Coverages for Contractors: Only the Strong Survive as a Tough Market Gets Tougher

What’s the biggest problem area in the California insurance market these days?” When asked that question, most in the know would probably, without any hesitation, reply, “Workers’ comp.”

But there are others who, with equal conviction, would say that right alongside workers’ comp is another candidate for that designation: Contractors. In fact, some would outright give it the title of “Most Difficult Class to Place.”

Don’t use the ‘C’ word
Tom Gassen, president of Trinity E&S Insurance Services in Bermuda Dunes, Calif., described an experience he had at the recent annual meeting to the American Association of Managing General Agents (AAMGA). “We were speaking with an underwriter from a very large British organization who said that if he heard the word ‘contractor’ again, he was going to die,” Gassen said. “He said, ‘Everybody wants to talk about contractors, particularly California contractors,’ and he just didn’t want to hear it.”

Many insurance professionals involved with those risks use similar words to describe current conditions in the contractors arena: difficult, expensive, limited, evolving. And the root of the problem would seem to stem from two current realities: the state of the overall market (hardening); and the state of the legal climate (litigious).

“More of my practice is based on advising insurers about policy terminology and climate of litigation and what the courts are doing,” said Jeff Bolson, an attorney in the firm of Hahn & Bolson LLP in Los Angeles who has dealt with construction defect litigation issues for the past 20 years. “The ordinary contractor, the guy with receipts anywhere between $2 million and $15 million a year, has few markets available right now. One of the primary markets that’s available for that class of business uses a policy form that pretty much I developed, and it’s very restrictive…Before, you could make a decision to take restrictive coverage [and] pay less premium or pay more premium and get broader coverage. Right now, from the brokers that I’ve talked to, the choice is no longer there. There are a lot of insurers who lost an awful lot of money who thought they knew what they were doing in California contractors.”

“There are two classes that are very, very difficult,” Gassen said. “A condominium contractor who’s building a new condominium from scratch—there’s just about no place to go to get coverage for him.” He added that a residential contractor will find an equally difficult, expensive and limited market.

And what’s worse is that many industry insiders don’t feel that the problem is going to get much better in the near future.

“We’re hearing stories of contractors liability renewing for two, three and four times what the expiring was,” Gassen noted.

“Since last year, probably half of our competitors in that field have disappeared,” said Casey Hamlin, president of the Southern California office of the surplus lines broker, Heath Insurance Brokers. “A number of the carriers that are writing the coverage now actually have very restrictive forms, and, perhaps in an attempt to keep pricing down, don’t offer as much coverage.

“We’ve taken a different approach with our program—to provide the coverage and charge accordingly,” Hamlin said. “That’s really what the insureds in most cases want and need—the coverage. Most of the time, they are willing to pay extra for it.” He added that contractors comprises about two-thirds of his company’s book of business.

Of course, things have been difficult for the big developers, who have borne the brunt of a litigious climate, for quite a few years now.

“[The general contractors] went and talked to their legal people, who basically changed the contracts [to] where the onus was going to be put back on the subcontractors if they wanted to go to work for some of the big builders,” Hamlin said. “As a result, the insurance marketplace completely changed. Where it was very difficult six or seven years ago to get the insurance for the general contractors and not as difficult for the subs, it’s now just the opposite.”

Hamlin said that for subcontractors, the marketplace has dried up to just a handful of carriers able to provide any coverage, adding that his company does have an in-house underwriting facility to write residential subcontractors—from the tougher classes, like the roofers, framers, graters, to the easy ones like painters and electricians.

Now a subcontractor working for a general is almost always required to name the general as an additional insured and add him to the subcontractor’s policy. As a result, when claims come down on construction defect, a subcontractor will pick up much of the cost of the general contractor’s or developer’s defense. And when a claim does get going on a tract—everybody gets named.

“It could be a leaky roof and the landscaping subcontractor will be served notice of the claim,” Gassen said. “Every subcontractor that comes on the tract gets named. Now he’s probably not going to be stuck with any indemnity, but he’s certainly going to have some expense to get relief from the suit.”

“I do talk to a lot of retail brokers and…companies are willing in some instances to waive condominium exclusions or limitations for generals who can pay a lot of premium,” Bolson said. “But when you’re dealing with an artisan contractor, it depends of the class of business, but if you’re dealing with a framer who does a lot of condominiums, it would be very difficult to purchase for that guy, including the condominium exposure.”

Bolson explained that one of the reasons for that is that in California, because of the way construction defect cases are managed, more and more of the liability and expense of litigation is running to the subcontractors.

“It’s not at all unusual for a general contractors’ or developers’ insurers to demand that subcontractors’ insurers fund 80-90 percent of the cost of defending a case,” Bolson said. “For that reason, people have minimum premiums and very restrictive coverage, more so for subs these days than general contractors.”

“[Coverage] is available if you’re willing to pay the price,” Gassen said. “Take condo contractors. It’s available if you want to pay an exorbitant price, [or accept] a lousy form quite frankly…Condo contractors would be the very toughest to get right now.”

