Construction Risk Construction Risk, Wrap-ups, and the challenges of the current economy

Susan Bryan, AIC, ARMRegional Underwriting ManagerConstruction Specialty ExcessAIG Excess Casualty

Ms. Bryan currently acts as the Regional Underwriting Manager for all excess construction liability coverage for the Western Region at AIG/American Home. This includes underwriting both wrap-up and program coverages for a wide variety of developers, contractors and trade subcontractors involved in all types of construction as well as the development of new products and coverages for those risks. Ms. Bryan spent 13 years as an adjuster handling construction defect, complex coverage and severe exposures in the Construction Defect and Major Case Units at Aetna and Royal Insurance Companies. She also spent four years as an insurance broker specializing in program design and placement construction risks including both renewable programs and wraps, working with all size of accounts and routinely consulting throughout the country. Ms. Bryan is routinely consulted for her expertise in coverage issues and has testified as an expert in coverage litigation and spoken at numerous seminars and conferences throughout the country.

Alan H. PackerNewmeyer & Dillion LLP

Newmeyer & Dillion, LLP is a California-based law firm provides a full range of litigation and transactional services to businesses and individuals, including home builders, real estate development firms, and others. Alan Packer is a partner in the firms expanding Northern California office. He has practiced law in California for over 20 years, most of it representing parties involved in real estate, home building, construction, and insurance matters.

Mr. Packer represents home builders, property owners, contractors, and business clients in a broad range of legal matters, including risk management, insurance matters, wrap consultation and documentation, efforts to coutner solicitation of homeowners, subcontract and prime contract documentation, as well as complex litigation matters involving construction projects, product defect claims, construction defect claims, cost recovery actions, additional insured coverage matters, and creative dispute resolution. He also handles mechanics lien, stop notice, real estate, and payment and performance bond issues in residential and commercial contexts.

Todays Topics

Topics for Today

Analysis of the types of risks particular to the construction industry& associated legal and underwriting issuesOCIPs, CCIPS, ROCIPS Brief overview of some of the impacts of current economic conditions on construction

Construction Industry Risks

Construction Industry Catastrophic RisksCatastrophic injury potentialsCourse of construction / Jobsite injuriesPost Construction/Products Completed Operations Exposures:Bodily injury arising out of negligent constructionConstruction defect Property Damage claims

Catastrophic Risk

Catastrophic risk potentialCourse of Construction Hazards

Sources of exposureMoving parts and activity: cranes, heavy machinery, height exposures, failures of structural components that can lead to collapse hazards

#1 Course of Construction LossesPersonal injury & wrongful death claimsMost commonly onsite construction workers are the injured parties, although sometimes bystanders are also hurtThe construction industry has one of the highest mortality rates of all industries in the US. Workers are in danger from:Falls,Electrocution,Heat-related deathsPollutants (asbestos and others)Lots of other causesOther lossesProperty damageBusiness interruptionDelay damagesMultiple bond claims

Catastrophic Risk

Catastrophic Risk

Catastrophic Risk

#2 Post Construction Calamities (big and small) create long tail exposuresAfter Construction is completed, liability exposure for injuries can continue for decades. For instance,Builder sued in 2003 for asbestos exposure of a janitor who worked in a high school in the 1950s that the builder built in the 1920s. An 80 year tail!Contractor sued 15 years after construction when someone fell down a flight of stairs and claimed that the stairs were not built to code.

Catastrophic Risk

Bridge collapsesPotentially liable partiesInspectorsRetrofit contractorsDesign professionalsConstruction managersOriginal construction (even decades later)Losses potentially insured:Personal injuriesDeathProperty damage to bridgeProperty damage to vehiclesBusiness interruption lossesReplacement costsMultiple bond claims

Catastrophic Risk

Catastrophic Risk: pub with no beer** Australia (as if you had to think about it)

Station fire (fireworks/rock band)

Potentially covered lossesInjuries & deathsProperty damageBusiness interruptionRebuildBand reputationPotentially liable partiesBandPromotorsLandlordPyrotechnics Contractors who installed flammable foamBuilding contractors

Construction Defect Exposures

Construction Defect Exposures#1 issue in the hearts of carriers that causes fear from residential exposures in CaliforniaStrict liabilityExpansion of residential claimsAttorney solicitationContinuing exposure issues (Montrose)Efforts at liability reform (SB 800)Inherently uneconomic litigation models prior to wrapsImpact of wraps

Potential liabilitiesStrict liability, negligence, breach of contract = explained

KasdanMilsteinShinnick & Ryan

Sample Complaint

Sample Cross-Complaint

Sample Cross-Complaint, p. 2

The Montrose Effect

3. The Montrose Effect (contd)Occurrence typically means an accident, including continuous or repeated exposure to substantially the same general harmful conditions.

Sheet1

January 1, 1996January 1, 1997October 15, 2006

C.N.A. POLICYSCOTTSDALEUNDERWRITERS @ LLOYDSRANGERAMERICAN SAFETY

Project beginsCompletionLawsuit Filed

Sheet2

Sheet3

Wraps and OCIPs

What is a Wrap Anyway?

No, what is a Wrap, really?CIP Controlled Insurance ProgramOCIP Owner CIPCCIP Contractor CIPSponsor (owner or contractor) provides insurance to all contractors and subcontractors for the project for general liability (sometimes w/c as well) for the term of construction and beyond into completed operations period

What is a wrap? (cont)Owner or General Contractor will purchase insurance and enroll subcontractors into program. All parties who work on contruction will be covered under a single program.Owner or GC responsible for premium and SIR or deductibles but will spread cost through contract deducts and/or indemnity provisions for deductible and/or SIR obligationsSingle carrier for all claims will presumably enable ONE lawyer to represent all parties for any claim avoiding the count the lawyers game.

