A decade of soft pricing, extravagant claims, and investment losses has the insurance industry scrambling to recoup profits, and residential construction is the first casualty. By Clayton DeKorne

We call it the 'battlefield,'" says Susan Brodahl, a Washington-state insurance broker, confirming reports that remodelers across the country are finding it increasingly difficult to get hazard and general liability insurance. "The number of carriers willing to write remodelers has shrunk to a handful," Brodahl says. "And the companies willing to write it have sharply increased premiums for policies with reduced coverage or higher deductibles."

In Texas, remodeler Michael Strong, Brothers Strong, Houston, feels lucky. He's paying only about 20% more on his commercial liability policy, which was renewed earlier this year. "We've never had a claim against us, which may be why we got off easy," Strong says. In Indiana, Mike Weiss of Weiss and Company, Carmel, is paying 25% more for liability coverage. "We haven't had a claim or missed a payment, but that's no longer the point," Weiss says. In Minnesota, Doug and Carolyn Nelson, principles of New Spaces, aren't sure what they'll have to pay. In March, Farmers Insurance announced it would not renew their commercial general liability policy. "They just up and cancelled," explains Doug Nelson. "We were given about six months notice, and we're still in the process of selecting a broker. But we're bracing ourselves for an increase two to three times higher than our last premium."

The scope of the crisis

According to Cox, Castle & Nicholson, a national real estate law firm based in Los Angeles, the insurance crisis is most acute in states with the highest incidence of construction defect litigation. States with rampant mold claims, namely California, Texas, and Florida, have been hit especially hard. The highest-profile cases -- including the $32 million settlement in Texas of Ballard v. Farmers Insurance (see Mold Prevention), a $3 million settlement in the California case, Anderson v. Allstate Insurance, and in one of the first big mold cases, an $11.5 million settlement of the Florida case, Centex-Rooney Construction Co. v. Martin County -- have drawn widespread media attention to mold in houses, inciting a flurry of claims that has sent residential property insurance markets into a tailspin.

Texas has suffered the most. Farmers Insurance, the second-largest homeowners policy writer in Texas, announced it would stop writing new HO-B policies after August 15, 2001. (An HO-B policy is a comprehensive homeowners' policy that covers nearly every problem that could go wrong with a house.) Other insurance writers, including State Farm, SAFECO, Allstate, and FarmBureau, followed suit by putting a moratorium on HO-B policies. With the moratorium on HO-B policies, insurers were still writing HO-A policies -- a "named perils" policy that covers only specifically named types of damage, while excluding others. However, in August 2002, Farmers decided to stop writing any new homeowners' policy, following a cease-and-desist order issued by the Texas commissioner of insurance that alleges unfair trade practice by the insurance company. Meanwhile, State Farm, the nation's largest property insurer, has stopped writing new policies in Texas, California, Arizona, Nevada, and Louisiana.

To recoup losses, the insurance industry is bailing out of all types of residential insurance, limiting the availability and raising commercial liability premiums for home builders, remodelers, and trade contractors in a number of states. In Florida, the number of carriers currently writing insurance for residential contractors has decreased by more than 50% in the past 12 months, according to Cox, Castle & Nicholson. In Minnesota, Farmers Insurance has pulled out of the residential contractor market, reportedly blaming the state's stringent energy code for creating excessively tight houses with a higher than average risk for mold problems. Industry sources named Allstate, State Farm, Farmers, and the Chubb Group among the carriers that have limited the availability or narrowed the scope of commercial liability and builder's risk coverage in Colorado, Arizona, Nevada, and other states.

Home builders have been hit the hardest. Where insurance is available, builders have reported 50% to 1000% premium increases. Remodelers have gotten off considerably easier, with increases ranging from 20% to 35% if companies can meet tightened criteria. If remodelers don't meet the criteria for new programs, they are looking at triple digit increases.

What are these tightened criteria? According to broker Susan Brodahl, it depends on a mix of several characteristics that carriers examine to appraise a contractor's risk: where a remodeler does business, business volume, mix of residential vs. commercial business, the number of employees vs. subs, and the specific nature of the company's sub vs. employee relationships. "Different carriers have different rules for how they determine whether or not a contractor qualifies for a particular program," explains Brodahl.

Beyond this, brokers are reluctant to disclose specifics of who qualifies, owing to an ever-churning mix of programs and rapid-fire changes from carriers. "The insurance industry has a unique ability to respond quickly to implement change," Brodahl says. "Unlike other big companies, most insurance companies are able to send out a policy change by e-mail on Friday and see that change enacted in regional and local offices by Monday. It can change just that quick -- and is especially unpredictable right now."