While there are a few markets out there willing to write custom home builders or smaller tract builders, in the latter case, companies will include a restriction in the policy, or a tract limitation, on the number of homes that can be built per year, or the number of homes that can be built in any one tract.

“If you take a guy that might be building 100-200 homes, right now he’s going to have a problem,” Gassen said. “There’ll be a little more market for the guy building 25 or less or 10 or less a year. And then if you are just a custom home builder, a guy that builds one home at a time, then there’ll be more markets that’ll entertain you.”

On the other hand, commercial contractors, building such things as small shopping centers and office buildings, seem to have an easier time finding coverage. Why?

“You don’t get the construction defect demons after you like you do on the housing tracts,” Gassen explained.

A litigation-driven market
More than anything else, the California contractors market is heavily influenced by liability issues, and most of what occurs in the evolution of coverages is driven by what happens in courtrooms. And construction defect has become the main problem for any kind of residential work.

According to attorney Bolson, the value of condominiums has decreased while the amount of litigation involving condominiums has increased.

“A lot of condominiums are not well maintained,” Bolson said. “We have in California what we call the ‘Statute of Repose.’ It means that after 10 years you can no longer bring an action against the developer of the property for any construction defects whether or not they’re known. That typically coincides with the shortfall in their maintenance fund, so a lot of condominium associations find themselves with a shortfall of the funds necessary to do routine maintenance but also to do major maintenance that’s required after 10 or 15 years. So one of the first solutions is to sue somebody. A lot of condominiums frankly weren’t built that well…You have owners who are upside down on mortgages and are simply…looking for ways to get out or ways to make their investment pay. And litigation is a fairly easy target.”

From a plaintiffs’ perspective, Bolson said condos are terrific because you have a homeowners association. “So you have a single client—you don’t have to go to a housing development and round up 100-150 owners,” he explained. “You have one client in the homeowners association.”

What happens is with a 100-unit condominium project, if something goes wrong with the framing, the assumption will be that it is wrong on every single one of the condos. In contrast, on a custom house job, if one of the windows leaked during the first rain, there’s only one damaged house involved.

Bolson also noted that he had once been quoted a statistic that 90 percent of all the condominium developments ever built in California have been the subject of litigation—a lot of that in Southern California as the result of earthquakes.

One case that had a very significant impact of construction defect cases and the way they are handled in California was Montrose Chemical Corp. v. Admiral Insurance Company, which essentially had the effect of increasing the number of policies potentially applicable to any continuing or progressive loss.

All the standard markets writing contractors “got killed by the Montrose decision,” said Patrick Farrell, executive vice president of managing general agency Commodore Insurance Services Inc. in Moraga, Calif. “Now you have the surplus lines market writing it—much more controlled, higher premiums, more restrictions on the coverages, and those are all a direct reflection of the court cases that we’ve had.”

Farrell explained that from the perspective of the small- to medium-sized customers his company deals with, contractors that are generating no more than $3 to $4 million in receipts per year, the market is shrinking to some extent. Commodore’s book of business is 100 percent contractors, accounting for about $15 million per year in premiums.

“I think that most of the coverages are still available, and the pricing has not gone up significantly yet,” Farrell said. “I think we’ll see that down the road in a short period of time, however. A restriction of coverages may be coming down the road also.”

Farrell noted that while there are markets going out, “there are still markets coming in, especially geared towards the type of business we do. We have the new markets like Interstate—and Lloyd’s still has paper out there—that have continued to maintain their pricing.”

Companies that were heavily writing contractor risks and are now gone include Reliance Insurance Co., which has completely gone out of business. And perhaps the biggest change to affect the contractors industry in the last year was the demise in February of Credit General, which wrote quite a lot of subcontractors and artisans. Other carriers have just pulled back and stopped doing the business.

“United Capitol, which was our program—gone as of July last year,” Gassen noted. “We were writing a million dollars a month of premium…Since then, we’ve been attempting to replace this program, which gives you an idea of how hard it is. We’re coming up to almost one year, and have not found a replacement carrier yet.”

Gassen emphasized that United Capitol had quite a different motive for when it stopped doing business. “Their parent corporation [Frontier] got hit so hard on their reserves, on their whole medical malpractice book,” he said. “That caused them to have their troubles. United Capitol, their subsidiary, had to bear the brunt of it along with Frontier.”

But, make no mistake, carriers have lost their shirts in contractors for the last several years, and they are tired of losing money.

“This is what creates a hard market that we’re into right now,” Gassen said. “Because there’s so much construction in California, there’s a huge amount of premium out there in the contracting business.”

Finding a remedy
On a brighter note, there has recently been some positive movement for the insurance industry from the California Courts in relation to contractors coverages.

Specifically, there was a decision that came down the end of last year from the California Supreme Court called the Aas decision, which limited the scope of recovery that home- or commercial building owners are able to receive in a construction defects case.

