If there was one thing that the July media frenzy over the possible heath risks posed by granite countertops should have prompted home builders to do, it was to double-check their insurance coverage.
Although no serious litigation may ever come out of the claims of dangerous off-gassing, the situation underscores builders' vulnerability to whatever the next big thing is in construction defect litigation. Builders have a very long 10-year tail when it comes to that type of litigation. And while they may not be building a lot of houses at the moment, they sure built a lot of houses in the past decade. One hardly has to get into the math to grasp that the magnitude of high-volume production builders' risk has never been greater than it is today.
However, there's growing industry concern that home builders' risk--and loss potential--is much bigger than most builders would believe. And, in some cases, the losses could be catastrophic in the event of a major class-action suit.
Changes within the insurance industry are making it ever more difficult--and expensive--for subcontractors to get insurance. There are fewer insurance providers, and the premiums and deductibles are on the rise, particularly for subs like framers and excavators who have more dangerous jobs and higher accident rates. Couple that with the housing slowdown, and many subs are struggling to afford insurance. The insurance industry is responding by reexamining the way it has historically written insurance contracts. Increasingly, that means that there are endorsements and exclusions in subs' policies that builders typically don't--and won't--know about because they won't show up on subs' certificates of insurance.
Case in point is the recent experience of a roughly 800-unit-a-year builder in the Chicago area. In an effort to further reduce costs, the private builder's finance executive was reevaluating the company's insurance program (this executive spoke on condition of anonymity due to the sensitive nature of the subject). After careful consideration, he determined that a captive insurance program with a wrap element, meaning the company's subs pay into the policy to participate in the coverage, was his best bet.
However, after he announced the change, he encountered resistance from some of the company's subs, who argued that the coverage was too expensive. According to wrap insurance experts, the cost of subs' participation in a wrap typically is plus or minus 10% to 15% of what they typically would pay for insurance. However, several of this builders' subs said that the cost of the wrap was 10 or 15 times what they were paying for their individual policies.
"I kept thinking, 'How are these guys getting it cheaper?'" the finance executive said.
To figure out the disconnect, the executive asked the company's subs for copies of their policies. After poring, line by line, over every policy, this builder and his insurance partners at J. Mading Cos. found that many of the insurance policies held by his subs had huge, gaping holes in their coverage. Stipulations that he considered usually covered by general liability insurance, as indicated in the company's subcontractor agreements, often were missing.
For instance, the company was not named as an additional insured on several subs' policies. Other subs' policies excluded coverage for product defects or completed operations, two of the main provisos all builders and subs need to protect against construction defect litigation. And there were other mind-boggling policy exclusions--an excavator whose policy excluded the moving of dirt and a framer whose policy excluded residential construction are two examples.
"[The exercise] exposed the unbelievable, unspoken truth of what's going on," said James Jackson, president of J. Mading Cos. "And we found it to be rampant."
Although no national statistics were available, other insurance specialists confirmed Jackson's assertion of the issue's widespread nature. The pervasiveness of the problem leaves many builders--and not just the disreputable ones--in a perilous situation in the event of litigation.
"I don't think builders know they aren't covered," asserted the private builder finance executive. "And I don't think a lot of our subs knew they weren't covered."
Although there is an insurance industry "professional standard," according to Karen Schwartzkopf, senior vice president for Zurich North America Commercial's construction-business unit, there are no formal safeguards within the insurance industry to ensure that subs understand the consequences of any endorsements or exclusions. It's the responsibility of the subs to read their policies' fine print, she said.
However, these days it's increasingly becoming the builders' charge. Legal precedent shows that homeowners and their legal counsels will go for what they perceive as the deep pockets of the home builder or developer. And if the subs' insurance policies have additional insured or completed operations exclusions, the builders' will get no help from their subs' insurance companies. Moreover, in many cases a sub will just fold up shop or reincorporate under a different mantle, making it difficult for lawyers to go after its assets.
Builders' singular line of defense is to verify their subs policies themselves.
"That's the rub," explained the finance executive. "You need to read every policy and every endorsement and have the insurance knowledge to be able to catch the 'gotchas.' There is zero chance of that."
For builders who lack the manpower or the free time to get into the nitty gritty of their subs' insurance policies, the alternatives are slim. They can hire a third party to collect policies and exclusions on the builders' behalf.
Zurich, for example, has a partnership with Go Kahuna, a Louisiana-based company that tracks and verifies subcontractors' licenses and certifications. As part of that service, the company monitors subs' insurance policies, tracking changes in coverage amounts or lapses. "It pulls a tremendous amount of risk off the table to verify the information," CEO Don Morgan said. Although the insurance monitoring aspect of the business currently excludes the tracking of endorsements, Morgan said companies like his have the capability of doing one-off projects of that sort for builders.
Another solution would be to consider going to a wrap insurance policy, where the builder ultimately has control over the policy's provisions. Subs generally push back against wraps, arguing they are more expensive or that they reduce the subs' pricing power in securing insurance for their other projects.
"Sometimes subs feel like a wrap is something done to them rather than something they participate in," noted Zurich's Schwartzkopf.
However, for many builders, wraps may be unavailable; insurance companies may refuse to offer builders that type of insurance product based on factors such as the amount of revenues they generate or their safety records. And with the insurance ever looking to restrict losses, it's hard for some companies to obtain wrap coverage.
"The developer can be caught between a rock and a hard place," explained Mark Himmelstein, a lawyer with Newmeyer Dillion in California. "If the developer can't get a wrap and the subs can't get insurance, where do you go? Developers are really going to take a hit in the case of defect litigation."