RISK MANAGEMENT
By Donald S. Malecki, CPCU
Carriers are quietly limiting liability coverage for contractors
One wonders if contractors actually realize how limited their commercial liability coverage is when their policies have been endorsed with the contractual limitation endorsement.
Considering the status of today's insurance market, it may come as a surprise to learn that the result of queries to insurance company underwriters around the United States indicates a growing interest in writing insurance on construction contractors.
Why, one might ask, are so many insurers interested in this line of business, when the market is still hard and, particularly, with the growing number of cases involving construction defects?
The answer may be that the coverage being provided is not as broad as it once was and, instead, is nothing more than "bare bones" protection. This is possible now, since underwriters have more tools enabling them to stay in this market and still provide very little in the way of coverage.
Whittling coverage made easy
It's not unusual, for example, to see commercial general liability policies issued with the contractual limitation endorsement. The impact of such an endorsement is to eliminate coverage for the tort liability that a contractor assumes under contract. What remains is coverage for some very limited contractual agreements--leases, easements and railroad sidetrack agreements, for example--that is likely to fall short of what contractors need.
Unless this is pointed out by the producer of record or a competitor, one wonders if contractors actually realize how limited their commercial liability coverage is when their policies have been endorsed with the contractual limitation endorsement.
The same goes for the explosion, collapse and underground property damage hazards, also known for short as X, C & U hazards. Prior to 1986, the custom and practice was for named insureds to pay for these coverages if desired. When the 1986 CGL forms were introduced, all three such coverages were said to be automatically included with the cost built into the rate.
Currently, underwriters have two endorsements at their disposal to eliminate all hope of coverage under these hazards. One endorsement applies on a blanket basis for all jobs. The other is used for site-specific work when the underwriter believes that the exposure is too hazardous an undertaking to provide coverage.
The end of an important coverage
One of the distinct advantages of the CGL for the general contractor who employs one or more subcontractors is that the general contractor obtains broad coverage when there's an allegation of property damage following the completion of work. The subcontractor, of course, has no coverage under its CGL policy for damage to work it has performed in light of the "damage to your work" exclusion.
The general contractor, however, has enjoyed broad coverage over the years, since the standard CGL policy, as currently constructed, not only applies for damage to completed work caused by the work of a subcontractor, but also for damage to the general contractor's work, or for damage to the work of others caused by the subcontractor.
This essential coverage, also known as "broad form property damage," has been available on a completed operations basis since 1966. Until the introduction of the broad form CGL endorsement in 1976, this broad form property damage coverage required an additional charge.
Contractors were happy to learn in 1986 that this broad coverage was automatically included in their CGL policies without additional cost. They were especially happy because this coverage enabled them to continue to hire incompetent and/or cheap labor and transfer the consequences of construction defect losses onto the insurers.
Many insurers, however, decided to draw the line on this conduct in 2001. This is when ISO introduced two new exclusionary endorsements to eliminate broad form property damage after operations have been completed. One is a blanket exclusion and the other is for site-specific jobs.
Unless contractors are informed about the impact of these endorsements on their policies, these endorsements are likely to result in big surprises to them. It also is important to note that these endorsements are not limited solely to policies purchased by general contractors who employ subcontractors. These endorsements also can be used on the policies of developers who employ general contractors, and on CGL policies of subcontractors who employ the services of sub-subcontractors.
These exclusionary endorsements have the capability of eliminating some very important coverages common to the needs of contractors, and their use is more prevalent than some might imagine.
In fact, underwriters are using these exclusionary endorsements with some frequency. One insurer is using the blanket endorsement automatically on every policy it issues for contractors. The simple explanation is that underwriters have come to the realization that to make money in writing contractors, they no longer can afford to give away the store, as has been the case during the good old days.
Course of construction problems
When it comes to course of construction policies, producers need to keep in mind that, while they may offer off-the-shelf policies of the insurers they represent, the exposures confronting candidates for this coverage vary with each job.
If a prospective client requires this type of policy, it's important to keep in mind that no one policy is perfect. But they often are flexible to accommodate special needs. For example, many contractors require coverage not only at the site of construction, but also while the property to be installed is temporarily stored off site, as well as while it's in the course of transit. The exposure characteristics here suggest an inland marine-type policy.
