Insuring Completed Operations Pollution Risks

Construction Contract Errors Can Result in Uninsured Pollution Losses

While the use of project-specific CPLs has increased significantly over the past several years, misunderstandings about certain provisions found in these policies may result in a significant loss of coverage for both owners and contractors. The interrelation of individual CPL policy language with individual contractual insurance procurement requirements may negate a significant portion of the coverage the policies are purchased to provide—the coverage for claims arising out of completed operations.

This potential gap in coverage arises from wording that project owners typically use to set forth the insurance requirements in construction contracts they sign with their contractors. Many times, these insurance requirements are drafted so that if the contractor obtains a project-specific CPL policy written on a claims-made basis, it is also required to purchase completed operations coverage for claims arising out of loss or damage occurring after the construction process has been completed. However, if the contractor procures a project-specific CPL policy written on an occurrence basis, it often is not required to purchase the additional coverage for the completed operations period. This can leave a considerable period of uncovered exposure for the contractor(s) and project owners where the risk of environmental damage continues past completion of the contractor's work.

To fully appreciate this coverage gap, we must first understand some basic language that is common to CPL policies. The insuring agreements in most occurrence CPL policies require that bodily injury, property damage, or environmental damage must occur during the policy period. To understand how this provision operates in practice, let's look at what can happen on an actual project.

Environmental Loss Scenario

Assume a contractor is hired by an owner to construct an apartment complex with 1,200 residential units. The estimated construction time is 2 years. When the owner drafted the insurance procurement requirements in its contract with the construction contractor, it stated that if the contractor obtained project-specific CPL coverage written on a claims-made basis, it was also required to purchase completed operations coverage for a 5-year period following completion of the work. The contract went on to state that if the contractor obtained project-specific CPL coverage written on an occurrence basis, no completed operations coverage would be required. The contractor did obtain a project-specific CPL policy written on an occurrence basis for a 2-year term and purchased no completed operations coverage.

How would this CPL policy perform in the event of an environmental claim? Assume the contractor completed construction of the apartment complex within the specified 2-year time frame. Three years after completion, several windows started to leak due to improper installation of seals by the contractor. Water intrusion as a result of this construction defect led to mold growth that resulted in claims for property damage and bodily injury from the residents living in the apartments.

These claims would most likely not be covered under the occurrence-basis project-specific CPL policy since the property damage, bodily injury, or environmental damage did not occur during the policy period. The fact that the construction activities did occur during the policy period is irrelevant under most policy forms. The insuring agreement in most CPL policies clearly states that the "damage" must occur during the policy period. In our example, the "damage" (property damage and bodily injury due to mold growth) did not occur until 3 years after the policy period was over. For coverage to be provided in this scenario, the contractor would have needed to purchase the additional coverage for a completed operations period of at least 3 years.

A possible solution to this problem would be to purchase an occurrence-basis CPL policy with a term long enough to cover the latent defect exposure associated with such a project. However, most insurers price "policy term" years at a higher rate than they apply to "completed operations" years. In our scenario, purchasing an occurrence-basis project-specific policy for 5 years will likely be significantly more expensive than purchasing the same policy for a 2-year policy term with additional coverage for a 3-year completed operations period.

Completed Operations: How Long Is Long Enough?

This raises a further question with respect to project-specific CPL insurance—how long a completed operations period is needed to provide adequate coverage for a given project? Unfortunately, there is no easy answer for this question. Several project details will factor into this decision, including the type of job, jurisdiction in which the project is constructed, statutes of limitations and repose within the jurisdiction, and even the local climate.

A key factor to consider is whether the majority of the pollution exposure exists during the construction period or the exposure is greater in the period following completion of the construction work. Certain projects are characterized by conditions and activities where the pollution exposure is greater in the years following job completion than during the execution of the construction. These projects typically include construction of residential, education, and healthcare buildings. It also includes the construction of refineries, pipelines, and petroleum storage facilities. A majority of claims seen in these types of projects involve construction defects that do not cause environmental damage until after the project is completed.

Other projects, however, are characterized by conditions and activities where a majority of the environmental exposures occur during the construction work. These usually include road building, construction of warehouses and other nonresidential buildings, and grading or excavation projects. For example, during an excavation project, the majority of the pollution exposure often occurs during the execution of on-site activities. It is during the excavation that a contractor may hit an underground utility line or an unknown underground storage tank. Site work may also result in the migration of contaminated soil or sediments that impact neighboring properties, streams, or bodies of water. However, once the excavation activities are complete, there is a significantly lower risk of future pollution incidents from the excavation activities. As a result of this risk profile, excavation projects can typically be adequately covered with project-specific CPL policies that include coverage for completed operations periods that are shorter than those required for construction of residential buildings.

In contrast, mold damage (a form of pollution) in residential buildings seldom manifests itself during the execution of the construction work. As with the project scenario described above, the damage most often occurs after the project is finished and occupied by owners or tenants. For these projects, owners and contractors should strongly consider purchasing CPL policies with completed operations coverage for the longest terms available that do not distort the cost of the construction services. This consideration applies to policies written on either a claims-made or an occurrence basis.

Conclusion

Project owners and contractors need to learn to avoid using or accepting "cookie-cutter" environmental insurance requirements in construction service contracts. Completed operations coverage should ideally be purchased for both occurrence and claims-made project-specific CPL policies, especially for projects where the risk of environmental damage is greatest in the post-construction period. CPL policies are different from other types of liability insurance policies and from other environmental insurance policies. It is imperative that project owners and contractors consult with insurance brokers experienced in environmental coverage placements before drafting insurance requirement language in construction contracts or purchasing environmental insurance policies for construction projects.