**3.2 Construction risks amenable to insurance risk transfer and relevant available insurance policies**

Several standardized insurance risk transfer policies are available for use in alleviating the financial consequences of risk realization at construction sites. These policies cover different aspects of construction risk and generally satisfy the ideal characteristic of an insurable risk discussed previously.

#### *3.2.1 Builders risk insurance*

Builders risk insurance (aka "course of construction insurance") is a policy to protect the risks to property associated with a project under construction. It is insurance often written on an "all risk" basis, meaning it covers all risks except those specifically excluded by contract language. Such a policy does include a wide range of pertinent construction risk exposures such as materials, equipment, and partially completed work (completed operations however is covered under the Commercial General Liability policy). Losses can be the result of theft, fire, explosions, wind damage (except in some coastal areas), hail, glass breakage, etc. Usually excluded are ordinary wear and tear, corrosion and rust, mechanical breakdowns, employee theft, acts of war and terrorism, and damage due to faulty workmanship, materials, or planning. Builders risk insurance is essential, and covers exposures not covered under standard property risk policies since there is much higher risk of loss during the construction phase.

There is no "standard" builders risk insurance policy in the marketplace (all projects differ), so the builders risk contract should be read carefully. If the policy selected is written on an "all risk" basis it may be that certain construction defects or even faulty workmanship are covered, however this will generally depend on the contract language. Some policies have a faulty workmanship exclusion, for example. Builders risk insurance is typically project-by-project with coverage starting once the building materials are delivered to the worksite and stopping when work is complete and the finished project delivered. If a contractor or owner is going to insure several projects at the same time, they can obtain coverage on a blanket basis, which may reduce costs. Defects discovered after job completion will not necessarily be covered by builders risk insurance, and another type of insurance is needed to cover these [4].

#### *3.2.2 Workers' compensation insurance*

A very large percentage of a contractor's expenses are attributable to workers' compensation (WC) costs. Among all occupations in the USA in 2017, construction labor workers ranked as the ninth highest in terms of the number of workplace injuries and illnesses [5], and contributed 2.6% of all workplace injuries and illnesses in the USA. A 2010 report from the Bureau of Labor Statistics (BLS), said the average employer cost for workers' compensation insurance nationally was 1.6% of spending but for the construction industry this rate was 2.75 times higher (at 4.4%) [6]. A study by the National Institute of Occupational Safety and Health (NIOSH) has documented that construction industry workers experience higher rate of fatalities and injuries and higher amounts of lost work, increased WC claims and disability than the other industries. Additionally, smaller construction firms are worse, with firms having less than 10 employees being responsible for half the fatal injuries while only comprising a fourth of the construction industry [7]

All USA states (and most countries in Europe) have workers' compensation laws, and purchase of workers' compensation insurance to fulfill the statutory requirements of the WC laws is required in all USA states except Texas.

The objective of the WC system is to provide a mechanism to compensate workers' workplace injuries. The WC laws in various jurisdictions require employers to pay workers a statutory amount for work-related injuries and illnesses without regard to who caused the injury or illness, that is, the employer has strict liability (no negligence is needed for compensation). Strict liability adds additional financial incentive for employers to improve work conditions. As a counterbalancing to the WC laws, the workers' compensation system provides WC settlement as the exclusive remedy for the worker to recover damages. This means they cannot use the legal system as a remedy for costs or damages that reduces costs to the employer [2].

**39**

*Different Market Methods for Transferring Financial Risks in Construction*

WC insurance provides four main coverages: medical costs for the injured worker, a reimbursement of a portion of the injured worker's wages, rehabilitation services for the worker, and death benefits of the worker who died in a workplace accident. All WC systems provide these four benefits, however the level of the each

Of course, the likelihood and severity of a job injury differs significantly by employment duties, i.e., an office worker will have a much lower workers' compensation insurance rate than a carpenter or a roofer working for the same contractor. Insurers set premiums for the construction firm in accordance with the number of

Several types of WC rating plans are available for larger sized insured. These include having experience rating where an "experience modifier" is created for the firm according to how their historic loss experience has been relative to the average insured's loss history. For example, if the loss history of a particular contractor is only 85% of the average contractor's loss history, then the modifier of 0.85 is applied and the premiums paid by this contractor will only be 0.85% of the manual (average) WC rate. The multiplier can also be above 1.0 if the contractor has worse than average loss experience. Experience rating provides another incentive for workplace

