Common-sense claims reduction: Insurers must recognize the need to educate construction contractors about coverage and liability, to solve the problem of rising claims costs. (Property/Casualty).

Creating the houses, factories, office buildings and hospitals that characterize life in the United States is, for some, an alluring part of the American dream. For many builders, however, construction contracting has lost its attraction, mainly because of the liability associated with it.

The story is the same across the country--in Seattle and New York and Los Angeles, where lawsuits for water intrusion, mold and mildew plague the industry. Homeowners associations, as well as those who monitor them, have won large settlements from insurers due to design defects, manufacturer defects and faulty workmanship.

Claims adjudication can stretch out for years and require that insurers spend substantial amounts of money for contractors' defense. Settlements can climb to the multimillion-dollar range, leaving contractors and subcontractors to find that continued insurance is either unavailable or unaffordable.

Contractors and their insurance companies face increased liability together. Neither one has done a good job of limiting liability, and now both must change to improve their financial outcomes.

A Sensible Approach

Common sense may lead to the solution. In the last several years, workers' safety has been a hot topic. Fall-protection plans, traffic plans, trenching plans and many other construction safety plans have been instituted to protect workers in case of injury Ergonomics has recently become a major issue related to worker safety. Ergonomics will greatly affect the U.S. work force, in terms of cost and productivity.

This common-sense approach has paid off for employers who have invested in safety. Employers who created safety plans, safety policies and ongoing safety training have had a great return on their investment through reduced employee time loss and fewer retroactive or reimbursement programs.

The same common-sense approach can be used to combat or reduce construction-defect claims. Contractors should implement a quality-control plan, which would include a claims-protection plan. Since contractors and their insurers are facing these serious claims together, they should develop a "zero claim tolerance" plan together.

Educating the Contractor

Construction-related insurance premiums should include a cost for educating the contractor. The approach could be, at the minimum, a series of required seminars, which would include a zero claim-tolerance plan developed jointly by the insurance company and the contractor association, such as the Associated Subcontractors of America or other associations that wish to address the staggering claims issues.

Contractor education should specifically identify means and methods, while providing the contractor with tools that can be used to reduce or limit claims liability. Education should improve the contractors' understanding of insurance and their understanding of contract language as it relates to claims. It may be accomplished through seminars or a formal classroom setting, using a curriculum predetermined by the insurer.

Insurance IQ

Insurers have overestimated the insurance IQ of contractors. Contractors understand the necessity of insurance for licensing purposes and to meet contract requirements. Many contractors do not understand the definition of the endorsement "primary additionally insured" or the consequences of this endorsement. Also, many contractors do not understand what a "wavier of subrogation" is or what "aggregate" means or how it affects them.

After a contractor purchases insurance, the communication between the agent and the contractor is minimal until renewal. Insurers have failed to properly evaluate the need for ongoing contractor education about insurance.

Insurance companies instead allow contractors to receive their education through experience, which in turn is costing the insurers and insureds millions of dollars in claim settlements, as well as littering the courts with bankruptcy cases.

Each year, hundreds of new contractors enter the construction industry, and hundreds of new insurance agents enter the insurance industry, both aggressively obtaining business.

Insurance companies make it relatively easy for new contractors to buy insurance. But easy access to affordable insurance coverage for inexperienced contractors has resulted in a concentration of losses. Inexperience alone is not necessarily the reason for the claims, but linking inexperience with aggressive scrutiny by building monitors has resulted in unheard-of settlements.

An inactive approach to the claims problem is to simply raise insurance premiums to cover the cost of losses and insurance. A proactive approach is raising premiums until claims reduction is achieved through contractor education. The provision of affordable insurance to the construction industry must resume once both industries together develop a plan, process and specific method of claims reduction and management.

Zero Tolerance, Zero Claims?

The claims liability faced by contractors and their insurers is aggravated by the additional burden of contract laws and state laws governing both industries. A zero-tolerance claim plan developed by contractors and their insurers may be the tool that both educates contractors and reduces their claims.

A zero-tolerance plan is no different from a written safety plan, which includes the overall safety policies of a company A zero-tolerance plan would include the overall policies regarding the reduction or elimination of defect claims or other claim liability issues. The purpose of the plan is to provide training, awareness and specific tools to employees while working within contractual constraints and state law. A zero-tolerance plan should be inclusive of all employees, as is a safety plan.

A subcontractor may determine that the zero-tolerance plan needs different forms or employee "tools," which are effective in controlling claims. One example is a "deficiency notice." A deficiency notice is a form that subcontractors can use to generate special attention to deficient conditions or work performed by others.

A deficiency notice should include any deficiency that may affect the liability of the insured or insurer. For example, if an employee of a specialty contractor notices that flashing around windows is being installed in multiple overlapping pieces in lieu of a continuous piece, a deficiency notice should be sent to the general contractor noting the situation, the location and the possible resulting damage.

The deficiency notice also should include disclaimer language in a nonoffensive manner. For example, "Due to contractual obligations and our desire to eliminate the potential of a claim we hereby notify you of what we believe to be a deficient condition as noted above. Please review and correct the deficiency and provide us with written direction as to how we should proceed. If we are directed to proceed with our work without the deficiency being corrected, we shall not be responsible for the resulting damage."

People in the insurance profession may look at this as a meager means of limiting liability. But it is important not to overlook the wisdom and power of common sense and its use in the construction industry. If prepared properly in the right format and used consistently, a deficiency notice may be just the tool an individual or insurance company can use effectively, along with supporting documentation, to defend against a claim.

The fact remains that many buildings are completed quickly, using the lowest bids and the least expensive design. The result may be oversights, as well as the use of unsuitable products. Since claims monitoring and claims litigation are a growth industry, quality and design must be foremost in the minds of contractors. A zero-tolerance plan should include a quality-assurance section to guard against poor-quality products and installation.

Time for Transformation

A transformation must take place in the minds and actions of those in the construction and insurance industries. Insurance companies must re-evaluate the insurance IQ of the contractor and address the need for contractor education. Contractors, owners, architects and people employed by them must transform their attitudes to conclude that insurance is a privilege and not a right. These same people also must abandon their preconceived and subconscious ideas that insurance will "take care of the problem."

There is a growing number of people in the construction industry who are under the impression that insurance companies pay out large settlements to justify raising rates. This perception, coupled with the number of claims in litigation, should indicate the need for contractor education.

Insurance companies and contractors must be profitable to continue providing their goods and services. The mindset of insurance companies should be one of education and control. The mindset of contractors should support a fiduciary, symbiotic relationship between them and their insurance companies.

Change is the common denominator that motivates people to take action. Change normally involves costs, such as the cost of education. The long-term benefits of contractor education and preventive claims-management planning will reduce losses, creating a profitable industry while keeping the American dream a reality for those who aspire to become contractors.

Pete Battisti is president of U.S. Drywall Inc., a commercial drywall business based in Tacoma, Wash.