J & N REALTY, INC.

Construction Insurance  

Risk Allocation  

Construction contracts provide key information about a contractor’s risk exposures.  In addition to specifying the scope of work, the contract price, and the target completion date, the construction contract stipulates how risks will be allocated and the types and amounts of insurance each party must provide to cover these risks.  To properly serve contractor clients, agents and brokers must gain an understanding of their contractual obligations.   

Unfortunately, many construction contracts are drafted by attorneys with an inadequate understanding of insurance coverage or the impact of insurance market conditions on coverage availability.  As a result, it is not unusual for these contracts to require coverages that are unavailable or difficult and costly to obtain.  Even more common are out-of-date requirements.  

When astutely negotiated, the construction contract can become a valuable risk management tool.  Unfortunately, many contractors routinely accept onerous contractual provisions either because they are unaware of the risks they are assuming or because they simply do not want to risk losing the job.  A better approach is to educate the other party as to the benefits of drafting clear and reasonable risk allocation and insurance provisions.  These benefits include fewer contract disputes, improved coordination of coverages, and potentially lower construction costs.  (Insurance costs are passed back to the owner in the contract price.)  While contractors may not always be able to win the desired concessions, at least they will have a clear understanding of the risks they face, and they can plan accordingly.  

Although virtually any section of a construction contract can have significant risk management implications, a few specific areas should always be reviewed: (1) indemnity (hold harmless) provisions; (2) waivers of subrogation; and (3) insurance requirements.   

Indemnity Provisions  

Indemnity or hold harmless, agreements are contractual provisions under which one party (e.g., the contractor) agrees to be responsible for certain liabilities for which another party (e.g., the project owner) would otherwise be legally responsible.  The party who agrees to take on another’s liabilities is known as the “indemnitor,” and the one that is shifting its liabilities is the “indemnitee.”  (The term “indemnify” means “to make compensation to an entity, person, or insured for incurred injury, loss, or damage.”)  

Indemnity provisions are standard in most prime construction contacts (between the general contractor and the project owner) as well as most subcontracts (between one contractor and another).  

Typically, risk is transferred “downstream,” with the project owners at the top of the construction chain, followed by the general contractor, and various tiers of subcontractors.   

Ideally, the party that is in the best position to control a loss—i.e., the one actually performing the work —should bear the risk of loss associated with the performance of that work.  Unfortunately, what often ends up happening is that the party with greater bargaining power—typically the hiring, or “upstream,” party—shifts as much risk as possible to the other party, including some liabilities over which the indemnitor has little or no control.  Significant strides have been made in drafting contracts that are more equitable but still provide adequate protection for the party hiring a contractor or subcontractor.  However, small variations in wording—in both the construction contract and the insurance policy—can have huge ramifications on the scope of the contractual risk transfer and the corresponding scope of insurance coverage.  

Types of Indemnity Agreements  

Some indemnity agreements transfer a much broader range of liabilities than others.  The three basic categories of indemnity agreements are broad form, intermediate form, and limited form (sometimes referred to as comparative negligence form.)  These are defined briefly in Exhibit 1.1.  

Exhibit 1.1 Types of Indemnity Agreements   

Limited (or comparative fault) form indemnity: As its name implies, this type of agreement obligates the indemnitor to provide indemnity only to the extent that the indemnitor was responsible for the damages.  This form of indemnity mirrors the obligations imposed by tort law.  For example, if the contractor was 20 percent at fault and the owner was 80 percent at fault, the owner would be entitled to indemnification for 20 percent of the damages sustained.  Limited form indemnity is the only type of indemnity allowed in a few states.  Intermediate form indemnity: The indemnitor assumes responsibility for certain liabilities (e.g., bodily injury and property damage) arising out of the project, except when the indemnitee was solely at fault.  Under this form of indemnity, the indemnitor must provide indemnity for liabilities arising out of its own negligence, as well as the indemnitee’s negligence, if indemnitor was responsible for any part of the loss, however slight its contributory negligence.  Whether a contractor was 10 percent at fault or 90 percent at fault, it nevertheless must indemnify the owner (indemnitee) for 100 percent of the damages).  Intermediate form indemnity is illegal in some states.  Broad form indemnity: The indemnitor assumes responsibility for certain liabilities (e.g., bodily injury and property damage) arising out of the project, regardless of which party was actually at fault.  Thus, even if the damage, injury, or claim was the sole fault of the indemnitee, the indemnitor must bear all costs associated with the loss.  Broad form indemnity is illegal in construction contracts in the majority of states.   

Clearly, the contractor’s contractual liability exposure increases as the scope of the indemnity agreement is broadened.  While at first glance, limited (comparative fault) indemnity may appear to only mimic the indemnitor’s liability under general principles of common law, it can in fact increase the liability exposure, particularly in the case of a third-party-over action.  (See Exhibit 1.2 for an illustration of a typical third-party-over action.)  In this scenario, the contractor must pay not only the workers compensation benefits proscribed by statute, but also indemnify the project owner for damages and expenses incurred as a result of the employee suit.  The amount of indemnity owed will be dictated by the type of indemnity provision in force.  

Because the obligation to indemnify is based not on statute or tort law, but solely on the contractual agreement entered into by the parties, it is a form of “contractual” liability.  The standard commercial general liability policy automatically includes coverage for many contractual liabilities, including those assumed in most construction contracts.  

Most states limit the scope of allowable indemnity.  Most commonly, they forbid or severely restrict the use of broad form indemnity in construction contracts.  Where indemnity for one’s own negligence is allowed, particularly for one’s sole negligence, the contract must clearly and explicitly state that it is the intention of the parties that the indemnitor assume liability for the indemnitee’s negligence in order to be enforceable.  

Waivers of Subrogation  

A waiver of subrogation is an agreement not to pursue legal rights of recovery against the party in whose favor the waiver is executed.  Construction contracts routinely require contractors and subcontractors to waive subrogation rights against the owner or upper tier contractor.  By agreeing to waive its own subrogation rights, the contractor is also waiving its insurer’s right to recover amounts paid under the policy from negligent third parties.   

Suppose a contractor agrees in the construction contract to be responsible for certain losses and to provide insurance to fund any losses that do occur.  A claim is filed, and the insurer pays the claim.  Absent a waiver of subrogation provision, the insurer could then make a claim against the project owner for all, or a portion, of that loss on the grounds that loss was at least partly the result of the owner’s negligence.  Clearly, this outcome—in which the project owner ultimately bears the loss—is inconsistent with what the owner and contractor agreed to in the contract.  

Waivers of subrogation allow contracting parties to effectively allocate risk in the agreed upon manner, and therefore constitute a very important and effective risk allocation tool.  However, if they are executed blindly, without consideration of insurance policy conditions, they can produce undesirable results.  A contractor that waives an insurer’s subrogation rights without that insurer’s consent jeopardizes its own ability to collect under the insurance policy.  

Many standard insurance policies (e.g., general liability) permit insureds to unilaterally waive subrogation rights prior to an actual loss, but others clearly do not permit such waivers to be executed without the insurer’s permission.  In nonstandard lines of coverage, including builders risk, commercial umbrella, contractors professional liability, and contractors pollution liability, insurers’ positions on waivers of subrogation vary.  Some allow insureds to waive subrogation rights in advance of a loss, while others clearly do not.  Often, the waiver must be in writing to be enforceable.  Workers compensation policies never allow insureds to waive subrogation rights without the insurer’s consent.  

Insurance Requirements  

Most construction contracts include a section on insurance that stipulates both the types and the amounts of coverages that each party is to provide.  Given the importance of insurance as a means of financing construction risks, it is surprising how little attention the insurance specifications sometimes receive.  Some owners and contractors forward this portion of the signed contract to their agent or broker for review, but even that basic step is frequently overlooked.  

Insurance requirements should be reasonable and obtainable.  In their desire to ensure adequate protection, owners sometimes attempt to impose overly strict insurance requirements.  This merely complicates the contracting process by making it virtually impossible for many contractors to meet the requirements.  Even if the requirements can be met, the price may be more than the parties are willing or able to pay.  

Insurance requirements should parallel the risk allocations made elsewhere in the contract.  At a minimum, most contracts address the provision of the contractor’s liability insurance (including general liability, auto liability insurance, and workers compensation and employers liability insurance), the owner’s liability insurance, and property (i.e., builders risk) insurance.  The purpose of these requirements is to ensure that the resources are available to fund the risks that each party has assumed in the construction contract.   

Contractor’s Liability Insurance  

General contractors are normally required to carry workers compensation and employers liability insurance, automobile liability insurance, and general liability insurance.  Most standard construction contracts specify only the types of coverage that must be provided.  Supplementary requirements stipulating the required limits and any additional coverage requirements are then attached to the contract.  (The required limits for each coverage will vary by project and by type of contractor.)  While umbrella liability insurance is not specifically required, many contractors need this coverage to meet the required minimum limits of coverage.   

Workers Compensation and Employers Liability Insurance  

Owners require contractors to carry insurance that will respond to claims arising out of work-related injuries.  For most contractors, a standard workers compensation and employers liability policy is sufficient to meet this requirement.  The workers compensation portion of the policy covers benefits proscribed by the applicable statute for work-related injuries.  Employers liability insurance, which is usually purchased in conjunction with the workers compensation policy, provides coverage for claims arising out of work-related injuries that do not fall within the confines of the workers compensation statutes, such as a wrongful death action by a deceased worker’s spouse or children.  

Owners sometimes require waivers of subrogation from contractors for injuries covered by workers compensation insurance.  However, the standard workers compensation policy does not permit the insured to waive the insurer’s subrogation rights.  A waiver of subrogation endorsement is needed to waive the workers compensation insurer’s subrogation rights.  A standard endorsement exists for this purpose, but in many cases it requires a significant additional premium.  Some insurers are reluctant to provide the endorsement at all.  Depending on state law, a waiver of subrogation may also encourage claims against negligent third parties, including the contractor’s indemnitees, which result in additional contractual liability claims on the contractor’s CGL policy.  

General Liability Insurance  

General liability insurance provides coverage for a broad spectrum of liability exposures.  To ensure an adequate scope of coverage, the construction contract will usually specify that the contractor must carry a specified amount of general liability insurance, and that the policy must include coverage for specific types of claims, including third-party bodily injury and property damage claims, contractual liability claims, and completed operations claims.  Some contracts will also stipulate that the policy must include broad form property damage, personal injury liability, independent contractor liability, and/or cross liability coverage.  All of these coverages are automatically provided in standard commercial general liability (CGL) policies.  

Sometimes, the contract will stipulate that the coverage provided by the CGL policy must be at least as broad as that provided under a standard policy, typically the standard Insurance Services Office (ISO) CGL policy.  While this approach provides the owner with some degree of certainty regarding the scope of coverage, it creates a burden for contractors regarding policy exclusions (which may be unavoidable) and by interfering with their established insurance company relationships.  Further, unless owners keep up with standard policy revisions, they may be surprised to find certain coverages have narrowed or disappeared under new policy editions.  

In addition to providing insurance that covers their own liability arising out of the construction project, contractors are often required to provide “additional insured” status for the project owner (or, in the case of a subcontract, for the general contractor).  Additional insured status serves a number of purposes.  First, it acts as a backup to the contract indemnity provision.  If for some reason the indemnity agreement is declared unenforceable—and therefore the policy’s contractual liability coverage does not apply—the owner can file a claim directly under the policy as an insured.  Additional insured status also provides the right to a defense from the insurer.   

While additional insured status is an accepted part of construction contract risk transfer techniques, it is also one of the most hotly contested and litigated issues in construction liability insurance.  

Additional Insured Issues   

Covered Operations 

The additional insured’s coverage should be limited to claims arising out of the operations that are the subject of the construction contract.  Otherwise, the additional insured would have coverage for liability arising out of its own operations under the contractor’s policy, which is clearly not the contractor’s intention.  This limitation should be included in both the construction contract and the insurance policy provision or endorsement where additional insured status is granted.   

Vicarious Liability versus Direct Liability 

Serious and contentious differences of opinion exist regarding the scope of coverage provided to additional insureds for their own negligence.  In many instances, resolving these disputes comes down to how the additional insured requirement and/or the additional insured endorsement are worded.  Standard additional insured endorsements have historically been interpreted to provide coverage for the additional insured’s negligence, but insurers have become increasingly reluctant to provide this broad scope of coverage.  New editions of the standard endorsements unequivocally exclude coverage for the additional insured’s sole negligence.  The key for contractors is making sure the coverage provided under the insurance policy satisfies the contract requirements.  If the contract requires a scope of coverage that the policy does not provide, the contractor must negotiate changes in the contract requirements, the insurance policy, or both, to avoid a breach of contract.   

Other Insurance 

When the additional insured has other coverage that will respond to a claim, such as its own liability insurance policy, disputes may arise as to which policy should pay first—the policy on which it is the named insured or the one on which it is an additional insured?  Usually, it is the understood intent of the contracting parties that coverage available to a party as an additional insured will be primary.  However, these intentions should be clearly stated in both the construction contract and the insurance policy.  The current edition of the standard ISO CGL policy automatically states that it is primary.  However, an exception applies when the named insured also has coverage as an additional insured under another policy.  In that case, the CGL is excess.  If both parties have a CGL with this type of provision, the order of payment will be clear.  However, nonstandard policies sometimes state that they are excess over all other available insurance.    

As an alternative to requiring additional insured status, owners sometimes require the contractor to purchase owners and contractors protective (OCP) liability insurance.  OCP insurance provides coverage to the named insured, which in this case would be the owner, for claims arising out of the designated contractor’s operations for the insured.  

Outdated Terminology  

A recurring problem with insurance specifications is the use of out-of-date terminology.  For example, although the comprehensive general liability form was withdrawn in 1986 and replaced with the commercial general liability form, many construction contracts still require “comprehensive general liability insurance.”  (Some may even require older forms of coverage, such as “manufacturers and contractors” (M&C), “owners, landlords and tenants” (OL&T), or “public liability insurance”; the latter term has not been used since the early 1950s.)  Further, a number of coverages that once required endorsements—e.g., contractual liability, broad form property damage, and personal injury and advertising injury liability—are now automatically provided by the standard CGL policy unless they are excluded by endorsement.  Nevertheless, some construction contracts still require that the CGL policy include the old endorsements.  Use of such outdated terminology confuses and complicates the contracting process.  The insurance agent or broker can bring real value to the process by periodically reviewing their clients’ construction contracts and offering recommendations for updating them to reflect current insurance terminology and methods of providing coverage.   

Auto Liability Insurance  

Most construction contracts also require automobile liability insurance.  The standard business auto coverage form (CA 00 01) is sufficiently broad to cover most of the types of exposures of concern to contracting parties, including contractual liability arising out of the use of an automobile.  (Although the CGL policy provides contractual liability coverage, it excludes liability arising out of the use of an auto.)  

Owners frequently request additional insured status on the auto policy, as well as the general liability policy.  Although the standard business auto policy’s “who is an insured” provision automatically accomplishes this by including as an insured “any party that is liable for the conduct of an insured,” many owners insist on an endorsement naming them as an insured.  Standard endorsements reiterating the owner’s status as an insured can be attached when an owner is reluctant to trust the general coverage grant, and insists on an endorsement.  

Umbrella liability Insurance  

Umbrella liability policies provide “blanket” additional limits over the contractor’s general liability, automobile liability, and employers liability policies.  In addition, umbrellas typically broaden the scope of coverage, picking up some forms of liability that are not covered in any of the underlying policies.  Construction contracts usually do not require contractors to carry umbrella liability coverage, but they often need this coverage in order to satisfy the required limits of coverage.  (CGL insurers typically only write the first $1–3 million of coverage.)   

Most umbrella policies provide some combination of excess, or “follow form” coverage, which extends higher limits to the underlying coverages, and umbrella coverage, which adds additional coverage as determined by the policy terms and definitions.  Under follow form coverage, the terms and conditions of the underlying policy take precedence over the terms and conditions of the umbrella.  For contractors, follow form coverage provides assurance that the coverages arranged under the CGL policy (e.g., additional insured status for the project owner) will carry into the umbrella layer of coverage.  If the policy does not provide follow form coverage, contractors must be careful to make sure that both the CGL and the umbrella provide coverage that conforms to contract insurance requirements.  Because policies often use different terminology and formats, this greatly complicates the compliance process.  

Builders Risk Insurance  

The construction contract should clearly delineate four key elements of builder risk coverage.  First, it should specify who will be responsible for purchasing insurance for the property under construction.  Second, it should stipulate who is covered under the policy for their interest in the property.  Third, because builders risk insurance is written primarily on nonstandard coverage forms, it should dictate a minimum scope of coverage the policy must provide.  Finally, the contract should stipulate who is responsible for any policy deductibles.  Each of these topics is addressed in more detail below.   

Who Buys the Insurance?  

Builders risk insurance can be purchased by either the project owner or the general contractor.  Some owners prefer to purchase the builders risk coverage, but unless an owner has an ongoing construction program, the contractor can often obtain broader coverage at a comparable (or lower) price through its established markets.  Since they generally bear the risk of loss, most contractors prefer to provide the insurance so they have more control over the coverage terms.  Because they buy this coverage year in and year out can take advantage of long-term relationships with underwriters and claims adjusters, including favorable negotiated rates.  If the benefits of contractor-provided coverage are explained, owners will often agree to allow the contractor to provide this coverage.   

Who is Covered?  

Since construction work is performed in stages and often involves one or more subcontractors, it is possible—even likely—that a single covered event will cause damage to various types of property owned by various parties to the project.  If each party insured its property (e.g., building materials) separately, it would be necessary to determine who owned each damaged item at the time of the loss to allocate the loss among the various insurers.  These insurers would then likely attempt to collect from other negligent parties for all or part of the amounts paid.  The potential for disputes over who owned which property and who was responsible for the damage would almost certainly delay the completion of the project.  

A better approach to insuring the property under construction, including materials and equipment that will eventually become part of the completed project, is to include all parties with an insurable interest in the project as insureds under a single builders risk policy.  That is, the owner, general contractor, at least two tiers of subcontractors (more if the lower tier subcontractors have an insurable interest in the property), and sometimes suppliers would all be named insureds under the builders risk policy.  Because all parties are insured under one policy, there is no need to ascertain who owned which portions of damaged property.  Further, as a first-party coverage, builders risk insurance applies without regard to fault; therefore, delays and disruptions will be minimized.   

Minimum Scope of Coverage  

Because builders risk insurance is generally written on nonstandard policies, the construction contract will typically dictate some minimum coverage specifications as a way of providing assurance to all parties regarding the scope of coverage.  For example, most contracts require that the builders risk policy will provide “all risks” coverage on a “replacement cost basis.”  “All risks” coverage, which covers all causes of loss except those that are specifically excluded, is broader than its “named perils” counterpart.  However, because “all risks” coverage can vary from one form to another, coverage for certain categories of property and causes of loss are specifically required in the contract.  For example, many contracts stipulate that the policy must provide coverage for property stored off-site and property in transit and that earthquake, flood, windstorm, false work, testing, and startup must be covered causes of loss.  

Deductibles  

The construction contract should stipulate who is responsible for paying any applicable deductibles under the builders risk policy.  Sometimes owners will try to make contractors responsible for paying deductibles under the theory that it provides an incentive to exercise a higher degree of care.  The problem with that rationale is that the owner often buys the policy and decides what deductible to select.  The owner may choose a higher deductible to reduce the premium and, in the process, expose the contractor to an unmanageably large uninsured loss.  This presents a situation where all of the benefits of a higher deductible are reaped by the owner, while much of the cost is borne by the contractor.  One way of addressing this issue is to require the owner to be responsible for paying any deductible amounts.  Another reasonable option is to share the responsibility for the deductible—with the contractor and subcontractors being responsible for a small portion of the deductible, and the owner responsible for the remainder.  

Owner’s Liability Insurance  

Often, the owner’s liability insurance program is not addressed in the contract insurance requirements.  Contractors can attempt to negotiate a requirement that the owner carry liability insurance to protect against the possibility of being held responsible for the owner’s negligence if the owner could not respond to a claim, as well as to protect the owner’s ability to pay for the work called for under the contract.   

Certificate of Insurance  

The most common method of ensuring compliance with contract insurance requirements is to require a certificate of insurance.  Certificates of insurance are typically issued by the contractor’s insurance agent or broker, the underwriter, or some other authorized representative of the insurer.  Certificates of insurance provide valuable documentation of coverages that are in force.  However, they are not failsafe, and they do not guarantee that the contract requirements have been met.  They merely represent the coverage that is in force at the time they are issued, and they provide very limited information about the true scope of coverage available in the policies.  For example, while certificates of insurance typically indicate the policy limits, they do not reveal whether prior or existing claims have been made on the policy, which might reduce the aggregate amount of coverage remaining available to pay claims arising out of the certificate holder’s project.  Nor do they necessarily indicate exclusions or other limitations in the policy that could restrict the scope of coverage available.  Further, policies expire; therefore, it is necessary to request new certificates periodically throughout the project to ensure ongoing compliance.  

Builders Risk Insurance  

Builders risk insurance is first-party property insurance designed to cover damage to the property under construction, as well as loss or damage to materials that are destined to become a part of the building or structure.   

Most builders risk policies are written on inland marine forms because the exposures are better matched by this type of policy than by a permanent property policy.  Although ISO introduced a standard builders risk policy form (CP 00 20) in 1992 as part of its commercial property series of forms, inland marine (nonstandard) forms tend to be broader; therefore the standard commercial property form is not widely used.  Because the coverage terms in nonstandard lines can vary widely from one form to the next, it is important to read these policies carefully.  

Key aspects of builders risk insurance include who is insured under the policy, what property is covered, and what causes of loss are covered.  Each of these is examined in more detail below.   

Covered Persons/Entities  

The party commissioning a construction project usually holds title to the land and will ultimately be the owner of the completed building.  However, the so-called project owner is seldom the sole owner of property under construction until final payment has been made to the general contractor.  Most often, the general contractor and various subcontractors purchase the construction materials and are reimbursed periodically during the construction process.  Sometimes, materials are purchased ahead of time and stored until they are needed.  Those providing financing for a construction project likewise have an ownership interest in the property.  As a result, contractors and lenders sometimes have a legitimate claim to the builders risk insurance proceeds.  

To avoid disputes between insurers over which property belongs to which party, it is advisable, and common, for a single builders risk policy to be purchased to cover all parties, including the project owner, general contractor, and subcontractors.  Including all such parties as named insureds under the policy ensures that their claims to the policy’s proceeds will be valid and enforceable.  The construction contract will dictate who is responsible for purchasing the coverage (i.e., the project owner or the general contractor) and which parties are to be insureds under the policy.  (Although some subcontractors may not have an insurable interest under the policy, to avoid unintentional omissions it is better to use blanket wording that includes all contractors and subcontractors.  Subcontractors will not be able to collect under the policy unless an insurable interest can be established.)  

The builders risk policy should be considered the first and primary source of recovery for damage to property under construction.  It would be a mistake to rely on the contractor’s general liability policy for damage to the project as there are serious limitations on the coverage available under the contractor’s general liability policy for damage to the construction project.  Further, some losses will not meet the policy’s basic requirement that the insured be legally liable for the damage.  For example, the construction contract may hold the contractor responsible for repairing any damage caused “in whole or in part” by the contractor or any subcontractors, but this obligation will not extend to certain losses over which the contractor has no control, such as those caused by perils of nature (commonly referred to as “acts of God”) including lightning, wind, flood, and earthquake.  Builders risk insurance will cover these types of losses.  

Covered Damage  

The most obvious form of loss associated with damaged property is the cost of materials and labor to repair or replace the damaged property.  These are commonly referred to as the “hard costs” of construction.  All other costs of construction—including insurance, bonds, contractor profit, and financing costs to name a few—are thrown into a catch-all category called “soft costs.”   

Most builders risk policies also cover the cost to remove debris caused by a covered property loss.  Debris removal coverage is generally included in the basic form—no endorsement is required—and is typically subject to a separate limit of liability.  

In builders risk insurance jargon, the terms “soft costs coverage” or “delayed completion coverage” are sometimes used to refer to a separate coverage under the policy that insures those costs that are “time sensitive.”  Soft costs include lost revenues and additional financing costs due to delayed completion, as well as extra expenses incurred to expedite repairs and minimize delays.  Coverage for soft costs is generally available as a separate coverage for an additional premium.   

The coverage trigger for soft costs claims is physical damage to covered property.  Therefore, a crucial step in defining covered damage is defining covered property.  Therefore, determining the scope of coverage provided under a policy requires a close examination of both the “Property Insured” and “Property Excluded” sections of the policy.  

Property Insured  

The “Property Insured” (or “Covered Property”) section of a builders risk policy denotes broad categories of property that fall within the scope of coverage.  The principle category of covered property is the machinery, fixtures, equipment, and materials that make up the building or structure under construction.  In addition, most inland marine policies cover materials and equipment that are not yet, but will eventually be, incorporated into the project.  

 Many policies also cover certain types of property such as scaffolding, false work, temporary fences, and other structures that, although they will not become a permanent part of the project, are incidental to its construction.  Coverage for these types of property is often subject to a sublimit or a separate limit of insurance.  While some policies cover materials and other incidental property only while they are located at the designated construction site, most provide coverage for such items while they are in temporary storage awaiting deliver to the site and while in transit to the site.  (When off-site and in transit coverage is not part of the standard policy, it is often available by endorsement.)   

Other potentially covered items include office trailers used by the construction team, new underground works, sidewalks and paving, and landscaping.  Many policies include sublimits for these types of property or restrict coverage for property located somewhere other than the construction site at the time of loss.  Where it is not included in the basic forms, coverage for these items can usually be added by endorsement.  It is important to consider the value of these items when determining the policy limit.  

Most builders risk forms include coverage for property of others for which the insured may be liable.  For example, borrowed or rented equipment that would be covered by the policy if owned by the insured contractor are covered if the insured is responsible for damage to the items and the policy’s other conditions of coverage are met (e.g., property is located at an insured location, no exclusions apply, etc.).  This coverage is important because most commercial general liability (CGL) policies exclude damage to property of others that is in the insured’s “care, custody, or control” and the equipment owner’s insurance may not cover damage to property loaned to others.  The builders risk policy is often the only source of recovery for this type of loss.  

Excluded Property  

In most inland marine builders risk forms, the list of excluded property is short.  The following categories of property are often excluded.  