A common rating plan used by large contractors is the "retrospective rating" plan. This is similar to experience rating except the actual rate paid is determined at the end of the policy period based on actual experienced losses during the year. This retrospective adjustment of premiums at the end of the policy period can save money for doing a good job of controlling losses during the policy period. Of course, the contractor who does not control losses may be forced retroactively to pay additional premiums. Again, this provides incentives for safety and loss control. Another distinction between experience rating and retrospective rating is that in retrospective rating the contractor does not know what their premiums will be until

In construction, it is common for subcontractors on a jobsite to have their own WC insurance. A general contractor should make sure all subcontractors have WC insurance since this may affect some of the contractor's own defenses against claims by injured workers. For example, in many jurisdictions, "statutory employer immunity" that protects the owner or general contractor against claims by subcontractor's employees only applies if the general contractor has a written requirement that all subcontractors carry sufficient WC insurance [8]. For a detailed description of WC coverage, details on the history, current issues and

A major category of insurance coverage for owners and contractors is Commercial General Liability (CGL) insurance. This generic product covers all liability exposures except those that are specifically excluded. Typical exclusions include automobile liability, workers' compensation liability, professional liability, certain injuries incurred during the construction itself, certain liabilities for faulty workmanship, and liability for completed products. Some of these can be added back by attaching an endorsement to the CGL, and most others are excluded because they are handled best by a separate policy (e.g., a commercial automobile

The CGL policy has three major coverages: Coverage A—Bodily Injury and Property Damage Liability, Coverage B—Personal and Advertising Injury Liability,

and Coverage C—Medical Payments. We examine these in turn.

*DOI: http://dx.doi.org/10.5772/intechopen.84748*

of these benefits can vary substantially state to state.

workers they have in each job classification [2, 4].

safety to save on mandated premiums [4].

the end of the premium period.

controversies see [2].

*3.2.3 Commercial general liability (CGL) insurance*

policy, a workers' compensation policy, etc.).

#### *Different Market Methods for Transferring Financial Risks in Construction DOI: http://dx.doi.org/10.5772/intechopen.84748*

*Risk Management in Construction Projects*

*3.2.2 Workers' compensation insurance*

Builders risk insurance (aka "course of construction insurance") is a policy to protect the risks to property associated with a project under construction. It is insurance often written on an "all risk" basis, meaning it covers all risks except those specifically excluded by contract language. Such a policy does include a wide range of pertinent construction risk exposures such as materials, equipment, and partially completed work (completed operations however is covered under the Commercial General Liability policy). Losses can be the result of theft, fire, explosions, wind damage (except in some coastal areas), hail, glass breakage, etc. Usually excluded are ordinary wear and tear, corrosion and rust, mechanical breakdowns, employee theft, acts of war and terrorism, and damage due to faulty workmanship, materials, or planning. Builders risk insurance is essential, and covers exposures not covered under standard property risk policies since there is much higher risk of loss during the construction phase. There is no "standard" builders risk insurance policy in the marketplace (all projects differ), so the builders risk contract should be read carefully. If the policy selected is written on an "all risk" basis it may be that certain construction defects or even faulty workmanship are covered, however this will generally depend on the contract language. Some policies have a faulty workmanship exclusion, for example. Builders risk insurance is typically project-by-project with coverage starting once the building materials are delivered to the worksite and stopping when work is complete and the finished project delivered. If a contractor or owner is going to insure several projects at the same time, they can obtain coverage on a blanket basis, which may reduce costs. Defects discovered after job completion will not necessarily be covered by builders risk insurance, and another type of insurance is needed to cover these [4].

A very large percentage of a contractor's expenses are attributable to workers' compensation (WC) costs. Among all occupations in the USA in 2017, construction labor workers ranked as the ninth highest in terms of the number of workplace injuries and illnesses [5], and contributed 2.6% of all workplace injuries and illnesses in the USA. A 2010 report from the Bureau of Labor Statistics (BLS), said the average employer cost for workers' compensation insurance nationally was 1.6% of spending but for the construction industry this rate was 2.75 times higher (at 4.4%) [6]. A study by the National Institute of Occupational Safety and Health (NIOSH) has documented that construction industry workers experience higher rate of fatalities and injuries and higher amounts of lost work, increased WC claims and disability than the other industries. Additionally, smaller construction firms are worse, with firms having less than 10 employees being responsible for half the fatal injuries

All USA states (and most countries in Europe) have workers' compensation laws, and purchase of workers' compensation insurance to fulfill the statutory require-

The objective of the WC system is to provide a mechanism to compensate workers' workplace injuries. The WC laws in various jurisdictions require employers to pay workers a statutory amount for work-related injuries and illnesses without regard to who caused the injury or illness, that is, the employer has strict liability (no negligence is needed for compensation). Strict liability adds additional financial incentive for employers to improve work conditions. As a counterbalancing to the WC laws, the workers' compensation system provides WC settlement as the exclusive remedy for the worker to recover damages. This means they cannot use the legal system as a remedy for costs or damages that reduces costs to the employer [2].

while only comprising a fourth of the construction industry [7]

ments of the WC laws is required in all USA states except Texas.

