Size up subsidence and earth movement exclusions

More than a decade ago, law firms specializing in construct defect litigation sprang up in California and the West. Construction defect cases in the building industry became all too common, and construction insurance claims and premiums skyrocketed. Most of the traditional carriers abandoned the market. The construction defect fiasco in California also led to the creation, by the specialty insurers, of the subsidence exclusion for attachment by endorsement to the commercial general liability policies of homebuilders.

Expansive soil conditions are typical in California. Many houses are built on hills or other areas where it is difficult to create a stable foundation, which may result in cracked foundations or floor slabs and other damage to the building. If subsurface conditions are not properly compacted and prepared for adequate drainage, it is likely the property will experience problems such as subsidence, structure moves or shifts, flooding and, in many cases, more severe problems such as landslides.

Originally, the subsidence exclusion applied only to completed operations property damage and was limited to subsidence generally caused by foundation failures. However, it has potentially evolved into one of the contractor’s worst nightmare.

Many construction carriers have extended the subsidence exclusion into an “absolute earth movement exclusion” including earthquake. Most no longer limit the exclusion to either property damage or completed operations. One admitted regional insurer puts the exclusion on every policy it issues. Because the exclusionary language is generally so broad, it could be strictly interpreted against the finding of coverage. There is a big problem if there is damage arising from an earthquake caused by defective construction. The courts in California have been of no help in mitigating the negative effects. (See Blackhawk Corp. v. Gotham Ins. Co., 54 Cal App 4th 1090.)

Contractor concerns

Why is there a big concern for most contractors?

• Any earthquake-induced bodily injury or property damage is excluded. If structural failure occurs arising out of construction defects, there is no coverage.

• There is no coverage for bodily injury arising out of a trench collapse on an ongoing job.

• There could be possible coverage problems arising out of equipment upset.

• Subcontractors may have this exclusion on their policies.

Knowing that information, the following are a few suggestions that can help eliminate or mitigate the problem.

• Use a different insurer. Several A-rated insurers cover subsidence.

• Request the exclusion be deleted — especially for premiums higher than $50,000. This is frequently not difficult to accomplish.

• Require subcontractors to disclose all exclusionary endorsements.

• Obtain a side letter from the insurer limiting the areas where the exclusion applies.

• Large general contractors and public entities, such as Caltrans, are becoming more sensitive to the use of exclusionary endorsements on policies issued to their contractors where they are named as additional insureds. There is a requirement in both the Caltrans insurance specifications and the Associated General Contractors of California standard form subcontract that exclusionary endorsements must be set forth in the insurance certificates.

Robert G. Mahan is managing member of Mahan Insurance LLC, with offices in Irvine Calif. E-mail: bob@mahaninsurance.com.