History of Wrap-Ups1940s Introduced on the U.S. defense plants1950s Applied to other projects (such as Lincoln Tunnel) 1990s Significant increase in popularity on commercial and public works projectsLate 1990s Start of use on residential projects in western United States

Benefits of WrapsCovers all defined project risks under one policy.In theory, limits the number of parties, attorneys, and claims professionals on any given claim.Reduces uncertainties arising from subcontractor insolvenciesReduces uncertainties arising from insurer insolvenciesReduces uncertainties arising from varying subcontractor insurance (Montrose, residential exclusions, prior work exclusions, etc.)

Wraps Underwriting complicationsUnderwriting information on insuredsSetting premiumsDiffering types of projectsMixed use vs. conventional projectsAggregates and limitsSIRs and deductiblesWhat happened to the loss history?????

Wraps Legal ConsiderationsAll relevant documents need to be carefully coordinated through legal counsel familiar with wrap issues.Subcontract indemnity provisionsSIR/deductible provisionsWarranty provisionsSubcontract insurance provisionsNon-wrap exposure insurance and indemnity provisionsEven the wrap policies themselves may require modification based on the program involved. (Not all cookies are from the same mold.)

New Wrap Disclosure ObligationsAB 2738

Also new SIR limitations

Defense Costs: Unified Defense is Still a MythMany older residential wrap-up programs are believed to potentially have inadequate limits as a result of both availability and cost

New Wrap DisastersExample

Builder buys $10,000,000 wrap-up policy covering builder and all tradesBuilder and trades build the project and sell itA few years later, builder goes bankrupt (2008)The policy has a $1.0 million SIR before any obligation to the subcontractors, who have NO OTHER INSURANCE because their practice policies exclude any project on which a wrap-up policy exists.

Defense Costs: Unified Defense is Still a MythEXAMPLE Actual wrap policy

Aggregate Limit: $25,000,000 for completed operationsCoverage Territory: All projects in CaliforniaDefense Fees: INSIDE limitsNumber of Homes Constructed in Coverage Territory: Over 10,000 per yearCoverage per Unit Constructed (actual): $1,750, including defense feesCoverage per Unit Constructed (actual), assuming 20% litigation: $8,753, including defense fees

Covering the gaps in the wrapsExcess and DIC wrapsCurrent hot coverage enhancementProvides excess wrap coverage to contractors, occasionally without additional premiumVarious limitations in varying endorsementsExcess applies only for non-residential projectsApplies only to projects with minimum limits

Looking ForwardCurrent Market Conditions

So how bad can it really be?December 2008 statistics:Sales of new homes dropped by their biggest margin since 1994, falling 14.7%New home sales (seasonally adjusted rate, homes per year):December 2008: 331,000 homes. July 2005: 1.389 million homesNationally, spending on home construction fell 27.2% in 2008In California CBIA forecasts that only 63,400 units will be produced in 2009, down from 2008. (Comparison: The low point of the homebuilding recession in the early 1990s was 84,656.)

Impact in California alone

Some more of the Numbers

California builders sold 3,500 units in November 08California sales were .859% of national sales; historically California made up 12.5% of National sales figuresInventory: 374,000 new (11.4 Months) competing with and extra 1.5M existing and unoccupied units for sale (Nationally)

Foreclosure activity

Market driven losses - example

Market Driven Losses

Abandoned, incomplete structuresSafety concernsAttractive nuisance issuesCalTrans exampleOwnership & completionWho is responsible for what after completionWho retains responsibility during recess? What about contractual indemnity and AIs???Increased homeowner dissatisfactionTranslating into more homes in litigationNew claims for advertising, sales negligence, predatory lending, etc.

Impact on Builders & TradesBankruptcies on the riseMany trade contractors have gone bankrupt or are on the edge of the cliffSome builders have gone under

Impact on:SIR paymentsPremium paymentsQuality of ongoing warranty reponses and resulting impact on claims

Automatic stay in bankruptcy.

Looking towards the futureResidential Market Coma: Projected to last at least another 1-2 yearsReduced ability to pay for appropriate levels of insurance (not buying umbrellas/excess)SIRs and ability to payDecreased staff for customer service leading to more claimsEvolving impact of legislative, policy, underwriting, and construction practice changesPotential for high volume of coverage litigation under wraps and recent, non-ISO/manuscript policy formsShifting landscape of insolvencies among builders, subcontractors, insurersIncreased product defect litigationIncreased bankruptciesNewer technologiesCommercial sideCredit markets keeping projects on holdMore competition squeezes profit marginsResidential contractors spreading their wingsUptick in infrastructure from government stimulus

Impact of the Green RevolutionSolar panelingInsulationTight buildings Title 24 and impacts on constructionPotential dirty green technologiesAdvertising claimsDefinitional problems

New Building ProductsOne of the following products really did get marketed:

Siding that disintegrates into cottage cheese-like substanceLightweight fake roof shingles with paper insideExterior stucco made mostly from styrofoam

New Building ProductsNew Products New Problems

Weve already seen:EIFSHardboard sidingShakertown sidingCentaur pipePEX pipes/Kitec fittingsAtlas Shingles

New ideas sometimes lead to great results.Other times, just new kinds of claims.

Impacts from the economy

Impacts on construction defect litigationForeclosuresFalling valuesBankruptcies of developers, tradesImpacts of governmental economic stimulus projectsHuge public works dollarsExposure on wraps vs. non-wrap; feasibility of wrapsImpacts on insurance marketUncertainty as to construction volume/exposuresReturn premiums or additional premiumsHow many homes, roads, bridges are you going to build this year?For some contractors, it depends on the marketThe pork barrel problem

Questions?

*******