*3.2.1 Builders risk insurance*

**38**

WC insurance provides four main coverages: medical costs for the injured worker, a reimbursement of a portion of the injured worker's wages, rehabilitation services for the worker, and death benefits of the worker who died in a workplace accident. All WC systems provide these four benefits, however the level of the each of these benefits can vary substantially state to state.

Of course, the likelihood and severity of a job injury differs significantly by employment duties, i.e., an office worker will have a much lower workers' compensation insurance rate than a carpenter or a roofer working for the same contractor. Insurers set premiums for the construction firm in accordance with the number of workers they have in each job classification [2, 4].

Several types of WC rating plans are available for larger sized insured. These include having experience rating where an "experience modifier" is created for the firm according to how their historic loss experience has been relative to the average insured's loss history. For example, if the loss history of a particular contractor is only 85% of the average contractor's loss history, then the modifier of 0.85 is applied and the premiums paid by this contractor will only be 0.85% of the manual (average) WC rate. The multiplier can also be above 1.0 if the contractor has worse than average loss experience. Experience rating provides another incentive for workplace safety to save on mandated premiums [4].

A common rating plan used by large contractors is the "retrospective rating" plan. This is similar to experience rating except the actual rate paid is determined at the end of the policy period based on actual experienced losses during the year. This retrospective adjustment of premiums at the end of the policy period can save money for doing a good job of controlling losses during the policy period. Of course, the contractor who does not control losses may be forced retroactively to pay additional premiums. Again, this provides incentives for safety and loss control. Another distinction between experience rating and retrospective rating is that in retrospective rating the contractor does not know what their premiums will be until the end of the premium period.

In construction, it is common for subcontractors on a jobsite to have their own WC insurance. A general contractor should make sure all subcontractors have WC insurance since this may affect some of the contractor's own defenses against claims by injured workers. For example, in many jurisdictions, "statutory employer immunity" that protects the owner or general contractor against claims by subcontractor's employees only applies if the general contractor has a written requirement that all subcontractors carry sufficient WC insurance [8]. For a detailed description of WC coverage, details on the history, current issues and controversies see [2].

#### *3.2.3 Commercial general liability (CGL) insurance*

A major category of insurance coverage for owners and contractors is Commercial General Liability (CGL) insurance. This generic product covers all liability exposures except those that are specifically excluded. Typical exclusions include automobile liability, workers' compensation liability, professional liability, certain injuries incurred during the construction itself, certain liabilities for faulty workmanship, and liability for completed products. Some of these can be added back by attaching an endorsement to the CGL, and most others are excluded because they are handled best by a separate policy (e.g., a commercial automobile policy, a workers' compensation policy, etc.).

The CGL policy has three major coverages: Coverage A—Bodily Injury and Property Damage Liability, Coverage B—Personal and Advertising Injury Liability, and Coverage C—Medical Payments. We examine these in turn.

In the bodily injury and property damage section, the CGL covers bodily injury or property damage caused by "an occurrence" for which the insured is legally responsible. For coverage to apply, the damage must arise from the insured's products, or completed works, or operations performed on or off site. If a lawsuit occurs, the CGL policy provides a lawyer to defend the claim.

The personal and advertising injury liability coverage (Coverage B) differs from the Coverage A in that the Coverage A is very broad whereas Coverage B only covers claims for specific offenses. If a claim does not arise from one of the listed causes, it is not covered. Another difference is that Coverage A covers damage from an occurrence resulting from negligence of the insured, which is unintentional. Coverage B, on the other hand, covers specific intentional or deliberate acts that result in harm and which arose out of business operation.

The medical payments Coverage C will pay (without their needing to be a lawsuit) for a third party's medical expenses associated with an injury from an accident occurring in the course of business activities of the insured without regard to who was at fault, and without a lawsuit. This differs from Coverage A and B where the insured needed to be responsible for the injury to be covered.

#### *3.2.4 Professional liability insurance*

Professional liability (also called errors and omissions) insurance protects a professional service provider from being held fiscally responsible in a professional negligence lawsuit. The coverage pays for defending against the claim that the insured failed to perform their professional service, or produced a professional product that did not meet normal professional standards, and that this failure to give adequate professional service resulted in a loss to the client. The coverage focuses on financial loss caused by alleged errors in professional judgment, or omissions of required and usual professional responsibilities, failure in professional oversights, or professional negligence in the service or product sold by the insured. Professional liability claims are not generally covered by a CGL insurance policy. The professional liability insurance policy is usually written on a "claimsmade" basis, meaning that claims are only covered if they are made during the policy period. Common exclusions in professional liability policies are intentional or dishonest acts, and bodily injury and physical damage claims (as these are covered by CGL policies).

