Construction Risk

Construction Risk, Wrap-ups, and the challenges of the current economy

Susan Bryan, AIC, ARMRegional Underwriting ManagerConstruction Specialty ExcessAIG Excess Casualty

Ms. Bryan currently acts as the Regional Underwriting Manager for all excess construction liability coverage for the Western Region at AIG/American Home. This includes underwriting both wrap-up and program coverages for a wide variety of developers, contractors and trade subcontractors involved in all types of construction as well as the development of new products and coverages for those risks. Ms. Bryan spent 13 years as an adjuster handling construction defect, complex coverage and severe exposures in the Construction Defect and Major Case Units at Aetna and Royal Insurance Companies. She also spent four years as an insurance broker specializing in program design and placement construction risks including both renewable programs and wraps, working with all size of accounts and routinely consulting throughout the country. Ms. Bryan is routinely consulted for her expertise in coverage issues and has testified as an expert in coverage litigation and spoken at numerous seminars and conferences throughout the country.

Alan H. PackerNewmeyer & Dillion LLP

Newmeyer & Dillion, LLP is a California-based law firm provides a full range of litigation and transactional services to businesses and individuals, including home builders, real estate development firms, and others.

Alan Packer is a partner in the firm’s expanding Northern California office. He has practiced law in California for over 20 years, most of it representing parties involved in real estate, home building, construction, and insurance matters.

Mr. Packer represents home builders, property owners, contractors, and business clients in a broad range of legal matters, including risk management, insurance matters, wrap consultation and documentation, efforts to coutner solicitation of homeowners, subcontract and prime contract documentation, as well as complex litigation matters involving construction projects, product defect claims, construction defect claims, cost recovery actions, additional insured coverage matters, and creative dispute resolution. He also handles mechanic’s lien, stop notice, real estate, and payment and performance bond issues in residential and commercial contexts.

Today’s Topics

Topics for Today

Analysis of the types of risks particular to the construction industry& associated legal and underwriting issues

OCIPs, CCIPS, ROCIPS Brief overview of some of the impacts of

current economic conditions on construction

Construction Industry Risks

Construction Industry Catastrophic Risks Catastrophic injury potentials

Course of construction / Jobsite injuriesPost Construction/Products Completed

Operations Exposures: Bodily injury arising out of negligent construction Construction defect Property Damage claims

Catastrophic Risk

Catastrophic risk potentialCourse of Construction Hazards

Sources of exposure Moving parts and activity:

cranes, heavy machinery, height exposures, failures of structural components

that can lead to collapse hazards

#1 Course of Construction Losses

Personal injury & wrongful death claims Most commonly onsite construction workers are the injured

parties, although sometimes bystanders are also hurt The construction industry has one of the highest mortality rates

of all industries in the US. Workers are in danger from: Falls, Electrocution, Heat-related deaths Pollutants (asbestos and others) Lots of other causes

Other losses Property damage Business interruption Delay damages Multiple bond claims

Catastrophic Risk

Catastrophic Risk

Catastrophic Risk

#2 Post Construction Calamities (big and small) create long tail exposures After Construction is completed, liability

exposure for injuries can continue for decades. For instance,

Builder sued in 2003 for asbestos exposure of a janitor who worked in a high school in the 1950s that the builder built in the 1920s. An 80 year tail!

Contractor sued 15 years after construction when someone fell down a flight of stairs and claimed that the stairs were not built to code.

Catastrophic Risk

Bridge collapses

Potentially liable parties Inspectors Retrofit contractors Design professionals Construction managers Original construction (even

decades later)

Losses potentially insured: Personal injuries Death Property damage to bridge Property damage to

vehicles Business interruption

losses Replacement costs Multiple bond claims

Catastrophic Risk

Catastrophic Risk: pub with no beer*

* Australia (as if you had to think about it)

Station fire (fireworks/rock band)

Potentially covered losses Injuries & deaths Property damage Business interruption Rebuild Band reputation

Potentially liable parties Band Promotors Landlord Pyrotechnics Contractors who installed flammable

foam Building contractors

Construction Defect Exposures

Construction Defect Exposures

#1 issue in the hearts of carriers that causes fear from residential exposures in California Strict liability Expansion of residential claims Attorney solicitation Continuing exposure issues (Montrose) Efforts at liability reform (SB 800) Inherently uneconomic litigation models prior to wraps Impact of wraps

Potential liabilities Strict liability, negligence, breach of contract = explained

Kasdan

Milstein

Shinnick & Ryan

Sample Complaint

Sample Cross-Complaint

Sample Cross-Complaint, p. 2

The “Montrose” Effect

3. The “Montrose” Effect (cont’d)

“Occurrence” typically means an accident, including continuous or repeated exposure to substantially the same general harmful conditions.

C.N.A. POLICY SCOTTSDALE UNDERWRITERS @ LLOYDS RANGER AMERICAN SAFETY

Project begins Lawsuit FiledCompletion

Wraps and OCIPs

What is a “Wrap” Anyway?

No, what is a Wrap, really?

CIP – Controlled Insurance Program

OCIP – Owner CIP

CCIP – Contractor CIPSponsor (owner or contractor) provides insurance to all contractors and subcontractors for the project for general liability (sometimes w/c as well) for the term of construction and beyond into completed operations period

What is a wrap? (cont)

Owner or General Contractor will purchase insurance and “enroll” subcontractors into program. All parties who work on contruction will be covered under a single program.

Owner or GC responsible for premium and SIR or deductibles but will spread cost through contract “deducts” and/or indemnity provisions for deductible and/or SIR obligations

Single carrier for all claims will presumably enable ONE lawyer to represent all parties for any claim avoiding the “count the lawyers” game.

