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Insurance prices for contractors are rising,
and coverage availability is shrinking. When available, insurers are making
significant changes to their policies in response to rising construction defect
claims. Coverage restrictions affecting known loss, EIFS, mold, earth movement,
residential construction, and additional insureds are becoming common. Agents
and brokers serving the construction market must closly examine CGL policy forms
and endorsements for irregularities in the language that could impact coverage.
by Ann Rudd Hickman, CPCU, ARM IRMI
An onslaught of construction defect litigation over the past 2 decades has
pummeled the construction insurance industry. Contractors must rely primarily
on their liability insurance programs for protection against construction defect
claims. Unfortunately, in some states the impact of construction defect claims
on coverage availability and affordability has reached crisis status. Subcontractors,
in particular, have experienced a drying up of insurance markets, because much
of the risk from construction defects falls in their laps. California, Nevada,
Arizona, Texas, Florida, and Colorado have the most significant construction
defect problems, but many other states are experiencing increased litigation
in this area as well.
Insurers have undertaken a number of strategies for dealing with the growing
cost of construction defect claims. General and umbrella liability insurers
alike have adopted an underwriting philosophy of avoiding altogether certain
classes of contractors, types of construction, or problematic regions. For example,
some insurers have stopped writing coverage for residential developers, general
contractors performing residential construction, and any contractor directly
or indirectly involved in the installation of synthetic stucco (commonly known
in construction and insurance circles as exterior insulation and finish systems,
Alternatively, insurers may decline to write contractors with more than a
certain percentage of their work in problematic areas, such as residential construction
or EIFS installation. Some insurers have completely withdrawn from construction
insurance markets in problematic regions, primarily California.
In addition to the underwriting restrictions described above, insurers will
likely attach a combination of coverage restricting endorsements. Many insurers
attach exclusions to contractors' and subcontractors' policies that target common
types of construction defects claims, such as mold and damages attributable
to the use of EIFS on the building. The precise combination of endorsements
will vary by class of contractor, type of construction, and by state.
Many insurers have also begun using restrictive additional insured endorsements,
which may leave a contractor in noncompliance with respect to their additional
insureds, and with less coverage than expected with respect to coverage they
receive as additional insureds on subcontractors' policies. This article discusses
some of the more common exclusionary endorsements currently being used on contractors'
liability policies and highlights key variations in these endorsements that
can have a significant impact on coverage. The changing scope of additional
insured coverage is also examined.
Eliminates coverage for damage to "your work" arising out of subcontractors'
work, and damage to the named insured's work that is caused by a subcontractor's
Construction defects often produce property damage that takes place over
a period of time. For example, moisture caused by faulty installation of windows
or seals may cause ongoing deterioration of wood and other materials. It is
possible, therefore, for a contractor to be aware of defects that are likely
to give rise to claims well before the claims actually surface.
Most insurance professionals would agree that losses, or potential losses,
of which the insured is already aware when an insurance policy is purchased
are not covered by the policy. However, the California Supreme Court ruled otherwise.
In Montrose Chemical Corp. v Admiral Insurance Co.,
913 P2d 878 (1995), the court ruled that prior to the determination of an insured's
actual liability for the injury or damage, the loss is neither certain nor fully
"known." Consequently, knowledge of a potential claim at the time the policy
becomes effective does not negate coverage (at least in that jurisdiction) as
long as there is uncertainty regarding the insured's actual degree of liability.
To counter the impact of the Montrose decision,
many insurers developed "known injury or damage" endorsements that specifically
exclude coverage for losses or potential losses of which the insured was aware
prior to the policy period. In 2001, Insurance Services Office, Inc. (ISO),
incorporated a known loss provision into its standard commercial general liability
(CGL) insurance policy insuring agreement which states that the policy does
not apply to injury or damage that is a continuation of damage known to the
insured at the inception of the policy period.
The effect of the ISO known loss provision is to make the policy in effect
when the insured becomes aware of the damage the last policy that will be triggered by the
claim. It does not, however, prevent multiple policies in effect during the
progression of damage from being triggered as long as the insured was not aware
of the damages prior to the inception of each of these policies.
Some insurers still use their own "known loss" exclusions, many of which
are broader than the ISO provision. For example, some known loss endorsements
limit recovery to a single policy by requiring that the insured first become aware of the injury or damage
during the policy period to be covered. This will be restrictive in states that
allow a continuous coverage trigger on progressive damage claims.