On the construction site, engineers, architects, electricians, plumbers, and other professionally licensed workers are held to have up-to-date professional knowledge and ability and work to professional standards. They can be held liable if their work is not up to standard and causes losses. For example, there are now professional liability lawsuits against the structural engineers, architects, and developer in the sinking and tilting 58 story Millennium Tower completed in 2009 in San Francisco, California. Because of this tilting and sinking, the tower has a minimum \$200 million in repair costs, plus lost property value [9, 10].

A relatively recent product in the professional liability insurance marketplace (Contractors Professional Liability Insurance developed in the 1990s) protects contractors who engage in design-build work. Like builders risk insurance, it can be project-specific if the contractor is only doing design-build on some projects. Prior to the availability of contractors' professional liability insurance, the coverage alternative available was to add an endorsement to a design professional liability policy, and a few insurers only offered this. Coverage extended by this endorsement was typically limited to the contractor's vicarious liability for design errors and omissions inherited from a third party (e.g., an architect or structural engineer hired by the contractor), and not that of the contractor [11].

**41**

*Different Market Methods for Transferring Financial Risks in Construction*

*3.2.5 Commercial umbrella insurance contracts and excess liability policies*

An individual primary insurance contract covers pre-specified financial consequence of a risk realization (stated in the contract) from above the specified deductible up to policy limits. If the experienced loss goes above that policy limit the contractor (or owner) is still liable for the risk consequences. Until this point in the chapter, we discussed individual primary insurance contracts like WC insurance, builders risk insurance, CGL insurance, and other primary insurance contracts (and clauses). These are viewed separately according to the risks they cover. To cover the risk of loss above the policy limits of a given liability policy, the contractor has the option of buying an additional (supplemental) policy that takes over the indemnification obligation above the maximum limits set in the underlying policy. This second policy protects the insured from potentially catastrophic losses associated with a very large liability claim. Such secondary policies are "excess insurance policies" (as they pay losses in excess to what the primary insurance pays). When the excess policy provides the same coverage details (insured events) as the primary insurance policy, the policy is a "following form excess insurance" policy. A detailed examination and discussion of the excess and surplus insurance

Another possibility to raise coverage limits for an insured exposed to multiple risks is to purchase an umbrella insurance policy. The umbrella policy, at the same time and within the same contract, provides supplemental coverage in excess of the policy limits of several distinct underlying insurance policies. Thus, the umbrella policy could cover losses in excess of the policy limits of any of builders risk insurance, workers' compensation insurance or general liability policy. Instead of buying three" following form excess" policies, a single umbrella policy provides the additional limit extension to a uniform project limit that is over all the risks and is the same excess limit for all the risks covered. The umbrella policy provisions usually set a minimum on the maximum payment limit requirement for each underlying policy it spreads above since the umbrella policy is secondary, and so the umbrella insurer wants higher limits on the

The market for excess and umbrella policies exists to provide the contractor with an option to raise the upper coverage amounts for all underlying policy exposures to have a consistent uniform higher limit on all. Even umbrella policies have upper limits, however, so at some point the insured must be willing to self-insure large risk consequences. The maximum coverage level the contractor sets for their umbrella can be a complex choice made in collaboration with their insurance broker. If the contractor requires subcontractors to hold high limit umbrella policies, then the

As noted previously, construction contracts often have incentive clauses that provide a pay bonus (per day) for finishing the project ahead of the agreed upon completion date, and impose a penalty per day for projects completed behind schedule. Unexpected delays create unexpected losses for owners, developers, construction companies, or others with a stake in the timely project completion. There is insurance coverage available to help transfer some of this risk to an insurer for indemnification. Called delay in completion (DIC) coverage (also known as delayed completion coverage, and sometimes delayed start-up, or delayed opening coverage, or soft costs coverage (like extra accrued real estate taxes, etc.), or advance loss of profits coverage, or loss of anticipated revenue coverage), it is similar to business interruption insurance. It is written typically as part of a builders risk

underlying primary policies insurance policies so they have less to pay [2].

contractor may hold lower limits on its own policy.

*3.2.6 Delay in completion or delay in start-up insurance*

*DOI: http://dx.doi.org/10.5772/intechopen.84748*

market is given in [12].

*Risk Management in Construction Projects*

and which arose out of business operation.

