Liability Insurance Basics

Many small to mid-size builders and architects think liability insurance is too expensive, only for bigger firms, or only necessary if they have a bank loan. These are the lucky ones — those who have not been sued. Anyone who has been subjected to litigation, justified or not, has learned the value of liability insurance. What may seem like a substantial premium can be dwarfed by defense costs from a single suit, not to mention the financial stress of having to pay out money to one’s opponent to settle a case.

The two most important variables to consider when purchasing liability insurance are gross revenues and percentage of work delegated to subcontractors. As either factor increases, so does potential liability and the need for liability insurance. As to revenue, the amount and frequency of claims increase directly with volume of business. As to subcontractors, your insurance will typically cover you for your subcontractor’s errors and omissions. The more subcontract work, the more protection.

Liability insurance pays for a lawyer to represent you and covers any judgment or settlement amount, up to the liability limit of your insurance. If you are a builder, the insurance will cover any claims arising out of poor subcontract work or poor materials. However, with claims that arise out of your own work, the coverage is more limited. It will not cover the cost of replacing your defective work; it only covers damage to items other than your defective work.

For instance, if you install the roof, deck and shingles with your own employees and the roof leaks, insurance will not cover the cost to fix or replace the roof because the project was “your work.” However, insurance will cover the cost to replace the homeowner’s personal items, such as furniture, damaged by your work. Furthermore, your insurance company will pay the cost to replace the roof if a subcontractor was responsible for the defective work. If you are an architect, the coverage is even broader, covering all legal damages that arise out of your errors and omissions. So, considering the roof again, if the leak resulted from a defective flashing detail, your insurance would cover the cost to replace/repair the roof system, as well as the cost of water damage to other portions of the structure and contents.

Case in point
One current liability insurance case involves a general contractor and subcontractor who are disputing whether they are covered under each other’s insurance policies. Both parties are arguing that the other’s insurance policy must pay for the damages sought by an injured worker. Many general contractors require subcontractors to purchase insurance naming the general contractor as an insured under the sub’s policies. Conversely, many subs and suppliers also have standard terms and conditions which request that the general include the sub/supplier as an insured on the general’s insurance policy. The outcome of this case will depend on the court’s reading of the fine-print language in the particular contracts. Regardless of how the court decides, the important message is to always write your contracts to require the other guy to include you on their policy.

The most common residential claims are those brought by homeowners (your valuable clients) against you for construction defects (CD claims). CD claims encompass not only poor workmanship, but defective materials as well — essentially anything that results in a less than acceptable construction product. Industry reports state that more than half of all CD claims in the upper Midwest involve water damage, either through leakage or condensation. Another common series of claims are those by subcontractors against builders, or by builders against architects, each seeking payment for claimed extra work. If the extra work arises from the failure of the base contract to properly include the extra work, then insurance will not likely cover the claim. However, if the claim for extras arises from changed conditions, insurance likely will cover the claim if the builder or architect’s fault caused the changed condition. So, for instance, if the architect specifies a one-hour rated fire wall rather than a two-hour wall, and the mistake is not discovered until after the builder installs the one-hour wall, then the cost to tear out and replace the wall should be covered by the architect’s liability insurance.

In addition to liability insurance, everyone should have workers’ compensation insurance. Even if you are a one-person shop, you should have coverage on yourself. Construction accidents can be career ending. Workers’ compensation is a necessary and deductible business expense. Builders risk insurance also is a really nice thing to have. It pays for damage to work under construction from wind, rain, fire and other perils. And often you can get the client to pay the premium.

Frequency and payouts
Insurance is not free; you must pay premiums. So it helps to recognize two factors which affect premiums: frequency of claims and total claim payouts. If you can resolve disputes short of forcing the insurance carrier to incur attorney fees and claim payments, that will keep your premiums down. This is really a case-by-case judgment call because obviously some disputes require your insurer’s involvement; this is why you bought the insurance.

Another technique to control premiums is to require the parties you deal with to include you as an insured under their insurance policies. Even architects can ask to be covered under contractors’ general liability policies (although the coverage may be limited by certain restrictions in the policies). In any event, getting yourself covered, even partially, under another’s insurance policy can reduce your premiums by reducing the claims history on the policies you purchase.

Insurance will not prevent lawsuits, but it will make them easier to deal with. Here are some ways to minimize the risk: Choose your clients carefully; be prepared to compromise and swallow your pride (at least to a degree); and don’t let your accounts receivable get too high or too old. While all lawsuits have as their stated reason some alleged bad work, most problems can be resolved short of suit by reasonable people. The cases that make it to court nearly always involve intractable clients or builders, or clients who don’t pay and then allege bad work as a reason not to.