They're big, ugly, and only arrive at the last minute. Meet the insurance quotes of 2003, whose appearance is almost guaranteed to make you scream. Just listen to the horror stories.
At Ryan Building Group, a Schaumburg, Ill.-based company building 650 homes annually, its insurance renewal came right down to the wire. "We secured it the last hour of the last day," says CFO Kevin Davis, who'd begun his research months in advance of the March 1 deadline, only to find himself scrambling for coverage as the quotes came in. "It makes decision-making impossible."
But don't even think of shopping around. Even if you could find some competition for your beast of a quote, you don't have time to wait for the information. After Bob Peterson of Associates in Building and Design learned that his insurer of almost a decade, Ohio Casualty, wouldn't renew the policy for his Fort Collins, Colo., building and remodeling firm, he received a quote from
American Family (which has since left the Colorado residential market). He was shocked. "The quote was 100 percent more than it had been [with Ohio Casualty]," he says. "My agent said, 'If you want it, you better take it, because they're not writing any more contractors' general liability after March 1.' I reluctantly wrote a check, because I felt I had no other choice."
The situation is driving builders to do things that sound crazy--simply because there is no other option. Since no one insurer could handle all of its business, Ryan Building Group now maintains five different policies with three different insurance carriers and ties with four different brokers. (Ryan operates in Illinois, Wisconsin, Ohio, Texas, and Florida.) "We had to break [our coverage] up. We had to establish all-new relationships," says Davis, who acknowledges there are no economy-of-scale efficiencies, at least in insurance, for this large builder. "Everybody suffered. Every state now has a separate policy, because it was more cost-effective this way."
It's enough to make builders dream of going bare. "We're paying $750,000 per year for insurance," Davis says. "At that point, you're paying someone so much money, you wonder why you have insurance."
There's only one reason: "You're buying it because you need the certificate of insurance," says Jeffrey Ferrand, a client executive for risk management firm Marsh USA.
To keep builders covered, Builder has assembled 11 strategies for coping with the ongoing insurance nightmare. We can't guarantee they'll protect you from increases. That won't happen until insurance companies see better returns on their investments, and right-to-repair laws, as hoped, lower the cost and frequency of construction-defect suits. But these tips should help you keep the insurance monster at bay.
1. Make your company an appealing risk to take.
The days of simply submitting your standard insurance renewal forms are over. "You have to make a firm that is shopping for insurance look pretty," says Stuart Price, former chair of the NAHB general liability insurance task force and partner of Granor Price Homes in Horsham, Pa. "It's not just skin deep--you need to provide a package of information that your broker can provide to insurers."
That package should include contracts with home buyers and trade contractors, warranty documents and other legal forms, happy homeowner letters, industry honors, and information on any practices or policies that differentiate you from other builders. You may also want to encourage your broker or underwriter to visit a jobsite--an invitation that shouldn't be restricted to renewal season.
"You should be doing a marketing job on your insurance carrier 12 months a year, making your company stand out as a good risk," says Stacy McDaniel, general counsel for John Laing Homes and a former insurance broker for builders. She has one more piece of advice: "Be aggressive about quality assurance. You have to be able to demonstrate that you have a coherent strategy in place that delivers a consistent quality product."
2. Start a risk management committee.
Yes, we know. No one likes committees. But this is one that's worth your time, says Bruce Zaccanti, national practice director for Ernst & Young's insurance risk advisory services group in Chicago. Members should come from areas such as estimating, legal, risk management, executive leadership, accounting, and operations. Once they're together, ask them about the risks they're managing. What type of insurance endorsements are they receiving from subs? Are any materials being stolen or damaged on the jobsite? How are new trades doing?
The answers may surprise you--and the solutions may be easier than you expect. As a risk manager, Zaccanti once worked for a mechanical company that was being rejected for jobs because of its poor insurance history. As a result of a risk management committee, the company invested $95,000 in videos and safety equipment, established pre-kickoff meetings emphasizing safety, and saw its workers' compensation losses fall by $2.8 million. "This is small dollars for big dollars," he says.
3. Boost customer service and warranty efforts.
In today's lawsuit-happy world, the softer side of home building--customer service--has developed a harder edge, especially if things go wrong. "Most construction-defect litigation can be traced back to a real or perceived failure of customer service," says Jeffrey Masters, an attorney at Cox, Castle & Nicholson, a Los Angeles law firm.
To avoid such a situation, builders must respond more quickly to their buyers, resolve warranty claims they might have rejected in the past, and serve their customers longer into a home's life. This applies even to difficult buyers whose nonstop requests have become a money-losing proposition. "A builder needs to do a new calculation on when to cut it off [and start saying no to customers], because if you let those buyers out of the tent, it's going to end up being more costly because of increased insurance and litigation costs," Masters says.
Beazer Homes is addressing the issue by hiring a national warranty manager who will be responsible for serving customers post-closing. To Mark Berry, vice president of risk management at Beazer, treating customers well (along with building quality homes) is one of the best ways for builders to improve their risk profile.