*3.2.4 Professional liability insurance*

covered by CGL policies).

lion in repair costs, plus lost property value [9, 10].

the contractor), and not that of the contractor [11].

In the bodily injury and property damage section, the CGL covers bodily injury

The personal and advertising injury liability coverage (Coverage B) differs from the Coverage A in that the Coverage A is very broad whereas Coverage B only covers claims for specific offenses. If a claim does not arise from one of the listed causes, it is not covered. Another difference is that Coverage A covers damage from an occurrence resulting from negligence of the insured, which is unintentional. Coverage B, on the other hand, covers specific intentional or deliberate acts that result in harm

The medical payments Coverage C will pay (without their needing to be a lawsuit) for a third party's medical expenses associated with an injury from an accident occurring in the course of business activities of the insured without regard to who was at fault, and without a lawsuit. This differs from Coverage A and B where the

Professional liability (also called errors and omissions) insurance protects a professional service provider from being held fiscally responsible in a professional negligence lawsuit. The coverage pays for defending against the claim that the insured failed to perform their professional service, or produced a professional product that did not meet normal professional standards, and that this failure to give adequate professional service resulted in a loss to the client. The coverage focuses on financial loss caused by alleged errors in professional judgment, or omissions of required and usual professional responsibilities, failure in professional oversights, or professional negligence in the service or product sold by the insured. Professional liability claims are not generally covered by a CGL insurance policy. The professional liability insurance policy is usually written on a "claimsmade" basis, meaning that claims are only covered if they are made during the policy period. Common exclusions in professional liability policies are intentional or dishonest acts, and bodily injury and physical damage claims (as these are

On the construction site, engineers, architects, electricians, plumbers, and other professionally licensed workers are held to have up-to-date professional knowledge and ability and work to professional standards. They can be held liable if their work is not up to standard and causes losses. For example, there are now professional liability lawsuits against the structural engineers, architects, and developer in the sinking and tilting 58 story Millennium Tower completed in 2009 in San Francisco, California. Because of this tilting and sinking, the tower has a minimum \$200 mil-

A relatively recent product in the professional liability insurance marketplace (Contractors Professional Liability Insurance developed in the 1990s) protects contractors who engage in design-build work. Like builders risk insurance, it can be project-specific if the contractor is only doing design-build on some projects. Prior to the availability of contractors' professional liability insurance, the coverage alternative available was to add an endorsement to a design professional liability policy, and a few insurers only offered this. Coverage extended by this endorsement was typically limited to the contractor's vicarious liability for design errors and omissions inherited from a third party (e.g., an architect or structural engineer hired by

or property damage caused by "an occurrence" for which the insured is legally responsible. For coverage to apply, the damage must arise from the insured's products, or completed works, or operations performed on or off site. If a lawsuit

occurs, the CGL policy provides a lawyer to defend the claim.

insured needed to be responsible for the injury to be covered.

**40**

### *3.2.5 Commercial umbrella insurance contracts and excess liability policies*

An individual primary insurance contract covers pre-specified financial consequence of a risk realization (stated in the contract) from above the specified deductible up to policy limits. If the experienced loss goes above that policy limit the contractor (or owner) is still liable for the risk consequences. Until this point in the chapter, we discussed individual primary insurance contracts like WC insurance, builders risk insurance, CGL insurance, and other primary insurance contracts (and clauses). These are viewed separately according to the risks they cover. To cover the risk of loss above the policy limits of a given liability policy, the contractor has the option of buying an additional (supplemental) policy that takes over the indemnification obligation above the maximum limits set in the underlying policy. This second policy protects the insured from potentially catastrophic losses associated with a very large liability claim. Such secondary policies are "excess insurance policies" (as they pay losses in excess to what the primary insurance pays). When the excess policy provides the same coverage details (insured events) as the primary insurance policy, the policy is a "following form excess insurance" policy. A detailed examination and discussion of the excess and surplus insurance market is given in [12].

Another possibility to raise coverage limits for an insured exposed to multiple risks is to purchase an umbrella insurance policy. The umbrella policy, at the same time and within the same contract, provides supplemental coverage in excess of the policy limits of several distinct underlying insurance policies. Thus, the umbrella policy could cover losses in excess of the policy limits of any of builders risk insurance, workers' compensation insurance or general liability policy. Instead of buying three" following form excess" policies, a single umbrella policy provides the additional limit extension to a uniform project limit that is over all the risks and is the same excess limit for all the risks covered. The umbrella policy provisions usually set a minimum on the maximum payment limit requirement for each underlying policy it spreads above since the umbrella policy is secondary, and so the umbrella insurer wants higher limits on the underlying primary policies insurance policies so they have less to pay [2].

