Coverage crisis: liability insurance goes through the roof

Custom Home, July-August, 2002 by Steve Maltzman

In recent discussions with custom builders, many have complained of big increases in insurance premiums, particularly for liability insurance. When they go to renew their liability policies, they are having difficulty getting their current coverage renewed and the rates are going sky high. I've heard that some custom builders who paid a $6,000 premium last year received renewal quotes of $30,000 for less coverage.

Most custom builders have a conventional liability insurance program that they renew annually. This program typically contains a primary liability insurance policy and an umbrella or excess policy, with liability limits selected by the builder with advice from his or her insurance broker. In the event of a third-party claim or suit the primary policy responds first, subject to a deductible, then the umbrella policy kicks in to cover any excess liability.

Until recently, builders have had a wide range of options and carriers to choose from in selecting liability insurance. But over the past 12 months there has been a steep decline in the number of carriers willing to write insurance for liability coverage. Carriers willing to write liability policies are reducing their limits and narrowing the scope of available coverage. Today, most new policies exclude claims arising from mold, EIFS, earth movement, and professional services.

According to a recent study prepared for the NAHB ("The Liability Insurance Crisis for Builders: Reasons and Responses" prepared by the law firm of Cox, Castle & Nicholson of Los Angeles), there are several key causes for the current liability insurance situation. During the last decade, insurance companies underestimated the risk they assumed with builder liability insurance. They undercharged for these premiums and failed to set aside adequate reserves for claims. Now the insurers are suffering losses said to be three and four times the premiums collected. Also, most liability insurance carriers pushed their risk of loss on the reinsurance market that, after claims from Sept. 11, is also feeling the effect of insufficient premiums.

A major reason for such large losses is that construction defect litigation and the costs associated with it often exceed the amounts paid by insurers to settle claims or judgments. And the incidence of these types of suits has spread from a few states to the entire country. The latest trend is to go after builders with claims of property damage and bodily injury arising from mold and indoor air quality.

With all these circumstances stacked against you, there are some things you can do to get the best insurance rate available. You must position your company as one that does more than buy insurance to one that manages risk. Begin by identifying potential loss exposures. This would include construction defects, jobsite safety, environmental and pollution risk, employment liability, and consumer non-disclosure claims. Once these areas are identified, take steps to minimize their potential loss exposure. That's done by avoiding liabilities, minimizing liabilities, shifting liabilities to other parties, and insuring liabilities. Here are some examples of steps you might take:

* Minimize exposure from construction defects by devising and implementing an effective quality control program that includes written quality control checklists.

* Minimize risks of injury by developing and implementing a jobsite safety program.

* Review and revise contracts to make sure that all your project documents (sales contracts, warranties, etc.) include protective provisions. These include clauses on alternative dispute resolutions (i.e., mediation and binding arbitration): notice to the builder of claimed defects enabling builder right of access, inspection, testing, and repair; the opportunity to correct claimed defects prior to a suit or arbitration; and clauses imposing consumer obligations regarding inspection and maintenance.

* Review your new home warranties to make sure they are risk management tools. They should include a clear roadmap of warranty claim procedures, which you must apply consistently.

* Develop an effective contract administration procedure to enable you to make sure all contractual insurance requirements are complied with. For example, make sure you have valid, up-to-date insurance certificates from your subcontractors that list the builder as an additional insured.

* Protect your assets. If a claim is asserted against a builder for which insurance is not adequate, the company's assets are at risk of being taken. Minimize exposure by undertaking an asset protection program. That means you minimize the number of assets held within the building company. Some examples:

Make sure that your building company is a corporation (S, C, or LLC) instead of a sole proprietorship or partnership to minimize personal liability.

Make sure that the corporation is truly being treated as a separate entity by keeping minutes and other corporate documents up to date and maintaining corporate formalities such as documenting all inter-company transactions as well as those between the corporation and its owner.