4. Be alternative.
For buyers who won't be satisfied, you may need an alternative--an alternative dispute resolution (ADR) clause in your home buyer contracts. "You want to keep these claims out of a civil tort case," says Masters. ADR does just that by requiring buyers to resolve claims through mediation or arbitration, two procedures that reduce legal costs, the chance of big money judgments, and the cascade of insurance problems that could follow.
ADR can be controversial. While mediation is voluntary and the mediator has no authority to force a builder or buyer to do anything, arbitration is often legally binding. Some home buyers have challenged builders' mandatory binding arbitration clauses in court, saying it's unfair to take away their right to sue. Others in the home building industry say consumers benefit from ADR by getting a faster resolution at a lower cost. "It's an advantage to both parties to avoid prolonged, expensive litigation," says David Jaffe, staff vice president for construction liability at the NAHB.
Builders interested in ADR should check with their state and their lawyer; rules vary around the country.
5. Get an outside inspector.
Builders say it's one of the most frustrating things in the world when shopping for insurance: Insurers don't discriminate between builders who do their jobs well and those who don't. "I've been around for 26 years. I've never had a claim on my policy, and I have always taken care of my customers, and boom! All of a sudden, I am classified as substandard," says Steve Holben, who saw insurance rates for his company, Holben Building Corp. in Denver, soar as high as 3,000 percent.
Holben isn't alone. "The insurance industry is no longer willing to take a builder's word that he's a quality builder," says Stan Luhr, president of Quality Built, a quality assurance firm in Poway, Calif. "They don't look at past history, because it hasn't proven to be a good insurance tool. For every other type of industry, yes, but not for home building, because builders change the type of product they build, the locations where they build, and the type of soil they build on."
But insurers are willing to rely on an inspector's word. "If you have a good third-party forensic firm that knows the issues that get litigated, you can get documentation in the builder's files that shows a home is free of those types of defects," says Mike Hopson, vice president of residential risks at Zurich North America, which insures about 40 builders and $15 billion to $20 billion worth of housing construction. "It lessens the likelihood of a defect happening and lessens the attractiveness [of those homes] to attorneys."
At Quality Built, which is working with Lennar to inspect all of its California homes, the process works like this: Quality Built performs a risk audit of the builder's current construction, establishing "exactly what level of quality they are building today," Luhr says. If an inspector sees a defect three times, it's considered a pattern. Those observations go into the risk audit, which creates an action list based on the top 10 issues discovered.
Quality Built also looks at the builder's customer service program, claims history, contracts, operations, and culture before assigning the company a rating between 1 and 5. If you're a 4 (and few builders are), you're doing "stellar work," Luhr says. A 3 is average. If you're a 1, well, if you haven't been sued yet, you will be soon. The program's goal is to move builders to a 5 rating within 24 months, a target assisted by Quality Built's detailed inspections. The company makes as many as eight field visits per home, inspecting more than 700 checkpoints for defects. The inspection program costs about $500 to $800 per house.
Involved, yes, but Luhr says such ratings and programs will soon become a critical factor for insurers "tiptoeing" back into the residential market with limited capacity and limited appetite for risk. "They're going to take the 2s and the 3s," he predicts. "They're not going to issue policies for the 1s. There's not enough insurance to go around."
6. Go captive.
If you're looking for the quick fix to insurance scarcity, skip this strategy. "A captive is not a short-term solution," says Ernst & Young's Zaccanti. "You have to make a large investment."
It's a complicated venture. A captive is a formal insurance strategy for a company interested in financing its "retained risk"--the expected and potential losses it is willing to pay out-of-pocket. It's different from self-insurance (which simply involves reserving enough money to cover those costs) in that it offers some tax advantages that simple self-insurance does not.
Establishing a captive is also more structured than just boosting one's reserves. Builders who choose the captive option will need to treat it almost like it's an insurance company, with an actuarial assessment of expected and potential losses. Based on that information, the home building company will basically pay "premiums" to the captive, which will then purchase reinsurance just as a typical insurance company would. A captive is not something that can be done in your spare time; you'll need to hire a person or firm to manage it.
7. Increase your retentions.
Captives are getting lots of play, but ironically, they aren't necessarily cost-effective for builders with few claims in their past. "You fund captives based on past claims experience, and we haven't had enough claims experience," says Darris McClure of Choice Homes. As a result, any captive Choice might establish would be "extremely small," but with all the full-fledged administrative costs of starting and maintaining a captive.
So Choice is pursuing another strategy. The private builder is staying with conventional insurance but it's boosting its self- insured retentions (SIRs). Despite their name, SIRs are not reserve accounts but instead are more like deductibles. They represent the out-of-pocket amount a builder will pay before its insurance coverage kicks in, but they extend beyond claims to include legal fees and other costs, depending on the policy. "Based on our own history, it made more economic sense to take higher SIRs," McClure says.
The decision hasn't reduced Choice's insurance costs--its premiums still more than doubled in the past two years--but those costs aren't as astronomical as they could be, given the tight market. McClure remains philosophical about the situation. "Insurance is just a cost of doing business," he says. "On the flip side, financing costs have been great."
