John Anglin, senior vice president of purchasing at Pardee Homes, remembers when he and Pardee's sub-contractors could predict what their insurance costs would be. There were many insurers from which to choose, and competition among them kept the prices within reason. But that was a distant three years ago.

“I had a guy just close his doors because his insurance premiums were so high,” says Anglin, adding that the now-defunct subcontractor did excellent work. “He didn't think it was feasible to keep on working with insurance premiums so high.”

The crisis in subcontractor insurance started on the West Coast, but the phenomenon is moving across the country like a wave, says Suzanne Xiros, managing director for Chicago-based insurance broker AON Corp. The inability of subcontractors to find insurance has become a “horrendous problem,” says Xiros. “Only 1 percent of subcontractors can meet home builders' [insurance] requirements, no matter how much they pay.”

In a study called, “The Liability Insurance Crisis for Builders: Reasons and Responses,” the NAHB found that even in states without major construction defect litigation, which has driven insurers out of many markets, builders cannot obtain more than one or two quotes from insurance companies. In Florida, the number of carriers writing insurance for residential contractors has decreased by 50 percent since 1991 so that only four insurers remain, according to the NAHB study.

The policies that insurers are willing to write are quite limited, and routinely exclude mold, for example. Insuring attached projects, such as condos or attached townhouses, is particularly problematic, according to the NAHB's findings. “Attached homes are riskier because there are many owners, so it's perfect for class action suits,” notes Xiros, adding that many such communities have homeowner associations that can be quite litigious. Additionally, a plumbing problem or noise complaint affects many people with adjoining walls.

Searching for Solutions The plight of subcontractors has brought them together. The National Subcontractor Association was founded in July 2003 in Bellingham, Wash., to try to confront the subcontractor insurance crises. NSCA founder Ray Gilbride, who quickly signed up more than 200 subcontractors in northwest Washington alone, at $175 a year in dues, says the crisis is acute.

“A lot of subs live paycheck to paycheck,” he says. In Washington, the state issues a cease-and-desist order the moment their insurance lapses, forcing the company out of business. “Subcontractors are falling by the wayside, and when they go under, a lot of employees lose their jobs,” he notes.

Gilbride should know: It happened to him. He worked as a steel subcontractor, and until 2003, his premiums were less than $5,000 annually. He'd never had a claim. His insurer, Safeco, announced it was pulling out of the subcontractor steel market in two months. When Gilbride went to search for new insurance, the policy prices quoted were $21,000 to $30,000 a year. “It was horrendous,” he says. “It's changing the industry. The subcontractors need a helping hand.”

Is This My Problem? The insurance crisis is a problem affecting virtually everyone involved in the construction of a home. A subcontractor that installs doors, for example, rarely used to have to worry about lawsuits, notes Bruce Wisk, a Redlands, Calif., risk management specialist. “Maybe the doors squeaked, maybe they were off center.” A typical subcontractor paid about $11,000 a year for liability insurance back in 1991, he observed. “Through 1997 or so, this company could buy a good insurance policy with a $1,000 deductible for $40,000 a year,” he recalls. “But their policy [today] has a $50,000 deductible, and they're paying $540,000 a year for it.”

Increasingly, big builders discovered the only way to keep their subcontractors steadily available was to offer “wrap” policies, which cover everyone on a jobsite under one policy, paid for by the builder. But the lack of competition among insurers has kept prices high.

Mick Pattinson, president of Barratt Homes in San Diego, one of the largest builders in California, says the market for wrap policies is still extremely tight. “Wrap policies are very expensive and difficult to get,” he says.

Is it a Wrap? Wrap policies, for now, are the lifeline, albeit an expensive one with many restrictions, for many subcontractors.

Under a wrap policy, if a lawsuit is filed, one lawyer—not a group of 40—defends everyone on a jobsite. This cuts down on the potential profits a plaintiff's attorneys can see; they can recover fees from only one company, not 40 different insurers. Legal fees are also reduced; the fewer attorneys in a case, the fewer the billable hours. Higher building standards and best practices during construction can fend off problems, and some wrap policies actually have third-party inspectors to check the quality as the home is built. “Of course, you pay for that,” acknowledges AON's Xiros. Prices for wrap insurance are no bargain, she says.

The exorbitant premiums are passed on to consumers in the form of higher home prices. “Insurance was one of the major cost drivers of 2003,” says Anglin. “And it's one of the reasons behind rising housing costs.” Waynewright Malcolm, vice president and treasurer of Miami's Lennar Corp., agrees.

“This is the hardest market for the longest time that I've seen in our short history,” Malcolm says. “Over the last three years, we have seen our premiums much more than double.”

But the American Subcontractors Association, a separate trade group based in Alexandria, Va., does not think wrap-up insurance is the solution. In theory, the wrap up looks fine, says David Mendes, the ASA's communications director, but in practice, it does not offer the subcontractors the insurance they need.

