In Search of Sasquatch and Construction Defect Insurance

Truth in Labeling

If insurers wanted to sell insurance coverage for replacing a contractor's defective construction, they would sell policies with the words "Construction Defect Insurance" in the title of the policy form. I have not been able to find any evidence of construction defect insurance being available at any price in the past 15 years. If it was truly the intent of insurance companies to provide coverage for the cost to repair or replace defective construction, it seems that the obvious marketing ploy would be to label the coverage something like "Construction Defect Coverage." Any insurance company selling this type of policy would be likely to sell a lot of it.  

Instead, insurance company marketers promote supplemental coverages on contractors' general liability and professional liability policies, such as coverage for "mitigation of damages" or "rectification expenses," that is then often inaccurately promoted as "construction defect" coverage to insurance buyers by producers.

Insurance company policy drafters are not usually in the game of implying coverage in obscure ways; they are quite clear in what they are providing, often stating it right in the title of the coverage itself. However, insurance company marketing folks have a knack for getting creative with describing exclusions, especially when the only coverage in a policy is found within an exclusion to an exclusion.

From my research into ever-elusive construction defect coverage, I found that where things go astray from being an obvious restriction in coverage created by an exclusion to prescribed coverage is the insurance marketing function takes over to describe the effects of an exclusion in words that please insurance buyers. The really big embellishments from the actual coverage in the policy happen at the insurance broker level. That is how an exception to a nebulous exclusion morphs into "construction defect insurance."

Insuring Agreements

The potential insurance coverage for the cost to repair defective construction rests in three lines of insurance: property insurance policies, general liability, and contractor's professional liability. To have coverage in any one of these policy forms, there needs to be a covered loss. The cost to repair or replace a contractors' work will usually not trigger the insurance agreements in these policies.

In the property policy, it helps to think along the lines of "was the cause of the loss a covered peril?" (e.g., fire, lightning, or windstorm). Of course, that ignores the concept of a special perils policy, but that is no longer called all-risk coverage for a reason. If the cause of loss is not covered by the insuring agreement, the effects of exclusions for defective building materials in a property insurance policy does not even come into play.

Under the general liability policy, to have a covered loss there needs to be an accident arising from the contractor's operations or completed operations that causes third-party bodily injury or property damage, including loss of use. Without an accident as the cause of loss, the business risk exclusions in the general liability insurance policy have no relevance.

The insuring agreement in a contractor's professional liability policy has apparently caused more confusion on construction defect claims coverage than any other type of insurance coverage. One of the common denominators in this type of liability insurance coverage is that in order to have a covered cause of loss there must be (1) allegations of negligence arising from rendering or failing to render a described professional service, and (2) resulting damages (not limited to bodily injury or property damage). I have never seen a contractor's professional liability policy with an insuring agreement that adds a third coverage part for "any request that you fix your faulty workmanship," which would be a necessity on a true construction defect insurance policy.  

Many times, a demand from the contractor's customer that the insured contractor repair or replace defective construction does not trigger the insurance agreement in any insurance policy purchased by the contractor. However, in the face of an expensive demand to repair or replace a contractor's own work where the fact situation does trigger an insuring agreement, there are a series of business risk exclusions built into the property and liability insurance policies sold to contractors to eliminate coverage for their construction defect loss exposures.

Business Risk Exclusions

There are a series of business risk exclusions in the insurance policies purchased by contractors that affect coverage for construction defect claims. The following is a list of the common ones found in contractors' professional liability (PL), general liability (GL), and property insurance policies.

1. Faulty Workmanship—PL
2. Warranties & Statements—PL, GL
3. Construction Means and Methods—PL
4. Damage to Your Work—GL
5. Damage to Property—GL
   1. (5) That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the "property damage" arises out of those operations; or
   2. (6) That particular part of any property that must be restored, repaired or replaced because "your work" was incorrectly performed on it. There is an exception to this exclusion if the defective work was performed by a subcontractor.
6. Impaired Property or Property Not Physically Injured—GL
7. Defective Construction Materials—Property coverage

Each of these exclusions individually plays a part in precluding coverage for construction defect claims. Keep in mind that these exclusions and restrictions are the second line of defense. They only come into play if an insuring agreement is triggered for a covered loss. Without a covered cause of loss, the policy usually won't respond at all.

