Construction Insurance
Chapter 20
Construction Insurance
I. Importance of Insurance Planning
Insurance is a crucial consideration in construction project planning as a means of covering losses and minimizing disputes among the parties on a project. No party involved in any aspect of the construction industry can afford to neglect or overlook the substantial impact and effects that insurance considerations may have on potential costs, fees, rights, and damages. Such neglect is a mistake that can leave a party exposed to liability for which it was never prepared.
Construction insurance is a highly specialized and complex field, which is often confusing and mysterious to the uninitiated. In addition, in an effort to control and predict insurers’ relative liabilities, the insurance industry is constantly changing and revising policy language in reaction to construction industry changes as well as to court decisions interpreting and applying the language of insurance policies that determine the rights and obligations of both the insurers and insured. There is no all-encompassing policy or coverage for any construction project or party to such a project. Instead, a web of policies, insuring agreements, coverages, exclusions, limitations, endorsements, deductibles, policy limits, and excess and umbrella coverages are stitched together among the parties to cover those relatively limited types of risks that are insurable on a construction project. Insurance policies generally begin by providing broad coverage for a variety of risks and potential damages in the insuring agreement found at the beginning of the policies. Upon more careful review, however, policies dramatically scale back purported coverage through exclusions, deductibles, implied exceptions, definitions, endorsements, policy limits, and other tools to limit the insurers’ liability.
Insurance planning for construction projects is extremely complex and specialized; therefore, it would be ill-advised to leave such planning to an inexperienced layperson. Even companies that employ full-time insurance specialists or risk managers must further rely on professional insurance brokers to assist in the procurement of the proper coverage at a competitive price.
This chapter presents an overview of (1) the types of insurance that are available and frequently at issue on construction projects, (2) the basic scope and framework of different insurance coverages and exclusions, (3) practical considerations in responding to potential insurance claims, and (4) some recurring coverage issues. The unique terms of individual policies and the peculiarities of individual state laws limit the generalizations that can be made about insurance issues. The broad principles described in this chapter, therefore, cannot substitute for specific reference to the contracts, the insurance policies actually at issue, and applicable state law.
II. Introduction to the Language of Insurance Policies
As a contractor plans its project risk management protocol, it is important for it to review and understand the policies that it is contractually required to obtain and the policies that the contractor may require another to obtain. While coverages under the various forms of insurance are different, all policies of insurance have certain common components. In general, an insurance policy can be broken down into six components: (1) declarations, (2) insuring agreement, (3) exclusions, (4) definitions, (5) conditions, and (6) endorsements. A general understanding of these common components will assist in navigating and understanding the various policies.
A. Declarations
Insurance policies begin with a “declarations” page or pages. (Sometimes the declarations page is referred to as the “information” page.) The declarations page is divided into sections and typically sets out the policy number, identity of the insuring company, producer’s name and address, named insured, named insured’s address, policy period, coverage type (e.g., commercial liability), policy limits, identification of attached forms (discussed below), and any other key information.
Perhaps the most important part of the declarations page for purposes of risk management is the “forms” section. The forms section identifies all the “forms” (with a corresponding form number) that make up the entire insurance contract. One of the forms identified will be the main policy form. For example, under a commercial liability policy the forms sheet may identify “Commercial General Liability Coverage Form.” All other forms essentially modify the main policy form and are “endorsements.” (See discussion regarding “endorsements” below.)
While the balance of the forms are essentially “endorsements,” they may not be labeled as “endorsements” in the declarations. If an endorsement is used to modify an “exclusion” or a “condition” to the policy, the endorsement may be titled as such. An example of these types of endorsement forms would be the “Nuclear Exclusion” or “Common Policy Conditions” forms.
Many carriers use the same type of forms, often referred to as “standard forms.” This is specifically helpful to the insured as it is then dealing with only one main policy form. The Insurance Services Office (ISO) is the most widely known provider of standard insurance forms. The interpretations of standard forms have been significantly vetted by the courts over the years. As such, the insured should be able to gauge the scope of coverage provided under the standard form within the applicable jurisdiction. By way of contrast, “nonstandard forms” are proprietary forms used by a specific insurer. Nonstandard forms may appear similar to standard forms; however, they have been modified by the insurer to redefine coverage. A familiarity with the standard forms cannot be relied upon in the interpretation of nonstandard forms. Nonstandard forms must be read closely, as the slightest change in sentence structure can result in a significant change in coverage. Finally, and much less common, “manuscript forms” are used when no form exists to define the requested coverage. The insurer, or the insurer and the insured, must “manuscript” a form specifically for the insured’s coverage needs. Any manuscript form must be read closely. By its very definition, there is no history of interpretation.
