Navigating construction defect claims in today's economy

The reconstruction following the aftermath of Hurricane Florence across the Carolinas will be vast, long-lasting and could bring immense rehabilitation opportunities to construction-focused industries such as contractors, subcontractors and insurers.

From an insurance perspective, it could also bring new exposures likely to be associated with construction defect claims.

Building booms, underwriting squirms

Construction defect is generally defined as a defect to a dwelling stemming from a flaw in workmanship, product or design, which causes damages to people or property. The trigger of construction defect claims is affected by many different aspects: laws, territory, climate, the insured’s role and case law, among other variables. Getting your insurance hands around such claims is difficult for carriers as it takes keen attention to detail and actions to attempt to pinpoint when a defect occurred. That by itself makes underwriting the risks at the front-end even more difficult.

In recent years, the U.S. has experienced unimaginable damage and exacerbation of construction defects due to hurricanes and tropical depressions from Hurricanes Sandy, Harvey to the most recent Florence and Michael. This reality comes alongside a projection made by The Bureau of Labor Statistics that by 2020, the U.S. construction industry, already worth $1.2 trillion, is projected to be among the fastest-growing business sectors.

The surge of destruction after natural disasters coupled with a booming construction market mean new construction inevitably will lead to an increase in construction defect claims.

Boots on the ground

To prepare for the rapid growth of the construction industry and such reconstruction efforts as those in North Carolina, Argo Construction, the construction underwriting unit at Argo Group, held a construction defect forum where multiple disciplines gathered to discuss potential exposures, legal vulnerabilities and actual construction defect cases. While each U.S. state, and even local counties, have unique experiences and different outcomes, the discussions uncovered several takeaways that will help insurers navigate construction defect exposures and claims as the industry continues to grow.

Takeaway No. 1: Experienced contractors reduce claims.

One of the main takeaways of the forum’s discussion was the need for contractors to be experienced and quality conscious at all times. The forum found that experienced contractors who have trained and skilled teams fostering a commitment to quality and safety will be in the best position to minimize construction defect allegations, and ultimately, potential claims.

Furthermore, a contractor who demonstrates quality control measures as well as awareness of proper building codes and valid subcontractor licenses and certificates is exercising the foundational best practices to avoid potential defect allegations.

From the experience of the forum participants, a quality end product is the direct result of the contractor paying attention to every details of their work, including the quality of the materials.

Unfortunately, even with the most quality focused contractor involved, failures can occur. When they do, it is imperative that each contractor exhibit a meaningful, professional and timely response to the issue or complaint.

Many states provide a Right to Repair mechanism, which are often short in duration so issues must be addressed and tackled immediately. Such a response also demonstrates to the owner their willingness to alleviate troubles and often helps decrease damages and ultimately reducing construction defect complaints. Contractors should provide an easy method for the homeowner or owner to report issues and have a process in place to ensure such issues are handled promptly and effectively.

Takeaway No. 2: Great record-keeping is essential.

With construction defect alleging workmanship issues, record-keeping becomes extremely important for carriers should a claim arise. The ability of the claims adjuster to have access to subcontractor documents, building inspections and quality checks can be an effective tool to mitigate damages claims.

In sports, it is often said a good defense is the best offense. That concept can be applied here as well. The contractors who anticipate potential issues, record and capture their build progress during the life of a project are in a strong position to demonstrate later on when questioned about their work and control processes. This provides claim personnel and legal professionals with key defense and materials necessary for rendering to the appropriate parties. Such care and concern in recording their progress will better position construction professionals and their carriers against allegations of neglect or poor workmanship and construction defect.

Takeaway No. 3: Knowledge eases local underwriting challenges.

When there are allegations of defect claims in U.S. states, the forum found that it is imperative for insurers to fully understand the project, the roles and responsibilities of all contractors on the job site, and the risk transfer positions. From this perspective, insurers should gain understanding of insured’s workflows, their experience level, the success of prior projects and the venues of their projects. These individual pieces to the construction defect puzzle will be helpful for underwriters to piece together a complete picture if in fact a claim does arise.

The forum discussed at length the differences between construction defect and non-construction defect states. To an extent, all states present construction defect exposures. Yet, some states, due to statutes or court rulings, are placed in a specific category. Construction defect states or “CD states” require enhanced underwriting skills and often follow specific guidelines and parameters depending on the particular appetite and book performance.

Meanwhile, in non-construction defect states, the hazards are slightly diminished allowing underwriters to have more flexibility in price and form usage.

The forum concluded that non-construction defect states typically have less climate factor impact, an element which plagues the construction defect states, and minimize the potential for water intrusion claims. Such claims have shown to be the main source of allegations when it comes to construction defect cases. With poor faulty workmanship being the main focal point of the construction allegations, underwriting the quality of insureds is certainly an important component of the underwriting review especially for contractors involved in excavation, foundation and exterior building envelope protection. A defect from such a trade can significant issues for the building and ultimately the owner in the form of cracks and leaks.

Looking ahead

With the industry projected to catapult in the next few years, insurers see the importance of focusing attention on the construction industry as contractor and subcontractor actions are highly impactful in regards to potential construction defect risks. The main challenge will be to successfully tackle difficult exposures in order to help contractors stay in business and ensure projects are completed on-time. As the industry continues to undergo a boom and storm severity persists, it will be critical for all parties involved to work together to ensure construction defect exposures and risks are handled in the utmost professional manner.

Jim Cornwell (jcornwell@argoconstructionus.com) is a senior vice president at Argo Construction. Prior to Argo, Cornwell worked for 17 years in the insurance industry.

See also: Construction insurance continues to see double-digital growth