.  Automobiles, trailers, aircraft, and watercraft  

.  Trees, grass, shrubbery, or plants  

.  Accounts, bills, currency, money, and securities  

.  Contractors’ tools, equipment, and machinery not destined to become part of the structure  

The exclusion of contractors’ tools and equipment should include an exception for scaffolding, construction forms, and temporary structures if coverage for these items is intended.  Similarly, an exception to the automobiles, trailers, aircraft, and watercraft exclusion is often available to provide coverage for office trailers used in conjunction with the construction project.  

Some insurers also exclude the following types of property.  

.  Maps, plans, blueprints, and drawings  

.  Existing buildings or structures  

.  Property being used or installed in any bridge, dam, tunnel, or similar construction  

A few forms exclude signs.  Since signs (some of them large and rather expensive) are conspicuously present at most commercial construction sites, an objection should probably be made to any such exclusion.  

Coverage for excluded types of property can often be negotiated, especially in competitive market conditions.  

Covered Locations  

At a minimum, the builders risk insurance will apply to covered property located on, or within a certain distance (e.g., 100 feet) of the construction site.  However, construction materials and equipment are often temporarily stored away from the construction site, and the contractor generally bears the risk of loss on property that is in temporary storage or in transit to the construction site.  To avoid an uninsured loss, contractors need coverage for these exposures.   

Coverage for property stored off-site and in transit to the construction site is readily available in the builders risk marketplace; therefore, forms that restrict coverage to property located at or within a few hundred feet of the construction site should be avoided.  Usually a limit for both property off-site and property in transit must be specified on the declarations page for coverage to apply.  (What is referred to here as off-site property coverage may also be labeled “temporary locations,” “any other location,” or “unscheduled” locations coverage.)   

While “in transit” coverage is readily available, it is almost always limited to inland transit.  If the project in question involves materials or equipment from overseas that will be shipped at the insured’s risk, an ocean marine policy will be needed to insure the property until it is no longer waterborne and otherwise qualifies as property in a covered location.  

Covered Perils  

Like other types of property insurance, builders risk coverage can be written on either a named perils or an all risk basis.  All risk coverage provides coverage for all perils other than those that are explicitly excluded, while named perils coverage covers only those perils that are listed on the policy as covered.  All risk coverage is more advantageous for the insured, and most inland marine builders risk policies provide all risk coverage.  

Excluded Perils  

In any all-risk insurance policy, the exclusions define the scope of coverage.  The number, type, and language of exclusions can vary significantly from one form to another, so a careful review of the excluded perils section is essential.  Exhibit 2.1 shows the most commonly excluded perils in builders risk policies.  

Many builders risk policy exclusions are negotiable.  In some cases, it may be possible to have a given exclusion deleted altogether; if not, it may be possible to limit its application.  There are several excluded perils (building ordinances, for example) for which coverage is routinely available by endorsement.  The exclusions in Exhibit 2.1 that are most open to negotiation are denoted with an asterisk.  

Exhibit 2.1 Common Builders Risk Excluded Perils   

. . . . . . . . . ... . . . . . . .  .. . ..  War, nuclear hazard, and seizure or destruction of property by governmental order Dishonest acts of the insured, the insured’s employees, and those entrusted with property (except hired carriers) Mysterious disappearance or inventory shortage Wear and tear, gradual deterioration, corrosion, rust, rot, mold, inherent vice, latent defect, insects, rodents, birds and other animals, except resulting unexcluded loss Changes or extremes of temperature and humidity Damage by rain, snow, sleet, or ice to personal property in the open Water damage caused by freezing of water in plumbing, air conditioning, or other systems, unless proper precautions have been taken Operation of building ordinances or laws* Mechanical breakdown or electrical injury*  Boiler explosion*  Testing* Earthquake, volcanic activity, and other earth movement* Flood, mudslide, sewer backup, and seepage* Settling, cracking, shrinking, or expansion of walls, ceilings, floors, roofs, foundations, etc. Design error, except resulting damage Faulty workmanship or materials, except resulting damage Release of pollutants, unless the release results from specified perils Delay, loss of use, loss of market, fines, penalties, and other consequential loss Fungus, wet or dry rot, and bacteria Asbestos removal Collapse, except from specified causes Loss covered under guarantee, warranty, or obligation of a manufacturer or supplier ______ *Often open to negotiation.   

Theft  

Virtually all builders risk forms have a dishonesty exclusion that precludes coverage for losses caused by the dishonest acts of the insured, the insured’s employees, or other parties to whom the property is entrusted (e.g., subcontractors).  Often there is a very important exception to this exclusion for the dishonesty of carriers for hire, which provides protection for theft of materials by the party hired to deliver them to the construction site or storage facility.   

Aside from the dishonesty exclusion, very few builders risk forms contain an exclusion for theft.  (Some builders risk forms exclude theft of building materials; of these, most contain an exception for theft of building materials from a fenced area.  If no such exception is built in to the language of the exclusion, an endorsement to that effect may be available on request.)  However, nearly all builders risk policies exclude mysterious disappearance or shortage that is found when taking inventory.  This exclusion is intended to prevent coverage for property that may have been misplaced, rather than stolen, and for bookkeeping errors that make it appear that property is missing that never existed in the first place.   

Wear and Tear  

The exclusion(s) of loss caused by wear and tear, deterioration, inherent vice, latent defect, animals, etc., are intended to eliminate coverage only for loss from those causes per se, but not ensuing damage.  If, for example, some defect in the property under construction were to be discovered during construction, but no damage to property other than the defective item had resulted, the latent defect exclusion would prevent coverage for the cost of repairing the defect.  However, if a latent defect were to cause the collapse of the building, the latent defect exclusion would not prevent coverage for the collapse (assuming the policy does not exclude collapse).  Many forms specifically affirm coverage for loss caused by the resulting collapse.  

Mold  

In the last few years, provisions that limit or exclude coverage for loss due to fungus have begun to find their way into builders risk policies.  Although they often use the term “fungus” or the phrase “fungus, wet or dry rot, and bacteria” (which is used in current ISO forms), they are primarily aimed at restricting coverage for loss due to mold, which is a type of fungus.   

Some forms simply exclude loss due to fungus that results from any cause other than fire and lightning.  However, many builders risk forms that contain a fungus exclusion also include an “additional coverage” for mold that adds back a small amount of coverage (such as $15,000) for loss from fungus.   

Asbestos  

Some builders risk policies exclude loss resulting from asbestos removal and enforcement of laws or ordinances regulating asbestos.  Since asbestos is no longer used in new construction, this exclusion is a concern primarily with respect to renovations, additions, alterations, and repair work.  

Ordinance or Law  

Most builders risk policies have an exclusion for costs incurred in complying with building ordinances or laws regarding repair and reconstruction of damaged buildings.  Many municipalities have ordinances that require any structure damaged to some specified extent (typically, 50 percent) to be demolished rather than repaired.  Reconstruction of the entire structure must then be in accordance with current code.  The building ordinance exclusion eliminates coverage for the cost of demolishing and rebuilding the undamaged portion of the building and the increased cost of rebuilding the damaged portion in accordance with current building codes.  However, building ordinance coverage (also referred to as demolition, contingent liability from building laws, and increased cost of construction coverage) is a built-in coverage option in some forms, and it is widely available by endorsement on request.  

Equipment Breakdown  

Many builders risk forms contain exclusions for mechanical breakdown, electrical injury to electrical devices, explosion of steam equipment, and damage to steam equipment caused by a condition within the equipment.  All of these are typical commercial property form exclusions and are aimed at loss exposures that, for existing structures, are normally covered by an equipment breakdown policy.  For property under construction, however, separate equipment breakdown policies are not common.  Instead, when a construction project presents significant equipment breakdown loss exposures, coverage is usually arranged under the builders risk policy by removing any applicable exclusion.  

The construction of a manufacturing, petrochemical, or other industrial facility presents the most obvious equipment breakdown builders risk loss exposures.  However, even office building or apartment complex construction projects can be subject to electrical or mechanical breakdown loss in connection with their heating and air-conditioning, security, and other such systems.  

Testing  

Many builders risk forms contain a testing exclusion, but the scope of testing exclusions varies significantly from one form to the next.  Most insurance and risk management professionals think of testing as running newly installed machinery and equipment at or beyond the specified limits of their capacity.  Some builders risk testing exclusions are worded so as to apply only to these types of tests.  However, a very broad testing exclusion could eliminate coverage for a surprising array of loss scenarios.  For example, an exclusion of all loss that results from testing could eliminate coverage for the collapse of a roof caused by a test of its load bearing capacity.  

Testing exclusions may include an important exception for resulting damage to property other than the equipment being tested.  Usually the exception applies to any resulting damage, but it is also possible to encounter an exception that applies only to resulting damage from specified causes, typically fire and explosion.  

Testing exclusions can sometimes be deleted by endorsement.  If not, it may be possible to have the exclusion amended to apply only to a specific testing operation or only to certain types of testing.  For example, many builders risk insurers will agree to cover damage from hydrostatic, pneumatic, or mechanical testing (types of testing that are likely to be involved in many different kinds of construction projects) but not “hot testing.”  Exactly what constitutes hot testing varies from one insurer to another, depending on the definition of hot testing in the applicable form or endorsement.  In some forms, hot testing may be defined so that it includes any kind of performance testing.  Generally, however, hot testing refers to testing a newly constructed processing facility by running the substance that the facility was designed to process through the system, to determine whether the facility meets specifications.  An oil refinery or a power plant is a classic example of a construction project with an undisputed hot testing exposure.  

Hot testing coverage is usually written subject to a separate, higher deductible.  Some insurers limit the duration of hot testing coverage.  

Faulty Workmanship or Materials  

All builders risk policies contain some sort of exclusion for losses due to faulty workmanship or materials.  The purpose of this exclusion is to avoid providing coverage for a contractor’s failure to perform the work properly.  However, most builders risk policies cover resulting damage to other property, either by exception to a faulty workmanship exclusion, or by using an exclusion of “the cost to make good or replace faulty or defective materials or workmanship” instead of a faulty workmanship exclusion per se.  This is a very important coverage distinction.  

To illustrate, suppose a faulty weld on a support beam caused the beam to collapse.  A builders risk policy that excludes loss from faulty workmanship or materials, but covers resulting damage to other property, would cover equipment and building materials struck by the falling beam and portions of walls or the roof torn down by the collapse of the beam; only the damage to the improperly welded beam would be excluded.  A builders risk policy that does not contain an exception to the faulty workmanship exclusion for resulting damage to other property would not cover any of the damage.  

Design Error  

Most builders risk policies have some sort of design error exclusion, but many provide coverage for resulting physical damage.  The latter type of design error exclusion eliminates coverage only for the cost of correcting design errors, leaving intact coverage for actual physical damage arising out of the design error.  

Collapse  

Collapse is a very significant builders risk loss exposure.  Nevertheless, some builders risk policies provide coverage on a limited basis and others exclude collapse altogether.  Under the former approach, referred to as “named perils” collapse coverage, the event leading to the collapse determines whether coverage applies.  To give some basic parameters for this coverage, Exhibit 2.2 lists the more commonly included perils in named perils collapse coverage.   

Exhibit 2.2 Named Perils Collapse Coverage—Typical Covered Perils   

....... . ..  .... . .. . . .  Fire  Lightning Explosion  Windstorm Hail  Smoke Aircraft or vehicles Riot or civil commotion  Vandalism Leakage from fire extinguishing equipment  Sinkhole collapse  Volcanic action  Falling objects Weight of snow, ice, or sleet Water damage  Hidden decay Hidden insect or vermin damage Weight of people or personal property Weight of rain that collects on a roof Use of defective material or methods in construction, remodeling, or renovation if the collapse occurs during the course of construction, remodeling, or renovation   

Named perils collapse coverage includes some important causes of collapse.  However, a glaring omission is collapse caused by design error, which is a significant exposure for property under construction.  Given the widespread availability of full builders risk collapse coverage, contractors should neither accept a collapse exclusion nor restrictive named perils collapse coverage.   

Flood and Earthquake  

Most builders risk forms contain exclusions for flood and earth movement, but coverage is often available by endorsement.  The availability and cost of flood and earthquake coverage will depend on the insurer’s assessment of that project’s loss exposures.  It is probably fair to say that flood and earthquake coverage are more readily available in a builders risk policy than in a permanent property policy.  Even so, flood and earth movement coverage are virtually always written subject to sublimits that are also annual aggregate limits, and subject to a separate deductible that is usually much higher than the deductible applicable to loss from other causes.  

Earthquake coverage on projects in high-risk areas (such as southern California) may be written subject to a percentage of loss or a percentage of value deductible, instead of a dollar deductible.  If available, a percentage of loss deductible is more advantageous to the insured than a percentage of value deductible.  To illustrate, if total values are $1 million, and an earthquake causes $100,000 of damage, a 10 percent of value deductible translates into a $100,000 deductible (and no loss recovery), whereas a 10 percent of loss deductible amounts to a $10,000 deductible and a $90,000 loss recovery.  If the exposure is judged severe, coverage may be very expensive.  Despite this, earthquake coverage is considered particularly important during the course of construction because of the reduced structural integrity of incomplete buildings.  

If coverage for flood and earthquake are being added by endorsement to a form that excludes them, it is important to compare the language of the flood and earthquake exclusions with the language of the endorsements that add back coverage.  The flood exclusion may well eliminate coverage not only for flood, but for most other types of water damage (such as sewer backup and seepage) as well.  In that case, the flood coverage endorsement should (ideally, at least) add back coverage for all of the types of water damage mentioned in the flood exclusion—not just for flood.  Otherwise, sewer backup and seepage are left uninsured.  Similarly, the earth movement exclusion is likely to be a sweeping exclusion not just of earthquake but of all types of earth movement.  Once again, the earthquake endorsement should (ideally, at least) add back coverage for all earth movement as described in the exclusion—not just for earthquake.  

Settling, Cracking, Expansion, or Contraction   

Subsidence and settling, cracking, expansion, or contraction of foundations, pavements, floors, ceilings, or roofs are likely to be excluded, either in the language of the earth movement exclusion or in a separate exclusion.  The distinction between subsidence and settling, according to Means Illustrated Construction Dictionary, is that subsidence is defined to encompass “settlement over a large area as opposed to settlement of a single structure.”  

It may not be possible to have the settling exclusion deleted; in that case, the exclusion can sometimes be amended to apply only to “normal” settling.  And if earthquake coverage is being provided, given the definition of subsidence just cited, it would be appropriate for the endorsement to specifically grant coverage for subsidence.  

Terrorism Coverage  

Builders risk policy forms that insure construction projects in the United States generally do not contain built-in exclusions of loss due to terrorism.  However, builders risk policies can be endorsed to exclude losses due to terrorism or to limit coverage for loss due to terrorism in some way, using the same standard terrorism endorsements that are used with commercial property policies covering existing facilities.  

Difference in Conditions (DIC) Coverage  

Contractors often worry about the adequacy of owner-provided builders risk coverage.  Whenever a contractor becomes involved in a construction project for which the owner is responsible for obtaining builders risk insurance, the contractor should request a copy of the policy and review it.  If coverage does not appear to be adequate (e.g., if coverage provisions fall significantly short of the modifications discussed in these pages), the contractor should attempt to persuade the owner to negotiate coverage enhancements.  Failing this, the contractor should obtain difference-in-conditions (DIC) coverage that will apply to the project.   

By attaching DIC coverage to its own builders risk policy, the contractor will have coverage during the course of the project for perils that are not insured under the owner-purchased builders risk policy but that would be covered by the contractor’s own builders risk policy.  In other words, the DIC coverage fills in the differences between the two policies.  The owner-provided policy is primary, and the contractor’s DIC coverage would apply as excess and DIC.  That is, it would pick up losses that are not fully insured under the owner’s policy or that are not covered at all under that policy.  However, remember that the DIC coverage does not expand the contractor’s policy, so any exclusions or limitations that would exist under the policy when it is the primary source of coverage will still apply.  

If the contractor has a blanket builders risk policy (one it maintains on an annual basis to cover a variety of projects), the insurer may be willing to attach an endorsement that provides blanket DIC coverage.  That is, whenever a project owner furnishes builders risk insurance, the contractor’s policy will provide DIC coverage.  An additional premium may be charged for this endorsement.  If the contractor purchases builders risk insurance on an individual job basis, DIC coverage may still be available for projects on which the contractor is covered under an owner-purchased policy.  DIC coverage is more difficult to obtain on an individual job basis, however, and will usually be more expensive than blanket DIC coverage.  

Delayed Opening/Soft Costs Coverage  

In builders risk insurance jargon, the term “soft costs coverage” is sometimes used to refer to a separate coverage for costs other than labor and materials arising out of a covered loss, such as lost earnings and additional costs incurred due to the delayed completion.  Losses under this coverage are typically time-sensitive, meaning that the longer it takes to repair or replace the damaged property, the greater the “soft costs” will be.  (“Delayed opening” and “delayed start up” are two other common names for this form of coverage.  Because it is more descriptive of the actual exposure being insured, this discussion uses the term “delayed opening” coverage in lieu of “soft costs” coverage.)   

Delayed opening coverage is generally available as a separate coverage for an additional premium.  Delayed opening coverage reimburses the insured for “covered loss” resulting from a delay in the project’s completion when the delay is a direct consequence of damage to the project by an insured peril.  (Note that coverage is predicated on a covered physical property loss.  If there is no physical damage, or the physical damage is not covered by the policy for whatever reason, neither will the resultant costs of delay be covered.)   

There are two basic types of delayed opening coverage: loss of income coverage and delay cost coverage.  Loss of income coverage applies to the income that would have been received had there been no delay in completion.  Delay cost coverage applies to the additional costs of the types specified in the endorsement that are incurred as a result of the delayed completion.  Commonly covered extra expenses include additional interest expense, additional real estate taxes, additional insurance costs, and, sometimes, additional advertising and promotional expense.  Of particular interest to contractors, some delayed opening endorsements provide coverage for “expediting” expenses incurred to expedite the repair or replacement of damaged property and thus complete the project with minimal delay.  

Some delayed completion coverage endorsements provide coverage for covered loss resulting from denial of access to the site by order of civil authority because of damage to property at a premises other than the construction site.  When this coverage extension is included, it usually grants coverage for loss suffered during either 2 or 3 consecutive weeks following the date of the order.  

Exclusions  

Delayed opening endorsements usually contain several exclusions that preclude coverage when reconstruction or repair delays are encountered due to the following.  

.  Strikes  

.  Suspension, cancellation, or lapse of a license, lease, contract, or order  

.  Building laws or ordinances  

.  Any consequential loss other than those specifically covered by the endorsement  

Coverage for damage to property in transit and enforcement of building ordinances is usually available by endorsement.   

Efficacy or Systems Performance Coverage  

Efficacy insurance, also referred to as systems performance insurance, is designed to guarantee the insured’s ability to pay its debt service costs (principal plus interest payments due under the permanent financing agreement) and other continuing expenses if the plant operations do not meet the expected level of performance.  The coverage can also be written to indemnify the insured for the costs to modify or repair the facility in order to achieve the expected level of performance.  When the project owner is the insured, there is often a recapture provision under which the project owner agrees to reimburse the insurer for its paid losses once the facility becomes profitable.  Sometimes this provision can be deleted for an additional premium.  

Efficacy insurance is typically written on energy-related construction projects, such as geothermal or hydroelectric plants.  Obtaining efficacy insurance can help the project owner secure the capital necessary to finance the project.  A guarantee that loan payments will be made even if the facility should prove unable to perform technically at the anticipated level can sway an otherwise undecided prospective lender.  While it is primarily designed to meet the needs of plant owners and their lenders, it can be written to cover the interests of others, such as the project designers and contractors.   

To avoid adverse selection, insurers require that the coverage be negotiated before the start of construction, even though the policy does not attach until construction and testing are complete.  The underwriting process is very involved.  Typically, the insurer retains an independent engineering firm to review the plans for the project, at the prospective insured’s expense.  The policy can be written to provide coverage for as long as 7 years after the start-up of the facility.  Normally, the policy is noncancelable except for nonpayment of premium, since it would be of little value without such a provision.  Premiums generally range from 1 to 10 percent of the selected limit of insurance.  

Limits  

Builders risk policies typically have not just one but several limits of liability.  The most common arrangement is to have one limit applicable to property at the construction site, another limit applicable to property in transit, and yet another limit applicable to property at off-site storage locations.  Sublimits may also apply to certain insured perils, such as earthquake, flood, and testing, or to certain types of property, such as scaffolding, fences, and temporary structures.  Flood and earthquake coverage sublimits are usually annual aggregate limits as well.  

Delayed opening (“soft costs”) coverage limits usually apply in addition to the builders risk direct damage limits.  There may be a separate limit for each specific delay cost that is covered, or there may be a single blanket delayed opening coverage limit that applies to all covered loss.  

Builders risk insurance can be purchased on either a specific or a blanket basis.  When coverage is arranged on a specific basis, the project owner or contractor simply purchases a separate builders risk policy for each project.  This method is appropriate for owners whose involvement in construction projects is infrequent.  Organizations with multiple construction projects under way at the same time, including construction contractors, can purchase a blanket builders risk policy covering all projects undertaken during the policy period.  The blanket approach to builders risk insurance allows the contractor to negotiate rates and coverages once a year instead of separately for each project.  

Blanket builders risk policies contain a “per location” loss limit.  Often, different limits (and different rates) will apply to different types of construction.  For example, there might be a $5 million per location limit applicable to construction of steel and masonry structures and a $1 million per location limit applicable to construction of frame structures.  Coverage for new construction projects is generally temporary (commonly, for 60 days from the onset of construction), and subject to a separate, reduced limit until the project has been specifically accepted by the underwriter.  

Valuation  

Builders risk insurance can be written on either a reporting form or a completed value form.  With either approach, the anticipated completed value of the project is used as the limit of insurance.  Where the two forms differ is in the area of premium calculation and payment.  

Completed Value Method  

The completed value form is by far the most popular method of insuring construction projects.  The policy premium is calculated at policy inception by multiplying the anticipated completed value of the project by a rate that is typically 50 to 55 percent of the reporting form rate.  This method recognizes the fact that the average value exposed to loss during the project is approximately one-half of the project’s completed value.   

Many completed value forms have a 100 percent coinsurance clause that penalizes the insured if the limit of insurance is less than the estimated completed value at the time of loss.  If the estimated completed value of the project changes during construction, these policies must be endorsed to reflect the new estimated value to avoid a coinsurance penalty.  Other forms require annual reports of the estimated completed value, and a report or audit of the final value at time of completion.  The premium is then adjusted in accordance with the actual completed value.   

Reporting Method  

Reporting form builders risk policies usually show the anticipated completed value as the limit of insurance.  The policy premium is generally calculated and paid periodically throughout the policy term based on the periodic (usually monthly) reports of values that the insured is required to submit.  The obvious advantage of a reporting form is favorable cash flow.  Not only does this scheme provide for monthly premium payments, instead of full payment at policy inception, but it also defers the bulk of the premium until the later phases of construction since values start low and increase gradually as construction progresses.  

However, reporting forms also have serious disadvantages.  It is essential that the reports be both timely and accurate.  Reporting forms impose severe penalties for late reporting and underreporting.  Most forms stipulate that late reporting limits loss recovery to no more than the value last reported for that location; locations not shown on the previous report of value are not covered at all.  The increased administrative burden and the risk of uninsured losses due to the failure to file accurate and timely reports is enough to persuade many contractors to sacrifice cash flow and use a completed value form.  

Most reporting forms also have a full value reporting requirement that is the equivalent of a 100 percent coinsurance clause.  Without this clause, insureds could increase their cash flow benefit by underreporting values since the higher premiums would be pushed further into the future.  Since the policy limit is the completed value, they could accomplish this without risking an uninsured loss.  Full value reporting requirements remove this incentive by providing that in the event of loss, if the insured is found to have underreported the values for that location on the last report, recovery is limited to the portion of the loss equal to the ratio of the reported values to the actual values as of the report date.  For example, if the last reported value is $1.2 million and the actual value as of that report date is discovered after a loss to have been $2 million, the insurer will pay only 60 percent (1,200,000/2,000,000) of the loss.  

Coverage for Overhead and Profit  

The valuation provisions in some builders risk forms make it very clear that the value of damaged covered property that is repaired or reconstructed includes the contractor’s overhead and profit.  For example, the valuation provision in one form states that the value of covered property will be “the actual cash value of that property, including your labor, reasonable profit, and delivery charges.”  Another form says, “We will pay the actual cost to repair, replace, or rebuild the damaged property with substantially identical materials, plus reasonable overhead costs, including profit, if these costs are included in the limit of insurance shown on the declarations....”  This type of language eliminates any doubt about whether an insured contractor is entitled to recover for overhead and profit on the repair work.  However, it is important to realize that all builders risk policies provide coverage for the contractor’s overhead and profit, regardless of whether the form in question contains a clear statement to that effect.  Contractor overhead and profit is a simply a component of the repair cost—one that is every bit as legitimate as the bricks-and-mortar component of the cost.  

Deductibles  

Builders risk coverage is almost always written subject to a per occurrence deductible.  In fact, often there are several deductibles: one deductible that applies to all losses except those subject to a specific deductible, and separate, higher deductibles applicable to loss from flood, earthquake, testing, and sometimes windstorm, vandalism, and theft.  If the policy includes other coverage options, such as delayed opening coverage, separate deductibles may apply to these as well.  

Waiver of Subrogation  

When a loss occurs on a construction project, the ultimate goal of the parties involved is to get the project back on track by replacing damaged property.  Since various parties may have ownership interest in property under construction or property to be incorporated into the project, it is widely recognized that all parties—including the owner, general contractor, and all subcontractors—should be insureds under one policy.  

One way to strengthen the contracting parties’ intent for the builders risk policy to be the sole source of recovery for damage to the project is to include a mutual waiver of subrogation provision in the construction contract in which the owner, the general contractor, and subcontractors mutually agree to waive their rights of recovery against one another with respect to losses covered by builders risk insurance.  When this is done, it is important that the insurance policy allow such waivers.  

Some builders risk policies permit an insured to waive its rights of recovery against another party prior to a loss.  The insurer, in that instance, forgoes its subrogation rights against such parties.  However, builders risk policies are not standardized, so it is important to carefully review the policy’s subrogation provision (sometimes called the waiver of recovery rights provision), to be certain the waivers of subrogation are allowed.  Some policies allow pre-loss waivers on a limited basis, with exceptions for specified parties, such as architects, engineers, manufacturers, or suppliers of equipment or materials, or some combination of these parties.  A waiver of subrogation endorsement specifically granting the right to waive the insurer’s subrogation rights adds extra assurance that insurers will not attempt to subrogate against the contracting parties.   