B. Insuring Agreement, Exclusions, and Definitions
Most policies begin with a “coverage” section, which contains the “insuring agreement.” The insuring agreement outlines in very broad terms the insurer’s obligations to make payments to an insured or on behalf of the insured. By way of example, under a commercial liability coverage form the insurer agrees to pay the insured for those sums that the insured is legally obligated to pay as damages because of bodily injury or property damage.
In a property policy, such as a builder’s risk policy, the insuring agreement is quite different. Property coverage comes in two similar, but different, types of policies. Some property policies provide in the insuring agreement that coverage is afforded for all causes of loss. The policy then identifies certain “excluded perils.” Under the second type, the insuring agreement simply identifies the “covered causes of loss.” If the cause of loss is not identified, the insurance does not apply. While there is a sharp contrast in the two types of insuring agreements, the scope of coverage actually afforded is typically not that different. For a more detailed discussion regarding coverage under the insuring agreement for property policies, see discussion regarding builder’s risk below.
While the insuring agreement under any policy form is drafted in a broad manner, the scope of coverage under all policies is then narrowed by “exclusions” and “definitions.” Under the exclusion section of the policy, the scope of the insuring agreement will be significantly narrowed. The exclusions work in various ways. Exclusions may focus on the manner in which the damage occurred, the type of damage, the type of risk that is involved, etc. Exclusions may eviscerate coverage or limit coverage. In the end, the exclusions section does the lion’s share in defining coverage.
The next component to any policy is the definition section. (The definition section is typically at the end of the policy form, but is best addressed with the exclusion section.) All policies of insurance have key terms, which are typically identified in the policy as a defined term by being printed in bold, italicized, or both. The definition of a key term can effectively broaden or narrow coverage. For example, under a commercial liability form coverage the insurer agrees to pay the insured for those sums that the insured is legally obligated to pay as damages because of “property damage.” “Property damage” is always a defined term and typically includes physical injury to property, including loss of use of the property. While one may not logically consider the loss of use of property as property damage, this is a good example of a policy expanding coverage through the definition of a key term.
C. Conditions
The conditions section of any policy outlines certain duties and obligations of the insured and the insurer. Unlike exclusions and definitions, the conditions section has no direct effect on the scope of the insuring agreement. However, noncompliance with the terms and conditions of the policy may absolve the insurer from having to provide coverage to an insured for an otherwise covered event. Of specific note, the conditions section outlines the insured’s responsibilities in the event of a loss. (See discussion regarding notice requirements below.)
D. Endorsements
As indicated above, the insured must read all forms to understand the scope of coverage provided. Stated differently, an insured may not simply review the main policy form. The main policy form is altered by the endorsement forms. An endorsement essentially changes or adds a provision to the main policy form. An endorsement may be used to broaden the scope of coverage, remove coverage, clarify coverage under certain situations, add named insureds or additional insureds, and so on.
It is good risk management practice to review every policy of insurance for errors. To assist in this regard it can be helpful to create a checklist, identifying coverage requirements. By way of example, a checklist may further identify those endorsement forms that your company requires in a policy and those that you will never permit in a policy. A good checklist may catch endorsement forms that could leave large gaps in coverage. (Please note that any checklist would be different if you are reviewing your company’s policy as opposed to verifying if a downstream contractor has obtained the contractually required insurance.) While the use of a checklist is recommended as a tool to assist you, it should never replace a proper and thorough coverage analysis.
III. Types of Insurance
Insurance policies that typically are purchased for construction projects, and therefore are discussed in this chapter, are commercial general liability, builder’s risk, and errors and omissions. Many other forms of insurance also may come into play on a construction project, which can range from everyday reliance on workers’ compensation insurance to a more unusual claim against a corporate officers’ and directors’ liability policy. Although some of the general principles described in this chapter may apply to these other forms of insurance, this chapter focuses on the aforementioned three most common forms of insurance relied on in resolving construction-related claims.
