As construction development in the United States reaches an all time peak, with overall spending up 7.5 percent in 2005 compared to 2004, agents and brokers writing contractor business are having a tough time locating markets to insure their clients. While business may be booming for contractors, finding insurance, especially general liability coverage, is not always an easy climb.
About $592 billion will be spent on residential construction alone, according to a recent report released by Willis titled “Willis Construction Market Review.” Residential construction accounts for over 50 percent of the U.S.’s total construction investment of just over $1 trillion, and the residential construction sector will continue to experience considerable growth compared to commercial construction.
Insurance for general contractors working on large residential projects is difficult to secure across the nation. Carriers are becoming more cautious and often hesitate to write primary general liability coverage, especially for contractors involved in the development of single-family homes.
Rudy Whitcomb, CEO of Redondo Beach, Calif.-based Whitcomb Insurance Services, said that the tightest market in contractors insurance is for single family homes, both individually and in large tracts. “It’s a very restricted market for single projects and smaller projects, and it’s even more limited for larger tract projects for single-family detached homes,” Whitcomb said. “There’s somewhat more [of a] market for apartment complex construction but there’s practically no market for condominium and townhouse projects on an ongoing basis.”
Paul Norman, of Dayton, Ohio-based Norman-Spencer McKernan Inc., agreed. “Whether it’s for a general contractor involved in residential construction or typically condos, townhouses and tract homes, it’s becoming much more difficult and the market is becoming much tighter than it has been in the recent 24 to 36 months, and it was tight then,” Norman said.
“The market for large residential projects is extremely limited, especially for the general contractors,” added Shirlee Davenport, RiskProNet construction practice group member and commercial lines marketing/risk manager for Ft. Lauderdale, Fla.-based Gateway Insurance.
Industry experts agreed that carriers are becoming tougher in their underwriting practices, scrutinizing on all levels before taking on large residential general contractors risks.
“Some companies want to write contractors involved in residential, but do no more than 25 percent to 30 percent general construction,” Norman said. “They want the residential contractor who does at least 60 percent to 75 percent of their own work.” Norman said that companies are more likely to write for a large general contractor if he or she does not “sub out” a lot of his or her work. “The more work that they do themselves, the better the opportunity of placing the coverage,” he said.
Norman pointed out that some companies may have a greater appetite for a general contractor if he or she has contractual agreements in place with subcontractors. “General contractors are more attractive to some companies if they see that there is truly a risk transfer program in place for general contractors, meaning that the general contractor has contractual relationships with artisan contractors or subcontractors and through the hold harmless and indemnification agreements are pushing all that liability back onto the subcontractor,” Norman said.
Carriers look favorably on contractors that put together in-house quality control programs, according to Scott Whiteside, executive vice president of San Francisco-based Gallagher Construction Services. “[Contractors] are designing best practices and other procedures to monitor their own work so that they’re building a better product,” he said. “Those factors will affect the underwriters and certainly a contractor that has an in-house quality control program, and mold protocols and other best practices for building residential projects, is going to get more favorable treatment from their underwriters.”
Charles E. Comiskey, chair of the construction practice group for RiskProNet International Inc. and senior vice president of Houston-based Brady, Chapman Holland and Associates Inc., said that there may be hope for contractors that do mostly commercial work that want to dabble in residential construction. But any firm that specializes in residential properties will have a difficult time finding any coverage. “Small- to medium-size contractors specializing in residential, especially those doing single-family work, are increasingly finding no coverage available or the pricing so high as to make it impossible to obtain,” he said.
The large carriers, such as Arch Specialty, AXIS, ACE, and AIG are willing to take on commercial risks, said Bob Olson, broker at San Diego-based Bliss & Glennon. But these companies, and others like Citigroup and Travelers, are mostly drawing the line on any residential contractors. “Not many of them are willing to write residential,” he said. “They might have a small segment of them but the residential market is by far the tougher market. I think the toughest segment of the construction market is the new start residential construction, whether it be tract homes, new condos being built or townhomes, I think that probably has the least amount of players in it, the least amount of competition.”
There are just a few carriers in most regions of the country that are willing to write residential general contractors. Most construction industry experts agreed that there have been relatively few, if any, new entrants into the marketplace.
“I know of no new carriers entering this field,” Comiskey said.
“We are not aware of new insurance companies in our region or nationally,” said Jim Dennison, director of construction practice for Leesburg, Va.-based AH&T Insurance. “We hear that some captives have slowly emerged, but very few and only for those contractors who have few claims and are willing to assume more of their own risk.”