Space limitations preclude a comprehensive discussion of what producers need to consider before suggesting the appropriate course of construction policy. One important area that nonetheless can be discussed, particularly since some producers have been caught up in litigation over it, turns on whose responsibility it is to purchase the coverage.
As a general rule, it doesn't require the reading of a construction contract to determine whose responsibility it is to obtain a course of construction policy. The usual question that needs to be asked is: Who is the owner of the project?
Construction contracts differ, of course. It's not unusual, however, for construction contracts to follow the dictates of the American Institute of Architects provisions comprising its A201 General Conditions. Sometimes attorneys who prepare construction documents rely on the foregoing AIA document as a prototype. While they may change certain portions of this document, they seldom change any provisions having to do with insurance.
What this means is that if the insurance provisions of the above AIA document are relied on (or something like them), it will be the project owner's obligation to obtain a course of construction policy for all contractors to be involved in the project. If the project owner decides that it might be better for a contractor to obtain the course of construction policy, the owner needs to notify contractors of this intent so that coverage can be arranged and charged back to the owner.
What sometimes happens is that no one follows up on the question of insurance. The contractors assume the owner is obtaining the course of construction policy, and the owner either fails to obtain this policy, or consciously decides to forgo its purchase and rely, instead, on its own permanent property policy.
This is why it's necessary for the producer to ask that question about insurance. It often is enough to trigger an investigation from among the owner and contractors over the responsibility of this important coverage. Short of doing that, producers can expect to encounter some serious accusations, since contractors who find themselves without protection will likely point the finger at their so-called "insurance expert" on whom they say they've relied for their coverage.
When it's the project owner's responsibility to obtain a course of construction policy, but the project owner fails to do so, the owner has sometimes been able to fall back on its own permanent insurance for protection. The reason is that many property policies today automatically include, as an added feature, coverage for loss while construction is in progress.
Of course, after the owner is paid for its loss, the property insurer can usually be counted on to file suit in subrogation against the responsible contractor or contractors.
Surprising insurers for a change
Some insurers who file these suits in subrogation are surprised to learn that they're precluded from recouping their losses from among participating contractors. The reason is that the AIA document A201 General Conditions, referred to above, contains a waiver of subrogation that not only impacts the coverage that should have been obtained, but also any other insurance that might be available to the owner.
The pertinent provision in question reads: "The Owner and Contractor waive all rights against each other . . . for damages caused by fire or other perils to the extent covered by property insurance pursuant to this paragraph ... or other property insurance applicable to the work ..."
What the provision is saying is that a waiver applies not only to the extent of the property insurance prescribed by the construction contract, but also to any other property insurance that may apply. This includes the property policy of the project owner even when the owner had no intention of using that policy to provide coverage as required.
There are a number of cases where insurers, in attempting to exercise their rights of subrogation after having paid their owners for loss, have discovered (much to their dismay) their inability to do so. One such case is Mu Chapter of the Sigma Pi Fraternity of the United States, Inc. v. Northeast Construction Services, Inc., et al., 684 N.Y.S. 2d 872 (1999).
The negligent contractor was fortunate in this case because the owner's permanent policy covered the loss while property was undergoing construction. Not all property policies do so, or if they do, the policies don't cover the loss fully. The fact that most property policies do cover some loss for some construction work, however, is an important point to remember.
Conclusion
Some producers today are technicians who want to delve into the intricacies of construction. They want to read contracts, analyze insurance policies and see to it that their clients are being protected to the fullest.
There are other producers who desire to do a good job for their clients without having to exert a lot of time and energy. This is still possible without being accused of conduct that falls below the standard. To accomplish this, however, it's necessary for producers to ensure that the policies of their contractor clients haven't been whittled down by all of the exclusionary endorsements that were pointed out earlier.
When it comes to property insurance, producers need to ask who is to provide the course of construction coverage. Just asking the question may be enough to provoke someone into thinking about it in more detail. If it is the owner's obligation, the contractors need to be advised to check with the owner to determine if they're covered by that policy.
Sometimes, it's worthwhile for contractors to maintain an installation floater to cover their insurable interests in work to be performed just in case those who have the responsibility for obtaining insurance drop the ball. It's a precaution that often is worth its weight in gold. *
The author
Donald S. Malecki, CPCU, is chairman and CEO of Donald S. Malecki & Associates, Inc. He is an active member of the CPCU Society, serves on the Examination Committee of the American Institute for CPCU, and is an active member of the Society of Risk Management Consultants.