A. Commercial General Liability
Commercial general liability (CGL) insurance protects the insured party from injuries it may cause to other parties or property. Coverage for contractors under the CGL policy is limited by exclusions, which embody the well-established business risk doctrine. These business risk exclusions are designed to limit coverage for defective workmanship by the contractor.1 The principle behind the business risk exclusions is based on the distinction made between the two kinds of risk incurred by a contractor.2 First, the contractor bears the business risk of replacing or repairing defective work to make the building or project conform to the agreed contractual requirements. In the presence of the business risk exclusions, this type of risk is not covered by the CGL policy. Second, the contractor bears the business risk that defective or faulty workmanship may cause injury to people or damage to other property. As the liability associated with this risk is potentially limitless, it is the type for which the CGL coverage is contemplated.3 Accordingly, a CGL policy is “third-party insurance” in that it protects the insured from claims of loss by third parties.
The insurance industry’s rationale for this limited coverage is that those business risks that are under the control of the contractor (e.g., additional costs incurred because of inefficient or substandard work), for which the contractor seeks a profit, should not be the subject of insurance. In the insurance industry’s view, a different result would essentially make the CGL policy into something that is similar to a performance bond issued by a surety. (See Chapter 17.)
1. CGL Insurance: “Occurrence” versus “Claims Made”
A CGL policy can be either an “occurrence policy” or a “claims-made policy”; the difference between the two relates to the timing of coverage. An occurrence policy provides coverage regardless of when the claim actually is made, provided the insured event occurred during the policy period. A claims-made policy is basically the opposite, extending coverage to claims made during the policy period, regardless of when the insured risk occurred.4
2. CGL Insurance: Costs of Defense and Deductibles
Another important distinction between types of CGL policies is whether the cost of defense is excluded from the policy coverage limits. If the cost of defense is excluded or is in addition to the policy limits, the costs the insurance company incurs in defending a claim do not erode the policy limits. For example, if there is a $100,000 claim on which the insurance company expends $25,000 to defend, the insured’s coverage is still the full $100,000 policy limit. If, however, the cost of defense is included in the policy limits, the liability protection afforded is considerably reduced. In the prior example, the $25,000 in defense costs would reduce the insured’s liability coverage to $75,000.
Policy limits define the ceiling of financial protection afforded by insurance, but there is also a floor to that protection, the deductible, which is the loss or expense the insured must absorb before the insurance company has any obligation to pay. The combined effects of a high deductible, policy limits, and included costs of defense can dramatically limit the real financial protection afforded by a CGL policy on many claims.
3. CGL Insurance: Layers of Insurance
CGL coverage often is purchased in multiple layers. The basic coverage is the “primary” policy, with the additional increments of coverage being “excess” or “umbrella” policies. The excess carrier typically will have no duty to defend or indemnify until the primary or other lower coverage is collected, reduced, or exhausted, similar to the deductible requirement. The specific language used in an excess policy to determine where the excess coverage will begin, the so-called attachment point, will control the events that will trigger that excess coverage. An insured must pay careful attention to the specific terms of those policies.5 Regardless of when the excess coverage attaches, prompt notice by the insured to the excess insurance carrier(s) is good practice.
4. CGL Insurance: Additional Insured
The overall impact of CGL coverage on a construction project can be expanded substantially by adding other parties as “additional insureds,” which then also enjoy coverage.6 Historically, it was not uncommon for owners to require the general contractor and subcontractors to include the owner as an additional insured on their CGL policies. Many insurance clauses in contracts now seek to extend additional insured coverage on CGL policies to other members of the construction project delivery team. For example, the AIA A201 (2007 ed.) requires the contractor to add the owner, the architect, and the architect’s consultants as additional insureds under the contractor’s CGL policy.7
General contractors, likewise, typically require subcontractors to name the general contractor as an additional insured on the subcontractor’s CGL policy. Inclusion as an additional insured not only provides protection to the named party against claims by third parties, it also protects the additional insured from subrogation claims by the insurance carrier, as insurance carriers are not legally permitted to subrogate against their own insured. Subrogation is the theory by which the insurance company, after paying on a covered claim, steps into the shoes of its insured and asserts the insured’s rights against a third party that allegedly is responsible for the loss, and is thereby reimbursed for the payment.8
Whenever an owner or contractor requires that it be named as an “additional insured,” it should confirm its additional insured status by obtaining a copy of each policy rather than by accepting a broker’s binder or even a certificate of insurance. While a certificate of insurance may indicate who is an additional insured, a certificate will not state what additional insured form is being used. The coverage extended to an additional insured varies greatly based on what form is utilized. The terms of that policy should be reviewed to determine which policy is primary in the event of a claim and to understand the coverage exclusions in that policy.