Although most insurance professionals would expect those with insured status to be exempt from subrogation actions for damages paid under the policy, that is not always the case.  The fact is, builders risk insurers can and do pursue subrogation against insureds for damages paid to other insureds under the policy.  That is, while the insurer may not be able to subrogate for damages paid for property owned by an insured, some insurers may pursue subrogation actions against one insured for damages caused to another insured’s property.  (This argument is generally based on the use of the phrase “as their interests may appear” in the granting of insured status.)   

In summary, there are three key steps to avoiding subrogation actions against contracting parties by the builders risk insurer:  

.           Include a mutual waiver of subrogation in the construction contracts with respect to damages covered by the builders risk insurance.   

.           Name all contracting parties with a potential insurable interest in the property as insureds on the policy, being careful to avoid using the phrase “as their interests may appear.”   

.           Attach a waiver of subrogation endorsement that affirms the insurer’s agreement not to pursue subrogation actions against the contracting parties.  

General Liability  

The standard Insurance Services Office, Inc. (ISO), commercial general liability (CGL) policy is divided into three basic coverages: bodily injury and property damage liability (Coverage A), personal and advertising injury liability (Coverage B), and medical payments (Coverage C).  Most construction-specific coverage issues, summarized below, pertain to Coverage A, “bodily injury” and “property damage.”  Consequently, that section of the policy will be the primary focus of this chapter.  Many coverage issues that are of interest to other industries or insureds are not covered at all in this section.  Rather, the purpose of this chapter is to identify the scope of coverage contractors can expect under a general liability policy for construction-related risks.  Excess and umbrella coverage is discussed briefly at the end of the chapter.   

For the remainder of this chapter, references to the CGL policy imply the 2004 edition of the standard Insurance Services Office (ISO) CGL policy (CG 00 01 12 04) unless otherwise noted.  Although some insurers use their own nonstandard policy forms, most provide coverage comparable to that provided in the standard CGL policy; however, contractors (and their insurance representatives) should read all policies carefully to make sure the coverage is as expected.  Unless otherwise noted, the discussion in this chapter assumes the named insured is a contractor or subcontractor.  

Construction Exposures  

Contractors face a number of construction-related liability exposures.  Damage to the property under construction, damage to other property, and injury to an employee or a third party are but a few of the exposures that contractors face on almost every project they undertake.  When these damages can be attributed to the contractor’s negligence, or another source of legal liability, the contractor is responsible for damages that occur.  In some cases, the contractor may be liable when someone else’s negligence was the cause of the loss—such as when they are held liable for injury or damage caused by a subcontractor and when they have contractually agreed to assume another party’s liability for such losses.  Liability can arise not only during the course of construction, but for many years after construction is completed.   

The preceding paragraph identifies at least five major “types” of exposures for which contractors look for coverage under their general liability policy.  For easy reference, these exposures and the CGL applicability to them, are summarized in Exhibit 3.1.  Although the CGL policy never specifically grants coverage for “broad form property damage”, “contractual liability”, or “independent contractor liability”, it provides all of these coverages—and then some—under its broad “Coverage A” insuring agreement.  The exact scope of coverage for these sources of liability is sculpted in the policy exclusions.  Broad form property damage and contractual liability coverage receive particularly detailed attention in the CGL exclusions.  In fact, what coverage exists for these exposures is defined in the exceptions to the exclusions.  

Exhibit 3.1 Construction Exposures and CGL Coverage   

Contractor’s Exposure:  The standard CGL policy:   

Damage to the property under construction - Provides significant coverage with respect to the contractor’s liability for damage to the property under construction.  (Sometimes referred to as “broad form property damage” coverage.)   

Independent contractor liability - Responds to a contractor’s liability for the actions of its subcontractors.   

Contractual liability - Covers the insured’s assumption of liability in an “insured contract”, which includes a hold harmless or indemnity provision in a construction contract or rental agreement.   

Completed operations - Covers bodily injury or property damage that occurs during the policy period, even if the work that produced the injury or damage was performed many years prior.    

“Other” third party bodily injury and property damage - Covers a broad array of claims for bodily injury or property damage sustained by third parties.    

Insuring Agreement  

The Coverage A insuring agreement stipulates the required conditions for coverage to apply, such as what events will trigger the coverage and what types of damages are covered.  These key elements of coverage are listed in Exhibit 3.2 and discussed further below.  

Exhibit 3.2 Elements of a Covered Loss   

. . . . .  “Bodily Injury” or “property damage” occurs during the policy period.  “Bodily Injury” or “property damage” is caused by an “occurrence.”  The “occurrence” takes place in the “coverage territory.”  The insured is legally liable for the loss.  The insured was not aware of the “bodily injury” or “property damage” before the policy period began.   

In addition to damages for covered “bodily injury” or “property damage,” the CGL will pay costs incurred in defending or settling a claim.  In the standard CGL policy, and most nonstandard policies, defense costs are payable outside the policy limit, which means they do not reduce the amount of insurance available to pay claims.   

Coverage Trigger  

Almost all contractors’ CGL policies are written on an occurrence basis, which means that the bodily injury or property damage giving rise to the claim must have occurred during the policy period.  Specifically, the policy states that it applies to “bodily injury” and “property damage” that occurs during the policy period and is caused by an “occurrence” that takes place in the “coverage territory.”  (Note that it is the occurrence of bodily injury or property damage, not the event that produces the bodily injury or property damage, that triggers the policy.  The time of the incident that led to the injury or damage is irrelevant to coverage under the CGL, as is the time at which the claim is filed.  Many insurance professionals and a number of courts have failed to recognize this distinction.)  

At first glance, it may appear that determining the time at which bodily injury or property damage occurs is a simple task, but in construction it often is not.  Sometimes injuries are the result of gradual exposure to a hazardous condition and are not immediately apparent.  Asbestosis is a classic example of a situation in which an injury may start at one point in time and progressively worsen until its effects are finally discovered.  Did the injury occur when the person was exposed to asbestos, when the first signs of injury would have been visible (had they known to check for it), or when the person began to feel the effects of the illness?  This distinction is important, because the time at which the injury occurred determines which CGL policy has been triggered by the claim.  (The answer to that question depends on a number of factors, including the jurisdiction in which the claim is filed.  The arguments for each position, however, are outside the scope of this course.)  Contractors are wise to maintain files of their expired policies for as long as space and administrative resources allow.  As long as the limits of coverage have not been exhausted, these policies may still prove valuable long into the future.  Insurers were paying pollution liability claims well into the 1990s or beyond on policies issued in the 1960s and 1970s.  

The occurrence trigger sometimes makes completed operations coverage confusing.  If expired policies will pay for injuries arising out of past projects, why do contractors need coverage for completed operations under their current policies?  Sometimes injury or damage arising out of past projects does not occur until well into the future.  Remember, it is not the time when the event that caused the damage (e.g., the negligent act) took place that triggers the policy, but the time when bodily injury or property damage occurs.  By covering injury or damage that occurs during the current policy period, but is the result of work that has already been completed, the policy is providing coverage that would not exist under prior policies.   

To illustrate, suppose a building’s roof collapses under the weight of snow in 2006, causing damage to the building and its contents and injuring five people.  The cause of the collapse is determined to be improper spacing of support beams in the roof, in direct non-compliance with the architect’s instructions.  The building (including the roof) was built during a time frame spanning May 2004– June 2006.  Which policy is triggered?  The one in effect in 2006 when the roof collapsed.  If the 2006 policy does not cover losses that are the result of completed projects, there would be no coverage for this loss.  

Beginning with the 2001 edition of the ISO CGL, a “known loss” provision is included in the insuring agreement which stipulates that, for coverage to apply, the insured must not have been aware of the bodily injury or property damage, or even the “occurrence” giving rise to the injury or damage, prior to the inception date of the policy.  The policy further specifies what constitutes “knowledge of a loss or claim.”  Insurance professionals generally understood this to be an accepted part of insurance law, but some court decisions to the contrary led insurers to explicitly include a “known loss” provision in the policy.  

Covered Damages  

The Coverage A insuring agreement provides that coverage applies to liability for “bodily injury” or “property damage.”  The policy’s definition of “bodily injury” includes sickness, disease, and death, as well as physical injury to a person.  Mental injuries, such as mental anguish and emotional distress and other disorders, are covered if the applicable case law deems these types of injuries to be bodily injuries.  (In most jurisdictions, these types of injuries are covered only if there is accompanying physical injury.)  Insurance professionals must distinguish between “bodily injury” and “personal injury.”  While attorneys frequently use the latter term to refer to physical injuries to a person (what the CGL refers to as “bodily injury”), insurance parlance clearly distinguishes the two.  In the CGL policy, “personal injury” refers to a variety of offenses against a person other than a physical injury, such as invasion of privacy, slander, libel, trespass, and false imprisonment.  Personal injury (along with advertising injury) is the subject of an entirely separate coverage part under the CGL (Coverage B), with its own insuring agreement and exclusions.  

The policy’s definition of “property damage” includes physical damage to property and the accompanying loss of use of that property, as well as loss of use of property that has not been physically damaged.  Loss of use claims can include loss of rents, increased living expenses, and even diminution in value.  This is important coverage for contractors where a damaged building or structure might be wholly or partially uninhabitable, or suffer a permanent loss in market value due to a contractor’s negligently performed work.   

Coverage Territory  

For coverage to apply to “bodily injury or “property damage” the occurrence must take place in the “covered territory.”  The CGL policy’s coverage territory categorically includes the United States, its territories and possessions, Puerto Rico, and Canada.  Coverage is also available under certain conditions for occurrences that take place in other locations.  For example, international waters and airspace are part of the coverage territory if the injury or damage occurs during transportation between the covered territories listed above.  Coverage applies worldwide with respect to injury or damage arising out of goods or products made or sold in covered territories or the activities of a person who resides in a covered territory but is temporarily away on business.  (Note that it is the event causing the bodily injury or property damage that must take place in the coverage territory, and not the injury or damage itself.)   

Exclusions  

Once the insuring agreement’s conditions have been met and the policy has been triggered, any liability for damages because of “bodily injury” or “property damage,” is covered, subject to the policy limit—unless an exclusion applies.  Most CGL exclusions are designed to remove coverage for exposures that are not common to most insureds, that are customarily covered under other insurance policies, that underwriters are not willing to cover on a blanket basis, or that are considered uninsurable.  

Many of the CGL exclusions remove virtually all coverage for a certain category of injury or damage.  However, exceptions to the exclusion are then used to sculpt a more precise application of the exclusion by stipulating certain types of injury or damage to which the exclusion will not apply.  Insurance professionals sometimes make the mistake of believing that the exception actually “creates” coverage, when in reality all it says is that in this specific instance the exclusion does not apply, therefore any coverage granted by the insuring agreement remains.  This is an important distinction, and the misunderstanding of the way coverage is granted has generated a great deal of confusion and litigation.  

To illustrate, the contractual liability exclusion contains an exception for liability assumed in an “insured contract” (see discussion below).  This exception has led some to believe that as long as the contract is an insured contract, the policy will cover any type of liability assumed in that contract.  This is not so.  All the policy says is that the contractual liability exclusion will not operate with respect to liability assumed in an “insured contract.”  Because Coverage A only insures against “bodily injury” or “property damage,” only contractually assumed liability for damages resulting from “bodily injury” or “property damage” are covered.  So, in looking at the following exclusions, and the exceptions to the exclusions, keep in mind that in no instance is the coverage retained through an exception to an exclusion broader than the coverage granted in the insuring agreement.  

Exhibit 3.3 Coverage A Standard Exclusions    

. . .. . . . . .  . . . . . . .  Expected or Intended Injury Contractual Liability  Liquor Liability Workers’ Compensation And Similar Laws Employer’s Liability Pollution Aircraft, Auto Or Watercraft Mobile Equipment  War Damage To Property Damage To Your Product Damage To Your Work Damage To Impaired Property Or Property Not Physically Injured Recall Of Products, Work Or Impaired Property  Personal And Advertising Injury Electronic Data (new in the 2004 CGL)   

Contractual Liability Exclusion  

As discussed previously, contractors often assume substantial liabilities in indemnity, or “hold harmless,” provisions in construction contracts.  In many cases, the CGL will cover such liabilities.  However, insurers certainly do not intend to cover all liability arising out of all contractual agreements the insured might make.  To clarify which contracts are covered, the contractual liability exclusion first eliminates all coverage for bodily injury or property damage arising out of an assumption of liability in a contract.  Two subsequent exceptions to the exclusion leave coverage in place with respect to liability (1) “that the insured would have in the absence of the contract or agreement,” and (2) assumed in an “insured contract,” as defined in the policy.  

The first exception to the exclusion, which clarifies that coverage is available to the insured when liability would exist even in the absence of a contract or agreement.  This merely prevents the insurer from using the fact that a contract stipulates that the contractor is responsible for damages caused by its own negligence (which it would be under common law even without the contract) to exclude coverage.  For example, assume that Trade Construction Company is retained by Buildings, Inc., to finish out some office space in one of its office towers for a new tenant.  The contract requires Trade to hold harmless and indemnify Buildings for any property damage to the building arising from Trade’s operations therein.  A fire erupts one evening, damaging several floors of the building, and it is determined that the fire resulted from Trade’s operations.  Since Trade is accountable by law for its own torts, the CGL policy should respond on behalf of Trade for its liability to repair the damaged building (except for any portion of the loss that is subject to the policy’s damage to property exclusion, exclusion j.).  The fact that Trade had also contractually agreed to be responsible would not preclude coverage.  

If the liability of the insured would not have applied in the absence of a contract or agreement, it must have been assumed in an “insured contract,” for the insured to have coverage.  For example, assume that the contract between Trade and Buildings requires Trade to indemnify and hold harmless Buildings for any damage to the office building, regardless of the cause.  The fire breaks out on a floor other than the one on which Trade is working and can in no way be attributable to Trade’s negligence.  Since Trade would not be liable in the absence of the contract, any coverage for liability Trade incurs for damage to the building because of this contractual agreement would be have to come under the second part of the contractual liability provision, the exception for an “insured contract.”   

Definition of “Insured Contract.”  

The CGL policy’s definition of “insured contract” includes six distinctive categories of contracts that will qualify for the exception to the contractual liability exclusion.  The first five parts of this definition grant “insured contract” status based on the type of contract.  The last part addresses a type of provision that can appear in a broad array of business contracts.  Fortunately, many of the agreements contractors routinely enter into are “insured contracts,” including property leases and indemnity agreements within equipment rental and construction contracts.  Exhibit 3.4 summarizes the types of contracts that meet the policy’s definition of “insured contract.”  

Exhibit 3.4 Categories of “Insured Contracts”   

CATEGORY  EXCEPTIONS (Not an “Insured Contract”)   

a. Lease of premises  That portion of the contract that indemnifies any person or organization for fire damage to the premises while rented to, or temporarily occupied by, the named insured (if the occupancy is with the owner’s permission.)   

b. Sidetrack agreement   

c. Easement or license agreement - Executed in connection with construction or demolition operations on or within 50 feet of a railroad;   

d. An obligation under city ordinance to indemnify a municipality - Contract for work for a municipality   

e. Elevator maintenance agreement   

f. That part of any other contract or agreement pertaining to your business under which you assume the tort liability of another party to pay for third-party “bodily injury” or “property damage.”  Agreement to indemnify a railroad for injury or damage arising out of construction or demolition operations, within 50 feet of any railroad property, including any railroad bridge, trestle, tracks, roadbeds, tunnel, underpass, or crossing.-  An agreement to indemnify an architect, engineer or surveyor for injury or damage arising out of: (a) the preparation or approval (or failing to prepare or approve) of design-related documents; or (b) giving (or failing to give) directions or instructions.  An agreement under which an insured architect, engineer, or surveyor assumes liability for an injury or damage arising out of: (a) its rendering (or failure to render) professional services; and (b) its supervisory, inspection, architectural, or engineering activities.   

It is very common for premises leases to include a hold harmless clause requiring the lessee to hold the property owner harmless for liability arising from the use of the premises.  This portion of the definition would pertain to the contractor’s leased premises, such as its offices and storage facilities, and not to the construction site.  An exception to this category of contracts is for damage to the premises caused by fire if the insured is liable solely on the basis of the contractual agreement, and not under tort law.  (Another policy exclusion excludes coverage for damage to property owned, rented, or occupied by the named insured for which the insured is liable.  This exposure is best handled by purchasing first-party property insurance on the leased premises to protect the interests of both parties.)  

Note that leases of property other than premises are not “insured contracts” under this part of the definition.  However, indemnity agreements within leases involving other types of property may qualify under category f. of “insured contracts.”  The distinction is important because the latter category is more restrictive with respect to the types of liability that are covered.  Specifically, the last category of contracts applies only to the assumption of another party’s tort liability, whereas the lease of premises category contains no such restriction.  

Many insureds have spurs or sidetracks that connect their facilities to the main railroad line.  The railroad will normally require the firm to hold it harmless from losses arising out of the use of the sidetrack.  Such sidetrack agreements are “insured contracts.”  

An easement is an interest that one party has in the land of another or a right of use over another party’s property.  An easement may be implied or it may be created by necessity or by prescription.  An easement by prescription arises when one person uses another person’s land for some period of time during which the owner of the property does not object to the use of the property.  For example, in a construction setting, an adjacent property owner may consent to allow the contractor to use its property to access the construction site.  A license is a right to come onto another party’s property that arises from the consent of the owner and can be revoked at any time.  With an easement or license agreement, it is generally the party enjoying the benefit of being on the property of another who assumes the liability of the property owner.  Easement and license agreements are “insured contracts” unless they are in connection with construction or demolition operations on or within 50 feet of a railroad.  Insurers active in construction insurance will usually attach an endorsement that brings indemnification agreements executed in connection with operations on or near a railroad under the definition of “insured contract.”  

Many municipalities have ordinances requiring indemnification from private citizens or organizations that erect any kind of obstruction or device that can cause bodily injury or property damage to members of the public, and these also qualify as “insured contracts.”  This indemnification requirement may simply result from an ordinance—it is not necessarily imposed by a specific contract between the municipality and the insured.  However, if a contractor performs work for the municipality, an ordinance-imposed indemnification in connection with that work is not included in this particular portion of the definition of “insured contract.”  Such indemnification is included as an “insured contract” under Paragraph f. of the definition.  

An agreement stipulating terms for maintaining or servicing elevators is an insured contract under part e. of the definition.  Because of the similar purpose, operation, and use of the two, this definition would probably encompass escalator service agreements as well.  

The last category of insured contracts, Paragraph f., is where contractors obtain coverage for liabilities assumed in construction contracts, purchase orders, rental and lease agreements for equipment or other personal property, sales agreements, and similar contracts.  To qualify, the contract must pertain to the named insured’s business and it must be made before the “bodily injury” or “property damage” occurs.  Thus, contractors cannot obtain coverage for liability assumed after a loss has occurred.  While it might seem unlikely that any contractor would voluntarily agree to pay such a loss, if not doing so means losing a valuable client, the contractor might consider the loss of future revenues to be more damaging than any amounts it has to pay for this loss.  Contractors are free to pay others’ losses even when they are not contractually obliged to do so, but they cannot look to their insurance policies to pay these losses.  

When an insured contractor agrees to assume the tort liability of a project owner, another contractor, or an equipment lessor for bodily injury or property damage, the contractor’s policy will respond to that liability, subject to the policy’s other exclusions and conditions.  No limitations are placed on the degree of contractually-assumed liability that is covered.  That is, the policy will respond to contractual liability arising from the indemnitee’s sole negligence, joint negligence, or contributory negligence as long as the contract in which the liabilities are assumed is an “insured contract,” the indemnity clause is valid and enforceable, and the liability is for bodily injury or property damage.  (An optional standard endorsement was filed in 2004 that removes broad form indemnity provisions—in which the indemnitee transfers liability for loss arising out of its sole negligence— from the definition of “insured contract.”  See the discussion of additional insured endorsements later in this chapter.)  

Notice that only the portion of the contract where the insured assumes the tort liability of another (e.g., the indemnity provision) is considered an “insured contract.”  This clarifies that the contractual liability coverage of the CGL policy will not respond to a warranty of performance, breach of contract, or any other form of contractual obligation that is not based in tort law.  The contract does not have to be in writing, although that is certainly helpful in establishing the intent of the parties.  In construction, this can be very beneficial in that work often begins before the contracts are actually signed.  If the existence of an implied or verbal agreement for indemnity can be established, the CGL policy will cover the contractor’s indemnification obligation.  

Three exceptions specify types of provisions that are not insured contracts.  The first of these is an agreement to indemnify a railroad for bodily injury or property damage arising from construction or demolition operations on or near railroad property.  Such indemnification is commonly imposed on street and road contractors as well as other contractors working on or near railroad property.  Since they are specifically not included as insured contracts, no coverage would apply to these assumptions of liability.  

The common method of insuring this exposure, and the method typically required by railroads, is for the contractor to purchase a railroad protective liability policy, under which the railroad is the named insured.  However, the purchase of such a policy does not necessarily eliminate the contractor’s contractual liability exposure under the agreement with the railroad for two reasons.  First, a liability loss involving a train can easily exceed the policy limits of the railroad protective policy, and the railroad will undoubtedly seek indemnification for its loss in excess of its insurance protection.  Second, railroad protective insurers usually maintain the right to subrogate against the contractor.  If the contractor was negligent in causing the loss—and would be liable even in the absence of the contractual assumption—the contractor’s CGL policy would cover the subrogation action.  If, however, the subrogation action is based on the indemnity obligation in the contract, the CGL policy would not respond.  For these reasons, this coverage limitation should be deleted from the CGL policies of contractors who agree to indemnify railroads in connection with their work.  A standard endorsement is available for this purpose.   

The second and third exceptions to the definition of “insured contract” pertain to professional liability with respect to architects, engineers, or surveyors.  These exceptions are intended to prevent professional liability claims from being covered under the CGL’s contractual liability insurance.  (A separate endorsement is often attached to the policy to preclude coverage for direct claims involving professional liability.)  While in general it is not legally permissible to contractually transfer the professional liability of an architect or engineer to another party, these types of transfers do sometimes appear in design contracts.  This exception makes it clear that such contractually assumed liabilities are excluded.  

The exception for the assumption of professional liabilities is frequently misunderstood to be a total exclusion of liabilities assumed in a contract with a design professional.  While contractors must be extremely careful not to accept transfers of professional design liability, other forms of liability that are transferred from a design professional to the contractor may be covered.  For example, liability incurred by the design professional arising out of ordinary (not professional) negligence would be covered if the contractor has assumed responsibility for these liabilities in an enforceable hold harmless agreement.  It is only the assumption of professional liability that is excluded.  

Defense of Indemnitees  

The prevalent practice among general liability insurers is to provide a defense for their insureds’ indemnitees in conjunction with the defense provided to the insured.  In most cases, the same cause of action will involve a claim against the insured contractor and its indemnitee, which makes mounting a defense for both parties not only practicable, but prudent.  Since the CGL insurer will probably be responsible for any damages awarded against the indemnitee (because of the insured’s contractual obligation to pay those damages), most insurers provide the indemnitee with a defense simply as a way of protecting their own interests.  

The issue of how costs incurred in defending indemnitees are covered is spelled out in the Supplementary Payments provision.  If certain conditions are met, a duty to defend an indemnitee is created, and defense costs are payable as supplementary payments outside the policy limits.  However, if any of the conditions is not met, there is no duty to defend, and the indemnitee’s defense costs are payable under the contractual liability coverage as damages.  (Both of these scenarios assume the contract in which liability for these amounts was assumed is an “insured contract.”)   

Unfortunately, there are some problematic conditions for qualifying an indemnitee’s defense costs for coverage under the supplementary payments provision.  First, the duty arises only when the insured and the indemnitee are named in the same suit.  A number of circumstances can give rise to a suit against the indemnitee (e.g., project owner) in which the insured itself is not a defendant.  By far the most common such circumstance is a third-party-over action, in which a suit is brought against the indemnitee by an employee of the insured contractor.  In that instance, the injured employee collects workers compensation benefits and is barred from pursuing further action against the contractor.  The employee can, however, file a suit against the project owner alleging some form of negligence, such as failure to warn of known dangers.  This scenario is played out frequently on construction projects and is in fact one of the main risks owners cite in requiring a strong indemnity provision.  Because the contractor is not also named in this suit (nor can it be), the duty to defend is not triggered.  Coverage in this case would revert to the defense costs being covered as damages.  If the defense costs plus any damages that are eventually awarded against the indemnitee exceed the available policy limit, the contractor is left holding the bag for the remainder.  

A second problem is the duty imposed on an indemnitee to notify its own insurer of the suit and to cooperate in coordinating coverage with that other insurer.  In other words, the contractor’s CGL insurer clearly contemplates some form of contribution toward the indemnitee’s defense costs from the indemnitee’s own CGL insurer.  Such contribution would undercut the very concept of indemnification and run counter to the indemnitee’s motive for requiring a hold harmless agreement from the indemnitor in the first place.  

This approach to defense of indemnitees falls far short of representing a reliable source of defense when the obligation of providing that defense has been contractually transferred to another party.  Additional insured status remains a useful method of guaranteeing access to defense rights under an indemnitor’s liability policy.  Additional insured status is discussed in greater detail below.  

Employers Liability Exclusion  

Liability for “bodily injury” to any of the contractor’s employees arising out of their employment is not covered under the CGL policy.  These injuries are normally covered by workers compensation insurance, but even if they fall outside the workers compensation statute, they are not covered by the CGL policy due to the employers liability exclusion.  Also excluded are claims for consequential bodily injuries by employees’ family members (e.g., mental anguish of an injured employee’s spouse) and dual capacity (e.g., a products liability suit by an employee) claims.  These types of claims are specifically covered under the employers liability section of the workers compensation insurance policy, which is discussed in Chapter 7.  

The only exception to the employers liability exclusion is liability that the insured contractor assumes under an “insured contract.”  This exception preserves coverage under the CGL policy for third-party­over actions, in which a contractor’s employee brings a suit against a third party (i.e., the project owner) for injuries sustained while working on the project.  The owner then looks to the contractor for a defense and indemnification of damages, in accordance with a hold harmless agreement in the construction contract.  The “contractual liability” exception to the employers liability exclusion preserves coverage for third party over claims.  

