California residential construction efforts reduce risk of defect litigation

Builders and trade contractors vie to bring carriers back to the Golden State.

During the past few years, builders and trade contractors in California have endured triple-digit rate increases and an exodus of insurance carriers, according to an informal survey conducted by the California Building Industry Association, headquartered in Sacramento, Calif.

In 2000, several dozen carriers offered general liability coverage to builders, while only a handful of carriers remain today, the CBIA research indicates. As a result of several years of adverse loss development, many insurers in 2002 became convinced that it was no longer possible to make a profit in residential construction in the Golden State, the world’s sixth largest economy.

Despite the residential construction market’s $60 billion per year impact on the state’s economy (as tallied by the Sacramento Regional Research Institute), insurers have walked away from the business.

The carriers that remained increased rates and became more selective of the risks they accept. The combination of limited competition and high premiums created a hard market. Many builders were forced to turn to the alternative market, including self-insurance or risk retention groups, to fill the void left by the traditional market’s absence.

Legislative changes
Since 2002, however, the building industry has made strides to control costs, improve risk management techniques and support legislative changes that limit exposures for builders and trade contractors. Those changes include SB 800, otherwise known as California’s Right to Repair Law, which has been in effect since January 2003.

The Right to Repair law provides consumers with a method to handle construction defect disputes without the need to file lawsuits. By taking the high transactional costs involved with litigation out of the equation, the construction industry believes that costs for insurers and their construction clients will be greatly reduced.

Additionally, builders believe the process makes good sense it creates satisfied consumers who do not want to be involved in time-consuming and costly litigation.

Multiple parties, including builders, trade contractors, insurance carriers and consumers, benefit under the new method. Currently, more than two dozen states have enacted similar laws.

While SB 800 mitigates overall exposure, recent legislation (AB 758) will modify the amount of risk that can be transferred from a builder to a trade contractor. The modification of indemnity agreements should allow trade contractor carriers to better understand the risk they accept. That also should result in more accurate pricing. The new California indemnity took effect on Jan. 1, 2006.

Risk management
In addition to legislative changes, California has been at the forefront of risk management initiatives. When the insurance market became increasingly difficult five years ago, a new cottage industry of risk management emerged. Firms offering risk assessment, third-party inspections, maintenance manuals and customer satisfaction consulting services, to name a few, now are common.

Most building professionals recognize the value and need for such services, and they welcome the additional level of risk management those services provide. By implementing proactive risk management programs, builders and trade contractors can present themselves in a favorable fashion to insurers.

Part of their willingness also stems from the fact that builders have more financial risk in the event of a claim, because first dollar liability coverage is a thing of the past. The trend in the construction industry is clearly moving toward considering the use of such services on a voluntary basis, as opposed to being a carrier-driven decision.

Because builders now are participating in losses by way of self-insured retentions or deductibles, the additional risk management techniques directly benefit the insurer as well as the builders, who also have a financial stake in claim activity.

George Dale, president of DBH Resources, a nationwide risk management firm, has been involved in construction defect issues for more than 20 years, first as a defense attorney and now as a risk management professional. Dale believes the exposure for loss has been impacted by a change of business practices and legislative activity.

“There has been a real shift in attitude by California builders toward building homes right the first time, adding additional post-sale customer service and basically doing whatever they can to delight their customers,” Dale said. “This shift has taken the builders away from seeing themselves as the victims of unfair litigation to one of aggressively preventing the trial lawyers from grabbing a toe-hold in the hearts and minds of homeowners.”

Twenty years ago, loss control was provided by carriers to large accounts and focused primarily upon builders risk, safety and property exposures, Dale explained. It was not until the late 1990s that it became clear that the real exposure was in the long-tail liability exposure of construction defect. Today, builders and contractors have more choices for products that provide a variety of loss mitigation services, and more are likely on the way.

New business transactions
CBIA estimates that 85 percent of the defense and indemnity payments in residential construction is related to construction defect. As a result, carriers and builders now have made construction defect the focal point of risk management.

The vast majority of carriers require risk assessments to be completed by an agreed upon firm, prior to binding coverage. In the past, that type of review was completed by the loss control employees of the carrier post binding. Now the review is being completed by separate firms made up of attorneys and risk managers as a condition of coverage. The firms then provide their findings directly to the carrier. The builders pay for those services upfront as part of the submission process.

That is a major change from the way business was transacted in the past, and the assessment has provided the carriers that remain in the market a greater degree of confidence that risk is being mitigated to the highest extent possible.

Another example of recent changes that have had a positive effect on the quality of construction, which already has led to fewer claims, is the proliferation of third-party quality control firms.

Many carriers require that a certain number of homes be inspected during the course of construction to prevent problems from occurring in the first place, as opposed to fixing a problem after the fact. While many insurers require the use of quality control firms, builders also recognize the benefits because claim payments generally affect them first in the form of a SIR.

Don Neff, president of La Jolla Pacific, which provides such inspections, agrees. “Growth in demand for our services is a clear indication that builders value the third-party peer review industry as a partner in their progress toward higher quality,” he said.

Attracting insurers again
Meanwhile, there are further efforts underway to continue the momentum of creating an environment that will draw insurers back to California. An example is the ongoing legislative effort to require plaintiff attorneys to fully disclose the potential downside to litigation. In the past, trial lawyers have “carpet bombed” neighborhoods with solicitation letters that, in the builders’ opinion, do not accurately disclose the downside to being involved in litigation, including the possibility of advising the future buyer that money was received from a lawsuit but was not utilized for repair. The proposed legislation also is expected to contain a disclosure regarding what would occur if the plaintiff were to lose the case.

Those changes will have a significant impact on mitigating the completed operations exposure in residential construction in California; the question is simply how much. Considering the high rates for both the trades and builders, when carriers return, they will likely get a solid rate for a lower exposure to loss.

Michael Strech is the director of Risk Management and Insurance for the California Building Industry Association in Sacramento, Calif. CBIA represents nearly 6,400 members of the home building industry. For more information, e-mail Stretch at mstretch@cbia.org, or visit the association’s Web site: www.cabuilder.com.

Topics Lawsuits California Carriers Contractors Construction Risk Management