Insurance for construction defect claims can be a moving target. A contractor is usually required to provide a certificate of insurance. But what does the insurance cover? What does it not? And how can owners and contractors protect themselves?
What Is Covered?
Many owners insist upon the production of a certificate of insurance and find comfort in the declaration that there is, for instance, $1,000,000 of liability coverage available. The natural inclination is to believe that if something goes wrong on the project, there is a safety net. But it is nowhere near that simple.
Most commercial general liability ("CGL") policies only cover losses to the property caused by the work, but not damage to the work itself. There is usually an explicit exclusion for "Damage To Your Work" that excludes coverage for "property damage to your work arising out of it or any part of it." For example, if a roofing contractor builds a leaky roof and water pours into the house, the CGL policy will cover water damage and, potentially, mold formation. But if that same terrible contractor fails to properly secure the shingles to the decking and they fly away with the first gust of wind, there is no coverage. Similarly, there is also usually a specific exclusion for "contractual liability," which is the basis for most claims. Owners are often very surprised when they learn how little the CGL policy that brought them so much comfort actually covers.
Most CGL policies cover the cost of defense, including attorney fees and expert witness fees. This can dramatically alter litigation dynamics. The contractor whose attorney fees and costs are being paid by an insurance company has a significant advantage over a claimant who is bearing their own fees and costs. Another consideration is how the cost of defense affects the available coverage. A "defense outside of limits" policy means that the cost of attorneys of expert witnesses are paid separately. A "defense within limits," or a "Pac Man policy," means that those costs are taken off the top of the policy limit. As litigation can be extremely expensive, this can substantially impact the coverage available.
Who is Covered?
An insurance policy covers the "named insured," usually the contractor who purchases the policy. But the coverage can be expanded to include "additional insureds," such as owners, general contractors, and upper tier subcontractors. An "additional insured" enjoys the full benefits of the insurance coverage, including liability coverage and defense costs.
Many prime contracts and general contractor form contracts specifically require the inclusion of all upper-tier parties as additional insureds. Failure to do so can create significant exposure. Consider this example: Contracts on large projects can be one hundred pages long. Buried in Addendum L on page 147 is a requirement to include various entities involved in the development of the project as named insureds. When the claimant names them all in a construction defect suit, the parties soon realize that the general contractor failed to ensure that an entity was included as an additional insured. That general contractor then has an indemnification liability to the party left without insurance coverage when the music stops.
As an "additional insured," the owner, general contractor, or upper tier subcontractor benefits from a first party relationship with the insurance company. Colorado statutory law requires the insurance company to treat insureds with good faith and fair dealing. The insurance companies cannot place their interest above their insured's and become exposed to severe penalties if it is determined they unreasonably delayed or denied payment of claim.
A common structure for insurance on construction projects is a "wrap-up" insurance policy. These policies bring all participants under a single umbrella of insurance, either through voluntary participation or contractual requirement. Wrap-up policies come in two forms, owner controlled insurance programs ("OCIP"), and contractor controlled insurance programs ("CCIP"), depending on which party sponsors the program.
Wrap-up programs can be very beneficial. If one insurance company is providing the defense and will ultimately provide the liability payment for all trades, all interests are aligned. There is no need for infighting or cross claims, which dramatically expand the proceedings and expose vulnerabilities in the defense of the work.
At the same time, these programs can create unexpected liabilities. For instance, a lot of CGL policies have an exclusion where there is a wrap-up program or a provision that the wrap-up/CIP program is primary and the CGL policy is excess coverage, only available when the full extent of the primary coverage has been exhausted. But if the wrap-up/CIP program has a self-insured retention, it could create a hole in coverage. A self-insured retention is like a deductible. The insured must pay defense costs and settlement or judgment payments up to a certain amount. If that amount is high, it will take some time to hit the limit. Consider this example. A subcontractor is required by contract to enroll in the wrap-up/CIP program. An owner brings a construction defect claim. There is a $5,000,000 self insured retention. The wrap-up carrier refuses to provide the cost of defense until this limit is hit. The subcontractor forced to enroll in the wrap-up program submits the claim to its CGL carrier, who denies the claim based on a wrap-up exclusion. The subcontractor paid for two policies, received the benefit of neither, and is now forced to engage counsel to defend a multi-party construction defect litigation.