5. CGL Insurance: Environmental Liability
The potentially far-reaching liability for environmental hazards is an ongoing and major concern in construction. Unfortunately, the protection afforded under a typical CGL policy is significantly limited when compared to the risk. Most CGL policies exclude coverage for all pollution damages except for that which is “sudden and accidental.” Policies are available to separately address broader environmental risks, but such coverage is costly and far from all-inclusive. For a broader discussion of the issue, especially in the context of mold claims, see Section IX of this chapter.
6. CGL Insurance: Endorsements
An endorsement is a form that is attached to a standard CGL policy form that modifies the terms of the policy. An endorsement may add or remove coverage for acts or things not contemplated in the form policy. A list of the endorsements is typically provided in a schedule found near the front of the policy. In a construction context, certain exclusionary endorsements can effectively obviate coverage for risks that are traditionally covered in standard forms. By way of example, ISO Form CG 22 94 and ISO Form CG 22 95 remove the subcontractor exception to the “your work” exclusion, essentially eliminating coverage for claims arising out of the work performed by the insured’s subcontractor. By way of further example, ISO Form CG 21 39 10 93 effectively removes coverage for damages for which an insured may be responsible because the insured contractually assumed the liability of another party. Since every policy of insurance has endorsements, which modify the policy by adding or restricting coverage, the endorsements should be reviewed to understand exactly how the standard policy form has been modified.
B. Builder’s Risk Insurance
Builder’s risk insurance provides coverage for damages to the project during construction. Builder’s risk is essentially property insurance that is designed to cover damage to the project during the course of construction by unforeseeable events such as fire, explosions, strong winds, lightning, theft, damages by aircraft and vehicles, and other risks. Accordingly, it protects against the insured’s loss, as distinguished from compensating the losses of others as with a CGL policy.9 Builder’s risk insurance typically is purchased for large private projects by the owner but often includes coverage extending to the general contractor and subcontractors. The general contractor and subcontractors also have an insurable interest and can procure their own builder’s risk coverage.
Builder’s risk coverage comes in two similar, but different, types of policies: “all-risk” insurance and “specified” perils. Builder’s risk insurance is typically written on an all-risk basis, which covers damage due to any cause not otherwise expressly excluded.10 The label “all-risk” is essentially a misnomer. All-risk policies are not all-loss policies. All-risk policies contain express written exclusions and implied exceptions developed by the courts over the years. However, if a loss is caused by a risk that is not specifically excluded, coverage is afforded.
A specified perils policy, in contrast, provides coverage only for listed risks and damage. In reality, although these two types of policies approach coverage from two extremes, the scope of coverage actually afforded typically is not that different.
As to the timing of an “occurrence” under a builder’s risk policy, courts look to the same “occurrence trigger” options as they have with CGL policies. See Section VII.A of this chapter for a more detailed description of the possible “occurrence trigger” tests used in various jurisdictions.
C. Errors and Omissions Insurance
Design professionals are covered for professional liability or malpractice claims under professional liability insurance policies. Such policies frequently are referred to as errors and omissions (E&O) policies.11 For example, an architect furnishes defective plans to the owner. The building is constructed, and, as a result of the plans, the building contains a defect. Ordinarily, the architect’s professional liability policy will pay the owner for its expenses in correcting the building defect. Or the defect may result in a catastrophic loss. Again, the architect’s professional liability policy should cover any damages incurred as the result of the loss up to the E&O policy’s limit of liability.