How did we get here?

While mold claims are often cited as the latest blow to the insurance industry, many sources agree the crisis was brewing before mold problems surfaced. "Soft pricing throughout the 1990s is certainly one cause," says Cam Dickinson, vice president of broker services for Woodruff-Sawyer & Company in San Francisco. Brodahl agrees. "The price of insurance premiums pretty much stayed flat through the boom, while contractors saw an increase in payroll offset by a tremendous increase in sales," she says. "General contractors sometimes saw rates decrease by as much as 15% per year. However, these rates were often too low to support the risk being insured."

Further evidence for the insurance industry's shortcomings comes from the overall contraction of the reinsurance market. The availability of liability insurance to residential contractors is directly dependent on the ability of reinsurers to cover substantial portions of the risks insured. Reinsurance -- the insurance that insurance companies purchase to distribute potential losses -- has been gutted by such cataclysmic events as the September 11 attacks and the collapse of Enron and other companies with ties to the surety bond market. Add the decline in investments on Wall Street by insurance companies and the losses deepen. To compensate, many carriers have been forced to dip into reserves they hold for anticipated claims. "When the rash of claims came rolling in, insurers were not prepared," Dickenson says.

In addition to mold, failures in exterior insulation finish systems (EIFS) have been a major source of claims, particularly in western and southern states, where stucco exteriors are common. Another source of claims has come from homeowners associations (HOAs) representing condominium and multifamily communities filing class-action suits. States with extended statutes of limitations or repose have been particularly vulnerable to HOA actions.

Once the insurance companies began to pay out on the high number of claims, reserves dwindled further, causing still greater problems. State Farm's reserves in California, for example, dropped from $605 million to $425 million in just two years, prompting the A.M. Best insurance rating agency to cut its grade for State Farm from A to B-plus. "The end result is that insurers are looking for ways to get out of anything they feel can't provide good earnings," explains Dickenson. In most states, that "anything" has been commercial liability in the residential construction market.

For the most part, workers' compensation insurance has not been as severely affected, but Dickenson says that is about to change, too. In California, the state legislature recently approved a 10% increase for all workers' comp policies, effective July 2002, and a pending bill to increase benefits to claimants is expected to cause an additional increase of 20% to 30% by January 1, 2003.

"The insurance crisis isn't going away anytime soon, and it will likely get worse," says Jane Lynch of Cox, Castle, amp; Nicholson. Recent industry developments seem to underscore this view. In October 2001, the Reliance Insurance Company was placed into liquidation in Pennsylvania following unsuccessful rehabilitation, and the Legion Insurance Company and an affiliate, Villanova Insurance Company, which insures subcontractors, went into rehabilitation in Pennsylvania. When an insurance company goes into liquidation, all outstanding policies are cancelled. The goal of liquidation is to use the money acquired from selling the company's assets to pay off the company's debts and outstanding insurance claims, but policyholders are left holding the risk on any open policies.

Practical solutions

Faced with steep premium prices and the possibility of losing coverage, remodelers are being encouraged to take a proactive review of their insurance coverage. "Policy details make for some dry, horrible reading," admits Mike Weiss, "but it's imperative that remodelers plow through this stuff and do everything possible to educate themselves about their coverage." Weiss compares the situation to conditions remodelers began facing a decade ago when it became necessary to conduct a thorough company overhaul to institute a safety plan and document work practices in order to comply with OSHA regulations. "Retain a good broker who can conduct a comprehensive risk analysis for your company," Weiss advises.

Michael Strong concurs, noting the overhaul won't be limited simply to insurance policies but will include a review of all contractual agreements with customers. "With each change in insurance, we have had to reexamine our agreements. Four years ago, we had to sign EIFS exclusions and have had to opt out of that work. Then it was lead paint, and we had to make sure homeowners received the brochure and signed an acknowledgment that they received it. Today it's mold. We have added another page to our contract that says if we find mold, we will stop work, and the homeowner will be responsible for testing and remediation before we proceed."

"Risk management is much more than buying insurance," insists Weiss. A comprehensive program involves a thorough review of company procedures and work practices to avoid and minimize liabilities. It includes a complete review of contract agreements to shift liabilities away from the remodeler -- either to the homeowner (as in the case of lead paint or mold) or to subcontractors, where appropriate. Requiring insurance certificates, indemnification, and "compliance with law" statements are vital elements to any subcontractor agreement. Finally, a risk transfer program includes a review of insurance coverage to identify gaps and overlaps in order to properly insure the liabilities a contractor must carry.

