Construction Risk Basics
Building owners and construction contractors each have unique coverage concerns that change as a project moves from start to finish.
Residential construction is also expected to be “steady”, according to the Canada Mortgage and Housing Corporation. New housing starts are forecast to rise from an average of 190,000 units this year to 193,800 units in 2013, with an upper end projection of nearly 220,000 units.
What does this mean for the broker? Simply put, it signals a growing need for specialized insurance to cover the myriad of risks associated with large building projects. In an insurance market that has seen soft pricing over the past six years, there is intense competition to place this business. But brokers have to ensure that the needs of both project owners and contractors are fully addressed in a comprehensive insurance solution. And they also have to be aware of key developments and trends.
There are two main types of project-specific insurance policies: Builder’s Risk, which is a type of property insurance, and Wrap-Up Liability, which provides liability insurance for a construction project. Builder’s Risk insurance (also commonly referred to as Course of Construction or COC) is intended to cover the value of the labour and material as it accumulates at a project site during progressive stages of construction. Wrap-Up Liability insurance covers the legal liabilities of the owners, contractors and to an extent, the consultants at the project site.
The Builder’s Risk and Wrap-Up coverages may be purchased by either the project owner or the general contractor and are typical contractual requirements in building construction and renovation, as well as heavy civil projects. It is also becoming increasingly common to find contractual requirements for stand-alone Environmental Impairment Liability (EIL) insurance. For example, in a number of jurisdictions, some public sector construction projects now require EIL policies for contractors (commonly referred to as contractor’s pollution). As government agencies and private companies become increasingly aware of their environmental exposures, we expect that the trend towards requiring environmental coverage will continue. Another trend observed relates to the frequency of water damage claims occurring in building construction near or just after completion. Imagine water escaping from an improperly installed dishwasher fitting into multiple completed high-end condo units, these losses can easily reach into millions of dollars in damages.
Let’s take Builder’s Risk first. Consider the construction of a new four-storey office tower (though this could apply to any project; a bridge or a campus building, or a new hospital interchangeably). The expectation of the project owner when negotiating the construction contract is that the completed structure will be ready for use on an agreed-upon date. Behind the scenes, he/she has undertaken a considerable measure of planning and perhaps arranged financing or acquired land for this new facility or structure.
The contractor will now also outlay financial resources to commence the project. The development might evolve something like this: Day 1 – fencing arrives at the job site, later a site trailer and the contractor has $100,000 in material delivered. Day 7 – excavation is underway, perhaps with shoring involved, value of material and work completed is now $175,000. Day 100 – project is now three stories above grade and formwork is in place for the fourth storey concrete pour; the value of work and material is $2 million. Day 300 – project is now closed in and interior finishing underway. Schedule is 80% complete and $8 million worth of work and material has accumulated at the project site.
The values accumulate rapidly towards the end of the project as the structure nears completion. At any time, a loss of work and material could cause financial harm to not only the project owner (and any lenders they’ve borrowed from), but also the general contractor and even the subcontractors who have invested time and work into the job. This is the subject of Builder’s Risk insurance. It is designed to indemnify the owner and contractors for their investment in labour and materials in a project during the course of its construction.
What about the legal liabilities? During the project (and even after its completion) an owner, general contractor or even the subcontractors could be alleged to be legally liable for bodily injury or property damage to a third party arising out of the construction of our new office tower.
For example, a leaking water pipe damages the building shortly after completion. This could impact the project owner, probably causing damage to his/her property and prompting (at the very least) an angry phone call to the general contractor or plumbing contractor who performed the work.
Enter Wrap-Up Liability insurance. Developed from a need to provide uniform coverages to all parties in a project and to allow coverage to apply to each insured separately, it is widely used in construction contracts. The uniformity of coverage for all insureds and the setting of a specific limit can establish consistency for multiple parties and contractors, especially for a large risk-managed construction project. In addition, Wrap-Up Liability provides a uniform deductible and greater ease in claims involving multiple parties. There are also potential premium savings if the general contractor and subcontractors price the job without their respective insurance costs. In fact, if used wisely, the Wrap-Up Liability policy can pay for itself. This works when the owner requests project pricing from the general contractor (who in turn should request the same from his/her subcontractors) excluding liability insurance costs, or only charging for “difference in conditions” coverage in their pricing. The Wrap-Up Liability policy is primary above all of the individual contractor’s liability policies for this particular project. The sum of the CGL premiums saved will often exceed the cost of the Wrap-Up Liability policy (or at the very least, heavily subsidize it).
Often a component of limited liability for pollution can be added to the standard Wrap-Up Liability policy by means of a Sudden and Accidental pollution liability endorsement (there is a pollution exclusion in most common Wrap-Up Liability wordings). For projects which require superior environmental coverage on a gradual basis, Environmental Impairment Liability (or Pollution Liability Insurance for Contractors) is available (commonly referred to as EIL). An EIL policy is purchased separately from the Wrap-Up Liability policy.
One of the key issues for brokers is that insurance carrier wordings on a specific construction project can reveal significant differences in coverage. There are standard industry wordings for Commercial General Liability (CGL) (upon which the Wrap-Up Liability policy is based) and Builder’s Risk, produced by the Insurance Bureau of Canada (IBC). However, in practice, the IBC wordings typically serve only as a baseline for coverages specified in a contract.
There is a plethora of wordings in the marketplace for Builder’s Risk, Wrap-Up and Environmental Liability. Not all are created equal. For example, some Wrap-Up Liability policies contain an excavation, collapse and underpinning (XCU) exclusion which intends to restrict coverage from some onerous operations that are not uncommon on construction projects. Wrap-Up Liability policies can vary from wordings custom-developed by insurers familiar with the class, to standard IBC CGL wordings with “Wrap-Up” endorsements grafted on.
When considering a project-specific insurance program, it is important for brokers to know that each project is individual. Its particular merits are often the factors that determine the rating of the risk and consequently the premium. For this reason, accurate and complete underwriting information is key in obtaining the best coverage at fair market price.
A typical insurance submission for a construction project will include an application detailing project class, location and size, project participants, experience and loss history, as well as copies of relevant engineering reports. A geotechnical evaluation report is standard for new building construction, most civil class construction projects and some building renovations where structural changes may be required.
Construction schedules and site plans (and in some cases, project drawings) are also extremely useful in fully appreciating the nature of the risk. This is the kind of comprehensive risk information that insurance underwriters need for construction projects.
As the market for building risks continues to expand and, in some cases, specialize, it is critical for brokers to assess the insurance needs of individual construction projects. Any unique exposures must be identified and the corresponding coverage should provide the right kinds of protection for the project owner or contractor.
The intricate nature of construction risks, coupled with a wide variance in insurance policy wordings, makes it even more important for brokers to work with knowledgeable placement partners who understand the construction business and have expertise in claims handling. Your construction clients would expect nothing less.
Marcus Raitanen is a senior underwriter at ENCON Group Inc. with over 14 years of experience in both the construction and insurance industries.
Copyright 2012 Rogers Publishing Ltd. This article first appeared in the April 2012 edition of Canadian Insurance Top Broker magazine.