Pollution Exclusion  

Debates over the extent of pollution coverage in the CGL policy have kept courts busy for decades, and the exclusion has been rewritten several times over the years.  The current standard CGL pollution exclusion, introduced in 1993 and modified only slightly since that time, is commonly known as an “absolute” pollution exclusion.  This is a misnomer, because contractors retain limited but important coverage for injury or damage caused by pollutants.  

A broad exclusion applies to a release of pollutants from a site owned by the insured contractor, and to operations involving the cleanup, storage, or transportation of pollutants.  Where the contractor’s primary function is to cleanup, monitor, contain, treat, or test for pollutants, the exclusion will apply.  Likewise, for liability arising out of the use of any site for storage, disposal, processing, or treatment of waste and liability arising out the transportation of wastes by or for an insured.  However, outside of those specific categories, contractors retain some essential coverage for their liability for bodily injury and property damage arising out of a release of pollutants in the course of performing normal construction activities.  The coverage that remains is summarized in Exhibit 3.5 and discussed in more detail below.  

Exhibit 3.5 Contractors’ Covered Pollution Exposures   

Ongoing Operations - Completed Operations   

Liability arising out of ongoing operations is not excluded if: Liability arising out of completed operations is not excluded unless:   

The contractor did not own, rent, or occupy the site at which the release occurred; AND The contractor owned, rented or occupied the site at which the release occurred; OR   

The contractor did not bring the contaminants to the site.  The purpose of the operation was to cleanup, monitor, contain, treat, or test for pollutants.   

The contractor did bring the contaminant to the site, but the nature of the contaminant is fuel, lubricant, or other substance necessary for the maintenance and operation of the contractor’s equipment, and the substance was accidentally spilled or leaked from the equipment.  The site on which the release occurred was being used for storage, disposal, processing, or treatment of waste.   

The injury or damage was the result of smoke or fumes from a hostile fire The release of pollutants arose out of the transportation of wastes by or for an insured.   

None of the statements listed under “completed operations” is true.   

With the exception of the types of operations described above, the exclusion only applies to operations on which the contractor (or its subcontractors) “are performing” operations.  The present tense implies that the exclusion does not apply to (thus coverage does exist for) completed operations.  Therefore, a broad scope of coverage is available for bodily injury or property damage caused by pollution at a site on which the insured contractor is no longer performing work.   

With respect to ongoing operations, the pollution exclusion only applies if the pollutants were brought onto the construction site by the contractor or its subcontractors.  For example, if the contractor accidentally ruptures an underground pipe that leaks contaminants into the soil, air, or waterways, the exclusion will not apply.  There are even a few exceptions to the exclusion for contaminants that are brought to the site by the contractor.  Most notably, a release of fuel, lubricants, and other potential “pollutants” that are needed for the operation of the contractor’s equipment is not excluded if they accidentally spill or escape from the equipment they are intended to help function.  That is, if a fuel tank on a bulldozer is punctured by a forklift and fuel leaks out, the exclusion would not apply.  However, if the contractor brings a fuel tank to the site for refueling purposes, and the tank is ruptured, the exclusion would apply.  

Other significant coverage with respect to construction operations that is left intact by the pollution exclusion includes liability for damages caused by heat, smoke, or fumes from a “hostile fire.”  (A “hostile” fire is generally defined as a fire that is outside its intended scope or boundaries.)  In other words, contamination of the air caused by smoke from an unintended fire at the construction site would not be an excluded “pollution” incident; on the other hand, contamination by smoke from the controlled burning of scrap, or from fires kindled in metal drums to provide warmth to construction workers, would be “pollution,” and any resulting liability would be excluded.  

Aircraft, Autos, Watercraft, and Mobile Equipment   

The CGL policy excludes, with a few exceptions, liability arising out of the ownership, maintenance, or use of aircraft, autos, watercraft and, in some cases, mobile equipment.  The reason for this exclusion is that this exposure is more appropriately insured under an auto liability policy.  

Contractors face a number of liability exposures arising out of the ownership and use of mobile equipment, such as bulldozers, cranes, backhoes, and cherry pickers.  Mobile equipment exposures include transportation of such equipment and operational exposures from the use of such equipment.   

Whether equipment is classified as “auto” or as “mobile equipment” can have a significant impact on the contractor’s insurance costs.  For vehicles not subject to compulsory insurance or financial responsibility laws, any liability arising out of the use of the operational use of mobile equipment is covered by the CGL.  However, liability arising out of the transportation of such equipment is largely excluded.  When mobile equipment is being transported by truck or other vehicle, the liability risks associated with the equipment is highly similar to the risks associated with using an automobile.   

Starting with the 2004 CGL, any vehicle, including "mobile equipment" that is subject to a compulsory insurance or financial responsibility law in the state where it is licensed or principally garaged is considered an “auto” under both the CGL policy and the business auto policy.  The effect of this change is to exclude coverage under the CGL for some equipment for which contractors previously had CGL coverage.  An exception to the exclusion preserves coverage for the operational use (but not the over the road exposure) of certain permanently attached equipment.  

Unfortunately, whether a vehicle is considered an “auto” or “mobile equipment” is not always clear, despite the rather detailed definitions of each in the policy.  In the case of vehicles with permanently mounted equipment, whether the loss was caused by the operation of the equipment or by the operation of the vehicle may also result in a coverage dispute.  (Avoiding disputes such as these is a good reason to place a contractor’s automobile and general liability coverages with the same insurer whenever feasible.)   

Damage to Property Exclusion  

The primary purpose of the CGL Coverage A is to provide coverage for bodily injury and property damage suffered by others.  Understandably, therefore, the policy does not cover damage to the insured’s own property.  Nor does it cover damage to certain other types of property where the risks are more representative of first party property than third party property, such as premises that the contractor rents or leases.  

The “damage to property” exclusion removes coverage for six categories of property, listed in Exhibit  

3.6. These categories, and relevant exceptions to the exclusions, are discussed below in more detail.  

Exhibit 3.6 Excluded Property Categories—“Damage to Property” Exclusion   

(1) Property the insured contractor owns, rents, or occupies;  (2) Premises the insured contractor sells, gives away, or abandons (a.k.a., “alienated property); (3) Borrowed property;  (4) Personal property in the contractor’s care, custody or control;  (5) “That particular part” of real property on which the contractor (or any subcontractors) are performing operations if the damage arises out of those operations; (6) “That particular part” of any property that must be restored, repaired or replaced because the contractor’s work (including work performed by a subcontractor) was incorrectly performed on it.   

Property Owned/Rented/Occupied By the Insured  

The first category of property addressed under the “damage to property” exclusion is property owned, rented, or occupied by the insured.  These types of property are more appropriately covered through first-party insurance policies (e.g., a building and personal property policy).  

Alienated Premises  

Also excluded is property damage to premises that arises out of any part of premises that are sold, given away, or abandoned by the insured.  The intent of this exclusion, which is commonly referred to as the “alienated premises” exclusion, is to preclude coverage for liability based on the legal obligation placed on the seller of a building to correct any known defects in the premises.  (Note that this part of the exclusion applies only to property damage; bodily injury arising from such premises and property damage to property other than the actual premises are not categorically excluded.)   

By exception, this exclusion does not apply if the premises in question are the named insured’s work and were never occupied, rented, or held for rental by the named insured.  This exception retains important coverage for developers and “turnkey” contractors who build on speculation.  (That is, they build the property without a specific owner in mind with the hopes of selling it later.)  Nevertheless, a potential coverage problem remains for turnkey contractors and developers who begin renting the property prior to sale to enhance its value.  An attempt should be made to remove the exclusion for contractors who routinely engage in this type of arrangement.  If that is not possible, the exclusion should be modified to apply only to premises that were occupied or rented by the contractor for more than a designated amount of time that corresponds with the contractor’s normal time of ownership prior to selling.  

Borrowed Property  

The damage to property exclusion precludes coverage for damage to property loaned to the contractor.  This part of the exclusion would eliminate coverage for damage to tools or equipment the contractor borrows from another party.  Contractors equipment insurance is the appropriate place to obtain this coverage.  (In most instances, such coverage must be added by endorsement.  See the discussion of contractors equipment insurance in Chapter 6.)  

Personal Property  

Damage to personal property in the care, custody, or control of any insured is also excluded.  Personal property is not defined in the policy, so it takes on its normal legal meaning, which is any property other than real property.  Real property, by definition, includes land, buildings, and certain items permanently attached to such property.  

Disputes often arise over what constitutes being in an insured’s “care, custody or control.”  While some insurers have argued that practically everything in or upon a construction site is in the contractor’s care custody, or control, courts have generally used an “incidental test” to interpreting the exclusion.  If damaged personal property is a necessary element of the work being performed by the contractor, it will likely be considered to be in the contractor’s care, custody, or control and will, therefore, be excluded from coverage.  However, if the damaged item is only incidental to the contractor’s purpose, the exclusion will generally not apply.  

The care, custody, and control portion of the exclusion is particularly problematic for contractors that engage in moving property and equipment that belongs to others.  For example, a crane is generally used to hoist heavy equipment, such as HVAC equipment, into upper stories of a building under construction.  Property on the crane’s hook is clearly within the crane operator’s “care, custody, and control,” therefore the contractor’s CGL would not cover damage to that property if it was dropped, bumped, or otherwise damaged during the lift.  This type of property damage represents a significant liability for contractors that use cranes, forklifts, or other equipment to move others’ property.  Riggers liability coverage that covers this exposure can sometimes be arranged by endorsement to the CGL policy.  

Property on Which the Contractor is Working  

If the insured contractor’s operations result in damage to real property, there is no coverage for damage to “that particular part” of the property on which the operations were being performed at the time of the loss.  The phrase “that particular part” is intended to define precisely what is covered (i.e., resulting damage to other property) and what is not covered (i.e., the faulty work or the item being worked on at the time of the loss).  Unfortunately, in many construction losses, damaged property is not always easily segregated.  For example, assume that in the process of installing a large switchbox at a shopping mall, an electrical contractor touches two poles with a screwdriver and shorts out the entire switchbox.  What is the “particular part” on which the contractor is working?  Is it the particular fuse he was working on when the poles were accidentally touched?  Is it the switchbox as a whole?  Or the entire mall?  

Based on a majority of court interpretations of this issue, “that particular part” is appropriately defined as “a single item of property which, though composed of many parts, is clearly a unit of property within itself, self-contained and a single item.”  In our switchbox example, “that particular part” of the property on which the contractor was working would probably be the switchbox as a unit, in which case the entire loss would be excluded.  However, if the contractor’s mistake had shorted the electrical system of the entire shopping mall, the resulting damage to the remainder of the electrical system (anything other than the switchbox on which the contractor was working) would be covered.   

The use of the phrase “are performing operations” limits the application of this part of the exclusion to operations that are in progress when the loss occurs.  Losses that occur after operations are already completed are not subject to this portion of the exclusion.  Damage to the project that occurs after work has been completed is the subject of the “damage to your work” exclusion, discussed below  

Faulty Workmanship  

The sixth and last category under the “damage to property exclusion is frequently referred to as a “faulty workmanship” exclusion.  Under this part of the exclusion, coverage is eliminated for property damage to “that particular part” of property that must be repaired or replaced because the contractor’s work was “incorrectly performed” on it.  (Unlike in the previous section of the exclusion, this portion of the exclusion is not limited to damage to real property.)  The purpose of this exclusion is to eliminate coverage for the contractor’s bad work.  Most insurers would argue that to cover poor workmanship would be a disincentive for contractors to be diligent in the quality of their work.  By specific exception, the exclusion does not apply to losses that are included in the “products and completed operations hazard,” which limits its application to damage arising out of ongoing operations.  (Coverage for damage to completed work is the subject of a separate exclusion, which is discussed below.)  

To illustrate this exclusion, assume that following a water leak in an office building, a restoration firm is hired to dry out and clean a tenant’s soaked carpeting and to treat it for mold and mildew.  An employee accidentally applies too strong a chemical, which discolors the carpet.  This exclusion eliminates coverage under the restoration firm’s CGL with respect to its liability for damage to the carpet.  

Damage to “Your Work” Exclusion  

The “damage to your work” exclusion is by far the most important exclusion pertaining to completed operations coverage.  This exclusion provides that Coverage A will not apply to damage to “‘your work’ arising out of it or any part of it and included in the ‘products-completed operations hazard.’”  

While a casual reading of the exclusion may appear to render completed operations coverage virtually worthless, at least with respect to damage to the work itself, nothing could be further from the truth.  The exclusion is frequently referred to as the “workmanship” exclusion because its purpose is to prevent the CGL policy from functioning as a warranty of the insured’s own work.  However, it is not designed to exclude coverage for damage to the work of others, or damage to the insured’s work that is caused by others.  By exception, the exclusion does not apply to damage to, or damage caused by, a subcontractor’s work.  The only damage to completed work that is not covered is damage to the insured contractor’s “work” that is the result of its own work.  The overall impact on the coverage retained by this “subcontractor exception” to the exclusion is summarized in Exhibit 3.7.  

Exhibit 3.7 Covered Damage to Completed Work   

. . . .  Damage to the insured contractor’s work that arises out of the work of a subcontractor.  Damage to a subcontractor’s work that arises from that subcontractor’s work.  Damage to a subcontractor’s work arising out of the insured contractor’s work.  Damage to a subcontractor’s work arising out of another contractor’s or subcontractor’s work.   

The application of this exclusion is further illustrated by the following loss scenario.  

Gencon Construction Company contracts to build a warehouse for Owncorp.  Gencon does 25 percent of the work itself and subcontracts the remaining 75 percent to various subcontractors.  Two years after completion, the warehouse is destroyed by fire, and the ensuing investigation traces the cause of the fire to faulty wiring installed by Gencon.  The complete list of claims filed against Gencon is as follows.  

.  Total loss of the warehouse—$1 million  

.  Loss of contents—$2.5 million  

.  Business interruption loss for Owncorp—$500,000  

.  Damage to an adjacent building—$250,000  

.  Business interruption loss for occupant of adjacent building—$100,000  

.  Death of a night watchman employed by Owncorp  

Assuming the completed operations limit is sufficient, Gencon’s CGL would cover most of these damages, as well as the cost of defending Gencon in these legal actions.  Damage to the contents is covered in full as it is the property of another and has no connection to the contractor’s work.  Likewise, damage to the adjacent building, and its occupant’s business interruption loss are covered.  (Remember “property damage” is defined to include loss of use due to covered property damage.)  Because the exclusion applies only to property damage, any liability associated with the death of the night watchman will also be covered.  

The only remaining loss to consider is the property damage to the warehouse and Owncorp’s corresponding business interruption loss.  Because the definition of “property damage” includes loss of use, the exclusion applies equally to both losses.  However, the exclusion applies only to work that was performed by the Gencon, which in this case is 25 percent of the loss.  Therefore, Gencon’s CGL would pay 75 percent of Owncorp’s loss, or $1,125,000.  Gencon is uninsured for the remaining $375,000, which represents damage to its work arising out of its work.  (Note that if the faulty wiring had been installed by a subcontractor, none of the damages would be excluded.)  These examples demonstrate that while the workmanship exclusion does narrow the scope of completed operations coverage, by no means does it render it useless.   

Subcontractor Exclusion Endorsements  

In 2001, ISO introduced two optional endorsements that remove the coverage that the subcontractor exception to the standard “damage to your work” exclusion leaves intact.  One of these endorsements eliminates all coverage for damage to “your work” arising out of subcontractors’ work, and the other removes such coverage only with respect to scheduled sites or operations.  These exclusions apply equally to damage to work performed by subcontractors and damage to the named insured’s work that is caused by a subcontractor’s work.  Contractors should make every effort to avoid these coverage restricting endorsements, particularly where a large percentage of the work is subcontracted, as they represent a significant reduction in coverage.   

 “Impaired Property” Exclusion  

The “impaired property” exclusion is perhaps the least understood aspect of CGL coverage with respect to construction claims.  The purpose of the “impaired property” exclusion was to address “passive defects” in buildings or other structures due to the presence of defective work.  A passive defect is one that has not yet failed, but that presents an increased risk of failure in the future.  In some instances, a passive defect may not render a building useless, but merely “less useful.”  For example, a known defect can lower the resale value of the building, or lower the amount of rents the property owner can obtain from tenants.   

The CGL uses a two-prong test to determine if property is “impaired property”:  

.           There must be tangible property other than “your work” that cannot be used or is less useful because “your work” is incorporated into the property.  Implied in this requirement is that at least some part of “your work” is known to be defective, inadequate, deficient or to produce a dangerous condition.  

.           The property can be restored to use by the repair or replacement of “your work.”  

When both of these conditions are met, the property is deemed to be “impaired property” and thus excluded under the CGL policy.  

To illustrate, suppose an electrical contractor negligently installs outlets of inadequate amperage for the types of equipment to be used in a manufacturing facility.  There is nothing wrong with the wiring or the outlets—they work perfectly fine.  But the property is not usable for its intended purpose because plugging high current equipment into low current outlets presents a significant fire hazard.  In this scenario, the manufacturing plant represents tangible property other than the contractor’s work (the installation of the electrical outlets) that cannot be used, or is less useful, because it incorporates the contractor’s deficient work.  Because this property can restored to use by the replacement of “your work,” both elements of “impaired property” are met in the electrical contractor’s policy.  The loss of use claim is therefore excluded, and any replacement of the outlets must be done at the contractor’s expense.  

Notably, the requirement that there be loss of use to tangible property other than "your work" renders the impaired property exclusion virtually insignificant with respect to general contractors.  That is, because the definition of "your work" includes work performed on the insured's behalf by subcontractors, the entire house is the general contractor's work.  The first prong of the impaired property test, therefore, cannot be satisfied with respect to the project itself.   

The impaired property exclusion is consistent with the notion that the CGL policy is not intended to cover the cost of repairing the contractor’s faulty work.  However, by exception to the exclusion, coverage is retained for loss of use that is the result of sudden and accidental physical injury to “your work” after it has been put to its intended use, which preserves coverage for losses that are caused by the actual failure of the defective work, as opposed to the mere risk of failure.  

While our discussion of the impaired property exclusion has centered on the issue of damage arising out of “your work,” it is worthwhile to make a few general observations on the other parts of the exclusion.  First, materials and supplies that are furnished by contractors in connection with their work are included in the policy’s definition of “your work.”  Most contractors, therefore, will not be impacted by the “your product” portion of the exclusion.  Second, a separate part of the exclusion eliminates coverage for “delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms.”  This exclusion negates coverage for loss of use claims arising out of the contractor’s failure to meet its deadlines, among other things.  For example, if a contractor agrees to have a building remodeled by a specific date, and fails to do so, claims for loss of use of the building during the extra time it takes to complete the project would not be covered by the contractor’s CGL policy.  

Electronic Data Exclusion  

Although the CGL covers liability arising out of “property damage,” meaning physical injury to and loss of use of tangible property, the CGL’s definition of “property damage” states that electronic data is not tangible property.  An electronic data exclusion was added to the 2004 edition of the CGL to reinforce the premise that the CGL is not intended to cover the loss of electronic data.   

At first glance, this exclusion would seem largely irrelevant to most construction contractors, who are not in the data business.  However, there are concerns that this exclusion might apply, for example, to preclude coverage for a construction contractor who severs an underground cable that transmits data.  The exclusion does more than reinforce the “property damage” definition.  It also excludes loss of use of computer hardware that will not function because its software has been damaged.  Since the exclusion applies to all liability under Coverage A, it would also preclude coverage for bodily injury liability claims that arise out of the inability to access data.  It might be difficult to imagine a scenario in which the proximate cause of bodily injury is a loss of electronic data, but claims of this type are possible.  An example might be severing a data line used by air traffic controllers.  

An endorsement (CG 04 37) can be used to modify the policy to provide coverage for electronic data loss that result from physical injury to tangible property.  The endorsement does not, however, restore coverage for bodily injury claims.  

Additional Insured Endorsements  

As noted in Chapter 1, construction contracts frequently require contractors to add other parties (i.e., the owner or other contractors) to their liability policies as additional insureds.  As an “additional insured,” an owner or general contractor can file claims directly under the contractor’s or subcontractor’s policy.  Thus, additional insured status is typically viewed as a second layer of protection for the contractual indemnity agreement.  (The first layer of protection is in the policy’s contractual liability coverage, but this coverage is dependent on the indemnity agreement being enforceable, whereas additional insured coverage is not.)  A key advantage of filing a claim as an additional insured is the insurer’s duty to provide a defense against that claim at its own expense.   

The scope of coverage provided to additional insureds has been gradually eroded over the past two decades.  The 1986 editions of the standard endorsement for granting owners and contractors additional insured status (CG 20 10) extended coverage to additional insureds for both ongoing and completed operations.  Further, the additional insureds enjoyed coverage for a broad range of claims including vicarious liability for the contractor’s negligence, as well as their own direct negligence, including their sole negligence.  

In 1993, the scope of an additional insured’s coverage was narrowed by limiting its application to liability arising out of the insured contractor’s “ongoing operations.”  Completed operations coverage thus went by the wayside.  

Most recently, ISO filed a new version of the CG 20 10 additional insured endorsement that limits the additional insured’s coverage to claims for injury or damage “caused, in whole or in part” by an act or omission of the named insured.  This change was designed to eliminate coverage for an additional insured’s sole negligence.  

Despite these limitations, additional insured endorsement CG 20 10 covers a number of key exposures.  For example, it provides coverage for what is referred to as the independent contractor exposure—the vicarious liability of a project owner for the actions of the contractor.  Common law prescribes, for example, that one who hires a contractor to perform inherently dangerous work may be held liable for injury or damage resulting from that work.  The project owner or general contractor who is an additional insured under the policy of the contractor performing the work would be covered for this and related types of vicarious liability.  

An additional insured can also incur liability for its own negligence in connection to the project.  For example, an injured party may allege negligence in performing whatever supervisory function the additional insured exercised over a contractor’s work, or failure to maintain safe conditions on the premises while the contracted work is being performed.  Additional insureds would be covered for these liabilities as long as their negligence was not the sole cause of the loss.  That is, an act or omission on the part of the named insured must have contributed to the loss.   

Additional Insureds—Further Considerations  

Additional insured requirements, and additional insured endorsements in particular, create some increased risks for contractors.  A few of these risks, and suggestions for managing them, are discussed briefly below.   

Policy Limits  

Because the policy limit applies collectively to all insureds, the contractor runs the risk of its limits being reduced or even exhausted by claims against additional insureds.  This risk is compounded as the number of additional insureds rises.  Therefore, contractors should be careful to only grant additional insured status where they are contractually required to do so.  Further, to the extent they can avoid an additional insured requirement – for the architect, or other consultants of the owners – through contract negotiations it should attempt to do so.  

Construction contracts also require contractors to carry minimum limits of liability insurance.  Contractors sometimes attempt to avoid providing more coverage to an additional insured than is contractually required by capping the limits of coverage available to the additional insured.  However, unless the indemnity agreement is likewise capped, the contractor will still be obligated to indemnify any amounts exceeding the coverage available to the indemnitee as an additional insured.  A better approach might be to give additional insureds full access to the primary layer of coverage (e.g., the CGL) but categorically exclude them from the excess layers.  This approach is only feasible if the contractors’ primary coverage meets or exceeds what is required in a large percentage of their contracts.  

Failure to Comply with Additional Insured Requirement  

An additional insured requirement in the construction contract does not automatically translate into additional insured status on the applicable insurance policy.  Contractors must follow through by instructing their agent or broker to add the designated party as an additional insured, and the agent or broker must follow through by submitting the request to the insurance company.  Because people make errors, there are times when a request for additional insured status does not reach the insurance company.  In that case, the contractor is in breach of its contractual obligation, and to the extent the other party suffers an uninsured loss due to this error, the contractor may have to pay the difference out of its own pocket.  

Blanket (or automatic) additional insured endorsements provide a way to avoid the risk of oversight in executing a request for additional insured status.  A standard endorsement is available for this purpose, and many insurers have their own blanket endorsements.  The trigger for additional insured status is a contractual requirement to add a party as an additional insured.  Some endorsements (including the standard ISO endorsement) require the contract to be in writing, while others do not.  

The scope of the additional insured’s coverage under a blanket endorsement is typically similar to that provided to scheduled additional insureds.  Coverage applies only with respect to the named insured’s ongoing operations for the additional insured—that is, the endorsement provides no completed operations coverage.  The standard automatic additional insured endorsement (CG 20 33) also contains a potentially dangerous restriction of coverage and goes well beyond limiting the additional insured’s protection to “ongoing operations.”  This endorsement limits the term of additional insured coverage to the time during which operations are actually being performed by the named insured.  This provision can be read as eliminating coverage for a loss that occurs while operations are in progress but that results in a claim against the additional insured after operations are completed.  Until this problem is remedied, nonstandard blanket additional insured endorsements may offer better coverage than the standard version.  

As in the scheduled endorsement, starting with the 2004 edition, the alleged injury or damage must be “caused, in whole or in part” by the named insured’s act or omission.  This language removes coverage for claims attributable to the additional insured’s sole negligence.   

CGL Endorsements  

The standard CGL policy is designed to provide some core coverages that are commonly needed by a cross section of industries.  Tailoring the policy to meet industry-specific needs of contractors commonly requires a variety of modifications to the policy.  Some of the more commonly needed (or commonly imposed) modifications of contractors’ CGL insurance policies, are discussed below.   

Designated Limit of Insurance  

To avoid the risk of limits erosion, contractors are sometimes required to provide a specified limit of insurance that applies exclusively to the designated project.  A standard endorsement is available for this purpose.  This endorsement (CG 25 03) provides that a separate general aggregate limit (called the designated construction project general aggregate limit) applies to designated projects.  A separate but equal general aggregate limit applies to losses that do not arise out of a designated project.  Losses arising out of the products-completed operations hazard are paid out of the separate products-completed operations aggregate, rather than the general aggregate limit, which continues to apply collectively to all of the insured’s projects.   

Joint Venture Coverage  

The CGL provides no coverage for liability of a contractor arising from the conduct of a partnership or joint venture that is not scheduled in the policy as a named insured.  This condition can pose significant coverage problems, especially in large organizations where some joint ventures might not be reported to the insurance agent or risk manager.  A manuscript joint venture endorsement can be used to provide blanket coverage for liability arising from a joint venture.  Coverage may apply to current ventures, past ventures or, ideally, both.  To maintain ongoing coverage for past joint ventures, this endorsement must be included on all subsequent policies.   

