Attorneys from Cox, Castle & Nicholson and Aon Discuss Range of Issues During Recent HB Teleconference
By Vivi Gorman
Engaged in construction projects with multiple parties? Client entwined in an OCIP or CCIP insurance program? The low-down on what’s going on with wrap-up policies was delivered during HB’s teleconference – Latest Developments In Wrap-Up Insurance – held and recorded on Aug. 13.
Background. Wrap-up insurance refers to an insurance policy or policies written to insure all parties involved in a specific construction project. Approximately 80 percent of these policies are written for commercial and public projects; a much smaller number are used in residential projects, but raise more of the contentious issues between parties. Wrap-ups take the form of owner-controlled insurance policies (OCIPs) or contractor-controlled insurance policies (CCIPs). Attorney Jeffrey Masters of Cox, Castle & Nicholson LLP in Los Angeles explained that wrap-ups came out of the commercial world and were successfully used for many years. In the late 1990s, he said, these policies became more prevalent in residential construction because subcontractors in the residential area were unable to obtain decent general liability insurance or maintain good additional insured status for the builder under the subcontractor’s policy into the future. The insurance dilemma arose because construction defect claims are progressive and often considered long-tail. There was a period where the market made certain insurance procurement difficult for subcontractors. Cox said wrap-ups are successful in the residential space despite some administration issues and issues for the owner/sponsor. Some legislative efforts have cropped up in various states recently, he noted.
Worthwhile Coverage. George Dale, Executive Vice President at Aon Risk Services, Inc. and Jim Holobaugh, Program Director, Senior Vice President, and Regional Director at Aon Risk Services Construction Services Group in Los Angeles – who also spoke on the teleconference – attested to the fact that wrap-ups are “fantastic” and provide worthwhile and necessary coverage at lower costs.
Potential Pitfalls at Procurement. The panel warned that certain steps early on in procuring wrap-up coverage will fend off messy and financially adverse situations down the road. First, obtain wrap-up coverage at the get-go, not later after project contracts have been signed.
And, you want to foresee how responsibility for any injuries, losses or damage will shake out — in writing. Make sure the responsibility is outlined in the building contract or the wrap-up policy, they said. Because builder’s risk insurance is more often than not simultaneously carried by the builder, an owner or contractor definitely should look into the scope of the builder’s risk coverage. The wrap-up may have an exclusion for property damage occurring during construction, while the builder’s risk policy may exclude faulty workmanship, leaving potentially no coverage either way. The wrap-up insurer might take position that it won’t pay for what is essentially a builder’s risk claim. The solution, the panel said, would be to enhance the builder’s risk policy to augment coverage for faulty work or at least for repairs.
Also, define the project site in the wrap-up. You want to have wrap-up coverage extend to damage or people beyond site, i.e., if a crane extends beyond the boundary of the site over a street and causes damage or injury. Coverage should be written for claims “arising out of” the site not just coverage for damage or people “at” the site, they said.
Coverage must also be arranged for any damage or injury occurring after a project is completed. When does completed operations coverage start? Some wrap-up policies provide completed operations coverage upon substantial completion, close of escrow or transfer of title. However, each state’s statute of limitations for bringing a claim must be considered and should match the completed operations coverage; otherwise claims arising during a gap period pose a problem as to whether there is coverage and which insurance should respond.
Very contentious issues crop up with coverage for punch-list and warranty work. One of the biggest advances in wrap-up brokering concerns coverage after a project is completed for punch-list, warranty work or customer service, the experts said. Any of the parties to the project could be exposed if an endorsement in the wrap-up limits warranty work to the terms of the warranty. Special attention is worthwhile in this area given that warranty work and customer service measures after completion are used to avoid construction defect claims, they explained.
It’s also a good idea to check as to whether another subcontractor can be substituted under the wrap-up if a subcontractor goes out of business after a project is completed.
Insolvency. Speaking of snags, what do you do if the wrap-up insurer associated with your project has gone insolvent? Is the owner of the project responsible? According to the teleconference panel, a recent California court in an unpublished decision said no. The court relied on the fact that the wrap-up made no express declaration that the owner was to become responsible if the insurer went under. However, the speakers said, this issue is sure to come up again with more insurer insolvencies.