History of Wrap-Ups

1940s – Introduced on the U.S. defense plants 1950s – Applied to other projects (such as Lincoln

Tunnel) 1990s – Significant increase in popularity on commercial

and public works projects Late 1990s – Start of use on residential projects in

western United States

Benefits of Wraps

Covers all defined project risks under one policy. In theory, limits the number of parties, attorneys,

and claims professionals on any given claim. Reduces uncertainties arising from

subcontractor insolvencies Reduces uncertainties arising from insurer

insolvencies Reduces uncertainties arising from varying

subcontractor insurance (Montrose, residential exclusions, prior work exclusions, etc.)

Wraps – Underwriting complications

Underwriting information on insureds Setting premiums Differing types of projects Mixed use vs. conventional projects Aggregates and limits SIR’s and deductibles What happened to the loss history?????

Wraps – Legal Considerations

All relevant documents need to be carefully coordinated through legal counsel familiar with wrap issues.

Subcontract indemnity provisions SIR/deductible provisions Warranty provisions Subcontract insurance provisions Non-wrap exposure insurance and indemnity provisions Even the wrap policies themselves may require modification

based on the program involved. (Not all cookies are from the same mold.)

New Wrap Disclosure Obligations

AB 2738

Also new SIR limitations

Many older residential wrap-up programs are believed to potentially have inadequate limits as a result of both availability and cost

Defense Costs: Unified Defense is Still a Myth

New Wrap Disasters

Example

Builder buys $10,000,000 wrap-up policy covering builder and all trades

Builder and trades build the project and sell it A few years later, builder goes bankrupt (2008) The policy has a $1.0 million SIR before any

obligation to the subcontractors, who have NO OTHER INSURANCE because their practice policies exclude any project on which a wrap-up policy exists.

EXAMPLE – Actual wrap policy

Aggregate Limit: $25,000,000 for completed operations

Coverage Territory: All projects in California Defense Fees: INSIDE limits Number of Homes Constructed in Coverage

Territory: Over 10,000 per year Coverage per Unit Constructed (actual):

$1,750, including defense fees Coverage per Unit Constructed (actual),

assuming 20% litigation: $8,753, including defense fees

Defense Costs: Unified Defense is Still a Myth

Covering the gaps in the wraps

Excess and DIC wraps Current “hot” coverage enhancement Provides excess wrap coverage to

contractors, occasionally without additional premium Various limitations in varying endorsements

Excess applies only for non-residential projects

Applies only to projects with minimum limits

Looking Forward

Current Market Conditions

So how bad can it really be? December 2008 statistics:

Sales of new homes dropped by their biggest margin since 1994, falling 14.7%

New home sales (seasonally adjusted rate, homes per year):

December 2008: 331,000 homes.

July 2005: 1.389 million homes

Nationally, spending on home construction fell 27.2% in 2008

In California –CBIA forecasts that only 63,400 units will be produced in 2009, down from 2008. (Comparison: The low point of the homebuilding recession in the early 1990s was 84,656.)

Impact in California alone

Some more of the Numbers

California builders sold 3,500 units in November ‘08

California sales were .859% of national sales; historically California made up 12.5% of National sales figures

Inventory: 374,000 new (11.4 Months) competing with and extra 1.5M existing and unoccupied units for sale (Nationally)

Foreclosure activity

Market driven losses - example

Abandoned, incomplete structures Safety concerns Attractive nuisance issues CalTrans example Ownership & completion

Who is responsible for what after completion

Who retains responsibility during recess? What about contractual indemnity and AIs???

Increased homeowner dissatisfaction Translating into more homes in

litigation New claims for advertising, sales

negligence, predatory lending, etc.

Market Driven Losses

Impact on Builders & Trades

Bankruptcies on the rise Many trade contractors have gone bankrupt or are on the edge

of the cliff Some builders have gone under

Impact on: SIR payments Premium payments Quality of ongoing warranty reponses – and resulting impact on

claims

Automatic stay in bankruptcy.

Looking towards the future Residential Market Coma: Projected to last at least another 1-2 years Reduced ability to pay for appropriate levels of insurance (not buying

umbrellas/excess) SIR’s and ability to pay Decreased staff for customer service leading to more claims Evolving impact of legislative, policy, underwriting, and construction practice

changes Potential for high volume of coverage litigation under wraps and recent, non-

ISO/manuscript policy forms Shifting landscape of insolvencies among builders, subcontractors, insurers Increased product defect litigation Increased bankruptcies Newer technologies Commercial side

Credit markets keeping projects on hold More competition squeezes profit margins Residential contractors spreading their “wings” Uptick in infrastructure from government stimulus

Impact of the “Green” Revolution

Solar paneling Insulation “Tight” buildings – Title 24 and impacts

on construction Potential “dirty” green technologies Advertising claims Definitional problems

New Building Products

One of the following products really did get marketed:

Siding that disintegrates into cottage cheese-like substance

Lightweight fake roof shingles with paper inside Exterior stucco made mostly from styrofoam

New Building Products

New Products – New Problems

We’ve already seen: EIFS Hardboard siding Shakertown siding Centaur pipe PEX pipes/Kitec fittings Atlas Shingles

New ideas sometimes lead to great results.Other times, just new kinds of claims….

Impacts from the economy

Impacts on construction defect litigation Foreclosures Falling values Bankruptcies of developers, trades

Impacts of governmental economic stimulus projects Huge public works dollars Exposure on wraps vs. non-wrap; feasibility of wraps

Impacts on insurance market Uncertainty as to construction volume/exposures Return premiums or additional premiums How many homes, roads, bridges are you going to build this year?

For some contractors, it depends on the market The “pork barrel” problem

Questions?