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Acme Construction, a home building company, constructed 20 homes in 2003. It hired subcontractors to perform the concrete work, plumbing, wiring, and roofing. One year later, it received complaints from two of the homeowners about cracks in their foundations. Acme notified its Liability insurance company. When the homeowners eventually sued Acme, the insurance company provided legal defense and set up reserves to pay for any resulting settlements.

Fast forward to 2005 when Acme built 35 homes to meet the demands of an active housing market. Other than the subcontractor who did the concrete work in 2003, Acme hired the same group of subs to work on these homes. When snow started melting after the winter of 2007, complaints started to come in about leaking roofs. Eventually, seven homeowners determined that they had to replace their roofs completely, and sued Acme for the faulty work. Acme again notified its insurance company. This time, however, the company denied the claims, saying that the insurance policy did not cover them. Acme had to pay for its own legal defense and liabilities.

What changed between 2005 and 2007? The insurance company added to the policy an endorsement that created a significant coverage gap: ISO form number CG 22 94 10 01, Exclusion-Damage to Work Performed by Subcontractors on Your Behalf.

This endorsement modifies an important exclusion contained in the ISO Commercial General Liability coverage form. Without this endorsement, the exclusion states that the insurance does not apply to damage to the insured’s work if the damage arises out of it or any part of it and if the damage occurs after the insured has finished the work. However, the provision gives coverage back if the damage arose out of work performed by a subcontractor working on the insured’s behalf. In the 2005 incident, Acme had hired a subcontractor to build the foundations for the new homes. Because the subcontractor had done the faulty work, Acme’s CGL policy covered the resulting defense costs and liability.

Endorsement CG 22 94 strips that coverage give-back from the policy. With it attached, the policy does not cover liability for damage to the insured’s work and arising out of it, even if another contractor actually performed the work. Accordingly, Acme’s policy did not cover its liability for the defective roofs. Without the attachment of this endorsement, Acme would have had coverage.

An insurance company might add this endorsement to a policy in the belief that faulty construction is a business risk, not an insurable one. Accidents such as slips and falls, unintentional fires, and injuries suffered while using a product are all examples of insurable risks. Performing work improperly, mismanaging cash flow, and making poor strategic business decisions are examples of business risks. Insurance companies feel they cannot insure business risks because to do so would remove an incentive to reduce those risks. If a carpenter knows he can collect insurance if he does a sloppy job building a house, he has less of an incentive to build it well. When a company attaches CG 22 94 to a policy, it is transferring the risk of a subcontractor’s poor performance back to the insured.

Almost all contractors subcontract at least some of their work, so this is an issue to take seriously. Review their Liability insurance with our agents to determine whether you have this endorsement. Since it can present a very significant coverage gap, discuss alternatives, such as negotiating with the company to remove it or seeking another company that is willing to leave it off. Even if it means paying an additional premium, removing the endorsement could save a lot of expense in the long run.

In 2008, U.S. employers reported 3.7 million nonfatal occupational injuries and illnesses, according to the U.S. Bureau of Labor Statistics. Although this number was down from the prior year, it still shows that workplace safety must be a priority for employers. When workers get hurt or sick on the job, productivity suffers, the employer becomes less attractive to the other employees, and managers’ attention shifts away from growing the business. Preventable accidents also hurt the bottom line in another way — they eventually raise Workers Compensation costs by increasing the employer’s experience modification factor.

The experience mod is a number calculated by the Workers Compensation rating bureau in the employer’s state. It’s a reflection of how the employer’s loss history for the prior three years (not including the current year) compares with that of an average employer in the same industry. It takes into account the size of the employer’s payroll for those years, and the number and severity of its losses. The formula penalizes an employer more for frequent losses than for expensive ones. For example, an employer with 10 losses of $3,000 each will have a higher experience mod than will a similar employer with one loss of $30,000. The insurance company must, by law, multiply the employer’s Workers Compensation insurance premium by the experience mod factor. A factor of less than 1.0 reduces the premium, while a factor greater than 1.0 increases it. Therefore, it makes financial sense for employers to take steps to prevent frequent on-the-job accidents.

There are several things employers can do to improve their accident records and save on Workers Compensation premiums.

