Understanding Wrap-up Insurance Programs

One risk facing the construction industry is liability for defects in a company’s work. Setting aside the complexity of modern construction, multiple tiers of contractors and suppliers are involved in a typical commercial or residential project and, despite their best efforts, they may interfere to damage the work of other trades or otherwise install defective work on a project.

Traditionally, all the stakeholders on a construction project maintain separate insurance to protect their own interests and perhaps those of other parties whom they are required to name as additional insureds on their liability policies. The cost of separate insurance—including the contractual liability insurance to insure complex indemnity obligations—is passed on to project owners in the price of the work.

The Wrap-Up Approach

The high cost of separate insurance throughout the tiers on a project and the conflicts between insurers as to a specific claim were the driving force behind controlled insurance programs, or wrap-ups, in which all participants are insured under a single program. The provision of broader coverage, the elimination of duplicate coverage and the resulting cost savings cause owners and general contractors to consider wrap-ups a viable option. While designed to help mitigate construction defect claims, wrap-ups can only reach that goal if all stakeholders take a cooperative approach.

All for One

Under a wrap, all stakeholders involved in the construction project are named insureds on the commercial general liability (CGL) policy, except for off-site fabricators and suppliers. While insuring all parties under a single liability policy has advantages, other issues in this “all for one and one for all” approach often arise, particularly in regard to construction defect claims.

One issue with wrap-ups is triggering coverage for a multiple-party claim. Most wraps are written on standard liability insurance forms and provide third-party coverage. In other words, to trigger coverage, a third party must file a claim against one or more participants in the wrap. In CGL policy parlance, there must be 
a claim for damages that the insured 
is “legally obligated to pay” to trigger coverage from the wrap carrier.

Sometimes, however, coverage is 
affected by endorsements to the policy, particularly “cross-suits” endorsements. Under these provisions, coverage does not apply to a claim or lawsuit brought by one insured on the wrap policy against another. This could have serious consequences in a construction defect claim in which numerous participants may be involved. Unless modified, such an endorsement can severely reduce coverage. 

One way to reduce this risk is to scale back the scope of the cross-suits exclusion so it does not apply to claims or suits brought by the “first-named insured” against another insured on the policy. Usually, the first-named insured is the sponsor of the wrap—the owner of an owner-controlled insurance program (OCIP) or the general contractor on a contractor-controlled insurance program (CCIP). In this way, a suit filed by the sponsor of the wrap against other participants can still trigger coverage, but the numbers of inter-participant suits that can be brought are still reduced. 

Note that in instances in which a third party files suit—such as a condominium homeowners’ association that is not insured on the wrap policy—the cross-suits exclusion has no effect. But to ensure maximum coverage for policy participants, parties should be careful when deciding who to name as insureds on a wrap policy or even when adding additional insureds when an unmodified cross-suits endorsement is attached to the policy.

Since a CGL policy in a wrap provides third-party coverage only, construction project owners and contractors must know how to trigger coverage. Often, standard CGL policies are used in wrap programs, and the general contractor will have broader coverage than subcontractors. CGL policies typically exclude coverage for the insured’s own work subsequent to completion of the project, but a general contractor usually gets the benefit of a “subcontractor exception,” which provides coverage for the general contractor for property damage resulting from the work of his or her subcontractors. Therefore, it is often more beneficial for a claim to be portrayed as having been made against a general contractor, rather than the subcontractor.

Joint Defense

One of the foundations of a wrap program is the reduction of litigation among the participants on the project, primarily by insuring all of them under the same policy and by somewhat restricting their ability to file claims and lawsuits among themselves. Nevertheless, none of those measures will eliminate the need to defend multiple participants in a claim or lawsuit brought by a third party. Therefore, most wraps include a joint defense arrangement, under which the participants agree to be represented by a single counsel in the event of third-party claims. 

A typical joint defense provision states that “absent an actual conflict of interest” between two insureds that requires the appointment of separate counsel, the insurer has the right to 
retain one counsel to defend all insureds in a joint defense. It will also have provisions for the preservation of attorney-client privilege and confidentiality.

Particularly when multiple participants are named as defendants, with allegations of damage to the project resulting from each participant’s scope of work, the potential for a conflict of interest is increased. In that instance, when a conflict of interest exists, the carrier will most likely be obligated to provide a separate defense for each participant, since the policy explicitly provides for a separation of insureds and treatment of each insured as if he or she were the only insured on the policy. Determining conflicts may add delay in the handling of claims and retention of counsel, raising the potential for more conflicts. 

Even the issuance of a reservation of rights causes conflicts of interest under some state laws, and due to the many issues surrounding 
coverage for construction defects, reservation of rights letters under wrap CGL 
polices are commonplace. Moreover, some participants may create or foster conflicts of interest themselves. For example, a general contractor may notify a subcontractor’s surety of a potential default involving defective work. Such actions are likely to create allegations of conflict of interest and the need for separate counsel.

Business as Usual?

Conflict in construction defect claims is commonplace, so successful wraps are possible only when the insurers, sponsors and participants recognize the value of a group approach and commitment from all concerned, often requiring a more cooperative approach to claims than the parties may be used to. The alternative to such cooperation is business as usual: adversarial claims.