Several factors influence the type of umbrella/excess liability coverage you should buy.
Faced with the possibility of a large accident, contractors often ask themselves if they have enough insurance coverage to cover their losses and protect their assets. The question of how much coverage is enough frequently leaves decision-makers wrestling with sleepless nights and reaching for an antacid. Many owners live in denial by simply hoping they have bought enough, while others actually evaluate their individual risk profile and make a consciousdecision on the limits procured.
Over the years, I have counseled contractors on this question and have developed a list of 12 areas for review, which, at the very least, will spark internal thought and debate among a firm’s leadership.
The review process begins with a net-worth test. If uncovered losses in the company’s balance sheet arise to damage the net worth, unexpected challenges will emerge that could impact operations funding and other obligations. In addition, a capital reduction from the impact on the balance sheet could hinder or eliminate bonding capacity—threatening a contractor’s ability to win new projects. Further restrictions, such as collateral or funds control, could be placed on your bonding program, putting more pressure on cash flow and increasing the risk of insolvency.
Assuming you don’t want to simply hand over the keys to your firm, consider the consequences of liquidating your assets to pay off liabilities.
Contractual obligations—to owners and general contractors—play a vital role in determining the final number for limits, yet a contractor should never use them as the sole deciding factor. In soft market conditions, contractors may not understand the consequences or the duration (often several years) of their obligations. Most contracts will contain an insurance requirement stipulating certified limits during the project life and for a period after completion. Pay particular attention to the limits required, especially during soft market conditions when rates begin to rise. When they seem out of touch with your project’s size, consider that those limits may not be commercially available at prices you can afford a year or two into the future. The contractual requirement for limits is rarely negotiable after the fact, and the costs of maintaining those limits will need to be recovered through new work.
Another important gauge for purchasing limits is the construction value of large projects. Given that each project has its own unique risk profile, project size will provide some relevant input on the overall exposure to the construction firm. Applying a factor of 25 to 50 percent of the largest single project works well as a means of discussing limits. Obviously, contractors will need to balance this factor with the 11 others influencing the decision.
Type of Projects
The type of work performed should be viewed as one of the key elements in determining how much coverage to buy. Even if your projects have a low contract amount, they still may be very risky. For instance, interior work poses the risk of damaging the businesses and residences of every tenant in a building. Rehabilitation work tends to have a greater risk profile than new construction work, because if something goes wrong, property damage to the entire structure is in play. Residential work, including condominiums and single family dwellings, have their own set of challenges. Examine the mix of work performed, evaluate the construction defect profile and adjust limits accordingly.
Typical Work Activities
Be prepared to consider the type of work performed as a serious gauge for limits. For example, if your contract calls for blasting, you will need higher limits than if your work involves masonry and straightforward exteriors. Steel erection tends to produce higher limit requirements, as well as highway work/barricades, HVAC and roofing. All these examples require adjusting limits for the work performed.
Different construction delivery methods can affect insurance coverage needs from a liability perspective. A construction management or design build contract involves a greater degree of responsibility, which could impact what you maintain in limits. Liability limits continue to expand along with new delivery methods, such as integrated project delivery (IPD). In most instances, separate limits of liability will need to be purchased for your professional liability exposure in construction management, design build and IPD.
With the number of recent court cases—such as Gilbert v. Underwriters at Lloyd’s London, Gilbane v. Admiral or Ewing v. Amerisure—project locations and how courts interpret coverage are becoming important components of limits purchased. Building laws for New York City have already impacted the reasoning for securing higher limits, as well as the labor laws that exist for the entire state. Statute of repose for completed operations will vary by state, and the litigious environment of a number of states will tend to place upward pressure on liability limits.
Type, Number and Garaging of Vehicles
Automobile liability claims are typically expensive, particularly if there are other factors engaged in the claim, such as negligent entrustment, drinking, texting or adverse driving records. The type and number of vehicles, such as dump trucks or heavy truck tractor units, will impact the decision, as well as garaging locations and distance to and from projects. In general, the total number of units on the road at any given time will raise the limit.
Percentage of Subcontracted Work
The risk involved in subcontracting work has changed over the past five years. While the risk profile for a contractor tends to be greater with the more work subcontracted, the challenges of additional insured endorsements and the anti-indemnity statutes have also caused this risk to grow.
Safety and Risk Management Best Practices
Having world-class risk management practices will temper the limits needed. Risk management and safety will ballast the factors that drive up limits. Benchmarking risk management successes against your competitors will prevent a false sense of security in your company.
Loss history and the stratification of losses will also tell a meaningful story on limits to buy. For instance, a frequency of auto or general liability incidents in excess of $100,000 over a 10-year period will put upward pressure on limits. The mix of losses—between auto liability and workers’ compensation claims, for example—will also be important.
Despite the risk profile factors suggesting higher limits, the decision will finally come down to how much coverage the contractor can afford. Insurance markets change—sometimes rapidly. The current construction insurance market is in transition from a soft to a stiff market. Pricing for limits will likely be higher, with availability restricted to only a select set of underwriters. The insurance market still has plenty of capacity for limits, but with today’s economic conditions, pricing will play an increasingly larger role than before.