“I don’t see any major changes for this category of builder in the coming year,” said Larry Heisler, manager of the contractors division at Des Moines, Iowa-based Reynolds & Reynolds Inc. “I do, however, see some new players looking at the 10 to 50 homes-a-year size builders.”
Norman said that there may be no new entrants into the residential contractors market, but some carriers may be willing to re-enter. “I think you’ll see some re-entrants into the market, people who played in it prior to 9/11 or the real hard market,” he said. “They’re just coming back because of the conditions in the insurance marketplace in general. This is in particular for your artisan contractors and your general contractors.”
Although Whitcomb said that established carriers have expanded capacity for the market, he cautioned that the expansions are slight. Dennison disagreed, stating that established carriers have not expanded their capacity as the reinsurance market pricing has decreased in light of the many construction defect claims over the years.
The coverage that general contractors are able to secure is expensive, especially for general liability. “If coverage is placed now, the pricing can be 35 to 45 percent higher than over the past few years as surplus lines carriers are taking a good deal of this business,” Davenport said.
“Except for the very large ones, single-family home contractors have great difficulty obtaining adequate coverage at any price,” Comiskey said. “The market for large apartment/condo/town home projects is tougher than for standard commercial projects, but nowhere near as difficult as that for the development of single-family homes.”
Construction defect litigation
Comiskey, Davenport and Dennison attributed the lack of competition and high premiums in the residential market to the fear of construction defect litigation and class action suits in many states around the country.
“California was once known for construction defect losses, but now many other states have similar laws and are just as difficult for insurers of residential projects,” Olson said. “Texas, Florida and Nevada present unique challenges for any carrier interested in insuring a residential construction project. And they are not the only states where construction defect litigation has caused some carriers to discontinue writing liability coverage for anyone involved in the construction of residential projects. For every dollar of indemnity paid by an insurance carrier in a residential construction defect claim, five dollars are spent in expense.”
Norman identified “pain states,” areas of the country where there is not a great appetite for risk in either the standard or the excess and surplus market because of the litigious environment of those states. Coverage placement for general contractors is much more difficult in pain states, he said. “Here in the Midwest, the placement of coverage may not be that difficult because we don’t face the same litigious issues that may be prevalent in some other states,” Norman said. “I think your pain states are all along the West Coast, including Washington, Oregon, and California, and Arizona, Nevada, Colorado and Texas. Some markets have difficulty in Florida, Louisiana, New York and Illinois.”
Whitcomb, Whiteside and Comiskey all agreed that California by far has been the state most affected by construction defect litigation.
“I think construction defect litigation has been the principal cause for the market restriction here in California,” Whitcomb said. “There are some other contributing factors to the limitation, action over type claims, but primarily the thing that’s driven the market here has been construction defect or alleged construction defect and class action construction defect claims, especially on condominiums. That’s affected availability.”
“Locally, the litigation doesn’t seem to have been as much on the rise as the fear of litigation,” Comiskey said. “Certainly this issue has taken on a life unto itself in California.”
Whiteside attributed the fear of claims to overzealous law firms. “The plaintiffs’ law firms that specialize in construction defect claims are very aggressive and start marketing their services to homeowner associations soon after those associations are formed. They’ve also opened branch offices in Nevada, Arizona, Colorado and other Western states that are building a lot of residential projects. Have lawsuits increased? Probably not. I’ve talked to some underwriters who expect one lawsuit on any condo project that’s built, but I think that’s a little extreme.”
Comiskey said that the insurance industry is practicing good risk management and is becoming more successful at reducing claims. Whiteside agreed, saying that contractors and insurance companies are building better projects and this may help decrease the effects of construction defect litigation on the market.
“They’re using third party quality control firms to inspect the work during construction,” he emphasized. “They’re using outside peer review forms to look at the plans and specifications to make sure the project is buildable as designed, that there is compatibility between materials that are selected for the job. I think the defense has gotten a lot more sophisticated at protecting themselves against defect lawsuits. I think time will tell if those efforts are going to pay off by making it more difficult for the homeowner association to sue.”
Carriers are increasingly coming out with wrap-up products in order to better manage risks in the residential market. One insurance policy is typically written for the entire project, covering the owner, developer, and all the subcontractors that work on that project. “Most carriers are attracted to the idea of writing the liability in this fashion because they believe that they can manage the risks associated with a new residential project better, or a new condo, multi-family project better,” Olson said. “If there is a claim, there will only be one attorney representing the project as opposed to numerous attorneys representing each and every subcontractor that worked on the project.”