Coverage Litigation

From my research into the availability of coverage for construction defects, I was amazed to discover that virtually all of the information on the topic is within the context of litigated coverage disputes. Most often, it was over whether an insuring agreement was triggered by the fact situation of a loss followed by which part of exclusions for the cost to repair or replace defective construction applies or does not apply to a loss. The litigation outcomes vary by state for similar fact situations.

The most reputable source for information on construction defect insurance issues is a book published by IRMI titled Insurance for Defective Construction. It is filled with information on litigated claims looking for insurance coverage on construction defect claims. I was unable to find anywhere in it a definitive statement that construction defect insurance truly exists.

In contrast to television producers promoting fruitless searches for Sasquatch, promoting liability insurance to pay for the costs to repair or replace a contractor's defective workmanship is not harmless fun. There is a downside to that promotional activity. Customers tend to become seriously disappointed in the face of an unexpectedly denied loss, especially if they have been led to believe that there would be coverage to repair or replace defective construction. If the loss is big enough and the customer has enough money to pay for lawyers, coverage litigation ensues. I found it amazing in researching this paper that virtually all of the information on "construction defect insurance" is in the form of the outcomes of coverage litigation. There is something fundamentally wrong with that picture.

Coverage litigation for construction defects and insurance broker professional errors and omissions (E&O) claims could be avoided if insurance buyers fully understood the effects of exclusions when a policy was sold. A lot of confusion on the coverage provided in an insurance policy can be avoided if the insurance proposal simply pointed out the effects of the ever-present business risk exclusions.

An informed insurance buyer should not be disappointed at claim time to find out that there is usually no insurance coverage to repair or replace defective construction. Where things get dicey is when an insurance producer sets expectations of coverage in an insurance proposal that is unrealistic.

Insurance Marketing Spin on Exclusions

The insurance marketing spin on exclusions and exceptions to exclusions rest at the core of a lot of needless insurance coverage litigation. Insurance marketers like to find words that please insurance buyers when describing restrictions in coverage. Take, for example, the introduction of "sudden and accidental pollution coverage." This pollution "coverage" was born of an exclusion added to the 1973 comprehensive general liability policy. The brand new exclusion to the general liability insurance policy stated that coverage would not apply to bodily injury or property damage arising out of the discharge, dispersal, release, or escape of various pollutant-like materials (e.g., smoke, vapors, soot, or fumes), as well as other irritants, contaminants, or pollutants. All that was new in 1973 was an exclusion; there was never new coverage. Prior to the new exclusion, general liability policies were silent on pollution releases causing bodily injury or property damage.

The new exclusion had an exception to the exclusion: "if such discharge, release or escape is sudden and accidental," the pollution exclusion would not apply. Insurance company marketers ran with this exception to an exclusion and peddled the new exclusion as sudden and accidental pollution "coverage." Since when is a new exclusion a new coverage? The marketer's spin on an exclusion being "coverage" set off decades of coverage litigation and the demise of the comprehensive general liability policy form.

There are many parallels between the insurance marketing follies associated with exclusions for repairing defective construction and pollution exclusions. One key point to keep in mind is that if you are reading the exclusions section of a policy to figure out where the "coverage" is, there's something wrong with that picture.

Insurance Marketers Strike—Rip and Tear Coverage Is Not Construction Defect Insurance

A contractor's professional liability policy without the faulty workmanship exclusion is about as close to a construction defect insurance policy as you can get, but there is still one big holdup. The restriction is there still needs to be a claim for damages from a loss arising out of an actual or alleged negligent act, error, or omission in the performance of "professional services" to trigger coverage under the policy.

