‘Gimme shelter’: construction and engineering firms are crying “gimme shelter” as they seek to manage their risks amid a lack of insurance capacity, tighter coverage restrictions and a storm of litigation in the housing market
While there is no shortage of demand for new homes in a hot housing market, construction and engineering firms are having a tough time finding shelter when it comes to obtaining insurance coverage for residential and mixed-use projects.
Affordable coverage for construction defects that can emerge years after a housing project is built has become a scarce commodity due to a surge in lawsuits and some adverse court rulings that have hit both insurers and general contractors.
For their part, the small group of insurers willing to provide coverage for “habitational” projects, which account for more than half of U.S. building activity, are laying down plenty of restrictions.
“The whole residential issue related to construction defect is huge, and it’s spreading,” says Mark Boyle, general manager of Turner Casualty & Surety, which manages insurance and surety programs for the nation’s leading general builder, Dallas-based Turner Corp.
“It was more localized as an ugly risk in California, but it has now dearly spread to Florida, Texas, Nevada and Washington state. That’s a big one that’s costing owners a lot of money,” says Boyle, who is based in New Jersey.
The problem is being driven by a wave of construction-defect lawsuits that has swept across the nation from California, says Karen Reutter, senior vice president in the national construction practice for brokers Willis Inc.
What we’ve seen, particularly in the last year and dearly in ‘05, is still angst and worry from the carriers and the underwriters around construction defect,” says Reutter, who is based in Minneapolis.
Insurers also have made it more difficult for subcontractors to extend their coverage to general contractors, cutting down on a traditional means of risk transfer in the industry, and forcing general contractors to develop alternative risk management strategies.
As building trends shifted toward condominium projects, however, a key California court ruling in the 1990s spawned a host of lawsuits in residential construction defect cases, often as pre-emptive moves by homeowners associations to keep the statute of limitations, or repose, from running out.
“It’s extremely common now for those associations to file suits even if it’s to toll the statute of repose,” Reutter says. “They’re all seared to death that if something does go wrong in seven years–the windows leak, or there’s a sound issue from floor to floor … they’re just afraid that the unit owners themselves will sue the [condominium] board.”
The California state court ruling involved a Los Angeles-area company, Montrose Chemical, which made DDT from 1947 until 1982 and was sued by the state and federal government for dumping chemical waste. The court ruled that because the dumping occurred over a period of time, all of the carriers that had insured Montrose over that period of time had a duty to defend the company as long as there was some potential that its claims for coverage might be valid.
That theory of continuous loss was soon extended to construction defect lawsuits, and had the effect of triggering all insurance policies in effect at any time from a project’s inception. On top of that, plaintiffs’ lawyers often went after every contractor and subcontractor that had worked on a project to trigger all of their insurance policies. The ruling and the lawsuits that followed led insurance carriers to put in place so-called “Montrose” exclusions to limit their exposures to losses from prior years.
The effect of the California ruling and lawsuits has spread to other states.
“Insurance legal trends and case law originate out of California … and that sets a precedent for other states,” Reutter says. “Carriers usually look to the West to see what’s coming, and that’s where this construction defect started. It’s national now: You can look at Texas; yon can look at Florida.”
The restrictions put in place to deal with states such as California affect the whole country because the limitations that carriers set on coverage are determined to a large extent by their reinsurers.
“From an insurance company standpoint, their restrictions are usually driven by the reinsurance treaties, which are national,” Reutter says.
While Montrose hit insurance companies, a 1997 Florida court ruling that involved defects in the construction of a school roof has had the effect of limiting coverage that general contractors can claim under general liability policies for work performed by subcontractors.