Olson said that a year ago, there was probably only four or five residential wrap-up programs in California, and now there are 10 to 12 markets.
Whitcomb disagreed. “To my knowledge there would be a total of perhaps three or four that would address a townhouse or condo project on a wrap up basis here in California. I think there’s been one more entrant into the condominium and townhouse project wrap up market than there has been for the last two or three years.”
Whiteside said that general contractors use wrap-ups to provide liability and workers’ comp insurance for their subcontractors. “The subcontractors have a very difficult time meeting their contractual requirements for insurance in the subcontract agreements that the generals prefer to see,” he said. “They have a hard time getting limits sometimes. They have exclusions and limitations of coverage that are not allowed by the general contractor, and so we see a number of generals trying to put together their own general liability only wrap up program on a rolling basis so they don’t have to worry about the insurance their subs bring to the table.”
Whiteside said that wrap-up policies are used on most new condominium projects around the country. But the benefits of wrap-ups come at a price.
“Owners have sticker shock the first time they see a quote for a general liability wrap up on the condominium,” he said. “One of the things that agents and brokers need to do is make sure that their owners and developer clients understand the process and the cost of wrap-ups for condominiums. It’s much different and much more expensive than insurance on a commercial project.”
Agents and brokers need to be fully aware of the many restrictions and exclusions for residential general contractors. “General contractors have to be careful about the general liability coverage that’s available because there are a lot of exclusions and limitations in coverage that didn’t exist a few years ago,” Whiteside said.
General contractors must be careful about exclusions for mold and silicosis, for example. He said that the silicosis exclusion poses a particular problem, since it is an ingredient in cement.
“We’re not sure how the courts are going to view that specific exclusion,” he said.
“Restrictions on prior work, contractual liability and the inclusion of defense costs within the policy’s limit of insurance are some of the more recent changes to a general liability policy issued to anyone working on residential construction projects,” Olson said. “Agents and brokers need to be extra vigilant to make sure that full disclosure of every limitation or restriction in coverage is completely and thoroughly explained to the insured before he purchases the insurance policy. Insureds need to either accept the risk that is no longer acceptable to the insurance carrier or seek alternative means of risk transfer.”
Additional insureds form
A major change in the last few years has been the elimination of CG 2010 1185, the ISO form for additional insureds. The form, which gave additional insured status on completed operations, was popular with carriers, but they are no longer providing it for any new residential tract contractors. “There’ve been various approaches to a substitute for the additional insured form,” Whitcomb said. “Some are supposed to be individual companies’ own wording equivalent to the CG 20101185, and others are so restrictive that they’re really not going to be an Additional Insured form at all.”
“The market has gone from providing additional insured status for completed operations and the additional insured’s concurrent and sole negligence to no completed operations and coverage for only the additional insured’s vicarious liability,” Comiskey said.
Comiskey explained that there are other restrictions that agents must be prepared for in the residential construction market, including smaller carriers’ refusal to provide primary/noncontributory and aggregate per project endorsements. Other carriers have redefined “insured contract,” eliminating indemnification for a third party’s sole negligence and coverage for the contractual assumption of liability altogether. Other carriers delete the exception to the Damage to Work Performed by Subcontractors exclusion. “Each of these places significantly enhanced burdens on agents/brokers that will invariably lead to increased E&O claims experience,” he warned.
Olson said that residential construction is one of the key driving forces in the U.S. economy and will continue to be for years to come. He predicted that more and more apartments, condos and townhomes will be constructed because they are often the only option for home ownership for young first time buyers.
Whitcomb said that there has been an ongoing construction boom for several years that shows no signs of abating, particularly in California. He predicted that the residential market will continue as it has over the next 18 months, with little competition and high prices. But despite these negative trends in the marketplace, Whitcomb said contractors are willing to pay higher premiums.
“The unit price for general liability insurance for contractors on condos is very high and yet the market is booming,” Whitcomb said. “If you were to look at the cost to build a house in materials and labor and all the rest of it, that part attributable to insurance is not unreasonable in my view even in this marketplace. The contractors that are building condominiums must be making so much money that it’s worth their while to pay for the insurance premiums, high as they may seem to be. I’m not sure [they've] got that much to complain about.”