Professional liability insuring design professionals and CGL policies insuring contractors both cover claims arising from bodily injury and physical damage to property. CGL policies, however, ordinarily do not cover economic loss claims. Such claims would include the cost of repairing defective construction or delay damages. Such claims are normally not covered because CGL policies generally only cover bodily injury and property damage claims, and because of the business risk exclusions of the standard CGL policy. Professional liability policies insuring design professionals, however, do cover claims for economic loss as well as claims for bodily injury and property damage.
As in all insurance policies, E&O policies contain a number of exclusions. All E&O policies exclude coverage for dishonest, fraudulent, or criminal acts; employment liability; automobile liability; workers’ compensation claims; and liability assumed under contract. Many E&O policies typically exclude coverage for express warranties and guaranties. Most of these exclusions will, however, provide coverage for warranties or guaranties that the work will meet generally accepted architectural or engineering standards or for work that the design professional would otherwise be liable for regardless of the written warranty or guaranty.
Many E&O policies will not cover claims that arise from the activities of related controlled entities. By way of example, a design firm may be affiliated with a contractor. Typically, E&O policies exclude coverage for any claims made against the design professional by a company that the insured operates, manages, or controls, or any entity that is owned more than 50 percent by the insured. This could be significant to firms doing design-build work that set up a design-build entity which contracts with the design firm.
The cost of E&O insurance is substantial and, like most insurance, ever increasing. Moreover, many design professionals believe that investing in E&O coverage actually encourages claims rather than protects against them.
Owners are increasingly requiring construction managers to carry professional liability coverage similar to that maintained by design professionals. Similarly, design-build contracts often require contractors to obtain the coverage of an E&O policy or to require the design member of the team to carry such insurance.
D. Alternatives to Traditional Insurance Programs
Although notoriously cyclical, the insurance industry, like any business, is dynamic and adaptive. Policies evolve as underwriters adjust the premiums, terms, and conditions consistent with the perceived risk. Further, underwriting is susceptible to competitive pressures. In addition, new insurance products are regularly rolled out, especially at the upper ranges of premium risk.
1. Contractor Default Insurance
The stability of contractors is a concern on every job. To protect against non-performance, owners and general contractors have traditionally relied upon performance bonds. As an alternative to performance bonds, owners and general contractors may consider contractor default insurance (CDI), commonly known as Subguard®, the trademark name used by Zurich U.S. Construction for its CDI product. CDI essentially indemnifies the insured (the owner or general contractor) for losses in the event a subcontractor or a supplier fails to perform their contractual obligations. Since CDI is a first-party insurance product, not a bond, the insured may avoid a confrontational bond claim process.
Contractors should carefully analyze whether to replace traditional performance bonds with CDI. While CDI may simplify and streamline indemnity in case of default, certain inherent benefits to performance bonds are eliminated. Unlike a surety, insurance companies do not implement an extensive subcontractor prequalification process. The contractor essentially becomes the one to manage and review the subcontractors’ qualifications—not an easy task as subcontractors may be very hesitant to share financial information directly with the general contractor. Next, as CDI is an insurance product, there is typically a deductible for each loss and an aggregate limit. Hence, the insured will never be made 100 percent whole (there is a deductible) and available indemnification dollars may be eroded during the project. Finally, since CDI is an insurance policy, coverage is subject to exclusions. While the exclusions found in a CDI policy are typical exclusions found in property and casualty policies, these exclusions are not present in performance bonds.
2. Owner-Controlled and Contractor-Controlled Insurance Programs (OCIPs and CCIPs)
An OCIP is a single insurance program that is purchased and controlled by the project owner. The OCIP program essentially consolidates (wraps up) coverage under multiple lines of insurance for project participants. Accordingly, OCIPs also are sometimes called “wraps” or “wrap-ups.” The OCIP insures the project owner, general contractor, and all subcontractors performing work on the project. The coverage provided under an OCIP is for project-specific risks and most often includes commercial general liability, workers’ compensation, employers’ liability, and excess liability. Other insurance, including automobile liability insurance, typically is not provided as coverage under an OCIP. The premiums for the program are paid by the sponsor (the owner in an OCIP) and in return all participating contractors reduce their bid price by the cost of their own insurance. In short, individual insurance requirements are removed. A CCIP is basically identical to an OCIP, except the general contractor, not the project owner, sponsors a CCIP. In the end, the difference is merely a question of control and responsibility for premium payments.
