Coverage interpretation and claims litigation at odds

Today’s construction underwriters and their claim departments may not be following the same blueprint on issues of coverage interpretation for losses involving general liability and property damage claims, says Paul Becker, president of Willis North America’s Construction Practice.

This “phenomenon,” which he describes as occurring during the hard market of the last five or six years, created a fundamental change in carriers’ claims approaches.

“It wasn’t subtle; it was a distinct trend that we identified a couple of years ago,” he said. The trend ties back to large general contractors on general liability coverage, known in the industry as business risk doctrine,” he said.

Coverage interpretation and claim litigation surrounding the definition of “occurrence” relative to the business risk doctrine will remain volatile in the construction market segment, according to a Willis report written by Becker earlier this year titled, “Construction Insurance Property & Casualty Market Update.”

“Basically that says any damage that occurs to the work that you’re the general contractor on is not going to be covered under your general liability policy even if it’s caused by your subcontractors. Obviously that’s important and it’s driven by court jurisdictions and each state has their own jurisdictions,” Becker said.

Becker blames the problem on a “disconnect” between today’s construction underwriters and claims departments — a disconnect that created some bad outcomes in claims litigation for some of Willis’ largest contractors.

“Expectations that they (general contractors) had when they went with a particular carrier were not met by what happened when a claim occurred,” Becker said.

Becker said a number of states have interpreted business risk doctrine in favor of the contractors. But, he added, a number of fairly influential states, such as South Carolina, Georgia, Florida and others have interpreted business doctrine the other way. “And that’s changed how carriers have approached handling the claim,” he said.

The Willis report notes “more court cases seemingly negate coverage for third-party property damage claims caused by faulty workmanship, stating they do not trigger the policy because they are not an ‘occurrence.’ This gets to the heart of what is a business risk and what should or should not be covered and defended by the general liability policy.”

In the last soft market court cases generally gave very liberal interpretation of coverage, and such cases were getting covered, Becker said. “Over the last four to five years, we’ve seen it go the other way. In other words, they (claims departments) are very closely reading the policy, and it’s not whether they should defend the claim, it’s whether they can defend the claim or deny a claim.”

According to Becker, construction underwriters have “steadfastly” said they expect to cover such risks, but they have little or limited influence over the claims departments interpreting coverage and handling the claim.

Becker acknowledges that during the last hard market, underwriters and claims worked very closely together, in more of a “business relationship.”

“Now we’ve seen claims departments say, ‘our job is not to make every client happy, our job is to interpret the coverage within the jurisdiction that we are in.’ That is meaningful to a general contractor.”

The Willis report warns that contractors should be aware of the clear delineation as to what underwriters intend and how claim units will interpret coverage.

“Today, in certain states, new case law is emerging that generally finds no coverage for faulty workmanship type claims that historically have been covered,” the report says.

But as the market steps up competition, Becker expects coverage to expand. In the last couple of months, “we’ve actually seen some movement in coverage, specifically around this issue.”

Becker predicts by the end of the year most of his larger customers — contractors able to take some form of a deductible and retention — will be able to open the door with their carriers to obtain the perfect wording in their policy, solving the problem. “And the way coverage typically expands in a soft market, it starts with the big guys and over time … they have to start offering it to others.”

Excess liability

Perhaps the most variability in the overall construction market can be found in the excess liability market, the Willis report says. While rate trends for this line show decreases of 20 percent or more for larger contractors, the line shows high variability dependent on exposures, loss history and underlying limits.

Becker views the excess liability line as both a positive and a negative.

On the positive, tremendous amounts of capacity is available, he said. “You can build extremely large umbrella and excess liability limits, well over $200 million for contracting if you so desire.” The availability and the number of players increased noticeably during the last year and a half, he says.

On the other side, one issue affecting the umbrella/excess market is the coordination of limits between project-specific placements (often in a wrap-up format) and contractors’ master programs. “Underwriters have been particularly sensitive to stacking limits on risks. This happens when they are offering coverage under a project policy as well as additional limits on the insured’s master program,” the Willis report says.

“So what ends up happening is that carriers become extremely cautious and are not providing coverage for contractors without a whole lot of conversation about what kind of wrap ups they have been in and whether or not that same contractor is insured by that same carrier somewhere else,” Becker said. “That’s created a large concern by many of our customers about potential holes in their program.”