Nowhere does the myth of construction defect insurance persist as strongly as it does in the area of contractor's professional liability insurance. I recently had an insurance broker send me an email questioning how it could possibly be that a claim for the costs to repair her general contractor's defective work was being denied under a contractor's professional liability insurance policy. The policy had a clear exclusion for faulty workmanship, mirroring in effect the defective construction exclusions in the general liability policy. Even the insurance broker's claims department jumped on the bandwagon, sending emails to lend support to the argument that the purpose of contractor's professional liability insurance is to pay for construction defect claims. There were two things seriously wrong with the correspondence. First, the insurance brokerage team, and I would expect their customer, expected an insurance policy with a faulty workmanship exclusion to pay for the costs to repair or replace faulty workmanship. Second, emails like these set the producer up for a professional E&O claim. If the contractor decides that their insurance broker is responsible for the lack of insurance coverage on a multimillion-dollar loss, the emails will show up in the discovery process and indicate that the insurance broker had the wrong idea about why contractors need professional liability insurance. This broker was not alone in thinking contractor's professional liability insurance would cover construction defect claims.

My daytime job is working as a wholesale insurance broker. I place a lot of liability insurance policies on contractors for my retail insurance producers. About 10 years ago, I started to receive inquiries from insurance producers in search of construction defect insurance. I did some investigation into where producers came up with the wrongheaded idea that the coverage existed and what set off the sudden influx of inquiries from coast to coast. It turns out that it was a promotional piece for the new "mitigation of damages coverage" from a prominent provider of contractor's professional liability coverage that captured the attention of the insurance salesforce. Construction defect coverage is also promoted by insurance company marketing teams as "rip and tear" coverage.

To have a covered claim, the insured would still need to have a loss arising from a covered professional service, and there needed to be a demand for damages as defined in the policy. With this new coverage, if the contractor's work had to be removed to access the defective construction that, if left in place, would have produced a covered damages claim under the policy, then the cost to tear out the work and replace it to avert the otherwise covered cause of loss would be covered. That is a very narrow coverage extension because a lot of things need to fall in place at the jobsite and in the fact situation of the alleged damages to get an otherwise covered cause of loss.

Most producers did not think things all the way through before they embraced the construction defect "coverage" they would be selling in error. In reality, nowhere in such policies did this slang term "rip and tear coverage" appear. It was achieved through the removal of the policy's faulty workmanship exclusion and any exclusion for warranties. That sounds promising; remove the exclusion for claims arising from the cost to repair or replace faulty workmanship, construction, fabrication, installation, assembly, erecting, etc., and bingo, you have coverage for your defective work, right? Not so.

It turns out the coverage for "rip and tear" costs was even more restrictive than it would appear in the policy form. The innovative insurer promoting the coverage would not sell the new and improved policy form to any insured who was a general contractor. The rip and tear coverage was only available to artisan contractors. Many insurance brokers did not catch that the insurance company offered two different policy forms: one with the exception to the faulty workmanship exclusion and one without the exception. Both were titled contractor's professional liability, which just added to the confusion in the insurance marketplace.

Competitors of the early innovating insurer matched the product offering within months, and confusion over "rip and tear coverage" being construction defect insurance still runs rampant in the marketplace. But, at the end of the day, even with the fancy policy forms providing coverage to rip out and build back the insured's work to avoid an otherwise covered cause of damages, the remnant coverage is still an exception to an exclusion. As with any form of insurance where the coverage is being provided through exceptions to exclusions, the reliability of the policy to pay those types of claims is very suspect.

Conclusion

I could find no verifiable evidence that Sasquatch exists. In addition, after 2 years of research for this article, I could find no evidence that an insurance policy with construction defect insurance in the insuring agreement exists either. If a reader can provide any insights into the existence of an insurance policy with an affirmative coverage grant for construction defects, I would very much appreciate hearing from you. As for Sasquatch, I want to see an unaltered high-definition photo!