3. Captive Insurance Companies
As the commercial insurance market in general has grown more restrictive in its underwriting, captive insurance companies (a “captive”) are being utilized to provide direct insurance solutions for contractors seeking to save money on insurance premiums and increase control over what risks are insured during a project. These captives allow more direct management of the risk as well as potential savings and rebates. Captives also can provide more expansive underwriting. Specifically, a captive insurance company is essentially a private insurance company that is formed and capitalized by one or more companies. Under a group captive arrangement, various member companies join together to pool their insurance risk. The captive members structure all aspects of the captive, including required premiums, self-insured retentions, stop-gap coverage, and so on. Each captive member essentially commits itself to sharing a portion of the other members’ liabilities as structured by all captive members. As all members are essentially owners of the captive, premiums are minimized and/or returned to members in the absence of unanticipated liabilities.
IV. Contract Requirements for Insurance
Insurance coverage must be planned for each individual project. Although there are certain industry standards regarding which party provides what kind of coverage, insurance is too important and too specialized to assume anything. Each party must review its respective contract on each project to confirm how insurance requirements are addressed. This review is necessary to confirm compliance with the contract and to verify that others are providing the protection required by the terms of the contract. It is important to confirm that those contractually defined requirements are satisfied by all involved. Unexpected gaps in coverage are unpleasant surprises.
A. Standard Contract Clause
The typical insurance arrangement is reflected in the 2007 version of the AIA A201, the ConsensusDocs (© 2011, Revised 2014), and the EJCDC C-700, all of which are recognized industry form contracts.
Article 11 of the AIA A201 (2007 ed.) makes several changes in the insurance required by the contractor from its 1997 edition, the most notable relating to additional insureds and completed operations coverage. As previously mentioned, the AIA A201 now requires the contractor to add the owner, the architect, and the architect’s consultants as additional insureds under the contractor’s CGL policy for claims arising from the contractor’s negligent acts or omissions during the contractor’s operations.12 The contractor also must obtain completed operations coverage, or coverage for claims arising out of the contractor’s negligent acts or omissions after the contractor has completed its work, and name the owner as an additional insured.13 The endorsement, adding the owner as an additional insured, does not require the contractor’s insurance carrier to cover claims arising solely out of the acts or omissions of the owner or architect.
Because AIA A201 now requires the contractor to add the owner, the architect, and the architect’s consultants as additional insureds in the contractor’s CGL policy, the AIA removed the requirement to provide project management protective liability insurance (PMPLI) to cover the owner’s, contractor’s, and architect’s vicarious liability for construction operations. Since the coverage terms vary between the AIA A201 (2007 ed.) and earlier versions of AIA A201, it becomes ever more important to understand exactly what coverage is required in order to avoid being faced with a contractual requirement for insurance coverage, such as PMPLI, which may no longer be available.
Under AIA A201, the owner also can obtain liability coverage but is not required to do so.14 The owner is, however, required to obtain builder’s risk insurance on an all-risk basis,15 and this builder’s risk protection extends to project subcontractors.
Under Standard Agreement and General Conditions Between Owner and Constructor, ConsensusDocs 200 (© 2011, Revised 2014), contractors are not required to purchase and to maintain liability coverage for the owner that is primary to the owner’s own liability insurance, but it is an option.16 If such coverage is mandated, then owners and contractors are given a choice of two options regarding additional liability coverage. Contractors either can purchase an Owners’ and Contractors’ Protective Liability Insurance (OCP) policy or can name the owner as an additional insured on the contractor’s CGL policy.17 The additional insured coverage is limited to liability caused by the negligent acts or omissions of the contractor or those acting on behalf of the contractor.18
Under Standard General Conditions of the Construction Contract, EJCDC C-700 (2013 ed.), the contractor is required to add the owner, engineer, and their consultants as additional insureds under the contractor’s CGL policy.19 The contractor also must obtain completed operations coverage for three years, with continuous coverage to the additional insureds.20 The EJCDC C-700 specifically enumerates which additional insured endorsements must be procured, e.g., ISO Endorsements CG 20 10 10 01 and CG 20 37 10 01 (together).21