The market for excess and umbrella policies exists to provide the contractor with an option to raise the upper coverage amounts for all underlying policy exposures to have a consistent uniform higher limit on all. Even umbrella policies have upper limits, however, so at some point the insured must be willing to self-insure large risk consequences. The maximum coverage level the contractor sets for their umbrella can be a complex choice made in collaboration with their insurance broker. If the contractor requires subcontractors to hold high limit umbrella policies, then the contractor may hold lower limits on its own policy.

#### *3.2.6 Delay in completion or delay in start-up insurance*

As noted previously, construction contracts often have incentive clauses that provide a pay bonus (per day) for finishing the project ahead of the agreed upon completion date, and impose a penalty per day for projects completed behind schedule. Unexpected delays create unexpected losses for owners, developers, construction companies, or others with a stake in the timely project completion.

There is insurance coverage available to help transfer some of this risk to an insurer for indemnification. Called delay in completion (DIC) coverage (also known as delayed completion coverage, and sometimes delayed start-up, or delayed opening coverage, or soft costs coverage (like extra accrued real estate taxes, etc.), or advance loss of profits coverage, or loss of anticipated revenue coverage), it is similar to business interruption insurance. It is written typically as part of a builders risk

policy (or a marine cargo policy wherein it covers delays due to late arrival of critical shipped materials or components to the worksite). DIC policies can vary significantly from policy to policy, but DIC policy forms require the delay in completion to be caused by direct physical damage or direct physical loss to insured property. The period of indemnity is limited to an agreed upon maximum length beginning when the business that contracted for the construction would have started operation, if not for the loss. The length of the indemnity period is the time needed to remedy the delay loss. Importantly, the coverage trigger date is only applicable for start of the delay claim if the contractor can show that they would have completed on time if not for the direct physical damage or loss to insured property. To show this, the contractor may have to hire an expert, and this may be covered by the insurance.

It is important to read the policy language because not all delays are covered by all policies. Causes of delay which may not be covered depending on the contract are delays caused by having a need to redesign or rectify discovered faults or defects, damages for breach of contract, site shutdowns due to inadequate funding, or losses due to fines and penalties causing delay [13].

#### *3.2.7 Subcontractor default insurance*

General contractors compete for dependable subcontractors, particularly when construction is expanding. However, when subcontractors fail, general contractors face a host of challenges, including project delays, costs associated with work stoppage, complexities arising from trying to replace the subcontractor and potential reputation damage. Such risks tend to increase in booming construction markets, as subcontractors may take on more work than they can handle, which can exacerbate cash flow struggles. Subcontractor default insurance can help the contractor hedge this risk. In addition to contractually requiring the subcontractor have their own insurance with the contractor listed as an additional insured, and having the subcontractor agree to a hold harmless agreement written into the master contract with the subcontractors, a subcontractor default policy can be very useful.

Subcontractor default insurance, introduced by Zurich Insurance about 25 years ago, provides a way for contractors to transfer the financial consequences of subcontractor's default or non-completion of work. Until recently, few insurers have offered the product, but the market is expected to expand, and become more available to smaller contractors [14].

Retention levels on the policy (the deductible) vary from \$500,000 to several million dollars, although retention levels have been going down. The premium rate charged to transfer risk to the insurer vary according to the contractor seeking coverage and depend strongly on the individual contractor's prequalification procedures for their subcontractors, on the loss history of the contractor, and on the specific loss control mechanisms implemented. The rate for subcontractor default insurance is usually fixed for 2 or 3 years [14].

The leading historical reason for subcontractor default is financial, followed by quality. There are more defaults now because of labor shortages than anything other reason. With an insured's increase in claims, insurers may make policy changes to keep the insurance viable, such as excluding coverage for problematic trades (e.g., framing) ([14], quoting Rose Hoyle).

#### *3.2.8 Operational risks: Insurance against defective construction or faulty workmanship claims*

While a large number of liability risks are covered by the CGL policy, these relate mostly to third party fortuitous or accidental bodily injury and property damage.

**43**

*insurance*

*Different Market Methods for Transferring Financial Risks in Construction*

Most insurers have traditionally considered claims about faulty construction or workmanship as a "business risk" for the contractor. Thus, monitoring workmanship was to be taken on as a normal part of monitoring the quality of work performed while doing business, and this was viewed as being under the control of the contractor. Insurers therefore have generally excluded such claim responsibility from coverage by appending a standard "faulty workmanship" exclusion clause to the CGL policy.