To obtain broad coverage for the joint venture, and to protect a participating contractor’s insurance program from claims and suits involving other participants, a separate policy should be purchased for the joint venture.  The individual participants can endorse their policies to respond excess of the joint venture policy with respect to their individual liabilities arising out of the joint venture.  

Contractual Liability—Railroads  

The contractual liability—railroads (CG 24 17) endorsement deletes the exception to the definition of “insured contract” that precludes liability coverage for hold harmless agreements issued in favor of railroads.  When a project involves work affecting a railroad, contractors are generally required to both purchase a railroad protective liability insurance policy in favor of the railroad and hold harmless the railroad.  Unless this endorsement, or one comparable to it, is attached, the contractor’s CGL policy provides no coverage for a claim filed by the railroad under the hold harmless agreement (e.g., if a particular claim exceeds the limit of the railroad protective policy).  

Alienation of Premises—Turnkey Jobs  

Coverage for property damage liability to premises sold by the insured is excluded by the basic CGL policy.  This exclusion could present problems for those engaged in turnkey operations on a speculative basis where a building, such as an apartment complex, is constructed and some of the units are rented before it is sold to a developer or investor.  Contractors who perform projects of this type should attempt to modify this exclusion so that it will not apply to turnkey projects.  At a minimum, it should exempt properties that are owned, occupied or rented by the insured contractor for less than a specified amount of time, e.g. 6-12 months.   

Total Pollution Exclusion  

Despite its “absolute pollution exclusion,” the standard CGL policy provides insured contractors with some important coverage for third-party bodily injury and property damage caused by pollutants and arising out of their operations.  (See the preceding discussion of the pollution exclusion.)  However, insurers can remove all coverage for pollution damages from the CGL by attaching a total pollution exclusion (CG 21 49) endorsement to the policy.  Contractors whose operations entail direct involvement with pollutants—hazardous waste contractors; lead/asbestos abatement contractors; contractors working in oil rig, oil refinery, or chemical plant construction; installers of underground storage tanks, etc.—are most likely to be subject to this exclusion, but some insurers automatically attach it to all contractors’ policies, including general contractors and trade contractors whose operations are not tied in any way to the handling or disposal of pollutants.  

Contractors should resist the attachment of a total pollution exclusion, but if one cannot be avoided, they should insist that a hostile fire exception is included.  This exception retains the very important coverage for smoke, fumes, or vapors caused by a hostile fire, as long as the site from which the fire emanates is not, and has never been, used to treat or store waste, and the contractor’s operations are not remedial in nature.  The current version of the standard endorsement contains this exception.  

Professional Liability Exclusion Endorsements  

The standard CGL policy contains no professional liability exclusion.  However, most insurers will carve these claims out of the CGL policy and require contractors needing this coverage to purchase separate professional liability insurance.  Two standard endorsements are available for excluding professional liability on contractors policies.  

The broader professional services exclusion (CG 22 79) removes coverage for damages arising out of professional design services provided by the contractor (or its subcontractor) in its capacity as an architect, engineer, or surveyor.  By exception to the exclusion, coverage is specifically preserved for liability arising out of ordinary “means, methods, techniques, sequences and procedures” employed by the contractor during the course of construction.  While the exception is important to most contractors, it leaves considerable room for dispute over what activities are considered to be “means and methods” of construction.  

The more limited exclusion (CG 22 80), on the other hand, is designed to specifically extend coverage to contractors for liability arising out of their rendering of professional services in connection with a project they are also responsible for constructing.  A significant advantage of this exclusion over CG 22 79 is that it is not necessary to determine whether the damage arose out of professional activities or ordinary means and methods of construction; as long as the contractor was also responsible for the construction of the “work,” the policy will respond to bodily injury or property damage claims.   

While this endorsement provides significantly broader coverage than its counterpart, a significant professional liability exposure is left uninsured in the CGL—the risk of a passive defect.  A passive defect is one that does not produce bodily injury or property damage, but rather a purely economic loss.  For example, a design error results in a delay in construction that causes a retail shopping outlet to be 6 months late in opening, missing the holiday season entirely.  Because there is no “bodily injury” or “property damage” there would be no coverage for this claim under the CGL even if there is no professional liability exclusion attached to the policy.  

Because of the gaps in the CGL’s professional liability coverage, contractors with any professional liability exposure should consider the purchase of contractors professional liability insurance.  Several markets exist for this coverage.   

Subcontractor Exclusion Endorsements  

Two standard endorsements, available for use at the insurer’s option, remove important coverage from contractors’ CGL policies.  Specifically, these exclusions allow for the removal of coverage that the subcontractor exception to the “damage to your work” exclusion leaves intact.  (See Exhibit 3.8 for a review of the coverage the exception retains.)  One of these exclusions (CG 22 94) is total, eliminating all coverage for damage to “your work” arising out of subcontractors’ work.  The other (CG 22 95) retains such coverage except with respect to scheduled sites or operations.  Because this represents a significant reduction of coverage, especially for general contractors who subcontract a significant portion of the work, every effort should be made to keep these endorsements off their policies.  

Mold Exclusion Endorsements  

In 2001, ISO introduced a standard “fungi or bacteria exclusion endorsement” (CG 21 67), that excludes virtually all claims arising out of exposure to or inhalation of fungi, which includes all varieties of mold, or bacteria.  This exclusion is widely used on contractors’ general liability policies.  The latest version has a 2004 edition date.  

For a while, contractors who carried the coverage could find protection for mold claims under their pollution liability insurance policies.  In the most recent soft market, many of these policies were modified to specifically cover mold and other bacteria.  Currently, most contractors pollution liability insurers routinely exclude coverage for claims alleging damage caused by mold, but will add the coverage back for an additional premium.  

EIFS Exclusion  

Exterior insulation and finish systems (EIFS) are multilayered exterior wall systems that are designed to provide high energy efficiency.  EIFS gained attention from the insurance industry when claims began to arise alleging damage caused by moisture.  Typically, these claims alleged faulty installation or some other product defect that allowed water to penetrate the walls, where it became trapped.  Wood rot and mold were some of the problems encountered by the owners of the properties.  EIFS have been at the core of a significant amount of construction defect litigation, particularly in warm climates such as Southern California, Florida, Texas, and Nevada.   

In light of the tremendous losses suffered by the insurance industry related to these insulation systems, EIFS exclusions began to appear on the policies of EIFS installation subcontractors, as well as virtually any other contractor whose work could conceivably be tied to the infiltration of moisture (e.g., roofers, HVAC, window and garage door installation contractors, and plumbing contractors).  Currently, they are in widespread use for both residential and commercial construction contractors.   

The standard exclusion—exterior insulation and finish systems endorsement (CG 21 86) is broad, removing coverage for any liability associated with the exterior insulation and finish systems, including the manufacture, sale, installation, maintenance, or repair of such a system, or any component thereof.  Because a standard endorsement was not available until 2004, many insurers developed their own nonstandard endorsements to exclude the EIFS exposure.  Some will likely continue to use their own endorsements rather than the standard endorsement.   

Wrap-Up Exclusion  

Many project owners prefer to provide some of the basic insurance coverages for the project themselves, rather than having each contractor provide separate insurance for their own liabilities arising out of the project.  These consolidated insurance programs, also known as “wrap-up” programs, present an opportunity to realize savings in the insurance costs (due to high premium volume and implementation of a comprehensive safety and loss control program).  However, they present some coverage challenges for the contractors who participate in these programs.   

When a contractor becomes involved in a wrap-up project, its own insurance becomes duplicative to the extent the same lines of coverage are provided in the wrap-up.  Contractors have two options for eliminating this duplication in coverage: they can exclude the wrap-up project from their own insurance program, or they can make their own insurance program excess over the wrap-up program.  In most instances, the latter option (sometimes referred to as “residual” coverage) is the better solution.  

A standard endorsement (CG 21 54) is available for suspending a contractor’s own general liability coverage with respect to a wrap-up project.  The exclusion applies to both work in progress and completed operations, and without regard to whether coverage is provided by the wrap-up policy.  If the wrap-up coverage is suspended for any reason, CG 21 54 must be removed immediately to reinstate coverage for these operations.  

Modifying the contractor’s policy to provide residual wrap-up coverage requires a manuscript endorsement.  The language of the endorsement should provide that when the wrap-up coverages are canceled or suspended for any reason the contractor’s CGL coverage will be fully reinstated with respect to that project.  Further, it should provide “difference in conditions” coverage for the contractor, which means that if the contractor’s coverage is broader in any area than that available in the wrap-up, its own CGL will pick up losses that are excluded under the wrap-up policy.  Finally, if the loss exceeds the limits of the wrap-up insurance, the contractor’s policy will provide excess coverage up to its available policy limit.   

X, C, U Exclusion  

The “X,C,U” exclusion removes coverage for one or more of the three designated hazards—explosion (X), collapse (C), and underground property damage (U).  These hazards may be excluded individually or in any combination by indicating on the endorsement which of the three hazards is to be excluded.  

The explosion hazard excludes property damage arising from blasting operations or other explosions.  The collapse hazard excludes coverage for structural property damage caused by the excavation and demolition activities specifically listed in the endorsement.  The underground property damage hazard exclusion removes coverage for property damage to specifically listed types of property (e.g., wires, pipes, tunnels, and sewers) caused by mechanical digging, pile driving, excavating, or similar equipment.  

The X, C, and U hazards exclusion applies only to property damage arising out of: (1) operations in progress and (2) operations performed by the insured.  Therefore, the exclusionary endorsements do not affect coverage as it applies to the products-completed operations hazard or to the independent contractor exposure.  And under no circumstances does it apply to liability for bodily injury.  

There are two standard XCU endorsements, which are identical except in regard to the projects to which they apply.  One of the endorsements (CG 21 42) applies the exclusion only to those operations (e.g., projects) that are scheduled in the endorsement.  The other endorsement (CG 21 43) takes the opposite approach, making it applicable to all of the insured contractor’s operations except those that are scheduled in the endorsement.  

The X,C,U exposure represents a significant third-party property damage exposure.  While fairly substantial premium reductions may apply when the exclusion is added to the CGL policy, it is usually advisable to have coverage for these exposures.  If an exclusion is attached, it is important to understand which approach is used—exclusion of scheduled operations or blanket exclusion with scheduled exceptions.  

Umbrella Liability Insurance  

An umbrella liability policy provides excess limits of coverage, over and above the limits provided in various basic liability policies.  Specifically, most umbrella liability policies provide excess coverage over the contractor’s general liability, auto liability and employer’s liability insurance.   

Unlike primary (underlying) liability policies, umbrella liability forms are not standardized, which means each insurer develops its own form.  The only way to know for sure what a particular umbrella form covers is to read it in its entirety.  Umbrellas should be reviewed carefully to ensure that the coverage needed and desired is provided and arranged to coincide with underlying primary policies.   

The following paragraphs provide a brief synopsis of umbrella exclusions that have special ramifications for contractors.   

“Property Damage” Exclusions  

Umbrellas typically contain a number of “property damage” exclusions.  The property damage exclusions with the most important coverage implications for contractors include property in the insured’s care, custody or control, damage to “your work,” damage to property on which the contractor is performing operations, and alienated premises.  The impact of these exclusions is summarized in Exhibit 3.8.  Most of these exclusions compare closely to their CGL counterparts.  Not all umbrellas contain all of these exclusions, but most forms contain some combination of these exclusions.  

Exhibit 3.8 Umbrella “Property Damage” Exclusions   

Alienated Premises - For developers or other contractors participating in turnkey operations, it is important to ensure the alienated premises exclusion does not apply to “your work,” (defined to be the named insured’s completed operations including work performed by subcontractors), which preserves coverage with respect to properties the named insured contractor built, but then sold without ever having occupied or rented to others by the insured.  This approach matches that of the standard CGL policy’s alienated premises exclusion.   

Property In the Insured’s Care, Custody, or Control - The umbrella policy may exclude coverage for nonowned property in the care, custody, or control of the insured.  Unlike in the CGL policy, some umbrella policies apply the exclusion to all property, as opposed to just personal property.  This substantially restricts the contractor’s coverage with respect to real property and can result in messy coverage disputes regarding what constitutes “care, custody, or control” of real property.  Contractors should attempt to have such exclusions modified to match the underlying CGL policy.   

Damage to “Your Product” and “Your Work”  Comparable to CGL exclusion.    

Impaired Property  Comparable to CGL exclusion.    

Contractors Limitation Endorsements  

The contractor’s limitation endorsement is designed to eliminate some of the umbrella policy’s coverage with respect to certain loss exposures common to the construction industry.  This type of endorsement will virtually always be attached to construction contractors’ umbrella policies, and sometimes to service contractors’ policies.  

The contractors limitation endorsement is usually organized around two groups of exclusions.  The first group states that coverage will only be provided for the listed items to the extent that coverage is provided in the underlying insurance.  In other words, if the underlying insurance covers a particular loss, the exclusions do not apply.  This, in effect, provides “follow form” coverage for the described hazards.  Common exclusions in this first group include the explosion, collapse, and underground property damage hazards, contractual liability, and property in the contractor’s care, custody, or control.  (As noted in Exhibit 3.8, the latter exclusion is sometimes in the basic policy form instead of the endorsement, and may require modification in that instance.)   

The second group of exclusions is normally absolute, applying whether or not the exposure is covered under the underlying insurance.  Typically, these exclusions include such items as liability arising from the contractor’s participation in a wrap-up insurance program, joint ventures, professional liability, mold damage, etc.  Some insurers will make adjustments to these exclusions on a case-by-case basis.  For example, if the contractor has modified its CGL to apply as excess and DIC over a wrap-up insurance program, the wrap up exclusion in the umbrella policy should be removed or modified, if possible, to preserve the coverage through all layers.  

As a word of caution, some contractors’ limitation endorsements contain only absolute exclusions with no provisions for follow form coverage.  Endorsements of this type should be strictly avoided.  

Protective Liability  

As noted in the previous chapter, hold harmless agreements are often used to allocate certain risks to the contractor and to protect the hiring party from liability arising out of the contractor’s operations.  However, because hold harmless agreements can be challenged, sometimes successfully, property owners typically also require some form of direct coverage (i.e., coverage that is not dependent on the named insured’s contractual liability) for claims arising out of the contractor’s work for them.  

One method, discussed in the previous chapter, is to name the owner as an additional insured under the contractor’s CGL policy.  As an insured, the owner can make a claim directly against the contractor’s CGL for its liability arising out of the contractor’s operations.  Another method is for the contractor to purchase an owners and contractors protective (OCP) liability policy with the owner as the named insured.  (Other variations of protective liability insurance include project management protective liability (PMPL) and railroad protective liability (RPL) insurance.  These coverages are discussed further below.)  

Owners and Contractors Protective Liability  

Owners and contractors protective (OCP) liability insurance covers a party that has hired an independent contractor for claims brought against the hiring party that arise out of the independent contractor’s work on its behalf.  OCP coverage is unusual in that it is purchased by one party (the contractor) for the benefit of another.  That is, while the contractor obtains the policy and pays the premium, that contractor has no coverage under the policy.  The party for whom it is purchased, e.g., the project owner, is the named insured with all the rights and benefits of the named insured.  (OCP coverage is sometimes purchased by a subcontractor for the benefit of the general contractor, but for simplicity the remainder of this discussion will be written from the perspective of the owner who has required this coverage from a contractor.)  

OCP insurance and additional insured status on the CGL policy are normally considered alternatives; that is, the owner should require one or the other, but not both.  In reality, some owners do require both, but doing so results in substantial duplication of coverage at a significant extra expense.  The relative advantages and disadvantages of OCP coverage, versus additional insured status, are addressed later in this chapter.  

Covered Losses  

The OCP insuring agreement specifies that coverage is provided to the named insured for its liability arising out of the following two exposures.   

.           Operations performed by the contractor named in the policy declarations (or its subcontractors) for the named insured in connection with the specified project.  This covers the owner’s vicarious liability for the activities of the contractor named in the declarations.  

.           The named insured’s acts or omissions in connection with its “general supervision” of the named contractor’s work on the specified project.  Coverage for the insured’s general supervision of the contractor’s work is included because claims of contractor negligence are often accompanied by claims directly against the owner for failure to adequately supervise the contractor’s operations.  

No coverage is provided for the named insured’s direct liability arising out of any activity other than its direct supervision of the designated contractor’s work on the project.   

Exclusions  

A list of standard exclusions in the ISO OCP policy is provided in Exhibit 4.1.  Some of the exclusions are slightly different from their CGL counterparts in wording, application, or both.  Most of these differences are designed to reflect the different coverage intent of the OCP policy—i.e., covering only the named insured’s vicarious liability and its direct liability for its general supervision of the project.  Only two of the OCP exclusions—the “completed operations” exclusion and the “acts or omissions of the insured” exclusion—have no counterpart in the CGL policy.  

Exhibit 4.1 OCP Exclusions   

Exclusions that appear in the OCP policy but not the CGL policy are indicated in bold.  Exclusions that appear in both the CGL and the OCP, but with some variations are indicated by italics.  The remaining OCP exclusions are identical to their CGL counterparts.    

Work Completed or Put to Intended Use Workers’ Compensation and Similar Laws   

Acts or Omissions by You and Your Employees   Employer’s Liability    

Contractual Liability Expected or Intended Injury   

Damage to Property Pollution   

Damage to Impaired Property or Property Not Physically Injured War Mobile Equipment Electronic Data   

The changes to the modified exclusions are designed primarily to reflect the different exposure being insured—that is, the insured’s liability for the contractor’s operations.  The following discussion highlights only the two additional OCP exclusions and their implications for coverage.   

Completed Operations Exclusion  

The OCP policy excludes bodily injury or property damage that occurs after the project has been completed and put to its intended use.  Although such damage could be the result of the contractor’s work (e.g., a railing that was not properly secured gives way and a number of visitors are injured), the owner would not be covered under the OCP for corresponding claims for damages due to the policy’s completed operations exclusion.  Coverage would be available under the owner’s CGL policy for these claims, and unless the construction contract included a waiver of subrogation for these types of losses, the CGL insurer could look for reimbursement from the negligent contractor.  (This exclusion would not apply to injury or damage that is sustained during the policy period but does not produce a claim until after the project is completed.)  

Many construction contracts require insurance coverage to be provided for the project owner for 3 to 5 years after the work is completed.  If that is the case, an OCP policy will not fulfill the contractor’s obligations.  If the project owner agrees to accept an OCP policy, the insurance requirements should be modified to remove the completed operations coverage requirement; if completed operations coverage is to be required, the owner should consider requiring additional insured status in lieu of an OCP policy.  

Acts or Omissions of the Insured Exclusion  

Perhaps the most significant OCP exclusion applies to “acts or omissions of the insured.”  As previously noted, the principal exposure insured under the OCP policy is the named insured’s vicarious liability, that is, liability imposed on the named insured arising out of the contractor’s work on its behalf.  OCP coverage does not apply to liability arising out of the owner’s own negligence except in connection with the owner’s general supervision of the contractor’s work.  

Some examples may help clarify the application of this exclusion.  Suppose that OWN Manufacturing Company hires CON Contractors to install some ventilation equipment in one of OWN’s factories.  A CON truck, in the process of delivering equipment and materials to OWN’s premises, accidentally backs into an adjacent building owned by another business, causing structural damage.  The owner of the damaged building sues both CON (as the negligent party) and OWN (as the project owner).  Because the damage did not arise out of any act or omission of OWN or its employees, the OCP policy would respond to the suit.  Suppose, on the other hand that, in the course of performing the installation work, one of CON’s employees drops a toolbox from the factory roof and injures a truck driver employed by one of OWN’s vendors who was on OWN’s premises making a delivery.  The truck driver sues both CON and OWN.  The suit against the owner alleges that OWN negligently failed to warn third parties coming onto its premises that dangerous construction work was in progress.  There is no judicial consensus on what constitutes “general supervision.”  Unless giving such warning is considered to be part of the “general supervision” of an independent contractor’s work, the OCP policy will not respond to this suit.  

Acts or omissions of the named insured or its employees need not be the sole cause of injury or damage in order for this exclusion to apply.  If injury to a third party is caused by the joint negligence of a CON employee and an employee of OWN, the OCP policy provided to OWN by CON will not cover damages attributable to OWN’s employee’s negligence.  In some instances, allegation of any direct negligence on the part of the OCP insured has been held to defeat coverage even when the injury or damage was partly attributable to the contractor’s negligence.  

General Supervision  

The one area in which OCP coverage goes beyond insuring purely vicarious liability exposures is the named insured’s own negligence in supervising the work of the independent contractor.  Because this term is not defined in the OCP policy, it is subject to different interpretations.  However, case law on the meaning of “general supervision” indicates that courts will generally give the term an extremely broad scope, at least with respect to injury to the contractor’s employee.   

Waiver of Subrogation  

Given the parameters of OCP coverage—the named insured’s liability for the designated contractor’s operations and the named insured’s general supervision of those operations—the designated contractor will be responsible to some degree for almost every loss covered by the policy.  Since the contractor is not an insured under the policy, the OCP insurer is free to pursue recovery from the negligent contractor for the amounts paid on behalf of the named insured.   

However, contractors understandably balk at having to turn to their own general liability insurance program to cover a subrogated claim with respect to which they have already bought insurance protection for the other party.  To avoid this, a waiver of subrogation endorsement, such as ISO endorsement CG 29 88 which waives the OCP insurer’s right to subrogate against the designated contractor, should be attached to the policy.  

Comparison to AI Status  

The primary reason for requiring OCP insurance is as a backup to a hold harmless provision in the underlying contract.  In requiring direct coverage as a named insured—versus merely relying on the contractor’s contractual liability coverage to respond to its indemnity obligations—the owner obtains a separate limit of insurance for its liability arising out of the contractor’s work as well as immediate access to a defense from the insurer.  In this way, the owner obtains an extra degree of security that the underlying risk transfers will be affected.  (Claims for indemnity under the contractor’s CGL may not qualify for the providing of a defense by the insurer; instead, the insurer may reimburse defense costs only after the claim is resolved.  The latter approach is unacceptable to most indemnitees.)  Alternatively, owners can also obtain direct coverage by requiring the contractor to name the owner as an additional insured on the contractor’s CGL policy.  Additional insured status also provides the owner the ability to make a claim directly against the policy, and to obtain a defense against covered claims.   

Naturally, questions arise as to which of these approaches is better.  The advantages and disadvantages of each method are outlined briefly in Exhibit 4.2.  

Exhibit 4.2 OCP Policy Versus Additional Insured Status   

The following shows how named insured status in an owners and contractors protective liability policy compares to additional insured status provided by endorsement CG 20 10 to the commercial general liability (CGL) policy.   

Comparison Point  OCP Policy  Additional Insured Status   

Cost Moderate Inexpensive   

Limits Apply exclusively for named insured (NI) Shared with insured contractor and other additional insureds   

Excess or umbrella limits Not available usually available   

Impact on Contractor’s Insurance Program Minimal Claims will impact future CGL premiums;    

Other Insurance Provision Specifically applies as primary Clauses may conflict   

Notice of cancellation designated contractor and named insured receive notice only the named insured contractor receives notice   

Coverage for indemnitee’s own negligence Limited to general supervision only Coverage applies if the named insured contractor is at least partially responsible for the loss   

Personal injury perils not usually covered Covered   

Evidence that contractor has complied with requirement Copy of policy Certificate of Insurance (not binding on insurer)    

Subrogation Insurer can subrogate against contractor Insurer cannot subrogate against contractor   

1 Montana, New Mexico and Oregon statutorily prohibit requiring an indemnitee to provide insurance coverage that exceeds the level of indemnification allowed under the anti-indemnity statute.   

One of the primary benefits of OCP coverage versus additional insured coverage is that the owner obtains a separate set of limits applicable to its liability arising out of the project.  As an additional insured under the contractor’s CGL policy, the limit of insurance is shared not only with the contractor, but with every other party the contractor has named as an additional insured.  (Even if the CGL is endorsed to provide a project-specific limit of insurance, that limit is shared by the contractor and the additional insured.)  Other advantages of OCP insurance include fewer “other insurance” conflicts and guaranteed notice of cancellation for the owner.  (The CGL policy guarantees notice of cancellation only to named insureds.)   

The primary disadvantages of OCP coverage are higher cost, the lack of completed operations coverage, lack of access to the contractor’s umbrella and excess limits (however, the owner would still have access to these layers through the insured’s contractual liability insurance as long as the hold harmless clause is enforceable), and narrower scope of coverage than what is available on some additional insured endorsements.  In recent years, the availability of completed operations coverage and coverage for the additional insured’s own negligence have been substantially restricted, thereby negating some of the disadvantages of OCP coverage compared to additional insured status.  (Effective June 2004, the standard additional insured endorsement for owners and contractors does not provide coverage for liability arising out of the additional insured’s sole negligence.)  Depending on market conditions, additional insured status may be available for a nominal administrative charge, such as $50.  OCP insurance, on the other hand, may cost several thousand dollars, depending on the limits required.  

Railroad Protective Liability  

Railroad companies routinely require indemnification for bodily injury or property damage arising out of construction or demolition work performed on, over, or under a railroad right-of-way.  This requirement applies whether the work is for the railroad or not.  

While indemnity obligations assumed in business contracts are normally covered by the CGL contractual liability coverage, an exception is made for work performed in connection with railroad property.  Any indemnification with respect to work within 50 feet of a railroad and affecting railroad property such as tracks, bridges, tunnels, is excluded.  Further, easement or license agreements in connection with work on or within 50 feet of a railroad are specifically removed from the CGL policy’s definition of an “insured contract.”   

Railroad protective liability (RPL) insurance provides coverage with respect to liability arising out of construction or demolition work being performed by a contractor on or near a railroad right-of-way.  The contractor performing the work purchases the policy for the benefit of the railroad.  In addition to the named insured railroad, the policy also grants insured status to the railroad’s executive officers, directors and stockholders, and other railroads operating over the named insured railroad’s tracks.  The contractor is not an insured and receives no coverage under the policy.  

The RPL policy is divided into two parts.  Coverage A applies to third-party bodily injury and property damage and Coverage B applies to damage to property owned by or leased to the railroad.  Both coverages provide insurance for liabilities of the contractor that are not available in the standard CGL policy.  Most RPL policies are written on an occurrence basis, which means the bodily injury or property damage must occur during the policy period.  Some insurer’s proprietary forms provide coverage on a claims-made basis.  