8. Explore JDAs.
Forget PDAs. The hot acronym for subs and builders in California is JDAs--joint defense agreements. These legal arrangements, which are often addressed by the wrap policies builders buy to cover themselves and their subs on specific projects, are intended to curb the current three-ring legal circus of construction-defect litigation. "These lawsuits go from soil to chimney, and after about a year or two, most of the subs are dismissed. Until then, you've got 20 or 30 subs, plus their insurance companies, plus 20 or 30 lawyers," says Brendan O'Neill, executive vice president and CFO at Beazer Homes in Northern California. Under a JDA, "if we get sued, we then figure out what insurance company and lawyers will take the lead. If we can just do that, we'd save 40 percent to 60 percent of the money being spent" on construction-defect suits.
9. Rely on your JV partner.
Insurance isn't usually what comes to mind when builders think of Hearthstone, a company that invests institutional money in residential development. But perhaps it should. The San Francisco-based firm purchases $600 million worth of coverage annually in wrap and general liability policies from two insurance companies for its joint venture builder partners.
The approach accomplishes two things. It covers Hearthstone's risks from its ownership interests in a project and also provides coverage to builders working in geographical or product areas that are hard to insure, such as attached housing in Southern California.
Virtually all of Hearthstone's builder partners take advantage of the program, which is broader than most (Hearthstone's policies cover mold and soil problems, for example). The premiums aren't any cheaper, though, for Hearthstone or its partners. "In this market, I don't think anyone is getting a volume discount," says Mark Porath, CFO, who says Hearthstone builders pay market rates for the coverage, which is considered a project expense.
But Hearthstone isn't an option for problem builders looking for a little joint venture money and insurance to boot. Builders must agree to third-party inspections, and Hearthstone looks carefully at builders' loss histories prior to partnering with them. "Profitability is an indicator of a good builder and so are loss runs," Porath says.
In the Empire State, a group of builders believe they may have found a solution to their state insurance crunch: a reciprocal liability insurance company. "Our goal is to be the available product in good times and bad," says Phil LaRocque, executive vice president of the New York State Builders Association (NYSBA), which began exploring the reciprocal last year with assistance from Marsh USA. It hopes to begin business this fall.
Neither a captive nor self-insurance, a reciprocal insurance company is instead an arrangement where the owners (in this case, NYSBA members) are both the insurers and the policyholders of the reciprocal. Only members are eligible to apply for coverage, which is underwritten by the reciprocal, which collects premiums just as a traditional insurance company would.
Premiums won't necessarily be lower-- "If we're low-balling ourselves, we're just fooling ourselves," says LaRocque, who says pricing will be "competitive"--but control will be greater. "We'll manage and control our own program," LaRocque says. "We'll decide which cases we settle and which cases we'll defend and litigate."
There are other advantages. Unlike a captive or self-insurance, the reciprocal would be covered by the state's guarantee fund, should losses exceed reserves.
LaRocque is optimistic about the reciprocal. The 3,500-member NYSBA already operates a workers' compensation self-insurance trust that serves 200 builder members, and the reciprocal insurance company will need only 75 to 100 members by the end of the first year, with a goal of generating $5 million in earned premiums. Funding the reciprocal will require $1.5 million in reserves up front, an investment LaRocque says will be covered by builders and investors.
It's certainly not an easy solution, but LaRocque believes it's the right one for builders in New York. The state not only lost a significant amount of insurance capacity as a result of the World Trade Center tragedy but also because of state liability law, which holds third parties (such as builders) absolutely liable for any bodily injury that happens on their jobsites, regardless of their involvement. "I've been through three insurance crises in my career," says LaRocque, who's worked in insurance and home building for 23 years. "There's never been one so deep. I've never seen anything like it."
11. Put insurance and warranty coverage together.
Before the crunch, John Laing Homes handled its insurance the usual way. The Newport Beach, Calif.-based private builder maintained a traditional insurance policy on everything but its attached product, which it covered through per-project wrap policies--until premiums skyrocketed and coverage amounts shriveled.
So, in 2002, the builder tried a new tactic. It enrolled in Zurich North America's home builders protective policy, which addresses both insurance and warranty issues for the builder, its subcontractors, and its home buyers. The program, essentially a "rolling wrap-up" that covers all operations instead of just selected projects, is open only to builders that generate at least $100 million in revenue, submit to face-to-face underwriting, and have sufficient management, corporate, and quality controls in place. The Zurich policy is more expensive than handling insurance and warranty issues separately.
But McDaniel, the builder's general counsel, says the Zurich policy also offers better protection, with coverage for mold, soil problems, design defects, and contract claims, where buyers allege a defect in a home that hasn't actually been damaged. "Under traditional general liability policies, you had to have actual damage for the insurance to pay out," she explains. "The Zurich policy covers this. If there is a life safety construction defect, Zurich will respond."
It also covers subcontractors for their current and completed work through John Laing's eight- to 10-year warranty. "One of the reasons we decided to go into this program is that we knew our trade contractors were having a ton of trouble getting insurance or the endorsements we required," McDaniel says. "They would provide us with a certificate of insurance that looked good on its face, but there were so many exclusions [on their policies] that we had no real coverage and they had no real coverage."