Construction insurace

April 2018    |    16 minute read    |    By Indrani Nadrajah

Canada is one of the eight global construction markets (along with China, US, India, Indonesia, UK, Mexico and Nigeria) predicted to account for 70% of all global growth in construction leading up to 2030, according to the fourth global study by Global Construction Perspectives and Oxford Economics. In January, ReNew Canada reported that more than $186 billion was invested in the biggest infrastructure projects currently under development across the country. With construction projects becoming larger and more complicated, insurance coverage assumes even greater importance.

Construction site at sunriseThe sky’s the limit

Construction work has officially begun on a new supertall skyscraper in downtown Toronto and the mixed use building will rise to a height of 306 m (1,003 ft), making it Canada's tallest skyscraper when completed. But it will not be the only one for long - two other supertall buildings, and three others just shy of that classification, are in the planning stages for Toronto. Supertall buildings are those that are more than 300 metres high or 90 storeys tall.

According to Munich-based Alliance Global Corporate and Specialty (AGCS), there are over 100 supertall buildings around the world. By 2020, 10 of the 20 tallest will be located in China, with the average height of the tallest 20 expected to be around 600 metres. Currently, the world’s tallest building is the 828-metre Burj Khalifa in Dubai, United Arab Emirates. But even that super structure will be eclipsed by the one kilometre tall Jeddah Tower development (previously Kingdom Tower), scheduled for completion in 2020 in Jeddah, Saudi Arabia. Experts are also considering the achievement of a one mile (1.6 km) high building within the next 20 to 30 years.

AGCS is the lead reinsurer on the Jeddah Tower, which has an insured value of US$1.5 billion. Previously, the company has been involved in insuring both the Burj Khalifa and the 452-metre Petronas Towers in Kuala Lumpur, Malaysia. It said that risks of tall buildings include seismic activity and other natural catastrophes, wind loads and the “unique complexity of managing projects that can involve as many as 10,000 workers and over 100 subcontractors.” Then there are the technical issues which include placing concrete at extreme heights and variation in wind speeds between ground level and higher levels.

Fire risk is also a considerable challenge, leading to an “enormous focus” on sprinkler systems design, escape rooms and fire resistant structures at the design stage, AGCS said.

Woodframe construction

A 53-metre high student residence in Vancouver, Brock Commons Tallwood House, completed in 2016, is reportedly the tallest timber skyscraper in the world, but it will be dwarfed when Sumitomo Forestry Company completes a 350 metre, 70-floor “plyskraper” tower in Tokyo (expected in 2041). The new wooden building will include just 10% steel and its internal framework of columns, beams and braces will be made of a hybrid of the two materials. The interior structure, with 455,000 square metres of floor space, will be entirely made of wood. The skyscraper will undoubtedly set a new standard in construction cost – the estimated price tag of about US$5.5 billion is double that of a conventional skyscraper.

Insuring the construction of wooden buildings is correspondingly more costly. A 2016 study commissioned by the Concrete Council of Canada found a considerable difference in the risks and insurance rates for the construction of wood frame buildings compared to concrete buildings. The study, Insurance Costs for Mid-Rise Wood Frame and Concrete Residential Buildings, used data from interviews with three underwriters and the Canadian Wood Council (CWC). It revealed that builders' risk insurance rates per $100 monthly for comparable wood and concrete buildings are, on average, $0.008 for concrete and $0.053 for wood.

When CWC’s rate for wood frame insurance was excluded, the average rate for wood buildings increased to $0.06. The CWC’s rate was noticeably lower than the rates provided by the interviewed underwriters, Globe Advisors noted.

The study concluded that builders' risk insurance rates were 7.5 times higher for the construction of wood mid-rise buildings compared to those made of concrete. This is most likely due to the higher fire risk and the greater danger of water and moisture damage for wood frame buildings. According to the study, "Many insurance companies in Canada are hesitant to underwrite wood frame structures, or will aggressively limit their risk exposure for such structures, during construction and over the life of the asset.”

Construction defects

Managing director of the Institute for Catastrophic Loss Reduction (ICLR), Glenn McGillivray, says that poor quality of construction in homes and low-rise commercial buildings can be an issue for both insurers and owners.

He cites a storm system that roared through the town of Angus in Ontario in June 2014. A tornado blew out windows, ripped off siding, tore up fences and sheared off the tops of some homes. A new development was particularly badly affected. About 100 homes were damaged and 10 lost their roofs entirely, leaving about 300 people homeless. Environment Canada later confirmed the tornado’s windspeed was about 180 km/h.

According to Western University’s Gregory Kopp, quoted in the Toronto Star, much of the damage could have been prevented if certain small measures had been incorporated during the construction phase. For example the installation of “hurricane straps” — small pieces of metal costing about $1 apiece and which bind the roof truss to the top of the wall — could have saved most of the roofs. Kopp calculated that the homes could have survived the tornado relatively unscathed for a small investment of a couple of hundred dollars per dwelling. But even in tornado-prone areas, these small measures are resisted by builders, who see them as money out of pocket, Kopp told the Star.

McGillivray explains that the pneumatic nail gun used by roofers can inadvertently lead to missed joists, especially when nailing pieces of plywood sheathing to roof trusses at speed. “All you have to do is miss a few nails and the roof sheathing is half as strong as it should be.” This is something the ICLR has noticed in tornado sites across the country, especially on homes that were constructed within the last 10 years.