"In today's climate, effective risk management is the key to qualifying for insurance," says Brodahl. "A remodeler needs to look as attractive as possible to the insurer." This includes establishing an airtight record of good practice and documenting projects. A record of impeccable quality will certainly be a contractor's best defense against a claim. But it's also a sign to the carrier that a company is a good risk. "Sometimes it's difficult in the course of a job to capture all those small decisions made by a homeowner, but it's critical to do so," urges Brodahl. If a homeowner decides to change a vent path or opts for a cheaper vinyl floor to save money, document these decisions. And if an architect makes a mistake, point it out and correct it. "A contractor's defense that 'it's built to spec' no longer flies in our super-litigious climate," Brodahl says. "Defer to your own knowledge and experience."

According to lawyer Jane Lynch, contracts should also include protective provisions, such as alternate dispute resolution (ADR) provisions, including mediation and binding arbitration with a waiver of jury trial. Notice to the builder of claimed defects and a builder's right to access, inspection, testing, and repair are also key provisions in project documents that allow contractors to fix any problems that might arise before a claim is made to the insurance company, or before a civil lawsuit is filed. Again, any record of addressing claims speedily will make a company more attractive to insurers.

Retain a broker

Perhaps the most important step remodelers can take to secure good insurance is to retain the service of a reputable, service-oriented broker (see " Selecting a Broker," below). "There are a lot of programs out there," Michael Strong says. "When we started out, we only knew about the big three -- Farmers, Allstate, and State Farm. But there are many smaller carriers that specialize in remodeling and home building business coverage that a good broker will know about."

In the current climate, brokers can also shop for coverage, whereas bidding on insurance may be one of the worst things a contractor can do. "Carriers are looking for reasons not to write residential contractors, and shopping for price gives them more reason that you're not a good risk," Brodahl says. "Carriers don't want to waste time on a contractor who isn't interested in forming a long-term relationship," confirms Dickenson.

"Like most remodelers, we always used to buy insurance on price. That was all there was to it," says remodeler Michael Fast. "But now we rely entirely on a broker's services. The broker not only shops for us but knows what's coming in the industry and can tailor our insurance to match. The trick is finding someone you can trust." --Clayton DeKorne is a writer based in Burlington, Vt., and Brooklyn, N.Y.

Selecting a Broker

Broker selection requires a shift in thinking about what insurance is. Rather than treating insurance as a commodity, treat it as a service. This means hiring a broker in the same way you might hire a lawyer or accountant. You wouldn't shop for legal counsel or accounting services based on price but rather on the quality of the consultation. In the same way, insurance brokers are best judged on the basis of their performance.

Here are some key issues to consider in finding a broker that fits your company:

Ask for references from a trusted source. Local and regional trade associations often recommend or even sponsor a limited selection of brokers. Ask other remodelers which brokers are good.

How many similar contractors does this broker serve? Look for specific similarities with your business. If you do one or two high-end houses a year or specialize in oceanfront properties, ask the broker to show you a company they have represented in a similar category.

Ask to see the brokerage firm's marketing plan. How does this broker sell itself? In trying to determine whether or not you might be the only remodeler who has walked through their doors, the marketing plan will disclose whether or not the brokerage is at least actively trying to solicit your type of business, has hired staff to address this sector, and backs them up with industry specific research.

Brokers cold call all the time. Don't go with someone off the street who happens to call. However, if a broker does solicit your business, consider investigating who the broker has worked with and which sources might be willing to vouch for the firm.

Rely on your experience. Ask the broker point blank, what do you think the premium will cover? If you've been buying insurance, you have a sense for what's what. If a broker is shifty, it will be easier to spot than you think.

Don't shop for a new insurance policy every year. If you do, you may get pegged as a price shopper. It's much safer to expect a broker to shop for a new policy every three to five years.

Time it right. Begin your search at least 90 to 120 days before your premium comes up for renewal. At 60 days prior, make a decision to go with a broker, and then sit tight. This will give the broker time to get their ducks in a row, but keep in mind that often the broker will be locked out of buying a policy until the day before it comes due.

For more information

"The Liability Insurance Crisis for Builders: Reasons and Responses," a comprehensive overview of the insurance crisis prepared for the National Association of Home Builders, explains many of the important exclusions appearing in policies and provides a number of strategies for responding to the crisis to limit risk and retain profitability. Find it at www.coxcastle.com/Articles/liabilityinsurance.html.

Moldupdate.com offers a digest of breaking insurance news related to the incidence of mold in houses, mold claims, and legislation affecting mold-related insurance matters. www.moldupdate.com.