First, it is project specific, so after one project is completed, the sub is again uninsured. Furthermore, the administrative “hassles” of the wrap can stymie a subcontractor who needs certification after a project is completed that the work was done well and safely. “We are aware of numerous incidents where subcontractors have waited months, even over a year, for payments because of the administrative problems with wrap ups,” says Mendes, whose biggest problem is with the stop-gap nature of the wrap ups.

“Since [wrap-up insurance policies] are based on individual projects, they don't give subs long-term credit for safety and performance,” Mendes says. He says he believes that subcontractors should self-insure when they can, forming a pool of companies to share expenses and get better educated as to their options. “We're still educating our 5,000 members about the problem,” Mendes says. He says he hopes the cyclical nature of the insurance business means that this dip in insurance coverage, while long, is temporary. “It's a question of timing,” he says.

The Worst May be Over Fortunately, the problem may have peaked, say some experts. The insurance industry is cyclical, and some insurers may be dipping their toes back into home construction with stronger, better-written policies and practices that are better equipped to handle the litigious environment.

New legislation, plus quality controls and better customer care, are trimming the likelihood and profitability of some construction defect litigation. “Conditions will improve,” predicts risk manager Wick. “There will be fewer insurers doing better underwriting, and builders will see pretty high premiums for a long time.”

AON's Xiros notes that insurers, who were reeling from a series of setbacks, might have hit bottom. “A lot of carriers got smacked by Enron through their D&O [directors and officers] failures,” she notes. “September 11 also hit a lot of folks hard and took a bite out of the pool of money available.” Insurers are now looking at lines of businesses where they can make a risk-adjusted return, she said.

The insurance industry has noted the better home quality and better customer service builders are offering, she says, as well as the resilience of the housing industry. Cautiously, more insurers might enter the market. “We're starting to see more companies come to us inquiring about coverage,” Xiros says. When they get back into the business, she says, prices will come down.

A silver lining to the insurance coverage crisis will force builders to take responsibility for a problem and fix it before it becomes a lawsuit or an insurance claim, says Jeffrey Masters, a Los Angeles-based attorney with Cox, Castle & Nicholson, a risk-management practice.

In the mid-90s, for example, Masters handled a lawsuit that started with faulty garage door springs. “The springs kept breaking on one of these garages, so the door wouldn't open and close. If the builder had investigated and really drilled down to find out the problem, he would have discovered that it was a defective product,” Masters recalls. Instead, the builder's attitude was, “We replaced this twice, and that's enough,” says Masters. Of course, he says, when an attorney got involved, the lawsuit became not just about the springs, but about everything the lawyer could think of after an investigation of the house.

“I don't think it would happen today to a builder of that size,” says Masters. “But perhaps it could.”

Survival of the Safest What builders can do to avoid insurance problems. To keep insurance problems in check, builders must be proactive. Here are a few steps recommended by attorney Jeffrey Masters:

  • Document attention to quality in the field. Construction defect litigation has accelerated builders' efforts to be proactive about quality and customer service. A proven safety record and quality control systems enforced on the site will impress insurers and help keep premiums from skyrocketing.
  • Have a plan to manage complaints. This is particularly important from a homeowners' association if you build attached units. This is different from customer service, emphasizes Masters. Appoint a “building liaison” to advise homeowners' associations on their concerns. Anticipate and be aware of problems as they arise. “It's hard for homeowners to sue a builder they like and know,” he says.
  • Manage customer expectations. If it's normal for stucco to crack after a year, tell the homeowner. People can accept almost anything if they're prepared for it.
  • Provide maintenance information to homeowners. “People don't drive cars 50,000 miles without an oil change, but they expect their homes to last 10 years without something breaking,” says Masters. “Help them understand that maintaining the home is their business.”
  • What subcontractors can do to avoid insurance problems.

    Stephen Mysliwiec, a lawyer at the firm of Piper Rudnick, lectures frequently on the subcontractor insurance crisis. “It's not a good sign when so many people are interested in insurance,” he sighs. His primary advice: Insurers usually look at a subcontractor's claim history over the past five years. Subcontractors and general contractors should be “selective in choosing which claims to submit to insurers,” he suggests.

    Mysliwiec's other recommendations to subcontractors include:

  • Demonstrable quality control and safety programs, enforced on the jobsite;
  • Have a strong contract between the subcontractor and the general contractor or builder, which contains mandatory dispute resolution procedures to avoid lawsuits;
  • Require all parties to maintain liability insurance and to name the trade contractor as an additional insured on the builder's policies;
  • Maintain a practice of obtaining certificates of insurance from the subcontractors who have no history of cancellation of insurance;
  • Avoid installation of high-risk materials such as asbestos or synthetic stucco (EIFS).
  • Learn more about markets featured in this article: Los Angeles, CA.