Safety First. Ultimately, safety at the site is paramount and is the driver of how successful a wrap-up policy will be, they said. The general contractor is always responsible for safety regardless of whether a wrap-up is in place. However, a wrap-up insurer may impose stricter safety standards or drug testing, with the current trend being pre-employment testing, which raises issues with unions. Oddly enough, they said residential wrap-up programs don’t emphasize safety as much as in the commercial area. Construction defects are the bigger concern.
Trends in the Recession. The economic downturn, which greatly affected the construction industry, has lead to contractors being more apt to cooperate in the wrap-up insurance process because they are eager to get the work, the panel said. Though, after projects are completed, margins are slim and contractors often push back on any wrap-up requirements that could diminish profits.
On the broker side, Holobaugh said the economic environment is causing suspensions of projects, though premiums are still owed under policies. He said insurers are not refunding full collateral. Depending on the policy language, completed operations coverage may be voided because the project in many instances has not been put to its intended use.
Insurers, however, are remaining open to negotiations. They are offering the most flexibility when a project is delayed short-term as opposed to a delay of completion for a number of years. Shut-downs of projects presents a new issue in that new ownership of a project requires restructuring of a wrap-up policy, more collateral and, often times, the shut-down can void completed operations coverage. A new owner may want a new policy, Holobaugh said.
With respect to residential projects, the biggest thing is the involvement of bankruptcy courts and receivers and banks taking over projects. There is a steep learning curve as to how banks take over, he said, which essentially represents a new entity with power over the project. Lender involvement in wrap-ups will be big in the commercial area where lenders have gone from being an additional insured to the primary insured.
One of the biggest issues at the moment in terms of writing the policies is what constitutes an “occurrence,” Dale noted. “It will be interesting to see where the definition of occurrence gets to given some of the new right to repair issues,” he said.
Claims administration is a concern in the current economic environment where some builders can’t pay deductibles or self-insured retentions (SIRs), he said. This scenario raises the quandary of insurers participating in bankruptcy court. But insurers are cooperative if they are educated about the issues, he said. Some insurers are requiring third-party inspections especially when taking over unfinished projects — lots of issues and movement in that area, he said.
This is a soft market so rates are no where near what they used to be, but not all markets are created equally — there is cheap coverage with lots of holes, such as premiums under $100,000 for $1 million limits.
The panel added that the wrap-up arena is struggling with changing the function of a construction project, i.e., going from condo to apartment or from apartment to time-share. The economy has lots of smart people trying to make living and the insurance market follows the business flow, they said.
California & Kansas. Other new issues include new law in California, AB 2738, which mandates that a developer or owner cannot insure what it cannot indemnify — developers cannot obtain insurance without indemnity. In Kansas, HB 2214 includes language preventing sponsors of wrap-ups from imposing a charge on contractors for builder’s risk or general liability claims, Holobaugh said. Apparently, contractors are pushing back on some aspects of wrap-ups such as charges or deductibles for claims.
Disclosures are a big issue now especially with multiple projects (rolling wrap-up). Each contractor must have some information about limits of liability to determine if they want to participate in wrap-up.
Public Sector Picking Up. Some states have restrictions for public agencies using wrap-ups. However, the Aon execs are seeing an increase in public sector wrap-ups partly due to stimulus funding for public projects. The trend for OCIPs is with bigger projects such as a major city airport or large school district, whereas CCIPs are more appropriate for projects by water districts, hospitals and public transit agencies with their own insurance department, they said. Aon is neutral on OCIP vs. CCIP – Aon sees no advantage of one over the other, they said. Financial savings for contractor is driving it.
Holobaugh said there are opportunities for wrap-ups for infrastructure projects utilizing stimulus funds. Larger projects won’t be built short-term but most funding is being funneled to smaller projects, such as street projects, that can be part of a rolling owner-controlled wrap-up program. Municipalities and counties are considering rolling wrap-ups more and more. Public entities have a long RFP process so a rolling OCIP for short-term projects can be difficult, but OCIP makes sense if lots of such projects are on the table, he said.
