Residential construction projects pose unique risk transfer issues. This article will identify the unique challenges posed by residential construction and discuss why wrap-up insurance programs are the preferred risk transfer alternative to address these unique risks.
The term "residential construction" encompasses a wide array of project types.
- Single-family homes
- Apartment buildings
- Condominiums, townhomes, and cooperatives
- Dormitory, military housing, and assisted living
- Mixed-use of both residential and commercial space
Wrap-up insurance programs are commonly utilized on residential projects due to several unique factors affecting this type of construction.
- Prevalence of residential exclusions. There has been an increase over the past 2 decades of insurers adding "residential" exclusions 1 to the general liability and excess liability practice programs of contractors. Such exclusions exclude any liability for work arising out of residential construction projects (as defined in the exclusion) performed by the insured. This poses a risk to both the owner/developer/home builder as well as the general contractor/construction manager as it frustrates the intent of risk transfer to downstream parties.
- Potential for repeatable construction defects. Because these projects involve building the same or similar product multiple or even hundreds of times, if there is a construction defect, it is likely that it was repeated over numerous units, and the resulting damage and cost to repair the defects can quickly become expensive.
- The owners often live in their units. I often use the example that if a person is living in an apartment and doesn't like how the windows are drafty or leaking, they will likely nonrenew their lease and move to another community. With owned units, perhaps the occupants' largest single investment, if they continuously experience those same leaking windows, they will likely talk to their neighbors and, if they are experiencing the same issue, may lead to a class-action lawsuit.
- Attorneys are targeting these projects for class-action lawsuits. There are thousands of attorneys that dedicate their practice to litigating construction defect cases on residential projects. I've heard of attorneys proactively soliciting the board of directors at residential communities by offering them a free forensic assessment of their property to determine if there are any construction defects.
- The project may involve smaller subcontractors. The trade subcontractors can include smaller contractors (i.e., two men in a truck) to large, very sophisticated subcontractors. While the small contractors can very well be qualified to perform their craft, the risk issues are whether the company is willing and able to purchase quality insurance coverage and if the company will be in business through the statute of repose for the project.
- Broaden the pool of potential bidders. By utilizing a wrap-up program, the owner/developer/home builder is able to increase the size of potential bidders by expanding the bid list for subcontractors that may not be qualified to bid due to residential or other coverage restrictions on their general liability program. I recall one project where 18 of 21 subcontractors could not meet the client's insurance requirements. By purchasing a wrap-up program, they were able to create more price competition by including all 21 contractors in the pool of potential bidders.
- Lender requirements. We've seen an increase in lenders requiring a general liability/excess liability wrap-up program (owner controlled or contractor controlled) for residential projects. The risk issues for the lender are the prevalence of residential exclusions on contractor liability policies as well as the certainty of having the products-completed operations extension through the statute of repose. 2
Residential Exclusions
The Insurance Services Office, Inc., an organization that publishes many policy coverage forms and endorsements used widely by insurers, does not publish a "residential" exclusion. Rather, insurers craft their own language that can be as broad as excluding any project involving any type of residential construction to exclusions for specific types of residential projects. Insurers routinely apply these exclusions to contractor general liability and excess liability practice programs.
As a general observation, many insurers will exclude coverage on "for sale" residential projects such as single-family homes, condominiums, townhomes, etc. in which a residential unit is sold and owned by an individual. Some insurers will have a specific carveout, thereby granting coverage for residential property not owned by individuals, such as apartments, senior living facilities, dormitories, etc.
The key takeaway is that each insurer has its own exclusion, and it is important for project owners, general contractors, and construction managers, agents, brokers, and insureds to thoroughly review the exclusionary language as it relates to the project being constructed.
Condominium Conversion Exclusions
Even if a project is not being built "for sale" (e.g., apartments), there may be the potential that the owner/developer can convert the units to "for sale" units post-construction during the statute of repose. Because of this, some insurers will add a condominium conversion exclusion to the practice policy that excludes general liability and excess liability coverage if the residential project is converted to "for sale."
When such an endorsement exists, if the project is converted to "for sale" in the future, coverage under the liability program is voided for work performed on that project, although the contractors are still at risk for potential lawsuits through the statute of repose.
Residential Wrap-Up Marketplace
Wrap-up insurance programs are used on any size 3 "for sale" projects and on other residential projects where the owner/developer/home builder has a concern of not obtaining effective risk transfer due to residential exclusions on the contractor policies. Many of the projects utilize a general liability and an excess liability wrap-up program typically procured from excess and surplus (E&S) insurers. 4
There is a high degree of underwriting scrutiny on residential projects, and underwriters typically require a comprehensive list of data.
- Information about the project such as renderings, site map, detailed budget, and construction schedule
- Information about the general contractor/construction manager, including 5-year general liability loss runs
- Information about the quality control program and warranty process for "for sale" projects
- Geotechnical reports
- Supplemental applications
Some standard insurers (non-E&S) will provide a general liability/excess liability wrap-up program if the project is of sufficient size for their appetite (e.g., $200 million-plus). The standard insurers are more inclined to insure residential wrap-up programs if they can also insure the workers compensation exposure or as an accommodation to an existing client if their corporate program is of sufficient size to warrant such accommodation.
Some owners and many contractors have the ability to write a residential project as part of a rolling 5 wrap-up program. If the owner or developer does not have a rolling owner-controlled insurance program (OCIP), it can be advantageous to leverage a rolling contractor-controlled insurance program (CCIP), as those programs are typically priced on a large amount of construction volume and a mix of both residential and nonresidential projects. Thus, a rolling CCIP may be more price-competitive than the owner or developer securing a single project OCIP. 6
If a rolling OCIP or CCIP is utilized to insure the project, it is also critical to understand if and how the limits are shared by other projects insured under the rolling program. The OCIP/CCIP may have a "per project" general aggregate and/or products-completed operations aggregate limit, but the limit may have a cap on the total limit (e.g., $15 million maximum), regardless of the number of projects insured under the program.
A word of caution: even if a wrap-up program is purchased for a residential project, residential wrap-up policies often have a "residential" exclusion, and careful attention is required to ensure the policy language does not exclude the type of project the insurance is intended to insure. Additionally, if the project is not being built "for sale" (e.g., apartments), it's likely that the wrap-up policies will have a conversion exclusion, so it's critical to assess the probability of a conversion occurring before the statute of repose.
Summary
Given the prevalence of residential construction exclusions on contractor liability insurance policies, the most commonly used risk management tool for residential projects is to incept either a single project wrap-up program or insure the project under a rolling OCIP/CCIP.
Such an approach gives the key project stakeholders—such as the lender, owner/developer/home builder, general contractor/construction manager, and subcontractors—certainty that the intended risk transfer is secured by consistent, tailored coverage to address the project risk characteristics. It also provides certainty that the products-completed operations hazard coverage will be extended, typically through the statute of repose. However, careful scrutiny must be applied to the wrap-up policies to ensure they don't have any problematic exclusions.
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