Covered Damages  

Coverage A of the RPL policy covers the insured’s (i.e., railroad’s) liability for bodily injury or property damage arising out of “acts or omissions” in connection with the contractor’s “work” at the designated job location.  In most instances, the act or omission that causes the loss will be that of the contractor.  However, unlike in the OCP policy, coverage also applies to acts or omissions of the named insured railroad, unless such acts are the “sole proximate cause” of the bodily injury or property damage.  That is, while the RPL policy does not insure losses arising solely out of the railroad’s negligence, it does cover loss caused by the joint negligence of the railroad and the contractor.  The railroad’s coverage for its own acts of negligence, therefore, is much broader than that provided under an OCP policy, which is limited to acts of “general supervision” of the contractor’s work.  

Similarly, Coverage B insures damage to railroad equipment made available for the contractor’s use at the job location.  Construction and demolition work on or near railroad tracks often requires specialized equipment that contractors borrow from the railroad during the course of the project.  Damage to this equipment through the negligence of the contractor or one of its employees would likely not be covered under the CGL due to its “care, custody, or control” exclusion for personal property, but railroad protective liability insurance covers this type of loss.  The coverage conditions are the same as for Coverage A.  That is, the loss must arise out of acts or omissions at the job location that are related to the designated “work.”   

While the contractor who purchases the RPL policy receives no direct protection under the policy, it nevertheless benefits from the policy in that it provides coverage for liabilities for which the contractor has assumed responsibility, but would otherwise not have coverage.  It is therefore to the contractor’s advantage to make certain that coverage is written on sufficiently broad terms.  One point that is crucial to the scope of protection under a railroad protective policy is the designation of the “job location” and the “work” with respect to which coverage will apply.  Both items must be described in the policy declarations and both descriptions should be as inclusive as necessary to reflect the full scope of the project.  A “work” designation that is overly broad or general, however, will penalize the contractor, since the policy is rated on the total cost of the “work.”   

Exclusions  

Both Coverage A and Coverage B contain a number of exclusions that are common to liability insurance policies, including expected or intended injury or damage, contractually assumed liabilities, pollution, and damage to property owned by or leased to the railroad (these losses are covered under Coverage B discussed below).  However, a few exclusions, discussed below, are unique to the RPL form and/or reflect the special nature of the coverage.   

Workers Compensation   

Obligations under workers compensation, disability benefits, and similar laws are excluded from Coverage A.  While this exclusion is customary in liability policies, the RPL version contains an exception for the railroad’s obligations under the Federal Employers Liability Act, which is the legislation under which railroad employees are allowed to bring suit against their employer for job-related death or disability.  As a result, RPL insurance provides the railroad with a form of employers liability coverage for employee injuries arising out of the contractor’s work.  

Sole Negligence of an Insured  

As noted above, Coverage A does not apply to bodily injury or property damage caused solely by an act or omission of an insured.  This exclusion makes clear that railroad protective liability coverage is designed to address the railroad’s independent contractor exposure—liability the railroad might incur primarily because of the work being done by the contractor.  However, there are two important exceptions to the sole negligence exclusion.  Both of these exclusions address the potential for direct involvement of railroad employees in the contractor’s work.   

One of the sole negligence exceptions preserves coverage for third-party liability attributable to the acts of a “designated employee” of the railroad, and the other preserves coverage for injury to employees.  The latter exception applies not only to the railroad’s “designated employees,” but also to the contractor’s employees, and employees of the party hiring the contractor (if other than the insured railroad.)  “Designated employees” include railroad supervisory employees while at the job site, employees performing work at the job site on railroad equipment that has been assigned to the contractor (e.g., a work train made available for the contractor’s use in the project), and other railroad employees assigned to perform safety or security functions for the contractor in connection with the project.  

Coverage also exists, despite the exclusion, for injury that occurs at the job site to any of the railroad’s “designated employees” as listed above, to any employee of the contractor, or to any employee of the party hiring the contractor.  In short, the railroad protective policy covers the railroad’s sole negligence for third-party loss caused by a railroad employee directly involved in the contractor’s work, and for injuries sustained by a broad range of employees—the railroad’s, the contractor’s, and others’—while directly involved in the contractor’s work.  

Completed Operations  

Like other forms of protective liability insurance, railroad protective liability coverage is designed to apply to work in progress, not to completed operations.  The policy’s coverage ceases once the designated work is complete, except with respect to injury or damage caused by the presence or removal of tools, uninstalled equipment, or abandoned or unused materials.  The work is deemed to be “complete” when any one of the following criteria is satisfied.  

.           All work called for in the contract is completed.   

.           All work to be performed at the job site has been completed.   

.           That part of the work done at the job site has been put to its intended use by the railroad, the governmental authority (in the case of highway construction, for example), or any other party to the construction contract.   

Waiver of Subrogation  

The party against whom an railroad protective liability insurer is most likely to have subrogation rights is the designated contractor.  This possibility raises serious questions for a contractor because it violates the very purpose for which the contractor purchased the policy in the first place.  Furthermore, the subrogation action may not be covered by the contractor’s CGL policy, depending on whether the subrogation action is based on the contractor’s tort liability (would be covered) or its contractual obligation to indemnify the railroad.  The latter type of claim would not be covered because work on or within 50 feet of a railroad does not meet the definition of an “insured contract,” on which the policy’s contractual liability coverage is predicated.   

Closing the contractual liability coverage gap can be accomplished—theoretically, at least—in either of two ways.  The first would be to effect a waiver of subrogation, preferably by endorsement to the railroad protective policy.  Such an endorsement would incorporate an agreement by the railroad protective insurer not to seek recovery against the contractor for payments made to the railroad under the policy.  While such a waiver is routinely added to other forms of protective liability insurance, there is no standard ISO waiver of subrogation endorsement for use with the railroad protective policy.  Unless the RRP insurer is also the contractor’s CGL insurer, it is questionable whether the insurer would be willing to attach such an endorsement even if one were available.  An alternative approach to closing the gap is to remove the exception for work on or near a railroad within the definition of “insured contract” in the contractor’s CGL policy.  In the ISO program, this can be accomplished by attaching endorsement CG 24 17 (contractual liability—railroads) to the policy.  

With respect to Coverage B, the contractor could also be subrogated against because of physical damage to property borrowed or rented from the railroad by the contractor.  In that case, there would be no coverage even if the subrogation action is based on the contractor’s own negligence (tort liability) due to the CGL policy’s care, custody, or control exclusion.  This exposure is best handled with the purchase of first-party property coverage on the borrowed or rented equipment.  

Project Management Protective Liability Insurance  

Project management protective liability (PMPL) insurance was first introduced as an optional insurance requirement in conjunction with the 1997 edition of the American Institute of Architects (AIA) General Conditions of the Contract for Construction.  The driving force behind this requirement was architects’ concern over their coverage for vicarious liability arising out of a contractor’s means and methods of construction.  The PMPL option immediately generated confusion for contractors, owner, attorneys, and insurance professionals, as the coverage was unfamiliar, and it was not readily apparent what markets would provide the coverage.   

For several years after its introduction, only one market existed for PMPL coverage, which was written on a proprietary form.  In 2001, Insurance Services Office (ISO) introduced a standard endorsement (CG 31 15) that, when attached to a standard OCP policy, converts that policy to a PMPL policy.  As a result, any insurer that uses ISO forms now has the ability to write the coverage.  However, demand for the coverage has never been great.   

Although the buzz about the “new” coverage requirement has died down significantly, it still creates questions and confusion today.  This section outlines the scope of coverage provided by PMPL insurance, as well as the pros and cons of this coverage for both owners and contractors.   

Scope of Coverage  

With a few exceptions, PMPL coverage mirrors the underlying OCP coverage.  The most significant difference is that the architect (or other design professional), the contractor, and the project owner are all named insureds under the policy.  Most of the other differences are designed to merely maintain the intended scope of coverage given that the contractor and design professional are also insureds under the policy.  Notably, a professional services exclusion prevents the policy from being triggered in response to a professional liability claim against the architect.   

As in the underlying OCP policy, the PMPL coverage form covers the named insured for (1) vicarious liability arising out of the designated contractor’s work, and (2) direct liability arising out of a named insured’s general supervision of the contractor’s work (including work performed on the contractor’s behalf by subcontractors).  Note that as in the OCP policy, coverage is linked to contractor’s work on the designated construction project.  This prevents the policy from being triggered by the named insured’s non-related activities, such as their own business operations.  

Waiver of Subrogation  

The insurer waives its rights of recovery against the insureds for payments made under the policy.  This is a significant advantage over OCP coverage.  

Exclusions  

The PMPL endorsement adds a professional services exclusion that removes coverage for any loss arising out of the named insured’s professional activities.  All of the other OCP policy exclusions still apply.  

Advantages and Disadvantages  

PMPL insurance presents costs and benefits to the various parties.  Surprisingly, many of the negative consequences appear to be borne by the owner and the architect, while the biggest advantage appears to belong to the contractor.  The advantages and disadvantages of PMPL insurance, for both the owner and the contractor, are summarized below.   

Owner  

One obvious benefit of both OCP and PMPL insurance is that it avoids the risk of not being added to the contractor’s CGL as an additional insured due to administrative error or oversight.  Additionally, covering the owner, contractor, and the architect as insureds under one PMPL policy may result in a more coordinated defense for claims naming all of the insured parties.  However, unless more insurers begin writing PMPL coverage now that a standard form is available, many contractors will not have access to this coverage, which may disrupt the contracting process, especially in competitive bid situations.  Further, with PMPL insurance, the owner gives up one of the primary benefits of an OCP, which is a separate limit of insurance.  As named insureds on the PMPL, the owner, architect, and contractor share the limits of insurance.  And as with OCP insurance, the owner will not have access to the contractor’s umbrella liability policy because the policy does not qualify as an “underlying coverage” that would trigger the umbrella.)  

When considered in total, the disadvantages of PMPL insurance to the owner probably outweigh the benefits.  This may explain the low demand for the coverage.   

Contractor  

Many contractors prefer to provide protective liability insurance (which is charged back to the owner) versus additional insured status because it costs them nothing and protects their own limits of insurance from claims made against other insureds.  The waiver of subrogation in the PMPL policy is also a significant advantage over OCP coverage, as it preserves the parties’ intent that the protective liability policy is the primary source of liability coverage for insureds’ liability arising out of the contractor’s operations.  The only obvious disadvantages (over and above those that apply to OCP insurance) is that it is not widely offered by insurers.  

Auto Liability Insurance  

In the language of insurance, the term “auto” can include many types of vehicles other than cars.  The ownership or operation of an auto (defined as a land motor vehicle, trailer, or semitrailer designed for travel on public roads or subject to a compulsory insurance law) exposes a contractor to potentially large financial losses.  The contractor might be held legally liable to others for bodily injury or property damage arising out of an auto, or the contractor’s vehicle(s) could be lost, damaged, or destroyed by any of a number of perils.  Most contractors insure these loss exposures by purchasing a business auto policy (BAP).  While a comprehensive discussion of auto insurance is beyond the scope of this course, it will review certain policy provisions important to contractors.   

The business auto policy offers a variety of coverages, including liability, physical damage, medical payments, personal injury protection and uninsured/underinsured motorists coverages.  A series of ten “symbols” (identified by the numbers 1 – 10) are used to specify the coverages that are carried on various vehicles.  Most contractors will purchase liability coverage for all vehicles (symbol 1), and a combination of other coverages on different categories of vehicles.  With respect to physical damage, contractors should decide on which (if any) vehicles they can afford to retain the risk of loss and which should be insured.  Various symbols are available for use in establishing coverage for physical damage, medical payments, and other optional coverages.   

Most of the contractor-specific auto insurance issues fall within the liability section of the policy.  For that reason, the remainder of this chapter addresses Section II (Liability Insurance) of the business auto policy.  Keep in mind that variations in coverage exist across states based on state-specific endorsements that modify coverage as needed to comply with state laws.  

Insuring Agreement  

The Section II insuring agreement stipulates the required conditions for coverage to apply, such as what events will trigger the coverage, and what types of damages are covered.  These key elements of coverage are listed in Exhibit 5.1, and discussed further below.  

Exhibit 5.1 Elements of a Covered Loss   

. . .  “Bodily Injury” or “property damage” results from the ownership, maintenance, or use of a covered “auto.”  “Bodily Injury” or “property damage” is caused by an “accident.”  The insured is legally liable for the loss.   

In addition to covered “bodily injury” or “property damage,” the BAP will pay costs incurred in defending an insured or settling a claim against the insured.  These defense costs are payable outside the policy limit.  The insurer also agrees to pay “covered pollution cost or expense” sustained in connection with an accident that produces covered bodily injury or property damage.  For example, if a contractor’s covered auto collides with a chemical storage tank on the construction site, the BAP would respond to bodily injury or property damage caused by the accident, including the cost of restoring the property by cleaning up the spilled chemicals.  However, in certain instances, such as when public roadways or waterways are at risk, the government may also require the contractor to take certain measures above and beyond the normal cleanup of the chemical, to ensure public safety.  The “covered pollution cost or expense” provision extends coverage for the corresponding costs, subject to the conditions outlined above.  

Ownership, maintenance, and use are not defined in the policy, and these words would thus be afforded their normal meaning.  Although “accident” is defined in the policy, all this definition says is that the term will include “continuous or repeated exposure to the same conditions” when such exposure results in bodily injury or property damage.  This qualification is directed primarily at the policy’s pollution coverage.   

Covered Autos  

In most cases, contractors (like most other businesses) should select symbol 1 (any auto) for liability coverage, to ensure compliance with state financial responsibility laws and avoid oversights in keeping the list of covered autos up to date.  The BAP provides that with respect to all autos insured for liability coverage, various other categories of vehicles are also covered “autos” under that section of the policy.  These categories are listed in Exhibit 5.2.   

A December 2004 ISO endorsement (CA 99 51) modifies the “auto” definition of the BAP to parallel CGL changes that were discussed in Chapter 3.  These changes will also be reflected in the next edition of the BAP.  With these changes, any land vehicle that is subject to a compulsory insurance law or a financial responsibility law is considered an “auto.”  As a result, some vehicles that were previously considered mobile equipment and covered under the CGL are now considered “autos.”  They are covered under the BAP, and an appropriate premium for each vehicle will be charged.  

Also of particular interest to contractors is that mobile equipment is covered while being carried or towed by a covered auto.  See the discussion of the mobile equipment exclusion below for further discussion of coverage for such equipment.  

Exhibit 5.2 Additional Covered Autos—Section I (Liability)   

. . . .  An “auto” of the type indicated by the liability coverage symbol that you acquire during the policy period.  “Trailers” with a load capacity of 2,000 pounds or less designed primarily for travel on public roads.  “Mobile equipment” while being carried or towed by a covered “auto.”  Any non-owned “auto” used as a temporary substitute for your covered “auto” that is out of service because of its breakdown, repair, servicing, loss, or destruction, when used with the owner’s permission.   

Who Is an Insured  

The BAP’s liability coverage applies to amounts that an “insured” is legally obligated to pay as damages.  The definition of “insured” is broken into three segments—the named insured, permissive users, and anyone liable for the conduct of an insured.  The named insured—the person or entity listed on the policy declarations—enjoys the broadest scope of coverage of the three classes of insureds, with coverage for the use of any covered auto.  Permissive users include most persons (a list of exceptions applies) while using the named insured’s covered auto with the named insured’s permission.  For example, if the named insured lends a covered auto to a friend, that friend becomes an insured under the BAP.   

The third category of insureds—anyone else liable for the conduct of an insured—includes any person or organization not otherwise included or excluded by the first two categories of insureds, to the extent they are vicariously or statutorily liable for an insured’s conduct.  Commonly referred to as the Omnibus Clause, this provision is important to contractors who routinely agree to name others as insureds under their auto liability insurance.  For example, general contractors often agree to name project owners as additional insureds under their auto liability insurance.  This clause automatically provides insured status to the owner to the extent the owner is liable for the insured contractor’s actions.  

Consequently, additional insured endorsements are not needed for coverage to be afforded to another party who is liable for the conduct of an insured.  Nevertheless, many project owners continue to require that they be specifically added to the policy as an additional insured.  The designated insured endorsement (CA 20 48) can be used to satisfy this requirement.  This endorsement does not provide any additional coverage that is not already in the policy but merely reiterates that the person named on the endorsement is an insured to the extent the Who Is an Insured provision already says they are an insured.  

Exclusions  

The BAP liability coverage contains 13 exclusions, listed in Exhibit 5.3.  Many of these exclusions are dovetailed to the coverage that is provided in the CGL.  That is, the reason certain exclusions are in the policy is to avoid duplication of coverage that is provided under the CGL policy.  Those exclusions with particular significance for contractors appear in bold, and are discussed subsequently.  

Exhibit 5.3 Liability Exclusions   

. . . .  . . . . . ..  ..  Expected or intended injury Contractual liability Workers compensation and other statutory obligations  Employee indemnification/employers liability Injury to a fellow employee Owned property/care, custody, or control  Loss resulting from the handling of property Loss resulting from the movement of property by an unattached mechanical device Mobile equipment  Completed operations Pollution  War Racing, demolition or stunting events   

Contractual Liability Exclusion  

The business auto policy provides coverage for the insured’s contractual liabilities in a manner identical to that used in the CGL policy.  That is, the insured has coverage for contractual liabilities arising out of the ownership, maintenance, or use of auto if the liability would have existed even in the absence of the contract, or if the liability was assumed in an “insured contract.”   

The BAP policy’s definition of “insured contract” is similar, but not identical, to the CGL policy’s definition.  The primary difference, as far as most contractors are concerned, is an additional category of “insured contract” for indemnity obligations in a car rental agreement (except with respect to damage to the rental vehicle) and the absence of an elevator maintenance agreement.  Thus, the contractor has coverage for its obligation to indemnify another for liability arising out of the ownership, maintenance, or use of an auto arising out of any of the following categories of contracts.   

.           A lease of premises (e.g., an auto accident on the premises)  

.           A sidetrack agreement  

.           An easement or license agreement (except in connection with construction or demolition operations on or within 50 feet of a railroad)  

.           An obligation, as required by ordinance, to indemnify a municipality, except in connection with work for a municipality  

.           That part of any other contract or agreement pertaining to your business under which you assume the tort liability of another to pay for “bodily injury” or “property damage” to a third party or organization.  

.           That part of any contract or agreement entered into, as part of your business, pertaining to your rental or lease of any “auto”  Notable exceptions to this definition include an obligation to indemnify the lessee of an auto for damage to the vehicle, and an obligation to indemnify a railroad for damages arising out of construction or demolition operations within 50 feet of any railroad property, and an obligation to indemnify a common carrier (person or organization who transports property for a fee).   

If, for example, the named insured (lessee/indemnitor) leased property with a garage and someone is injured on that property in an auto accident involving a covered auto, the auto liability insurance would respond to any suit against the named insured (contractor) as well as the landlord, to the extent the contractor has agreed to provide indemnification for such losses.  Likewise, an obligation in the construction contract to indemnify a project owner for a claim for an auto-related injury to a person on the construction site (including an employee of the contractor) would be covered.   

The definition of “insured contract” precludes coverage for indemnification obligations arising out of construction or demolition operations within 50 feet of a railroad, but only with respect to obligations to indemnify the railroad.  Coverage does exist with respect to all other indemnitees.  For example, if a highway contractor’s operations are less than 50 feet from a railroad, its obligation to indemnify the project owner (e.g., the city or state, perhaps) is not impacted by this exception to the definition of “insured contract.”  

Owned Property/Care, Custody, or Control Exclusion  

The exclusion for damage to property owned or transported by the insured contractor, or in the contractor’s care, custody, or control precludes coverage for materials and equipment transported to the construction site by a covered auto.  This exposure is more properly insured in a first-party property policy, such as a builders risk policy.  Note that coverage for property in transit may require an endorsement to the builders risk policy.  Liability assumed under a sidetrack agreement is specifically excepted from this exclusion and is therefore covered.  

Mobile Equipment Exclusion   

Mobile equipment, such as cranes, cherry pickers, loaders, diggers, snow plows, etc., present an insurance challenge since at times they more closely resemble the exposures that are insured under a CGL policy—i.e., when being used to raise or lower machinery or people—and at other times, they more closely resemble an auto exposure—e.g. when being driven from one location to another.  The question arises as to which policy is the appropriate place to cover the liability exposures associated with such equipment.  As explained in Chapter 3, the approach taken in the ISO forms is to split the coverage between the two policies.  

It is always cheaper for equipment to be classified as “mobile equipment” than as an “auto.”  Consequently, it will usually be to a contractor’s advantage to have as much equipment as possible classified as “mobile equipment.”  Some common examples of equipment that are appropriately classified as mobile equipment include cranes, office or storage trailers, and even vehicles used exclusively at the contractor’s yard.  Nevertheless, the distinction between “mobile equipment” and “autos” is complicated, and some losses may fall into a gray area where it is not clear how to properly classify an item.  

Pollution Exclusion  

With two minor exceptions, the BAP pollution exclusion can be viewed as constituting an almost total exclusion of coverage for incidents involving pollutants, even if the discharge of the pollutant is sudden and accidental.  Keep in mind that in order for coverage under the BAP to apply, the release of pollutants must somehow arise in connection with the ownership, maintenance, or use of a covered auto.  

The auto pollution exclusion precludes coverage for liability arising out of the escape of pollutants.  The exclusion applies to the escape of pollutants during transportation (including unloading or unloading) by a covered automobile, or while being stored in the covered auto.  By implied exception to the exclusion, the insured would still have coverage for liability arising from a collision with another auto that is carrying pollutants.  

Coverage is also excluded for pollution incidents that occur before loading pollutants into or onto a covered automobile or after unloading pollutants at their final place of delivery, disposal, or abandonment.  (Coverage might be available for such exposures under the CGL policy.)  An exception applies when the release is the result of an “accident” that occurs away from the insured’s premises and the “pollutants” were released from property other than a covered “auto” as a direct result of upset, overturn, or damage caused by the maintenance or use of the covered auto.  To illustrate, suppose the insured contractor properly disposes of several tanks containing pollutants at a waste disposal site not owned by an insured.  After the delivery is complete, and the contractor’s driver prepares to leave the site, he accidentally backs the truck into one of these tanks causing the tank to rupture and pollutants to escape.  The pollution exclusion would not apply to such a loss.   

Another important exception to the exclusion applies to liability arising out of the discharge or escape of potential “pollutants” that are necessary for the normal functioning of the covered auto, such as fuel, lubricants, fluids, and exhaust gases as long as the pollutants escape or are discharged directly from an auto part designed to hold or dispose of them.  As an example, assume that the oil pan on a contractor’s truck is ruptured in a collision, and the oil from the crankcase creates an oil slick that causes another accident several minutes later.  If the contractor is held liable for the second mishap, the contractor would have coverage under the BAP for this liability loss, despite the pollution exclusion, because the pollutant (the oil) was necessary for the functioning of the covered auto and was released from the auto part designed to hold it (the truck’s crankcase).  

Transportation of Pollutants  

The pollution exclusion can be amended to cover a contractor’s liability arising out of the transportation of pollutants.  Specifically, when the pollution liability—broadened coverage for covered autos endorsement (CA 99 48) is attached to the policy, the portion of the exclusion that deals with transportation exposures is modified to apply only to contractually assumed liability.  With this endorsement, the contractor would have coverage for direct liability (but not contractually assumed liabilities) arising out of the transportation, loading, or unloading of pollutants by a covered auto.  For contractors who transport solvents and other chemicals or potential “pollutants” to or from a site, this coverage could provide valuable extra protection.  

The portions of the auto liability pollution exclusion that deal with discharges of pollutants before they are moved into or onto the covered auto and after they are moved from the covered auto are unchanged by this endorsement.  In other words, the exclusion of what would ordinarily be a premises-operations liability exposure remains in place.  (Note that the CGL policy excludes pollution liability arising out of a release of pollutants that are brought to the site by the insured.  Contractors who bring such pollutants to the job site would still have an uninsured onsite exposure.)  

Motor Carrier Act Coverage   

The Federal Motor Carrier Act of 1980 requires firms that transport hazardous materials on public highways to demonstrate their ability to pay pollution liability and environmental restoration claims.  To satisfy this financial responsibility requirement with insurance, a Motor Carrier Act endorsement (MCS-90) may be attached to the business auto policy.  This endorsement does not provide any additional insurance protection.  It serves only as a financial guarantee to third parties that the insured will respond to certain pollution liability claims arising out of an accident.  The insured is obligated to reimburse the insurer for any payments made under the endorsement for losses not covered by the business auto policy itself.  

Contractors Equipment  

The mobile nature of equipment and machinery used in construction exposes it to perils, such as theft and collision, not contemplated by policies designed to cover property that is permanently tied to one location.  As a rule, permanent property policies are not a suitable means of covering this exposure as coverage often applies only at scheduled locations.  As a result, the items would be uninsured while in transit or in off-site storage.  Builders risk policies provide coverage for equipment while on a scheduled construction site but only if it is destined to become part of the structure.   

Equipment and machinery used by contractors in the performance of their work—other than equipment that is actually incorporated into the work—is properly insured under a contractors equipment insurance policy.  Because of its mobile nature, contractors equipment insurance falls into the “inland marine” line of coverage.  A broad contractors equipment policy will provide insurance against physical damage to mobile equipment while located on the job site, in transit, or elsewhere.  Since these forms are not standardized, significant variation exists in the policies offered by different insurers.  Each form must be read closely to determine the scope of coverage and to evaluate the impact of other provisions.  

Coverage can be arranged on a scheduled basis, a blanket basis, or some combination of the two.  In scheduled policies, “covered property” will be defined as those items specifically listed on the schedule.  When coverage is written on a blanket basis, “covered property” is generally defined broadly to include equipment and tools owned by the contractor (or being purchased under a lease-purchase agreement) that are usual to the contractor’s business.  Periodic reporting will generally be required with blanket coverage.  However, blanket coverage removes the need to keep schedules up to date.  

Covered Property  

Contractors equipment policies cover machinery, tools, and other equipment of a mobile nature.  Most policies cover a wide range of items, such as cranes, bulldozers, pile drivers, drills, earthmovers, tractors, air compressors, generators, office and storage trailers, forklifts, cherry pickers, portable tool houses, welding units, hand tools, and scaffolding.  Some forms also extend coverage to spare and repair parts used for maintaining mobile equipment, and accessories used in conjunction with such equipment.  Newly acquired equipment is generally granted automatic coverage for a limited number of days, possibly subject to a sub limit or a per item maximum.  