According to a publication released by Ropers, Majeski, Kohn & Bentley, a large law firm which specializes in construction defect claims, “On the one hand, the Supreme Court has handed contractors a victory by limiting the scope of tort damages that can be recovered in a typical construction defect case.”

They use an example wherein if the wrong thickness of a wall board is installed by a contractor, but that omission causes no physical injury to the building, “no tort cause of action can be stated, even if though the homeowner did not get what he/she bargained for.”

However, the firm also notes that while this decision is a victory for contractors, “ironically, the Supreme Court may have boxed out the contractor from insurance coverage. For insurance coverage to exist, the contractor has to incur tort liability, and tort liability will not exist unless real physical damage has resulted from the contractor’s work. In the absence of physical damage, the building owner will be limited to a breach of contract theory, and, absent physical injury to the building, there will be no coverage whatsoever (and probably no duty to defend) for straight breach of contract exposure.”

The law firm notes that with a lessening of liability exposure, there may be a stimulation for new building, especially for condominiums, which have dropped about 90 percent from 25,000 per year in the mid-1990s. Consumers, on the other, might argue that the Aas decision will “encourage builders to violate building codes.”

Watching out for mold
Then there are new facets of construction defect litigation entering the picture that nobody considered a problem just a year ago.

“All of a sudden, mold is now going to be a construction defect situation,” Gassen said. “Mold has been there forever…Nobody ever considered it a construction defect thing… What came out of the blue is an attorney figuring out that he could stick an insurance carrier and the builder under a construction defect claim for mold.”

Gassen noted that at the AAMGA annual meeting, a number of underwriters asked, with regard to some of Trinity’s programs, what the company intends to do about mold. “We were proactive on it; we are developing a mold exclusion endorsement,” he said.

Hamlin agreed that mold has become a major concern. “Any type of contractor having to do with anything that would involve water is a higher risk,” he said. “That issue definitely impacts the insurance placement of a number of contractors.”

Clearly, contractors would be among the classes most welcome to the idea of tort reform. But that’s been common knowledge for years. Moreover, trial attorneys, viewed as one of the most powerful lobbies in the state, are expected to fight any effort towards tort reform every step of the way.

Fine-tuning the language
Another route for insurers to shield themselves from these kinds of liabilities is in the wording of the forms.

“I think it’s more important than the rates,” Bolson said. “Over the years a lot of insurers have not adhered to the limitations that do exist in their forms…I’m not a big believer in tort reform. I believe if people legitimately have defective housing, they should be able to sue somebody for it…Because of the way things have developed…insurers have borne a larger and larger portion of what used to be a contractor’s obligation to make a project right. That’s a burden that’s really hard to price… You can’t ask a guy who has receipts of $1 million a year to pay $100,000 of premium per year. So you can’t give him the same coverage he had 10 or 15 years ago.”

Bolson added that one of his clients was certainly the pioneer in this regard. “This company completely excludes liability arising from condominium projects,” he said. “In a recent case, a general contractor was quoted $38,000 annual premium for general liability coverage, including condominium coverage, and $12,000 excluding condominium. And you see [excluding condominiums] more and more these days with companies, particularly those dealing with smaller contractors, both general and artisan.”

Gassen, for one, fully adheres to the idea of tightening up language on forms, which his company has done. But he admits that getting underwriters to go along with him on it is another story because many of them have been burnt so badly.

“It’s a tough sell,” he admits. “I’ve got a lot of positive things going, and I may be able to put something together…[but] if I’m successful at putting something together, my company, Trinity, is going to have to participate in the losses.”

“Probably the one thing we try to get across when we’re selling to people coming to us with contractors business is coverage issues,” Hamlin said. “In the past, given the marketplace in general, price [was] everything. Everybody’s always been able to provide what was needed, and whoever was cheapest was going win…That’s changing a lot. Coverage now does matter. Not that price is secondary, but it certainly isn’t the only reason for making a buying decision when residential subcontractors are buying their insurance.”

Dire predictions aside, most agree that at this point in time, it is a bit premature to know exactly how any of the negative and positive changes that have occurred in the past year or so will play out in the long term.

“In the next three to six months, I think we’re going to see major changes of the impact of the reinsurance market,” Hamlin said. “Typically the reinsurance tightens up, and you start seeing an influence on the rest of the marketplace.”

But perhaps Gassen summed it up best when he recounted something an underwriter recently told him.

“He said, ‘I can never be fired for declining to write a contractors for you,'” Gassen said. “In other words, ‘Why should I run the risk? Nobody is going to be upset for me not writing it. But if I say yes, and by some quirk you’re not right, and your program goes sour, I’ll get fired.'”

But if this problem isn’t solved, some feel it will adversely affect the economic growth of California.

“But that’s the history of insurance, and somehow or another, our industry has been able to come up with a livable solution,” Gassen concluded. “I just hope we do it this time, and I just want to be part of it.”

Topics Lawsuits California Carriers Agencies Excess Surplus Contractors Market Construction