If the contractor's completed work or product is faulty, or if the work is not what was contractually specified, the contractor's unendorsed CGL policy will generally not cover the costs to remediate it (but see the builders risk section for in-progress claims). A California court elucidated this as follows, "Generally liability policies… are not designed to provide contractors…with coverage against claims their work is inferior or defective…. Rather liability coverage comes into play when the contractor's (insured) defective materials or work cause injury to property other than the insured's own work or products." See Clarendon America Ins. Co. v. General Sec.

The contractor can, however now buy an endorsement covering faulty workmanship from some insurers [16, 17]. These endorsements provide funds for claims due to faulty workmanship, materials, or products, even if discovered after the project termination. It is worth noting, however, that the coverage is only applicable for policies in force, so terminating (canceling) the policy when the project is done but before the expiration of the statute of limitations for clams has expired may leave a risk exposure for late filed claims. The contractor should check coverage with a broker since coverage interpretation of the CGL language is on a state-by-state basis, and many insurers have now created new coverage endorsements redefining the scope of coverage.

*3.2.9 Supply chain risks for contractors and contingent business interruption (CBI)* 

Supply chain risk is created by disruption in the sequencing of permitting, subcontractors' arrival for work, and the arrival of materials at the worksite when needed. Additionally, particular owner specified items can also be problematic to source, and owner-imposed requirements and impacts need to be documented to help manage this risk. Demand for globally sourced products such as marble from Italy, Saltillo tile from Mexico and machinery from Germany have increased. At the same time, the supply chain inventory for these products has become "leaner" and the use of "just in time" inventory control has grown in response to a competitive desire to increase efficiency and save inventory or holding costs. When the supply chain is properly functioning, such processes can result in cost savings. On the other hand, losses can occur if suppliers have disruption, such as an earthquake in Mexico or Iceland's Eyjafjallajökull volcano that shut down air traffic over much of northern Europe in 2010 (disrupting supply chains worldwide). These natural catastrophes can cause delays in the arrival of construction material and construction progression can suffer. Since the damage did not occur to the construction project's own physical site, losses associate with these supply chain disruptions will generally not be covered by the usual builders risk, general liability, or the contractor's other policies. There is an insurance policy that covers the risk of a supplier having damages that affect the contractor's ability to perform on their own construction project. This product is Contingent Business Interruption (CBI) Insurance. It covers losses to the contractor due to a disruption or delay in receiving products, components, or services from a supplier because of an incident at a supplier's property. Nonphysical damage events affecting the supplier could include strikes, pandemics; civil or military action; and regulatory actions against the supplier. The CBI policy can be written to cover either incidents at the location of a particular single named

Indem. Co. of Arizona, 193 Cal. App. 4th 1311, 1325 (2011), sited in [15].

*DOI: http://dx.doi.org/10.5772/intechopen.84748*

#### *Different Market Methods for Transferring Financial Risks in Construction DOI: http://dx.doi.org/10.5772/intechopen.84748*

*Risk Management in Construction Projects*

due to fines and penalties causing delay [13].

*3.2.7 Subcontractor default insurance*

available to smaller contractors [14].

insurance is usually fixed for 2 or 3 years [14].

framing) ([14], quoting Rose Hoyle).

*workmanship claims*

policy (or a marine cargo policy wherein it covers delays due to late arrival of critical shipped materials or components to the worksite). DIC policies can vary significantly from policy to policy, but DIC policy forms require the delay in completion to be caused by direct physical damage or direct physical loss to insured property. The period of indemnity is limited to an agreed upon maximum length beginning when the business that contracted for the construction would have started operation, if not for the loss. The length of the indemnity period is the time needed to remedy the delay loss. Importantly, the coverage trigger date is only applicable for start of the delay claim if the contractor can show that they would have completed on time if not for the direct physical damage or loss to insured property. To show this, the contrac-

It is important to read the policy language because not all delays are covered by all policies. Causes of delay which may not be covered depending on the contract are delays caused by having a need to redesign or rectify discovered faults or defects, damages for breach of contract, site shutdowns due to inadequate funding, or losses

General contractors compete for dependable subcontractors, particularly when construction is expanding. However, when subcontractors fail, general contractors face a host of challenges, including project delays, costs associated with work stoppage, complexities arising from trying to replace the subcontractor and potential reputation damage. Such risks tend to increase in booming construction markets, as subcontractors may take on more work than they can handle, which can exacerbate cash flow struggles. Subcontractor default insurance can help the contractor hedge this risk. In addition to contractually requiring the subcontractor have their own insurance with the contractor listed as an additional insured, and having the subcontractor agree to a hold harmless agreement written into the master contract

Subcontractor default insurance, introduced by Zurich Insurance about 25 years

Retention levels on the policy (the deductible) vary from \$500,000 to several million dollars, although retention levels have been going down. The premium rate charged to transfer risk to the insurer vary according to the contractor seeking coverage and depend strongly on the individual contractor's prequalification procedures for their subcontractors, on the loss history of the contractor, and on the specific loss control mechanisms implemented. The rate for subcontractor default

The leading historical reason for subcontractor default is financial, followed by quality. There are more defaults now because of labor shortages than anything other reason. With an insured's increase in claims, insurers may make policy changes to keep the insurance viable, such as excluding coverage for problematic trades (e.g.,

While a large number of liability risks are covered by the CGL policy, these relate mostly to third party fortuitous or accidental bodily injury and property damage.

