't work out, then, bam, they're gone."

Michael Hopson, vice president for residential construction at Minneapolis-based insurer Zurich North America Construction, says a two-year cycle would describe the standard market, but that's not what we're experiencing now. He doesn't see any softening in the market until the claims situation is resolved, and there's no indication of that yet.

"We're not seeing a slowdown in claims and we still have losses on old business," he says. "Until [claims drop], we won't see additional capacity come in."

How Bad Is It? Really, Really Bad

Builders used to be able to get first-dollar coverage and retentions of $10,000 to $25,000 to cover liability for up to $500 million in annual revenue, Hopson says. Now, retentions of $250,000 to $500,000 are common, and he says a range of $100,000 to $3 million won't be uncommon within a year.

"I can't define the traditional market right now," says Hopson. "It doesn't exist today. Last summer, I would have said cut your limits in half and add a zero to your premium. Now, I can't even guess."

Nationwide, builders are reporting drastically increased costs and dire situations with their trade contractors. Eric Brown, president of Phoenix-based Artisan Homes, says he spent about $85,000 for $10 million in coverage on his first loft building, in early 2000. On his latest one, the cost was $460,000 ? and he could get only $3 million in coverage on a $15-million project. Even though he had a wrap policy, a roofing contractor had to back out because his insurer forbade him to work on a multifamily project. On a recent row-house and townhome project, Brown says he's had to go to the fifth and sixth companies on his bid lists for first bids.

"I don't think there's a white knight who is going to come out of the insurance industry and give us 1995 pricing. We've got to do our part." ?John Skelton, Beazer Homes USA

Perhaps the most frightening aspect of the current crisis is the exclusions. Most builders say their current policies don't cover mold or EIFS. Terrorism coverage, of course, is gone. Coverage for attached projects is very difficult to find, and builders need to check their trade contractors' coverage carefully to make sure it doesn't exclude multifamily projects. "That's a bit trickier," says John Skelton, senior vice president of Beazer Homes USA. "It won't be on the certificate, but it'll be on the policy. In some markets, some subs may only be insured on a site-by-site basis. If you move them from one site to another, you have to make sure they're covered."

How Are Builders Managing?

The only way Crosswinds Communities is managing the situation is by carrying "a very high deductible," president and CEO Bernie Glieberman says. This year, had the Detroit-based builder kept its existing coverage, the rate would have tripled. Instead, the firm opted to go with a policy that sent its deductible soaring from $10,000 to $100,000 per occurrence.

"That's the only way we could write anything," says Glieberman. "We don't have a choice."

The problem wasn't their projects in California, where litigation and claims have skyrocketed, but completed operations coverage for attached housing.

Beazer has its lower limit coverage with Liberty Mutual and its umbrella coverage with Lloyd's of London. The company established a risk retention group, a form of captive insurance company, to cover the warranty on its 10-year guarantee.

Barratt American was able to negotiate its deductible down from $250,000 to $100,000 by documenting claims prevention efforts. The builder uses third-party inspectors on all jobs, including open space. Design guidelines go through peer review, and home buyers receive clearly worded maintenance manuals that outline their responsibilities.

"Those are the ingredients to try to hold on to your coverage," says Pattinson, whose company builds 500 homes yearly.

Insurance experts say key to getting and keeping insurance today is to make your company as attractive as possible to the underwriters. Document everything and submit as complete an application as possible. With the current crunch, underwriters are swamped and the easiest applications get handled first.

Finding the Silver Lining

If there is a positive in the situation, some builders admit it has made them more conscious about risk management. In the past decade, with insurance cheap and plentiful, it was easier to just write a check and transfer the risk. Now, builders are taking risk management to heart.

Crosswinds Communities has hired its first risk manager, a condition mandated by its insurance carrier.

"It was a good idea," Glieberman says. "In retrospect, it's something we should have had, but when you have the insurance company carrying all but $10,000 of the risk, you don't do it."

Beazer's risk management efforts include expanded use of Beazer University in Dallas, where construction supervisors are required to attend a weeklong home building "boot camp." The program's staff act as inspectors, reporting back on construction quality. Best practices are discussed in the "Best of Beazer" newsletter.

What's in the Future?

Captive insurance programs are one solution for major builders with enough capital and widely spread risk to justify the expense. Pulte has such a program, and most major builders are considering some form of one. Many industries operate group captives, but Skelton says he doubts it would win acceptance in home building.

"The general feeling is everyone's happy with their own risk but not anyone else's," he says. "It would be difficult."

Industry veterans like Pattinson and Skelton say that the true solution is construction-defect litigation reform. That will only come, they say, when it affects the families of lawmakers.

"When their sons and daughters can't afford to buy houses, then they'll act," Skelton says.

Brown says the impact will be sharply felt in urban, multifamily infill developments.

"You start getting to the point as a developer where you say, Why do we want to go through this brain damage to offer a product that's needed, when we can go to the suburbs and do single-family homes and not have any of the risk, comparatively?"

Rethinking Markets, Practices

Insurance, coupled with the increase in construction-defect litigation, has forced Pattinson to rethink his business model. While attached units once accounted for nearly 50 percent of his volume, he now does single-family houses almost exclusively.

"You could argue ? and we're typical of most California builders ? that we've lost half our business," he says. "If you look at the stats on the California building supply, [lack of insurance coverage] wiped out attached housing. There is no affordable housing in California now."

The insurance situation also has changed the way many builders approach the construction process. The number of on-site supervisors has gone up. Companies are rapidly hiring third-party inspectors; houses are being videotaped as they're built to provide documentation.

Crosswinds Communities has redone its designs to increase ventilation in the attics and allow the houses to breathe; it also has stopped offering tiled bathtubs and showers because of mold. Artisan Homes made the same change; it's solid surfaces only in bathrooms, and cultured marble or granite at that.

"It's cheaper than a lawsuit," Brown says.

Artisan has also tried to address the additional risk through these steps: For the first two years after a project is completed, the builder will go back with a third-party property inspector and fix anything under warranty that needs to be repaired. For the next seven years, the homeowners association is required to perform full, third-party inspections each year and report to Artisan anything that needs repairs. Artisan's buyer's contract also requires that disputes must go to arbitration instead of court. Additionally, Arizona law stipulates that home builders have 90 days to correct a construction problem before a buyer can file a lawsuit.

"Still, nothing works better," Brown notes, "than building it right and keeping your buyers happy."

That's also the prevailing attitude at Beazer Homes. The builder tied the bonuses of senior management to survey scores from home buyers who are asked about not only the quality of the construction but also the service they received.

"That really encourages us to build a house right the first time," Skelton says. "You always want to build a good home, but when it affects your paycheck, it makes the effort more focused."

It's going to take that kind of focus, he says, for builders to weather the storm. From site selection and house design to home buyer contracts and customer service, no one can slack off on any part of the process.

"I don't think there's a white knight who is going to come out of the insurance industry and give us 1995 pricing," Skelton says. "We've got to do our part."

Published in BIG BUILDER Magazine, September 2002