Exhibit 6.1 lists some categories of property that are either ineligible for coverage because they do not qualify as “inland marine” property, or that are specifically excluded from coverage.  These are discussed briefly below.  In many instances, coverage can be obtained by endorsement, sometimes at considerable additional cost.   

Exhibit 6.1 Excluded Property or Property Not Eligible for Coverage   

.  Automobiles.  Watercraft and other waterborne property.  Aircraft and airborne property.  Documents such as plans, designs, or blueprints.  Property located under ground or under water.  Property that is in unsound condition.  Property rented or loaned to others.  Property designed to become part of a structure.  Crane or derrick booms over a specified length, while in operation   

The nationally accepted definition of “inland marine” property excludes “motor vehicles designed for highway use and auto homes, trailers, and semitrailers except when hauled by tractors not designed for highway use and snow plows constructed exclusively for highway use.”  However, equipment permanently mounted on these vehicles usually does qualify as covered property.  For example, contractors commonly mount equipment such as generators, compressors, or welding units onto trucks to facilitate transportation of the equipment.  The vehicle in such a situation would be covered in a commercial auto policy, while the attached equipment is covered under a contractors equipment policy.  

If vehicles giving mobility to construction equipment are used exclusively to transport the equipment, and on-the-road use is completely incidental to the normal operation of the unit (particularly when the equipment is an integral part of the vehicle), it may be possible to delete or modify this exclusion such that the contractors equipment policy would also insure the vehicle.  Mixers, cranes, and graders are examples of equipment that may qualify as covered “equipment.”   

Some types of property are simply not mobile equipment of the type contemplated by the coverage form, and more specific insurance contracts are available to cover them.  Watercraft, aircraft, construction documents, and underground property fall into this category.  

Some types of property are insurable under certain circumstances, but categorically excluded when they present an increased risk of loss.  For example, property that is in unsound condition when the policy is written is generally excluded.  Some insurers may agree to delete the exclusion in exchange for a “warranty” that all property is in sound condition at the time the coverage is written.  This may or may not entail a physical inspection of the equipment by a representative of the insurer.   

Likewise, property that has been loaned or rented to others presents a concern for underwriters.   

This exclusion recognizes that the benefits of the insured’s training and safety programs are lost when the equipment is used by other parties.  Since lending or renting equipment to others at construction sites is very common, this exclusion can result in a substantial uninsured exposure.  If this exclusion cannot be deleted from the policy, contractors should not lend equipment to others.  In most cases, another contractor’s general liability policy would not cover any legal liability arising from damage to borrowed or rented equipment while in its possession because of the CGL policy’s care, custody, and control exclusion.  

The waterborne property exclusion commonly has a specific exception making it inapplicable when the property is in transit on a regular ferry, lighter, or car float.  (Some policies also exclude coverage for property while airborne, for similar reasons, although it is not as common as the waterborne exclusion.)  When operations involve the use of equipment from a barge or other watercraft, many underwriters will agree to delete this exclusion.  Since losses of this type are often constructive total losses, the additional premium for deleting the waterborne exclusion can be fairly high.  

Crane or derrick booms present extremely high risks given how they are used (to lift and move heavy items).  Most contractors equipment policies exclude loss or damage to crane or derrick booms over a specified length (e.g., 25, 40, or 50 feet) while in operation.  The primary purpose of the exclusion is to preclude coverage for losses arising from negligent operation of the equipment.  Because booms represent a substantial portion of the value of cranes or derricks, “boom” exclusions, if any, should be limited to loss sustained while the boom is in use.  

Covered Perils  

The majority of contractors equipment policies are written on an all risk basis, but named perils coverage is sometimes an option.  In a named perils policy, covered perils are those specifically listed on the policy.  In all risk policies, all perils are covered except those specifically excluded in the policy.  Exhibit 6.2 lists the causes or loss, or perils, commonly covered in named perils forms.  

Exhibit 6.2 Commonly Covered Causes of Loss “Named Perils” Coverage   

.  Fire.  Lightning.  Windstorm.  Hail.  Explosion.  Strikes, riot, and civil commotion   .  Earthquake, landslide, or mudflow.  Flood.  Upset or overturn of equipment.  Collision, derailment, upset, or overturn of a transporting vehicle.  Theft.  Vandalism   

Exhibit 6.3 lists the causes of loss commonly excluded in all risk forms.  Both types of policies preclude coverage for specific exposures insurers do not want to cover.  

Exhibit 6.3 Commonly Excluded Perils “All Risks” Coverage   

.  War, nuclear hazard, and government seizure.  Dishonesty of the insured, the insured’s employees, or others to whom the equipment is entrusted (other than carriers for hire).  Mysterious disappearance and shortage on taking inventory.  Electrical injury to electrical devices.  Mechanical breakdown.  Wear and tear, corrosion or rust, gradual deterioration, inherent vice or latent defect, temperature and humidity changes or extremes.  Delay, loss of market, loss of use, consequential loss.  Maintenance or repair of covered property.  Weight of load exceeding designed capacity.  Loss to crane or derrick booms while in operation, except from specified perils.  Puncture, blowout, or road damage to tires and tubes mounted on equipment, except from specified perils, unless loss is coincident with other covered loss.  Pollutant release except from specified causes.  Voluntary parting with property due to fraudulent scheme   

Debris Removal   

Most contractors equipment policies include debris removal as an automatic coverage extension; others usually offer an optional endorsement.  Coverage is restricted to the cost of cleaning up the debris of covered property damaged by a covered peril.  Some policies may further provide coverage for demolition costs of undamaged covered property that can no longer be used for its intended purpose.  For example, debris removal would pertain to the cost of clearing away scaffolding that was actually damaged, while demolition cost coverage would pay to tear down undamaged scaffolding that will have to be rebuilt because the unit is no longer structurally sound.  The limit of liability for this coverage is usually the lesser of a stated amount or a percentage of the overall policy limit (e.g., 10 percent of the policy limit or $100,000, whichever is less), and is generally additional coverage (i.e., not included in the property limit).  

Optional Coverages  

Several optional contractors equipment coverages are available from most insurers.  Common optional coverages include leased or rented equipment coverage, borrowed equipment coverage, continuing rental payment coverage, rental cost reimbursement, and coverage for employees’ tools and work clothing.  These coverages are discussed briefly below.  

Leased or Rented Equipment  

A leased or rented equipment endorsement to the contractor’s equipment policy covers the insured’s legal liability for loss or damage to equipment leased or rented from others.  (The contractor’s CGL policy almost certainly excludes coverage for liability resulting from damage to leased or rented equipment through its “care, custody, and control” exclusion.)  A separate sublimit normally applies.  

The premium rates for leased and rented equipment coverage are generally two to three times greater than the rate for owned equipment.  The premium for this coverage is based on the actual lease or rental fees paid during the period.  A deposit premium will normally be required when the endorsement is attached, with the final premium determined based on an audit of the actual exposure during the coverage period.   

Borrowed Equipment  

The loss exposure faced by borrowers of contractors’ equipment is very similar to the loss exposure confronting equipment renters.  An insured contractor that borrows equipment from others can sometimes be held liable for any damage to the equipment, even if there is no contractual agreement to that effect.  Remember that the insured’s commercial general liability policy usually provides no coverage for liability resulting from loss or damage to borrowed equipment because of the care, custody, and control exclusion.  Also, the business that loans the equipment may not have coverage under its own contractors equipment policy because of the exclusion of equipment rented or loaned to others.  

If the insured’s contractors equipment policy provides scheduled coverage, borrowed equipment can usually be covered simply by scheduling it.  Some blanket or combination forms include an unscheduled borrowed equipment coverage option that applies when there is a borrowed equipment sublimit on the declarations page.  Otherwise, blanket contractors equipment policies may not cover equipment owned by others that is in the insured’s care, custody, and control, and therefore would have to be endorsed to provide the coverage for borrowed equipment.  

Borrowed equipment coverage options and endorsements are very similar to leased equipment coverage options and endorsements except that the premium is based on the value of the borrowed equipment rather than the rental cost.  However, insurers may be less willing to provide blanket coverage on borrowed equipment than on leased equipment, because the informality of most short-term equipment loan arrangements may mean that there are no records that would serve as an accurate exposure basis for rating purposes.  

Rental Cost Reimbursement  

If a particularly important piece of construction equipment is damaged or destroyed, the contractor may find it necessary to rent a temporary replacement until repairs can be made or new equipment can be acquired.  A rental cost reimbursement endorsement (sometimes referred to as a “cost of hire” endorsement) can be added to the policy to pay the additional expenses associated with renting equipment on a temporary basis.  This endorsement is particularly important if the insured uses any specialized equipment that may be difficult to replace or repair and that is crucial to continuing operations.  Rental cost reimbursement endorsements typically impose a waiting period deductible (e.g., 48 hours) rather than a dollar deductible, and they usually contain both a per day and annual aggregate limit of liability.  When the coverage is written on a blanket basis, the loss recovery is often limited to a specified percentage (such as 80 or 90 percent) of the loss.  

Employees Tools and Clothing  

Coverage for employees’ tools and work clothing for which the insured may be liable can be endorsed onto contractors equipment policies.  (Some insurance companies automatically provide this as a coverage extension within the policy.)  Such items are covered only while located on job sites or in transit to and from job sites in vehicles owned by the insured.  Coverage will likely be subject to a very low per occurrence limit (e.g., $5,000) and an even lower per employee limit (e.g., $500.)  

Limits and Deductibles  

Contractors equipment coverage can be arranged on a scheduled basis, a blanket basis, or a combination of the two.  Coverage written on a scheduled basis requires that each item of equipment be listed on the policy, with a specified amount of insurance applying to each item.  Blanket coverage will contain an overall policy limit that applies to all covered types of property.  

Scheduled coverage is not practical for insureds with large amounts of equipment since maintaining an up-to-date schedule is very difficult.  When coverage is needed for a large amount of equipment, blanket coverage is the better method for obtaining insurance.  Under blanket coverage, the insured submits a list of all owned equipment at the beginning of the policy period, along with the value of each item.  At the end of a specified time period (usually 1 year but sometimes monthly or quarterly), an updated list of equipment is submitted, and the insured’s premium is adjusted for the actual value at risk during the period.  Under this approach, any new equipment purchased during the policy period is automatically covered (subject to a per item sub limit on newly acquired property) until the next equipment report.  Blanket coverage eliminates the administrative burden of reporting each purchase or sale of equipment individually.  

Policies with very large equipment schedules may include a catastrophe limit that sets a maximum amount the policy will pay for all damages (losses, expenses, and salvage charges combined) arising out of a single accident or event.  A policy with a $10 million blanket limit, for example, might have a $2 million catastrophe limit.  A catastrophe limit is sometimes imposed to make it easier for the insurer to obtain reinsurance on large schedules.  As long as the catastrophic limit is high enough to cover the exposure in any single area, contractors may find that the benefits (i.e., more insurers willing to bid on the account and possibly a lower rate) of accepting the limit justify the cost (i.e., the risk of an uninsured loss).  For obvious reasons, however, catastrophe limits are not appropriate unless the contractor has a sufficient geographical spread of risk.  

Sublimits may also be imposed on the policy’s flood and earthquake coverage.  Such sublimits may be imposed in addition to or in lieu of a catastrophe limit.  For example, it would be possible to have a $10 million blanket limit, a $3 million catastrophe limit (applying to all perils except flood and earthquake), and a $1 million flood and earthquake limit.  

When the list of scheduled equipment is short, flat-dollar per occurrence deductibles are typically used on the policy.  For large schedules, underwriters often use deductibles that are a percentage of the value of the damaged item, subject to a minimum and/or maximum amount.  Percentage of loss deductibles are also sometimes encountered.  If available, percentage of loss deductibles are actually more favorable to the insured than percentage of value deductibles.  The reason is that a percentage of loss deductible translates into a lower dollar deductible in the event of a partial loss; there is no difference between the two in the event of a total loss.  Annual aggregate deductibles may be included on policies with large schedules.  Under this approach, a single deductible of a substantial amount (e.g., $100,000) is specified.  All losses during the year are subject to the deductible until the aggregate amount paid by the insured equals the specified deductible.  From that point forward, the policy covers all claims during the policy period on a first dollar basis.   

Valuation and Coinsurance  

Because of the nature of construction work, the wear and tear on contractors equipment is substantial.  Therefore, it can physically depreciate fairly rapidly.  As a result, the difference between actual cash value and replacement cost can be much greater than for other types of property.  For this reason, most contractors equipment forms are written on an actual cash value (ACV) basis, although replacement cost coverage is sometimes available by endorsement.  In some instances, replacement cost coverage may only apply to specified items, such as certain types of equipment or items manufactured after a specified date.   

Most contractors equipment policies also contain a coinsurance clause to encourage insuring to value.  Failure to comply with the coinsurance clause can result in a reduced recovery (the amount of the loss less the coinsurance penalty); therefore, it is important that accurate values be listed for each insured item.  Penalties for underinsurance can be substantial.  Equipment policies are generally written with a 90 or 100 percent coinsurance clause.  Equipment sales representatives, manufacturer’s representatives, and certified appraisal firms can assist in determining the value of a piece of equipment.   

Contractors may prefer to eliminate the risk of coinsurance penalties by having the coinsurance clause deleted from the policy.  Insurers will sometimes write the coverage on an agreed amount basis, in which the contractor and the insurer agree that no coinsurance penalty will be applied at the time of the loss as long as the specified amount of coverage is maintained.  The agreed amount endorsement will normally provide for a reinstatement of the coinsurance provision at the end of the policy period if the insured has not submitted (or the insurer has not accepted) an updated schedule of equipment and corresponding values.  

Workers Compensation Insurance  

In most states, employers are required to purchase workers compensation insurance.  (Texas and New Jersey, where employers can elect not to participate in the workers compensation system, are the only exceptions.)  However, some states exempt employers with fewer than a specified number of employees from this requirement, so small contractors may not be subject to the workers compensation statute in these states.  Because employers who do not participate in the workers compensation system lose the benefit of exclusive remedy (i.e., they receive no protection from employee lawsuits), many contractors voluntarily choose to provide workers compensation benefits even when they are not legally required to do so.  (In most states, contractors who voluntarily provide benefits also receive the exclusive remedy protection.)  

The National Council on Compensation Insurance (NCCI) serves as the filing agency and rating organization for workers compensation insurance in the majority of states.  The standard NCCI workers compensation insurance policy is largely a standardized coverage, with most insurers electing to use the NCCI workers compensation and employers liability insurance policy.  A few states require all workers compensation policies to be issued on the NCCI form, but most allow insurers to file their own forms, although few do so.  

The standard workers compensation policy provides three basic coverages.  Part One, “Workers Compensation Insurance,” responds to the contractor’s statutory liabilities to injured workers in states (or U.S. territories) for which such coverage is listed in the policy.  Part Two, “Employers Liability Insurance” responds to claims by employees or their dependents that fall outside the protection of the workers compensation law.  Together, these two coverages respond to many types of claims arising out of injuries to employees.   

Part Three, “Other States Insurance,” broadens not the types of compensable claims, but the policy’s geographical application.  As noted above, Part One only responds to claims payable under the statutes of states that are listed for this coverage.  Part One is reserved, however, for states in which actual operations are in place.  While contractors should list all states in which they have ongoing operations under Part One, they may have incidental exposures in other states, such as when an employee is injured while traveling to a seminar in another state.  “Other States” coverage is designed to pick up these incidental liabilities, but only for the states for which such coverage is specified.  Where it is an option, the safest way to avoid coverage gaps is to list “all states except the monopolistic states.”  (Commercial insurers are not licensed to provide workers compensation insurance in monopolistic states, which require all workers compensation insurance to be purchased from a monopolistic state fund.  Currently North Dakota, Ohio, Washington, West Virginia, and Wyoming operate on a monopolistic basis.)   

Who is an Insured?  

The “insured” on the workers compensation policy includes the employer-entity, and as well as the individual owners of the entity.  For example, individual partners of a company are insureds, in addition to the partnership entity, but only with respect to their capacity as an employer of the partnership’s employees.  (Thus, if one of the partners has household employees or is involved in another business entity other than the insured partnership, that partner is not an insured with respect to benefits or damages owed to those other employees.)  

If the insured is a joint venture, only the joint venture entity is covered.  The individual entities that form the joint venture can also be made insureds with respect to work performed on behalf of the joint venture by attaching the “joint ventures as insureds” endorsement.  Neither corporate officers nor any other of the contractor’s employees are insureds under the standard workers compensation policy.  

Although there is no reference in the policy as to whether more than one entity may be insured under the same policy, the NCCI Basic Manual for Workers Compensation and Employers Liability Insurance provides for insuring “combinable” entities under one workers compensation policy.  Combinable entities are defined as those that share a common majority ownership interest.  While there is no limit to the number of entities that may be combined, each entity must be separately identified, classified, and rated.  

Additional Insureds  

Requests for “additional insured” status under a contractor’s workers compensation policy are inappropriate and should be stricken from any construction contract.  The sole purpose of the workers compensation policy is to cover injuries to the insured’s employees.  If another entity (e.g., project owner) is given additional insured status, it would be covered for injuries to its own employees, even if the injury is unrelated to the contractor’s operations.  Further, adding a project owner to a workers compensation policy would almost always violate the General Rules of the NCCI Basic Manual for Workers Compensation and Employers Liability Insurance, which states that “separate legal entities may be insured in one policy only if the same person, or group of persons, owns the majority interest in such entities.”  

Covered Damages  

As noted previously, state workers compensation statutes require employers to make specified benefit payments to employees who suffer a job-related bodily injury due to an accident or occupational disease.  Benefits payable under Part One (workers compensation insurance) directly mirror those that are prescribed by the applicable workers compensation statute.  That is, the policy will pay benefits required of the insured by the workers compensation statute, as long as the injury occurs during the policy period.  Generally speaking, the types of workers compensation benefits payable to an injured worker or the worker’s dependents are medical, disability, rehabilitation, and death.  The dollar amount of these benefits, as well as eligibility and other related rules, varies considerably from state to state.  The workers compensation policy makes no attempt to specify the types or amount of benefits payable, but merely states it will pay whatever is prescribed by the applicable statute.  

Part Two’s Employers Liability coverage responds to bodily injury claims that are not compensable under the workers compensation statute.  For example, many state workers compensation laws exclude part time or seasonal employees from their provisions.  Likewise, some states exempt employers with fewer than a specified number of employees (usually three) from the requirements of the workers compensation statute.  Claims made by workers for whom workers compensation benefit have not been provided would be covered under Part Two of the policy rather than Part One.  Because the CGL policy excludes most claims arising out of injury to an employee, this is the only source of coverage contractors have for such claims.  To qualify for coverage under Part Two of the policy, all of the following criteria must be met.   

.           The injury must arise out of and in the course of the injured employee’s employment by the insured.  

.           The employment must be necessary or incidental to work in a covered state or territory.  

.           The accident causing the injury or, in case of occupational disease, the last day of last exposure to conditions that caused or aggravating the bodily injury, must occur during the policy period.  

.           The original suit and any related legal actions for damages must be brought in the United States, its territories or possessions, or Canada.  

Note that claims under Part Two do not have to be filed by an employee.  Third party claims—such as by a spouse or child of the injured employee—are also covered.   

The insurer also agrees to defend, at its own expense, any claim or suit against the insured that is payable under the policy.  However, the insurer has “the right to investigate and settle” these claims or suits.  This is an important provision since it gives the insurer the right to settle workers compensation claims without the insured’s consent.  Contractors may wish to negotiate a claim agreement with the insurer that allows them to participate in claim settlement decisions, especially when a large deductible or other loss-sensitive rating program is in place.  

Uninsured Subcontractors  

In most states, the workers compensation statute specifies that contractors are liable for workers compensation benefits to the injured employee of an uninsured subcontractor.  Although the upper-tier contractor’s workers compensation policy will respond to such a claim (the obligation arises out of the statute, and the policy agrees to pay the contractor’s statutory liabilities), the insurer will retroactively adjust the insured contractor’s premium to reflect this increased exposure.  Normally, this will be done by adding the uninsured subcontractor’s payrolls for that project to the insured contractor’s premium base at the year-end audit.  In fact, the NCCI Basic Manual provides that if the contractor cannot furnish evidence that a subcontractor has workers compensation insurance, the auditor can automatically add those payrolls to the contractor’s premium base.  For these reasons, contractors should contractually require subcontractors to carry workers compensation insurance, and be diligent about verifying such coverage is in place, and remains in place for the duration of the project.  The most common method of obtaining such evidence of coverage is with a certificate of insurance issued by the subcontractor’s insurance agent or broker.  

Exclusions  

Although the workers compensation section of the policy contains no “exclusions” section, certain categories of damages are outside the scope of the insuring agreement.  Therefore, exemplary or punitive damages, fines, and penalties in excess of normal workers compensation benefits are not covered.  These penalties for wrongdoing (e.g., willful misconduct, employment law violations, failure to comply with health and safety laws, prohibited forms of discrimination, punitive or exemplary damages) that may be payable over and above the statutorily-proscribed benefits are the responsibility of the insured, even if they are prescribed under the provisions of the workers compensation law.  Similarly, penalties for employing someone in violation of the law, such as an illegal alien or a minor, are not covered.  

The Employers Liability section of the policy does contain a number of exclusions, which are outlined in Exhibit 7.1.  Of these exclusions, those with important implications for most contractors are discussed briefly below.   

Exhibit 7.1 Employers Liability Exclusions   

(Exclusions shown in bold are discussed in more detail below.)  .  Contractual liability.  Punitive or exemplary damages*.  Injury to illegally employed persons.  Injuries covered by the workers compensation statute or similar laws.  Intentional injury.  Injuries sustained outside the United States, its territories or possessions, or Canada, except with respect to citizens of the United States or Canada who are temporarily outside of these countries .  Employment-related practices.  Fines or penalties imposed for a violation of a federal or state law.  Injuries covered under a federal compensation act *Louisiana requires the workers compensation and employers liability policy to be endorsed to delete this exclusion on the grounds that it violates public policy.   

Contractual Liability Exclusion  

Liability assumed in a contract is excluded under the employers liability coverage part.  Although exclusive remedy generally restricts an employee’s ability to file a claim for benefits outside the workers compensation statute, it does not prohibit filing suits against other parties.  For example, in a construction setting, a contractor’s injured employee may collect workers compensation benefits from the contractor, and also file a suit for other damages (e.g., pain and suffering) against the project owner on the basis of some type of negligence such as failure to properly supervise or failure to warn of an unsafe condition.  

When this happens, the project owner often, based on the indemnity agreement in the construction contract, turns the claim over to the contractor for indemnification.  Part One of the workers compensation policy will not respond to this type of claim, commonly referred to as a third-party­over action, because the damages sought are outside of the workers compensation statute.  Part Two would apply if all of the conditions for coverage listed above are satisfied, were it not for the contractual liability exclusion.  They are excluded here because the CGL policy covers these types of claims.  This creates a dovetailing of coverages that removes the potential for coverage overlaps and the disputes that often accompany them.  (The CGL policy’s contractual liability and employers liability exclusions are discussed in Chapter 3.)  

Illegally Employed Persons  

Employers liability coverage does not apply with respect to injuries to illegally employed persons, including punitive damages assessed against contractors in connection with these injuries, if the executive officers of the company were aware of the illegal employment.  (Louisiana is the exception.)  Given the number of immigrants employed in the construction industry, particularly in certain areas of the country, contractors must be diligent to ensure these workers have the proper authorization to work in the United States.  Failure to do so could result in uninsured claims based on injuries sustained by these employees.  

Injuries Sustained in Foreign Countries   

Many states extend workers compensation benefits to employees injured outside their borders (i.e., in another state or country) provided that the contract of hire was made in the state or the principal place of the employment is in the state.  However, circumstances can arise under which such employees would not be entitled to state workers compensation benefits.  In that event, the employee would not be barred from filing suit under common law for injuries sustained.  With the exception of suits involving claims by citizens or residents of the United States or Canada who are temporarily out of the country on business, these claims would be excluded from coverage.  

With an increasing number of contractors undertaking work on an international basis, contractors should be alert to the possibility of suits that fall within the scope of the exclusion.  In the case of foreign assignments lasting the duration of a major construction project, there may be no coverage at all under the employers liability policy (nor would coverage be available under the CGL or any of the contractor’s other policies).  At a minimum, disputes as to how long an employee can be considered to be “temporarily” outside the United States are to be expected.  

Contractors operating in other countries (or sending employees to other countries on business) can address these potential coverage gaps by providing voluntary compensation benefits for employees for whom they are not statutorily required to provide coverage.  See the discussion of the voluntary compensation endorsement below for more details.  

Injuries Covered under a Federal Compensation Act   

A number of federal acts dictate special benefits for certain categories of workers, including maritime workers.  While construction workers are not categorically included, the nature of their work does sometimes bring them within the realm of these acts.  Beginning with the 1992 edition of the standard workers compensation and employers liability policy, benefits payable under a federal act are excluded from the policy.  Contractors can add coverage for benefits payable under one or more federal acts by endorsement to the policy.  Exhibit 7.2 lists and briefly describes the federal workers compensation and employers liability laws.  The standard NCCI endorsement for providing the coverage required under each law is given in parentheses.  

Of these federal laws, the ones with most frequent application to construction are those involving coverage for employees engaged in work on or near navigable waters.  Federal courts have tended to liberally construe the qualification parameters to make such construction workers eligible for coverage these acts.  For example, various circuit courts have found that workers constructing bridges over navigable waters are covered under the LHWCA, and the U.S. Supreme Court held that a construction worker working on a sewage treatment plant at the edge of navigable waters was also covered under the act.  Contractors with employees performing work on barges, floating casinos, or offshore wells should make certain the appropriate endorsements have been attached.  Some insurance professionals recommend that all contractors add certain federal coverage endorsements to their policies.  Because the benefits payable under these laws typically exceed those payable under state workers compensation statutes, failure to do so could result in a sizeable uninsured claim.  