*3.2.8 Operational risks: Insurance against defective construction or faulty* 

tor may have to hire an expert, and this may be covered by the insurance.

with the subcontractors, a subcontractor default policy can be very useful.

ago, provides a way for contractors to transfer the financial consequences of subcontractor's default or non-completion of work. Until recently, few insurers have offered the product, but the market is expected to expand, and become more

**42**

Most insurers have traditionally considered claims about faulty construction or workmanship as a "business risk" for the contractor. Thus, monitoring workmanship was to be taken on as a normal part of monitoring the quality of work performed while doing business, and this was viewed as being under the control of the contractor. Insurers therefore have generally excluded such claim responsibility from coverage by appending a standard "faulty workmanship" exclusion clause to the CGL policy.

If the contractor's completed work or product is faulty, or if the work is not what was contractually specified, the contractor's unendorsed CGL policy will generally not cover the costs to remediate it (but see the builders risk section for in-progress claims). A California court elucidated this as follows, "Generally liability policies… are not designed to provide contractors…with coverage against claims their work is inferior or defective…. Rather liability coverage comes into play when the contractor's (insured) defective materials or work cause injury to property other than the insured's own work or products." See Clarendon America Ins. Co. v. General Sec. Indem. Co. of Arizona, 193 Cal. App. 4th 1311, 1325 (2011), sited in [15].

The contractor can, however now buy an endorsement covering faulty workmanship from some insurers [16, 17]. These endorsements provide funds for claims due to faulty workmanship, materials, or products, even if discovered after the project termination. It is worth noting, however, that the coverage is only applicable for policies in force, so terminating (canceling) the policy when the project is done but before the expiration of the statute of limitations for clams has expired may leave a risk exposure for late filed claims. The contractor should check coverage with a broker since coverage interpretation of the CGL language is on a state-by-state basis, and many insurers have now created new coverage endorsements redefining the scope of coverage.

## *3.2.9 Supply chain risks for contractors and contingent business interruption (CBI) insurance*

Supply chain risk is created by disruption in the sequencing of permitting, subcontractors' arrival for work, and the arrival of materials at the worksite when needed. Additionally, particular owner specified items can also be problematic to source, and owner-imposed requirements and impacts need to be documented to help manage this risk. Demand for globally sourced products such as marble from Italy, Saltillo tile from Mexico and machinery from Germany have increased. At the same time, the supply chain inventory for these products has become "leaner" and the use of "just in time" inventory control has grown in response to a competitive desire to increase efficiency and save inventory or holding costs. When the supply chain is properly functioning, such processes can result in cost savings. On the other hand, losses can occur if suppliers have disruption, such as an earthquake in Mexico or Iceland's Eyjafjallajökull volcano that shut down air traffic over much of northern Europe in 2010 (disrupting supply chains worldwide). These natural catastrophes can cause delays in the arrival of construction material and construction progression can suffer. Since the damage did not occur to the construction project's own physical site, losses associate with these supply chain disruptions will generally not be covered by the usual builders risk, general liability, or the contractor's other policies.

There is an insurance policy that covers the risk of a supplier having damages that affect the contractor's ability to perform on their own construction project. This product is Contingent Business Interruption (CBI) Insurance. It covers losses to the contractor due to a disruption or delay in receiving products, components, or services from a supplier because of an incident at a supplier's property. Nonphysical damage events affecting the supplier could include strikes, pandemics; civil or military action; and regulatory actions against the supplier. The CBI policy can be written to cover either incidents at the location of a particular single named supplier or it could cover all suppliers depending on the terms of the contract. Coverage under these policies is triggered by interruption to contractor due to supply chain or logistical failure [18].

It should be noted that Contingent Business Interruption Insurance is different from regular Business Interruption (BI) Insurance. CBI covers the risk of damage (loss) to the contractor due to an incident at a supplier's location. On the other hand, regular BI Insurance addresses the risk of losses arising at the contractor's worksite that cause losses and interruptions to the contractor.