Becker said there has been some positive movement on this issue since last year, when underwriters were putting out blanket wrap up exclusions on excess liability policies. “They are starting to underwrite them individually … but it’s an area that you have to be extremely careful in,” he said.

Contractors’ professional services

Professional liability, including capacity, rates and appetite, are all improving relative to a year ago, the Willis report says. Historically, the professional liability marketplace has been targeted to large engineers and architects, but today’s construction delivery systems have changed, Becker said. “There are a lot more professional liability responsibilities that have been put through the contractor. … As the lines became blurred between what the responsibilities where as the contractor to the owner, that gets into professional services.”

Coverage forms for architects and engineers aren’t particularly well suited for contractors because they do things like exclude any actual construction, Becker noted. “So what has happened is the marketplace has developed forms that better address the professional liability exposures of general contractors and contractors in general. And that’s gotten better over the last several years.”

Some carriers began writing what Becker calls contingent liability policies that will cover a contractor should someone allege they performed a professional service without the appropriate standard of care.

An example might be an HVAC contractor who traditionally designs all the duct work for a new system to be installed. “And if the cooling system doesn’t work perfectly, it may not be that they didn’t build it right; it may be that they didn’t do an appropriate job of designing the duct work.” These “contingent liability exposures” have created a strong demand for contractors to secure some sort of professional liability coverage. During the last several years, a number of policies have addressed this need much better, he added.

Underwriters are also showing a lack of interest in covering the construction management (CM) at risk exposures on contractors’ professional liability coverage forms, the Willis report says. Underwriters continue to underwrite CM-agency but are more conservative on the CM-at risk model.

For CM agency, the contractor represents the owner. “The owner’s liabilities are your liabilities in that case,” Becker said. “You are being hired for your professional services, your advice, your counsel, your assistance in working with the contractor.”

With CM at risk, the contractor provides their professional services, plus they are in many cases stepping into the actual contract flow of liability flowing down from the owner, to the general contractor, to the subcontractors. “And that creates responsibilities for actually building or performing construction operations or having them occur, and … occur well,” he said. “At that point you can have things like bodily injury claims … things that you would expect to pay under a general liability policy.”

Becker says professional liability underwriters have a hard time drawing a line between the point where advice and counsel drove the loss, to the point where general supervision of the job drove the loss. “General supervision should be general liability, professional services should be under professional liability, construction management,” he said. “Where it blurs, the policy doesn’t perform particularly well.”

Keeping the status quo

For the most part, Becker expects the U.S. property/casualty market for construction to be nearly the same in 2007 as in 2006. However, one of the biggest threats to the construction market could be catastrophe losses in 2007.

Like in 2006, rates for contractors in 2007 should remain stable with modest decreases in most lines. Tighter terms and conditions for construction general liability and excess liability lines will continue, the Willis report says.

“Expect continued erosion of coverage granted in the general liability and excess lines of coverage, either literally by endorsement or effectively by claim handling and litigation in certain states and regions of the country grappling with the business risk issues involving faulty workmanship and the definition of coverage,” the report says.

Property lines, for the most part are stable with rates down, the report said, with the exception being coastal wind builder’s risk coverage and California earthquake coverage.

“Workers’ compensation is enjoying a great run, primarily due to legislative changes, while professional liability and environmental coverages require tailoring to fit specific defined exposures to assist underwriters in pricing of their risk,” the report concluded.

Becker says that despite some concerns, the construction market will remain competitive for the next year, maybe two years or longer.

“I actually think that the rates are going to be competitive for quite a while barring some major event, which obviously could always happen,” he said. “But right now I don’t see anything on horizon that would cause those rates to go up.”

He also predicts new capacity coming into the construction market will make umbrella and excess liability easier to get and negotiate, especially when it comes to wrap-up coverage, a major force in the industry.

Becker also predicts expanded coverage will follow today’s soft market rate decreases. “As soft markets continue to evolve, I believe that coverage will start to expand gradually, slowly and surely and not in any kind of smooth fashion,” he said. “As underwriters look to gain competitive advantage and offer more types of coverage … that will bring contractors more certainty on what they are buying.”

Overall, it’s an optimistic time for contractors and construction, Becker says.