Expert Commentary

Only Defense Costs Paid by Named Insured Satisfy the Self-Insured Retention

Here is a recent case from California showing the danger of being added as an additional insured (AI) on a subcontractor's commercial general liability (CGL) policy that contains a self-insured retention (SIR) endorsement. A court could decide that, unless and until the named insured subcontractor satisfies the SIR, the AI is not entitled to a defense or indemnity.


March 2010

In Forecast Homes, Inc. v. Steadfast Ins. Co., No. G040876, 2010 Cal. App. LEXIS 172 (Jan. 12, 2010), a homebuilder used about a dozen subcontractors to perform most of the work at a residential project in California. The homebuilder required the subs to add it as an AI on their CGL policies. After the project was complete, several homeowners sued the homebuilder for construction defects. The complaints named only the homebuilder, not the subs, and the homebuilder began defending itself.

When the homebuilder tendered the claims to Steadfast Insurance (the CGL insurer for a group of subs), Steadfast denied coverage. The CGL policies under which the homebuilder was claiming AI status contained two versions of an SIR endorsement.

The revised version stated:

"[I]t is a condition precedent to our liability that you [the named insured Sub] make actual payment of all damages and defense costs for each occurrence or offense, until you [the named insured Sub] have paid" the full SIR amount.
"Payments by others, including but not limited to additional insureds or insurers, do not serve to satisfy the self-insured retention."

The appellate court held that the language of the revised SIR endorsement was clear and unambiguous. Only payments of defense cost by the named insured subs could satisfy the SIR, not payments made by the AI homebuilder. The court noted that the purpose of disallowing payments by other parties is to make sure the named insured subs have "skin in the game" and retain a portion of the risk. Allowing other parties to pay the SIR on behalf of the named insured sub would defeat that purpose.

Because the named insured subs were not sued in the underlying construction defect cases, they did not pay any defense costs. Because the named insured subs did not satisfy the SIR amounts, the court decided the homebuilder's AI coverage was never activated.

The original version of the SIR endorsement was similar, but it only had one pertinent statement:

"[Y]ou [the named insured Sub] shall be responsible for payment of all damages and defense costs for each occurrence or offense, until you [the named insured Sub] have paid" the full SIR amount.

The court held that this language was sufficiently clear so as to reach the same result. Only payments of defense cost by the named insured sub could satisfy the SIR, not the AI Homebuilder.

Also, the court rejected the homebuilder's argument that, because the revised version of the SIR endorsement was amended to clearly prohibit payments by additional insureds, the original version of the SIR endorsement must have been ambiguous as to which party could pay defense costs. "It is against public policy," the court wrote, "to view modification of the policy as creating a negative inference."

Conclusion

So, what could the homebuilder have done to better protect itself? The court dropped a couple of hints. First, it noted that the insurance specifications of the subcontract with each of the subs stated that "the required insurance [provided by the subs] shall be subject to the approval of the [homebuilder]." Second, it noted that the subcontract "specified in great detail the required insurance policy language and coverage specifications" but that it "did not require any specific language regarding ... SIR provisions."

It appears as if the court was hinting that the homebuilder should have addressed the issue of SIRs in the insurance specifications. Perhaps the homebuilder could have (1) prohibited SIRs completely, or (2) required that any SIR attached to a sub's CGL policy be amended to (a) exempt the AI coverage from the SIR requirements or (b) expressly allow payments by the AI to satisfy the named insured sub's SIR amount.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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