Alternatively, some insurers attach endorsements in which all property damage
is "deemed" to have occurred at a specific moment in time. For example, the
endorsement may provide that all covered property damage is deemed to have
occurred at the moment damage first began, regardless of when it was
discovered. Under these types of endorsements, informally referred to by
some as "deemers," the
insured's knowledge of a claim is not relevant to which policy is triggered.
As with the "first knowledge" endorsement described above, only one policy can
be triggered by a given loss (assuming all the affected policies have this type
of provision), but the actual policy that is triggered could be different under
these two approaches.
Exterior insulation and finish systems (EIFS) are multilayered exterior wall
systems that are designed to provide high energy efficiency. (Synthetic stucco,
a popular building material in many regions, falls into this category.) EIFS
have been at the core of a significant amount of construction defect litigation,
particularly in warm climates such as Southern California, Florida, Texas, and
Nevada. Typically, these claims alleged faulty installation or some other product
defect that allowed water to penetrate the walls, where it became trapped. Wood
rot and mold were some of the problems commonly encountered by the owners of
In light of the tremendous losses suffered by the insurance industry related
to these insulation systems, EIFS exclusions began to appear on the liability
policies of EIFS installation subcontractors, as well as virtually any other
contractor whose work could conceivably be tied to the infiltration of moisture
(e.g., roofers, HVAC, window and garage door installation contractors, and plumbing
contractors). Although residential construction has been harder hit by EIFS
claims than commercial buildings (probably because damages are greatest on wood
frame construction), EIFS exclusions are in widespread use for both residential
and commercial construction contractors.
As of yet, there are no standard EIFS exclusions, but most insurers writing
contractors have developed their own endorsements that exclude this exposure.
While many contractors will not be able to avoid an EIFS exclusion, they should
examine the scope of the exclusion carefully. In their attempts to draft sweeping
exclusions for all EIFS-related losses, some of these endorsements, perhaps
unintentionally, go far beyond the actual EIFS exposure.
For example, one insurer's EIFS exclusion removes coverage for virtually
all claims associated with a contractor's work on an exterior fixture of the
building if an EIFS is included on any portion of the structure. That is, the
exclusion does not just apply to damages caused by the presence of an EIFS or
by the contractor's installation or other involvement with an EIFS system, but
to all losses related to the contractor's work on any exterior fixture of any
project that contains an EIFS. This exclusion may be appropriate if the insured
is an EIFS manufacturer or EIFS installation contractor, since virtually all
of their work involves the use of EIFS, but attached to other types of construction
contractors' policies it goes well beyond most contractors' and insurance professionals'
expectations for an EIFS exclusion.
In recent years, the construction and insurance industries have seen a dramatic
increase in the number of claims alleging bodily injury and property damage
caused by mold. Experts disagree on the prevalence of toxic molds and their
long term impact on people who are exposed to them, but clearly mold can produce
serious property damage. Molds tend to form where there is a combination of
moisture and poor ventilation, therefore any construction activity that has
the propensity to lead to water infiltration or restricted ventilation presents
a mold risk. Unfortunately, this includes a wide spectrum of contractors, such
as roofers, plumbers, window, sheetrock or siding installers, HVAC contractors,
and anyone performing grading, landscaping, or foundation work on the property.
Most insurers have attached mold exclusions to a broad cross section of contractors'
liability policies. Some insurers attach mold exclusions to all contractors'
policies, regardless of the risk assessment. The standard ISO "fungi or bacteria
exclusion" endorsement is very broad, removing coverage for all injury or damage
that would not have occurred "but for" exposure to any fungi (e.g., mold) or
bacteria, as well as any costs incurred in cleaning up the fungi or bacteria.
Mold exclusions are currently in wide use on contractors' general liability
policies, and most insurers are not open to negotiating on this issue. For a
while, contractors who carried pollution liability insurance could find protection
for mold claims under those policies. Today, most contractors pollution liability
insurers routinely exclude coverage for claims alleging damage caused by mold,
but will add the coverage back for an additional premium. The "buy back" may
be limited in terms of covered damages or a separate sublimit.
Contractors whose work involves the foundation of a building, or any form
of moving, grading, or compaction of land or dirt on the construction site may
see an "earth movement" or "subsidence" exclusion on their general and umbrella
liability policies. (Where the term "subsidence" is used, it is typically defined
to include virtually any form of earth movement, including landslide, mudflow,
collapse, or movement of fill, earthquake, and virtually any form of earth rising,
sinking, setting, eroding, tilting, or settling.) Some insurers attach these
exclusions only with respect to residential construction, or construction in
certain areas prone to earth movement, most notably California.
Much of the construction defect battle has been waged in the residential
construction arena, particularly multifamily housing such as townhomes and condominiums.
