To Grade Construction Defect Exposure, Know State Coverage Law
Prior to the coronavirus outbreak, the U.S. economy was performing well and the nation was at full employment. Macroeconomic conditions such as that lead simultaneously to a spike in demand for new construction and a labor shortage. History tells us this is a scenario that is ripe for the potential of defective construction, particularly in residential housing.
COVID-19 put the brakes on construction, but it will pick up again. The timing is anyone’s guess. When building activity is humming, will insurers be ready to underwrite the increased flow of risks and absorb construction defect claims? Now may be a good time to revisit your guidelines.
The basic coverage issues for construction defect (CD) claims - whether defects are covered under General Liability policies - have seen some clarity and stabilization in state courts across the nation. We have closely tracked the progress of this evolution and recently began an update of methodology and evaluations in our Construction Defect Compendium.
Classifying States by Construction Defect Coverage
Our team from Underwriting, Claims, Contracts and Treaty Pricing areas wanted to understand the prospects for profitably underwriting CD-exposed contracting classes of business. One outcome of the study was a new categorization scheme for ranking states based on the extent of coverage for defective construction - a scheme that lets us account for and explain measurable differences in the loss potential of different levels of coverage completeness.
To make the category assignments, we re-read the key cases from all 50 states that address the issue of whether or not defective construction can be an “occurrence” that causes “property damage” (PD) and then made a determination of exactly what kind of property, in terms of its relationship to the insured and the faulty work, can qualify as a occurrence and PD in that state. The results of that effort are documented in the state summary analysis of our Compendium, along with brief descriptions of the cases and additional notes for other CD coverage issues.
We classified states into five categories based on our findings of the CD law:
Testing the Grades
As the five categories describe how limited (or not) the state’s coverage is for damages that result from defective construction, one would expect that they would correlate with the average contractor loss costs (LCs). In fact, that is exactly what we find as we moved down in level from category one states to lower levels of coverage: Average loss costs decreased for contractor class Products/Completed Operations coverage.
This was one of the findings in a 2017 ISO1 study on the impact that changes in the law have on contractor loss costs. It also agrees with what we have observed in our own test of the relative levels of filed loss costs by state. While this might not amount to much more than an interesting factoid if filed LCs are always reflective of loss potential, when coverage law in a state does change, we found that loss cost adequacy is often, at least temporarily, undermined.
One of the benefits of this new categorization is that it should give us a way to quantify the extent of pricing deficiency by comparing the average level of loss costs across the state categories we’ve identified. The relative attractiveness of the underwriting climate in a state can be measured not just in terms of CD coverage and claims activity, but also in terms of filed loss cost inadequacy because of a recent change in coverage law.
Monitoring the Trends
As in the past, when new cases are published, states may make changes to the law, and we may change our assessment of states. We may also change our assessment if our view of the overall coverage environment changes. Every month or so a significant case is decided, and we consider its impact.
The basics still matter, even when a pandemic makes it hard to see beyond your front door or the next day. At Gen Re, we are always available to consult with our clients on CDs or any insurance issues important to their book of business.
- ISO Circular LI-BP-2017-018, Construction Defects: An Analysis of Select Court Rulings and Their Potential Impact on Loss Costs