Many rules for prohibiting wrap-ups for public projects have gone away in the past few years, with California leading the way, but the restrictions vary by state, he said. Jeff said there are restrictions in New York and other states.
Budget woes might invoke legislative assistance, they said. Many public agencies will engage contractors and rely on the contractor’s insurance as an additional insured and then buy their own insurance or be self-insured. The risk for a public agency is if the contractor’s insurance fails for whatever reason, eroding limits, insolvency, etc. Both bodily injury, ongoing-operations claims and construction defects, completed-operations claims exist in the public sector. Wrap-ups are an excellent way to handle those risks for public agencies, the panel said.
Conflicts & Reservations. Conflicts come up a lot under wrap-ups. A unified defense is central to wrap-up insurance, the panel said. All enrolled parties agree to be represented by the same counsel and experts. The goal is to minimize cross-claims and finger-pointing.
It is possible that a joint defense clause might be in the construction contract or appear in a wrap-up policy endorsement. A waiver of conflicts can be imposed; however, state law will determine the enforceability of an advance waiver of conflicts.
It is imperative to avoid allocation of fault rather than engaging in chasing additional-insured insurers as in construction defects cases, the panel said. Contribution disputes often arise, i.e., where an owner seeks to be made whole through deductibles from enrolled parties or an SIR is enforced when there is a claim against an enrolled party.
Dale said he favors minimal SIR contribution from enrolled parties where the sponsor can handle it or not pursuing SIR contribution in a completed operations setting.
Long-term thinking is required, he said. A single defense means defense costs often within limits; more lawyers will likely exceed limits. Another panel member added that there have been some instances of throwing a high deductible amount into a bid.
Subrogation. If one enrolled party is responsible for damage, could the wrap-up insurer subrogate against that party? Many states make it clear that subrogation can’t go against an insured but other states are not so clear on that point, the panel said. And endorsement is a good idea to protect the insured.
A second scenario concerns a builder’s risk loss on project where the builder’s risk insurer pays the loss and then subrogates against the contractor liable for the loss. That subrogation claim will be tendered to the wrap-up insurer. The question then arises as to who pays the SIR or deductible under that scenario. The experts suggested getting a waiver of subrogation as needed in builder’s risk and wrap-up policies. Holobaugh recommended naming the trade contractors as additional insureds under the builder’s risk policy; then the builder’s risk insurer cannot subrogate against its own insured.
Narrow Reservation of Rights. Insurers need to be wary of how and when they reserve rights. The insurer’s reservation of rights letter may create conflict justifying independent counsel. Other instances of conflicts warranting independent counsel include when a party named in a suit is not an enrolled party or not within the scope of coverage or if liability is for conduct away from insured site.
Sophisticated insurers are issuing more narrow reservation of rights letters to avoid triggering a right to independent counsel, they said. Automated reservation of rights letters often create conflicts and should be avoided.
“We see this as a really big issue right now,” Dale said. “Because the third-party administrators and claims folks are not really up to speed on wrap-ups, they don’t really understand the amount of money involved, and so they tend to send out these reservation of rights letters almost as a matter of course … A lot of them create these conflicts, not only in terms of counsel but they’re also very offensive to the risk managers and to the builders and general contractors who say, ‘Wait a minute, what do you mean this is the work product of somebody else. Everybody’s in the wrap.’
“We’re really at this early stage of claims, at least in residential, where we’re dealing with a construction defect, which has not been so much an issue in the commercial areas, where the learning curve of the lawyers, coverage lawyers and third-party administrators is very early … We’ve seen very few claims and very few cases, but this is where very early advocacy by the builder, broker and claims counsel to make sure that everybody understands what’s going on [is important] because the reservation of rights letters, to quote our President, are ‘stupid’ and cause all sorts of problems not only with the number of lawyers but also with the expectations of the parties.”
All parties involved in the wrap-up program from drafting to interpretation need to take careful steps, but most importantly, need to engage in open communication, the panel said.
Vivi Gorman is a freelance writer with over a decade of experience covering complex insurance litigation for the Mealey’s Litigation Reports, part of LexisNexis.