• Make workplace safety a top priority. The things that are important to managers become important to workers. Provide continuing training to workers on job site safety and enforce safety requirements.
• Obtain and review publications about the industry from the U.S. Occupational Safety and Health Administration. These publications provide practical recommendations for preventing injuries. For example, the “Construction – Hand and Power Tools” category has a document titled, Safeguarding Equipment and Protecting Employees from Amputations.
• Keep the work environment clean. This reduces the risk of employees contracting airborne illnesses; eliminating clutter makes trip-and-fall accidents less likely.
• Maintain machinery and equipment in good working order. Check it regularly for safe operation.
• Institute programs to keep the workplace drug and alcohol free. Within legal parameters, test employees for drug and alcohol use.
• Review loss information from insurance companies. Look for trends in the types of losses that occur. They could indicate dangerous work procedures, incentives that cause employees to rush, defective tools, or another factor in need of correction.
• Take advantage of the expertise in the insurance company’s loss control department, particularly if the company specializes in insuring businesses in your particular industry. They can recommend measures that have proven to work for similar businesses.
• Monitor employee morale. Unhappy workers can become careless or slipshod in their work. Take steps to improve morale and to deal with employees who might be causing problems.
• Review the experience mod worksheet with one of our insurance agents. Ensure that the insurance companies have reported all losses accurately to the rating bureau. Ask to have errors corrected, and follow up until it happens.
• Require employees to report all injuries, no matter how minor they appear. Make sure that injured employees receive prompt medical attention.

No one benefits when employees get hurt on the job. With focus and effort, employers can make workplace injuries less frequent and less severe. That will make your business a better place to work, and add hard-earned dollars to the bottom line.

Scenario #1: A structural steel erection firm wins a contract for the construction of a five-story office building in an urban location. The contract requires the firm to assume the general contractor’s legal liability for accidents occurring during the project and arising out of the steel work. One week into the project, a crane lifting a load of steel bars topples over into a street, damaging cars, nearby buildings, and injuring drivers and pedestrians. Several of the victims file suit against the property’s owner, the general contractor, and the steel firm. As per their agreement, the general contractor looks to the steel firm to defend it in court and pay any resulting judgments. The steel firm forwards the claim to its Liability insurance company, which proceeds to defend both the steel firm and general contractor. The company settles with the victims and pays on behalf of both contractors, up to the policy’s limits.

Scenario #2 is identical to #1, but this time the insurance policy contains a wrinkle. The policy includes a special endorsement, ISO form number CG 21 39 10 93, Contractual Liability Limitation. Accordingly, the insurance company defends the steel firm and pays an amount to settle its claims. However, it refuses to defend the general contractor or pay the amount of the loss the steel firm assumed under the contract. When the steel firm is unable to pay these sums out of pocket, the general contractor sues for breach of contract, setting off a long round of litigation.

What is the Contractual Liability Limitation Endorsement? What does it do, and why would an insurance company use it?

The Commercial General Liability coverage form states that it does not cover injuries or damages for which the insured must pay by reason of having assumed liability under a contract. However, it turns around and gives some coverage back: It will pay for liability the insured assumed under an “insured contract,” a term that the policy further defines. The term includes a real estate lease, a railroad sidetrack agreement, an easement or license agreement not pertaining to railroad work, a requirement to indemnify a municipal government, an elevator maintenance agreement, and other agreements in which the insured assumes the tort liability of another party. The Contractual Liability Limitation Endorsement changes that definition: It removes completely the last part (other agreements in which the insured assumes another party’s tort liability) from the definition. When a liability policy includes this endorsement, these types of agreements are not insured contracts, and the policy does not cover liability assumed under them.

In both scenarios, the steel firm (the insured) assumed the tort liability of the general contractor. In scenario #1, the steel firm had a liability policy without the Contractual Liability Limitation, and the insurance company paid for the amount of the loss the firm assumed. In scenario #2, the endorsement applies; the company does not pay anything for the general contractor’s defense or liability. For many construction firms, this can be a catastrophic gap in coverage.

An insurance company may add the endorsement to a contractor’s policy if it wants to approve the insured’s contracts selectively on a case-by-case basis, rather than insuring them all on a blanket basis. This gives the company some control over its exposure, but it can be slow and cumbersome for the insured.

All construction firms should review their Liability insurance policies with their agents to determine whether the company has added this endorsement. If it has, a discussion on what to do about it is essential. It will be too late to do solve the problem after a loss occurs.