Some insurers have withdrawn from residential construction markets altogether,
or in certain problem regions.
For contractors who perform primarily commercial construction but do some
residential work, insurers may carve out the residential exposure by attaching
a residential construction exclusion. (These endorsements are not standard,
and may carry a variety of titles.)
The scope of the exclusions can vary significantly based the type of construction
to which they apply—single versus multifamily housing and new construction versus
renovation work, for example. The inclusion of a residential construction exclusion
on a subcontractor's liability policy would also eliminate any coverage the
contractor may have had as an additional insured on that policy.
The CGL policy's "Damage to Your Work" exclusion, frequently referred to
as the "workmanship" exclusion, eliminates coverage for damage to the insured
contractor's completed work that arises out of the contractor's work. This prevents
the CGL policy from acting as a warranty on the insured's work. Although the
definition of "your work" includes work performed by subcontractors, by exception,
the exclusion does not apply to damage to a subcontractors' work nor to damage
caused by a subcontractor's work. In other words, the insured contractor's CGL
will respond to all of the following.
In 2001, ISO introduced two optional endorsements that remove the coverage
that the subcontractor exception leaves intact. One of these endorsements eliminates
all coverage for damage to "your work" that is, or is caused by, a subcontractors'
work. The other eliminates this coverage only with respect to scheduled sites
Thus far, the subcontractor exclusion endorsements do not appear to be in
widespread use, but contractors and their insurance representatives should be
on the lookout for them. Contractors engaged in residential work are particularly
likely to encounter these exclusions. For contractors who subcontract a significant
portion of their work, the reduction in coverage is significant.
With respect to construction defect exposures, most umbrella insurers have
chosen to combine various industry-specific exclusions into one endorsement
commonly referred to as a contractors limitation endorsement. In recent years,
many umbrella insurers have added a number of construction defect-related exclusions
to their contractors limitation endorsements. For the most part, these exclusions
mirror their CGL counterparts. Mold, EIFS, subsidence, and residential construction
are all potential exclusions on the contractors limitation endorsement. Contractors
should ensure that any such exclusions do not apply if the same damages would
be covered by the underlying the CGL policy. That is, the umbrella should provide
"following form" coverage with respect to these types of claims.
Construction contracts frequently require contractors to add other parties
(i.e., the owner or other contractors) as additional insureds on their liability
policies. Generally speaking, the additional insured wants broad protection
for any claim it might face with respect to the construction activity. In reality,
their coverage may be much more narrow than they expected.
The two key issues with regard to an additional insured's coverage are whether
coverage applies to completed operations, and whether there is coverage with
respect to losses caused by the additional insured's own negligence.
Prior to 1993, additional insureds enjoyed broad coverage for losses "arising
out of" the named insured contractor's work. This language was broad enough
to include ongoing and completed operations, and claims arising out of the additional
insured's own negligence, including its sole negligence. (Compelling arguments
have been made both for and against the "fairness" of providing coverage for
an additional insured's sole negligence.)
In 1993, the standard additional insured endorsements were modified to extend
coverage to additional insureds only with respect to the contractor's "ongoing"
operations for the additional insured, thus eliminating completed operations
coverage for the additional insured. For several years, insurers continued to
offer the older versions of the endorsement in recognition of the fact that
contractors needed this coverage to comply with their contractual requirements.
As construction defect litigation snowballed, and the insurance market in general
began to harden, more and more insurers stopped this practice. Most insurers
now offer only the newer versions of the endorsement, which do not include coverage
for completed projects.
Many insurers have drafted their own additional insured endorsements that
not only remove completed operations coverage, but also narrow the scope of
coverage for claims that can be tied to the additional insured's own negligence.
Some additional insured endorsements eliminate coverage only with respect to
the additional insured's sole negligence, while others eliminate all coverage
with respect to the additional insured's own negligence. (Note that coverage
for the insured contractor's contractual indemnification obligations are not
affected by the language of the additional insured endorsement. Consequently,
as long as the contractor's liability for such claims can be tied to a legally
enforceable indemnity agreement, the policy would pay claims involving indemnification
of an additional insured for its own, even sole, negligence, but perhaps on
less favorable terms.)
Until the tide of construction defect claims is stemmed, insurers will continue
to look for ways to limit their exposure in this area. Unfortunately, some insurers
are not completely forthcoming about changes in their policies that reduce contractors'
coverage, and, as a result, the restrictions may not be discovered until a claim
is denied. Agents and brokers serving the construction market, particularly
the residential construction market, must be diligent to examine CGL policy
forms and endorsements for irregularities in the language that could impact
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