Exhibit 7.2 Federal Workers Compensation and Employers Liability Laws   

Longshore and Harbor Workers’ Compensation Act (LHWCA)—Provides no-fault workers compensation benefits to employees other than masters or crew members of a vessel injured in maritime employment—generally, in loading, unloading, repairing, or building a vessel.  (WC 00 01 06 A)  Outer Continental Shelf Lands Act (OCSLA)—Extends LHWCA benefits to those other than masters or crewmembers of a vessel working on a continental shelf (as defined in the Act).  (WC 00 01 09 A)  Defense Base Act (DBA)—Extends LHWCA benefits to civilian employees working on military bases in lands occupied or used by the United States.  (WC 00 01 01 A)  Nonappropriated Fund Instrumentalities Act (NFIA)—Extends LHWCA benefits to civilian employees of the U.S. armed forces, e.g., employees of a military exchange store on a military base.  (WC 00 01 08 A)  Federal Employees Compensation Act (FECA)—Provides no-fault workers compensation benefits to all civilian employees of the U.S. government.  (The U.S. government self-insures FECA benefits.)  Federal Coal Mine Health and Safety Act of 1969 (FCMHSA) and Related Acts—Provides no-fault workers compensation benefits to coal miners in the event of death or disability due to black lung disease.  (WC 00 01 02)  General Maritime Law—The common law of the sea holds that vessel owners owe “transportation, wages, maintenance, and cure” to masters or members of a crew of a vessel in the event of injury or illness during the voyage, regardless of whether the injury or illness is work related.  Also, seamen can sue the vessel owner for damages resulting from the unseaworthiness of the ship.  (WC 00 02 01 A)  Death on the High Seas Act—Establishes a cause of action against those responsible for beneficiaries of persons (including seamen) killed on the high seas.  (WC 00 02 01 A)  Merchant Marine Act of 1920 (the Jones Act)—Provides seamen with a negligence remedy for on-the-job injury without having to overcome employer defenses of assumption of the risk or fellow servant liability.  Contributory negligence of the employee does not bar recovery, but recovery is reduced by the proportion of negligence attributable to the employee.  (WC 00 02 01 A)  Federal Employers Liability Act (FELA)—Provides employees of interstate railroads with a negligence remedy for on-the-job injury without having to overcome employer defenses of assumption of the risk, or fellow servant liability.  Contributory negligence of the employee does not bar recovery, but recovery is reduced by the proportion of negligence attributable to the employee.  (WC 00 01 04)  Migrant and Seasonal Agricultural Worker Protection Act (MSAWPA)—Establishes a private right of action for actual or statutory damages (as well as criminal and administrative sanctions) against employers and contractors of migrant or seasonal agricultural workers who violate the Act’s housing and motor vehicle safety requirements, motor vehicle liability insurance requirements, and job information disclosure requirements.  (WC 00 01 11)   

Limit of Liability  

Unlike the workers compensation section of the policy, employers liability insurance does have specific limits of liability.  

.           The “bodily injury by accident—each accident” limit is the most the insurer will pay for all claims arising out of any one accident, regardless of how many employee claims or how many related claims (such as a loss of consortium suit brought by the injured worker’s spouse) arise out of the accident.  

.           The “bodily injury by disease—each employee” limit is the most the insurer will pay for damages of this type to any one employee.   

.           The “bodily injury by disease—policy limit” is the most the insurer will pay for all such claims covered by the policy.  

The basic limits are $100,000 for “bodily injury by accident—each accident,” $100,000 for “bodily injury by disease—each employee,” and $500,000 for “bodily injury by disease—policy limit,” but these limits can be increased.   

Endorsements  

Endorsements are commonly used to make certain modifications to the NCCI standard workers compensation and employers liability policy.  Each state also promulgates standard endorsements for use only in that state.  For example, in many states an endorsement is needed to modify the policy’s cancellation provision to conform to state law.  Insurer-specific endorsements are also used to make changes in accordance with a company’s own underwriting standards.  The sheer number of standard and state-specific endorsements currently in use in workers compensation insurance makes a comprehensive discussion of such endorsements impractical for this course.  For that reason, the focus in the following discussion is on endorsements commonly needed on contractor’s policies.  

Stop Gap Endorsement  

Contractors with operations in monopolistic states (North Dakota, Ohio, Washington, West Virginia, and Wyoming) must purchase workers compensation insurance from the state fund.  However, the coverage purchased through these funds only applies to statutory benefits payable under the workers compensation law.  There is no separate employers liability coverage for liabilities arising out of the employment that fall outside the workers compensation statute.  Consequently, contractors with operations in monopolistic states have an employers liability coverage gap with respect to these states.  

The “employers liability coverage” endorsement, commonly referred to as the “stop gap” endorsement, eliminates this coverage gap.  As noted above, the primary use of this endorsement is to provide employers liability coverage in connection with operations in a monopolistic state fund state.  However, it can also be used to provide employers liability-only coverage when the employer is not subject to the workers compensation law of a given state and needs only employers liability coverage.  In addition, the endorsement can be used when the employer is self-insured for workers compensation benefits but elects to purchase employers liability insurance.  

Voluntary Compensation Endorsement  

In many states certain categories of employees, such as season or temporary employees, are not covered by workers compensation law.  In addition, some states do not require employers with fewer than a specified number of employees to provide workers compensation benefits.  (In some states, these exceptions may not apply to the construction industry.)  While contractors may not be required to provide workers compensation coverage in these instances, sometimes they will voluntarily do so to obtain the protection of exclusive remedy on these employees.   

NCCI publishes a voluntary compensation endorsement for this purpose.  Under this endorsement, the insurer agrees to pay such employees benefits equal to those that they would have received had they been subject to workers compensation law.  Because there is usually no charge for the voluntary compensation endorsement unless an exposure develops, contractors should routinely add this endorsement to their basic workers compensation policies.  As mentioned above with regards to foreign workers, the voluntary compensation endorsement is also used to cover U.S. employees who are temporarily on foreign assignments.  If such an employee is injured in the course of a foreign assignment, compensation benefits equivalent to the workers compensation benefits that would have been received in the employee’s home state are provided.   

If employees are hired or assigned by the contractor to work indefinitely outside the United States, a foreign voluntary workers compensation endorsement is appropriate.  These endorsements are not standard, but manuscript endorsements are in widespread use.  Typically, a foreign voluntary workers compensation endorsement consists of the text of the NCCI voluntary compensation endorsement plus language providing coverage for endemic disease and repatriation expense.  (Endemic disease coverage applies to injury or death arising out of a disease that is native or peculiar to a locality or region, even if the disease is not covered under the workers compensation or occupational disease law of the designated state.  Repatriation expense coverage pays the extra transportation costs associated with returning an injured, ill, or deceased worker to the United States, which can be substantial.)   

Joint Venture as Insured Endorsement  

When two or more contractors form a joint venture to undertake one or more construction projects, the workers compensation and employers liability policies of these individual contractors will not cover claims arising from work on the joint venture projects.  A separate workers compensation policy should be obtained with the joint venture named as the employer.  When such a policy is obtained, the insurer will add a “joint venture as insured” endorsement to the policy.  That endorsement’s purpose is to clarify that the coverage afforded by the policy applies to the individual members of the joint venture, but only with respect to work associated with that joint venture.  

Alternate Employer Endorsement   

Contractors who lend or borrow employees, such as when a contractor rents out a piece of equipment with an operator, will usually need to take steps to make sure workers compensation coverage is provided for these employees while they are working under such an arrangement.  To ensure coverage for such employees under the contractor’s workers compensation policy, an “alternate employer” endorsement should be attached to the contractor’s policy.  This endorsement extends coverage to employees injured while working for the specified alternate employer as though the alternate employer were an insured under the policy.  The endorsement also stipulates that the insurer will not ask the alternate employer’s insurer to share in a loss covered by the endorsement.   

Waiver of Subrogation Endorsement  

Contractors frequently are required by their construction contracts to obtain a waiver of subrogation from various insurers, including the workers compensation insurer.  The rationale behind such a request is that it will protect the project owner (or general contractor, in the case of a subcontract) against legal actions by the insurer alleging contributory negligence.  However, unlike the subrogation clause of most property and liability policies, the workers compensation policy does not allow the insured to waive the insurer’s right of recovery against a third party.   

To avoid disputes with insurers, contractors who agree to provide waivers of subrogation should always attempt to have a waiver of subrogation endorsement attached to their workers compensation policies.  The NCCI “waiver of our right to recover from others” endorsement can be used for this purpose.  However, when used exactly as written, this endorsement limits its application to work performed by the insured under a written contract that requires the insured to obtain a written waiver of recovery rights from the insurer.  Further, it only waives the insurer’s subrogation rights against persons or entities named on the endorsement.  

To avoid unintentional oversights, contractors may prefer to use a manuscript blanket waiver of subrogation that applies to all parties against whom the contractor is contractually required to waive its rights of recovery.  Some insurers charge a sizable premium for this endorsement, if it is available at all.  However, given the routine inclusion of waiver of subrogation requirements in construction contracts, not having this endorsement on the policy could result in a breach of contract and have long-term ramifications on the contractor’s relationship with that client.  

Kentucky, Missouri, New Jersey, North Dakota, and Wyoming do not allow, or severely restrict waivers of subrogation for workers compensation claims.  (Missouri forbids waivers of subrogation only in the construction industry.)  Contractors operating in these states should be careful not to agree to provide a workers compensation waiver of subrogation.  

Designated Workplaces Exclusion Endorsement  

Sometimes, contractors have multiple policies that may apply to a specific location.  For example, contractors participating in wrap-ups are provided with workers compensation insurance for that project under a comprehensive insurance program.  Contractors are expected to exclude such a project from their own workers compensation insurance coverage.   

To avoid double coverage (and the corresponding extra premium) on workplaces that are self-insured or insured separately, contractors can attach a designated workplaces exclusion endorsement (WC 00 03 02) to their regular workers compensation policy eliminating coverage for such workplaces.  However, this endorsement excludes all coverage under the policy with respect to the designated location.  If the contractor wishes to retain employer’s liability coverage for the workplace (on a primary or excess basis, depending on whether this coverage is provided elsewhere), a divided risk endorsement will be more appropriate.  Divided risk endorsements allow more specific delineation of exposures that are to be covered or excluded under the policy.  

Extended Protection (Monopolistic States) Endorsement  

Since coverage for incidental exposures in monopolistic states cannot be provided through the policy’s “other states insurance,” contractors have a coverage gap with regards to incidental exposures in these states.  For example, if an employee is injured while driving through a monopolistic state on business and decides to file a claim under that state’s workers compensation act, the contractor would have no coverage.  Although insurers are not allowed to provide direct coverage in these states, they are allowed to reimburse the contractor for payments made in a state in which they are not licensed to do business.  An “extended protection” endorsement provides that the insurer will reimburse the contractor for payments made to an injured employee under the workers compensation laws of a monopolistic state.   

Surety  

Suretyship is the pledge of one party (the surety) to another party (the obligee) that a third party (the principal, or obligor) will faithfully perform its obligations in an underlying contract between the obligee and the principal.  In a construction setting, for example, the surety guarantees that a contractor will build a project for the owner in accordance with the construction contract.  If the contractor defaults in its performance of the work, the surety must step in to complete the contract on the contractor’s behalf or pay the owner’s extra costs incurred in getting the work completed.  Thus, surety bonds are purchased by the contractor (principal) for the benefit of the owner (obligee).  (Contractors, likewise, may require subcontractors to provide surety bonds.  In that case, the subcontractor is the principal and the general contractor is the obligee.)   

Project owners obtain a number of benefits from surety bonds, the most important of which are the assurances that the project will be completed in accordance with the contract and will be free of liens by suppliers and subcontractors.  The surety’s prequalification of the contractor/principal provides reassurance that the contractor’s experience and financial wherewithal are adequate to perform the work called for in the contract.  General contractors obtain these same benefits when they require bonds of subcontractors.   

However, bonds are not without cost, and owners and contractors must make a judgment call about whether and of whom to require bonds.  Some owners require the general contractor to bond all subcontractors, reducing the potential for disruptions in the project from a subcontractor failure.  Likewise, on certain projects sureties require bonded contractors to bond their subcontractors, as it reduces the likelihood of a claim under the general contractor’s bond arising out of a significant subcontractor failure.  Owners can expect to pay higher construction costs when all subcontractors are bonded.  (Although market conditions will impact bond costs, a rough rule of thumb is that bonding all subcontractors will cost roughly 1 percent of the project value.)   

Although subcontractor bonds are frequently required by law on public projects, private owners often rely on the general contractor’s bond as their guarantee of performance and leave the decision of whether to bond subcontractors to the general contractor.  (The general contractor’s obligations to the owner are independent of subcontractors’ obligations to the general contractor.)   

This section provides an overview of the purpose and operations of surety bonds, beginning with a discussion of the major differences between surety and insurance.   

Standard bond forms are available from a number of sources, with the most widely used standard forms being those published by the American Institute of Architects (AIA.)  Many insurers have their own bond forms, but most are similar to the AIA form.  Some contractors and owners have their own bond forms that they require all contractors to use.  Sureties tend to be leery of private forms, however, as they sometimes “stack the deck” against the surety and its principal (the contractor) by granting the obligee unlimited power to declare or to remedy a default and to bill the surety for the corresponding costs.  Some surety companies flatly refuse to write bonds on private forms.  

Surety and Insurance Contrasted  

Many surety companies are owned by or affiliated with an insurance company.  Perhaps this alliance contributes to a misconceived notion that surety bonds are a form of insurance.  However, while both surety and insurance are methods of transferring risk, the differences between these two products far outnumber the similarities.  Furthermore, bonding operations are typically autonomous operating units that have little interaction with insurance divisions even when they are housed together.  A side-by­side summary comparison of some of the more fundamental differences between surety and insurance is provided in Exhibit 8.1.  

Surety Insurance   

.  Is based on an underlying contract.  Is a three-party contract.  Covers all defaults without regard to the cause.  Underwriter expects no losses.  Allows subrogation against the principal.  May require principal shareholders to pledge personal assets as collateral for claims.  Bonds are noncancelable.  Is independent of other contracts.  Is a two-party contract.  Covers fortuitous losses, subject to certain exclusions.  Underwriter expects some losses within a class of insureds.  Subrogation against an insured violates the purpose of the contract and is not allowed.  Does not require owners to pledge personal assets.  Policies frequently are cancelable   

Unlike an insurance policy, a surety bond is predicated on an underlying contract, the terms of which are incorporated by reference in the bond agreement.  In the event of a default, the surety’s obligations will be determined by the underlying contract.  (In contrast, insurance policies stand on their own merit and are not predicated upon the existence or terms of any other contract.)  Consequently, an important part of a surety’s underwriting review involves assessing the contract terms, including the type and scope of work, the expected date of completion, payment provisions, and various other contractual issues that might affect the contractor’s ability to complete the work called for under the contract.  

Surety is a three-party contract.  The principal purchases the bond from the surety for the benefit of the obligee.  Although the obligee does not sign the bond, it does have certain obligations under the bond, and failure to meet these obligations may result in a forfeiture of the right to collect under the bond.  (Insurance policies are two-party contracts between the insurer and insured only.  Rarely does a third-party claimant have contractual rights or obligations under an insurance policy, even those that are designed to pay third parties, such as a liability insurance policy.)   

Surety bond claims are triggered not by any actual or impending loss to the principal (e.g., contractor), but to the obligee (e.g., owner).  In fact, sometimes the reason a contractor walks away from a job is that it has become too much of a drain on the contractor’s resources.  In that scenario, the contractor’s short-term situation actually improves when it abandons the project.  (In the long term, the default may damage its reputation and make it more difficult for the contractor to obtain bonds.  Further, the surety is entitled to seek reimbursement for claims paid under the bond.  In some instances, the contractor’s personal assets may even be at risk.)  Surety bonds will respond even when the contractor deliberately breaches its contract.  For the bond to hold any value to an obligee, such as a project owner, the obligee must be certain that the surety will respond to a default regardless of the contractor’s reasons for not completing the agreed upon work.  Thus, the surety’s obligation to the obligee is not nullified by intentional acts of the contractor.  (Insurance policies almost always exclude losses that are intentionally caused by the insured.)  

Another fundamental difference between bonds and insurance lies in the expectations of the underwriter.  Surety bond losses typically are viewed as being largely preventable because often the events that produce a breach of contract are, to a great extent, within the contractor’s control.  For example, contractors sometimes take on too many projects simultaneously and become overextended and unable to complete all of the projects by the agreed-upon completion dates.  To avoid delays (and the corresponding liquidated or consequential damages) on all of the projects, the contractor might simply abandon one or more of the projects.  In some instances, this overextension of resources is unintentional—that is, unforeseen circumstances arise that make achieving all of the contractor’s contractual obligations difficult or even impossible.  However, in many cases, the circumstances that lead to an overextension are foreseeable if the contractor shows the appropriate degree of care in evaluating each project and in considering them in light of current commitments.  In these circumstances, the default(s) could have been avoided entirely by taking on fewer projects, which is within the contractor’s control.  

The surety underwriter’s job is to assess the contractor’s ability to fulfill its obligations under the contract in question.  If the underwriter has any serious doubts as to the contractor’s ability to perform the work called for in the contract, it will not issue the bond.  While some underwriters will inevitably perform more diligent reviews than others, an underwriter who issues a surety bond should be reasonably confident that there will be no claims made against the bond.  Therefore, the bond premium is primarily a reflection of the surety’s underwriting costs plus a fee for the use of the surety’s name and financial backing.  Unlike in insurance, “expected losses” are not part of the bond premium formula.  (Although they do not know which insureds will suffer a loss, insurance underwriters know that a certain number of losses will occur, and to expect otherwise would be unrealistic because of the nature of the perils being insured.)  

Surety bonds, once written, are generally noncancelable.  For the obligee to have confidence in the protection provided by the bond, it needs to know that the surety cannot back out of the bond contract if the contractor’s financial condition worsens.  (Virtually all property and casualty insurance policies allow the insured to cancel at any time, and the insurer generally may cancel after giving the required notice to the insured.  At a minimum, insurers typically retain the right to cancel if the insured fails to pay interim premiums when they become due.)  

Sureties can subrogate against defaulting contractors for amounts paid by the surety to remedy the default.  Absent a surety bond, an owner (or general contractor) would have certain legal recourses for collecting from a contractor (or subcontractor) who breaches a contract.  When a surety bond is available, the surety steps into the defaulting contractor’s shoes to complete the contractor’s work under the contract.  The surety is then subrogated to the owner’s rights to recover expenses incurred in obtaining performance of the contract from the defaulting contractor, just as a bank has the right to recover from a borrower who has defaulted on a loan.  (Insurers are not permitted to subrogate against a negligent insured for damage that is covered under its own policy.  To allow insurers to subrogate against their own insureds would violate the purpose of the insurance policy.)  Most sureties require principals to pledge their personal assets to indemnify the surety for costs incurred in obtaining performance after a default.  Having secured the personal indemnity of the principal (contractor), the surety can seek recovery of monies paid out in bond claims from the principal’s personal assets, as well as from any remaining corporate assets.  

Types of Construction Bonds  

Contractors may be required to provide up to three types of bonds on a construction project—a bid bond, a performance bond, and/or a payment bond.  The purpose of each of these types of bonds is summarized in Exhibit 8.2 and discussed in more detail below.  

Bid bond - Guarantees that if the contractor is awarded the job, it will agree to perform the work at the price quoted, and will provide additional bonds as required by the construction contract.   

Performance bond - Guarantees that the contractor will perform the work in accordance with the construction contract and related documents.    

Payment bond - Guarantees that suppliers and subcontractors will be paid for materials and labor furnished to the contractor.    

Performance bonds and payment bonds are required on most federal projects and are common on many private projects as well.  At the general contractor’s discretion, performance and payment bonds may also be required of subcontractors. Each bond serves a specific purpose at some phase in the project, but the contractor provides all three bonds for the protection of another party (e.g., the owner or an upper-tier contractor).  The bonds can be written as separate documents or combined into one or two documents.  (AIA document number A312 includes both a performance bond and a payment bond that can be issued separately or together as a single document.)  

Bid Bonds  

A bid bond is commonly required in competitive bid situations.  Submitted with the bid, the bid bond guarantees that if the contractor is awarded the job, it will agree to perform the work at the price quoted and will provide additional bonds as required by the construction contract.  If the contractor declines to enter into a contract to perform the work at the agreed-upon price, the bid bond will reimburse the obligee (owner or upper-tier contractor) the difference between the defaulting contractor’s bid and the next lowest bid, up to the bid bond penal amount.   

Bid bonds are written as a percentage of the amount bid, percentages ranging from 5 to 20 percent.  The bid bond’s promise extends only to the contract terms at the time the bond is issued.  Post-bid changes to the contract terms or scope of work are changes to the contract for which the contractor is entitled to an equitable change in price.  

Performance Bonds  

A performance bond guarantees that the contractor will perform the work in accordance with the construction documents.  If the contractor defaults on its obligations, the surety that issued the bond is responsible for completing the work called for in the contract subject to the bond limit, commonly known as the “penal sum.”  

When a contractor defaults in its performance of the contract, the surety has several options in how it responds.  If the contractor is suffering from temporary financial problems, such as a cash shortage, the surety can provide the necessary funds to keep the contractor afloat and complete the work.  Alternatively, the surety can hire another contractor to complete the work.  The final two options are to simply pay the obligee the amount sufficient to complete the work, up to the bond’s penal sum, or to deny the obligee’s claim entirely.  (The basis of denial could be failure to comply with the bond’s notice requirements, or some other breach of the bond terms.  A notable limitation on the surety’s obligation to pay a bond claim is where the contractor’s default is predicated by the owner’s failure to pay the contractor for completed work.)  

Some bonds are more specific than others in defining what types of costs the surety is liable for in the event of a default.  The AIA standard bond form provides that, in addition to completing the work called for in the contract, the surety’s obligations include the cost of correcting defective work; additional legal, design, and delay costs resulting from the contractor’s default or the surety’s failure to act promptly in its remedy of the situation; and liquidated or actual damages caused by the contractor’s failure to perform its contractual obligations.  

Payment Bonds  

The general contractor is responsible for contracting for all materials and labor needed for the project, and for paying for such materials and labor in accordance with the contract provisions.  The payment bond guarantees that suppliers and subcontractors will in fact be paid for materials and labor furnished to the contractor.  Payment bonds also protect lower-tier contractors and suppliers from attempts by general contractors to improve their own cash flow by delaying payments to suppliers and subcontractors.  (These lower-tier parties must comply with “notice of last furnishing” or similar notification clauses to preserve their payment bond rights.)  However, the ultimate purpose of the payment bond is to guarantee the owner a completed project that is free of liens.  

Payment bonds carry a penal sum (bond limit) that normally ranges from 50 to 100 percent of the contract value.  On public projects, special statutes may apply that dictate the bond terms.  Specifically, the Miller Act requires payment bonds equal to the full contract price on all federal projects exceeding $100,000 that involve the construction, alteration, or repair of public buildings.  Most states also have what are referred to as “little Miller Acts” that stipulate payment bond requirements on state projects.  

Underwriting  

The relationship between a surety and a contractor is more analogous to a credit relationship than an insurance relationship.  Bond applications are processed by the surety in much the same way as loan applications are processed by a bank.  Unlike insurance policies, which are typically written on an annual basis, surety bonds are written on an as-needed basis as the contractor takes on new jobs.  Therefore, surety underwriters need to keep their fingers on the pulse of a contractor’s operations because each job adds new information that could affect the contractor’s performance under any one of its open contracts.  

The surety’s underwriting review will include evaluating the contractor’s financial statements, work in progress, management experience and stability, past performance, staff expertise, and myriad other factors.  When taken as a whole, these factors form what is commonly referred to as the “three C’s” of surety underwriting: capacity, capital, and character.  Capacity refers to the contractor’s skill and experience in performing the size and type of work called for in the contract; capital refers to the contractor’s overall financial ability to take on the work under the terms of the contract; and character refers to the contractor’s track record and the general integrity and business philosophies of the owner and of management.  

Based on its assessment of the contractor’s overall creditworthiness, the surety will “prequalify” the contractor and institute a line of authority that establishes both the maximum penal sum it will write for the contractor on a single bond and the maximum aggregate limit for all bonds combined.  For example, a contractor’s line of authority may be set at $5 million for a single project and $20 million for all bonded projects.  However, even when a bond request is within the line of authority, the underwriter has the right to decline to write a bond if it is not comfortable with the contractor’s ability to perform the work, for whatever reason.  

Sureties and contractors alike tend to place a high value on the relationship aspect of their arrangement.  A good surety underwriter can help contractors avoid bad business decisions by refusing to bond projects when the contractor is in danger of overextending itself or when a contractor tries to venture into a type of construction in which it does not have adequate expertise.  These decisions need to be made and communicated judiciously, and most surety underwriters in that situation will offer suggestions for improving the contractor’s creditworthiness.  Sureties make their money by writing bonds, so anything they can do to help make contractors better bonding risks should improve their own bottom line.  

Bond Pricing  

Bond rates are regulated at the state level by the insurance department.  Bond forms and rates must be filed by each company in accordance with each state’s filing rules.  The Surety Association of America files advisory loss costs that surety companies may reference in their filings (assuming the state has approved the filing), along with company-specific multipliers that produce end rates when applied to such loss costs.  Alternatively, sureties can develop their own rates.  (Texas issues statutory rates that all sureties are required to use for bonds issued on both public and private projects located in the state.)  

Bond costs are based on the type of work called for in the contract, the expected duration of the project, and the contract value.  (Bond rates, which include the cost of both a performance bond and a payment bond, are typically stated in units of $1,000 of contract price.  As in insurance, rates typically fall incrementally as the contract price increases.  For example, for a commercial building project with an expected duration of 1 year, the rate for the first $100,000 may be $25 per thousand (i.e., the contractor’s cost will be $2,500 for the first $100,000), the next $400,000 might be $15 per thousand, the next $2 million might carry a rate of $10 per thousand, and so on.  

A rough rule of thumb regarding bond costs is that premiums for the bid bond, performance bond, and payment bond will be roughly 1 percent of the contract price for a 24-month project.  In a tight bond market, prices may be somewhat higher, and in a soft market, they may be lower.  Maximum aggregate rates may also apply.  For projects of longer duration, rates may be slightly higher.  On very large projects, because of the declining rate scale, the total bond cost may be less than 0.05 percent of the contract price.  

Contractors may be tempted to jump ship when a competing company offers enticements such as lower rates, higher lines of credit, or waivers of personal indemnities.  However, because surety bonds guarantee not only the contractor’s ability to do the work but also their moral character and willingness to do the work even when it turns out not to be as profitable as the contractor had hoped, bonding necessitates a level of trust and respect between contractor and underwriter.  Contractors should remember that their surety company might one day be the only thing between them and bankruptcy, and the “benefits” of bouncing from surety to surety may, at that moment, pale in comparison to the value of a long-term relationship with a surety underwriter.