CDCs: The contractor's virus

An insurance broker calls attention to the spread of construction defect claims

February 01, 2001 |

Construction defect claims (CDCs) are wreaking havoc on construction insurers and threaten to adversely impact the growth and viability of virtually all segments of the construction industry.

CDC litigation involves property damage liability resulting from construction activity. It encompasses numerous forms, including water intrusion (the most frequent), cracked foundations, "sick building syndrome," lack of insulation and noise abeyance. It can occur with respect to a first-party owned property or a third-party liability loss.

CDCs have evolved from tort law and continue to mutate at what appears to be an increasing rate. New legal doctrines and definitions of negligence or tortuous conduct have resulted in more frequent suits, and court settlements with increasingly high jury awards. A veritable cottage legal industry has arisen, complete with plaintiff attorney CDC specialists leading the assault.

Other factors are also behind this increase, however. The primary causes are shoddy construction practices, the use of substandard materials, poor design or engineering, work by transient subs employing untrained labor, and a "take-the-money-and-run" developer mentality-especially in areas experiencing rapid development.

The most frequent claims currently involve residential general contractors and condominiums and townhouses. Once these areas have been picked through, the CDC virus will spread to commercial and public works projects.

Subcontractors involved in any way with water intrusion are the most vulnerable. This includes installers of siding, roofing, gutters and windows. Suppliers are also on the front lines of the CDC assault, as targets of claims involving warranty and products liability. CDCs also are mutating into professional liability claims against design professionals.

The rise of CDCs has a direct correlation to rapidly developing areas, particularly in California, Nevada and the Pacific Northwest. These areas have many of the nutrients that allow CDCs to flourish, including labor shortages, an extreme, seasonal demand for subcontractors and inexperienced or unqualified employees.

Number of cases jumps

One of the region's largest insurers reports dramatic growth of CDCs in Washington State-from 80 in 1998 to 141 in the first nine months of 1999.

During this same period nationally, CDCs increased from 2,300 to 3,300.

Water leakage, soil erosion or conditions that expose new construction to loss may happen over a period of years. This lack of a time-specific event has magnified the problem for insurers, as the limits of liability for defense and settlements from the defendants is "stacked" or "pyramided." Potential defendants include developers, construction managers, architects, engineers, general contractors, subs, and suppliers. CDCs may occur at any time during construction, but are most frequently filed after the project's completion and, not surprisingly, before the statue of limitations runs out.

Public policy dictates that owners at some point need to assume responsibility for ongoing maintenance, and liability then transfers from the general contractor to the owner. But the statutes vary by state, and case law is moving in the direction of extending the statutes of limitation. In some cases, the time limits have been extended from the date of the last repair, not the completion of construction.

If sued, the A/E/C firm should obviously report a CDC to its insurer. The company also must fulfill the loss-reporting conditions of your insurance policy (property, builder's risk, general, professional or excess liability) when you are aware of an incident that may result in a claim long before a suit is filed.

Timely reporting is critical so that the company can avoid a reservation-of-rights action by its insurer. The company may impair its insurers' ability to defend it (and them) by late reporting.

Insurers are responding

Nonadmitted insurers have issued new general liability policy forms and added endorsements to prevent the CDC infection from spreading among multiple policy periods. They are also placing defense costs within the indemnity limits, so attorney's fees will displace the amounts available for a settlement. In addition, known losses are now being excluded prospectively from the renewal policies.

CDCs are driving standard insurers from the construction insurance market. For residential and commercial builders, cancellations and non-renewals are being imposed. Those companies that have not yet gone through the renewal process are in for a rude awakening. As premiums expire, new deductibles, called self-insured retentions, or SIRs, are skyrocketing from $5,000 to as much as $100,000 per occurrence.

This rise in insurance costs will have long-term effects on the general construction and real estate markets, causing construction costs to rise significantly and forcing marginal contractors out of business. CDCs could be one of the catalysts for the next downward cycle in building construction.

A more streamlined and less costly method of adjudicating these claims is needed. In many ways, the present situation is similar to the growth of pollution liability issues of 30 years ago, when problems were generally known but decades passed with little or no cleanup. It took considerable legal effort to move the wheels of justice and initiate significant environmental cleanup work.

Scott Strickland is a senior vice president of the Construction Group of insurance broker Raleigh, Schwartz & Powell, based in Seattle.

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