The current Ontario Building Code stipulates the bare minimum for standards and even these are sometimes ignored by builders, with the predictable result of shoddy workmanship, McGillivray says.

The province passes the responsibility for overseeing the Building Code down to the municipalities, and it is not mandatory for municipalities to conduct building inspections to ensure that the Code’s minimum standards are adhered to. The 100-odd homes in Angus that were damaged in the tornado were lacking really basic things like proper roof to wall connections, McGillivray explains.

Pursuing errant builders is often fruitless - builders sometimes register companies for the purpose of constructing a subdivision then immediately wind it up after the development is completed so that there’s no legal entity to go after.

A few insurers considered suing after Angus to recoup some of the estimated losses of $30 million. In the end, none were pursued. It came down to brass tacks – an insurer couldn’t prove definitively that a piece of damaged roof sheathing or a truss blown down the street actually came from one of its insured homes.

In the future, there may be a significant civil lawsuit or criminal negligence charge and perhaps that is what is required for change to take place, McGillivray says. Meanwhile, “the insurance industry does have influence and needs to ensure that every new construction project has the proper completed paperwork.”

Water damage

Marcus A. Raitanen, Vice-President, Construction at ENCON Group Inc., explains that water damage claims have proliferated in recent years and are now a leading cause of loss in construction. This is a major challenge facing insurers in this space, as the cost of these claims must be borne by the pool of premium collected, and is especially concerning during a soft market period where rates and premiums are at historically low levels. 

Worst case scenarios can have devastating outcomes. “Imagine a situation on a nearly completed multi-level building project where a pipe fitting fails in an unoccupied unit and the ensuing water release isn’t detected until it reaches the elevator shaft and cascades down to the main level. There could be extensive damage to many units with losses perhaps in the millions of dollars,” Raitanen says.

Certificates of Insurance

A certificate of insurance shows proof of insurance coverage and is for informational purposes only. Certificates of insurance are usually non-problematic, but can sometimes cause confusion because of the limited information conveyed. For example, the amount of primary liability insurance that is actually available may be far less than the policy limit reflected on the certificate, because of certain other endorsements that reduce coverage. 

A COI only confirms that the certificate provider carried the specified insurance at the time the certificate was issued. It does not guarantee that the actual policy is still in force. Furthermore, a COI is not the legal equivalent of a policy and does not create a contractual relationship between the certificate holder and the insurance company issuing the policy.

Raitanen says certificate holders are more frequently requesting notice of material change and this can be quite onerous for an insurer to manage. Material change is perceived differently by insurers and project lenders, Raitanen points out. Traditionally, a material change means a change in risk to an insurer. For example, a different construction procedure or change to the materials used for the project.  “While I can’t speak for a lender, I would assume they are interested in changes in policy coverage. Would they also want to know about changes in risk at the jobsite? And should they not inform the insurers similarly if they are aware of a change which we would consider material?” he asks.

More recently, Raitanen, who has been in the construction and insurance industries for 20 years, is seeing requests for notice of “any change,” which could mean something as innocuous as a change of mailing address.

“Contractors should be very careful about signing a contract with clauses like that. They should try to negotiate such clauses out of the contract,” he says.  For underwriters, such clauses present unnecessary complications especially since for a large project, there could be dozens of such certificates issued. It is very important to have insurance in place that satisfies the conditions laid out in the contract and certificates are only one part of it, Raitanen adds.

Insurance Products:

Commercial General Liability (CGL) insurance provides contractors with protection against a range of potential common claims, including bodily injury, property damage or personal injury.  A standard CGL also provides coverage in the completed operations phase for damage to work performed on the insured's behalf by subcontractors.

Builders’ risk (sometimes referred to as course of construction) covers a building or insured area when it is under construction. The policy will pay for damages up to the coverage limit, which must accurately reflect the total completed value of the structure. This policy will be in the range of one to four percent of the construction cost. Several types of projects (both residential and commercial) need builders risk -- new construction; remodel; restructure and installation.

Professional liability policies cover liability that arises from an insured’s performance of their professional services, which subsequently leads to a loss. On a construction site, architects, engineers and increasingly, “design-build contractors” require professional liability insurance. This insurance, which is also known as errors and omissions (E&O) insurance, provides coverage for claims for damages alleged to be the result of the negligent performance of professional services (which must include a mental or intellectual component) as defined in the policy.

Wrap-up liability is a liability policy that serves as all-encompassing insurance, which protects all contractors and subcontractors working on a large project. Wrap-up insurance is intended for larger construction projects and offers uniform coverage as the owner and all contractors are insured on one policy by one insurer. However, coverage is not as broad as a standard CGL policy as wrap-up policies exclude damage to the project in the completed operations phase to avoid long tail construction defect exposure. As the wrap-up is project specific, contractors still require CGL coverage to insure their other operations and past work. The policy period is typically 12 or 24 months.

Boiler and Machinery Insurance, or Equipment Breakdown Insurance, covers equipment installed during the course of a building’s construction, including air conditioning, heating and hot water, electrical, underground cables and building automation systems.

Builders’ risk property policies typically exclude loss or damage caused by electrical arcing and mechanical breakdown. Equipment manufacturers’ warranties also do not cover costs to remove and install replacement equipment, and business interruption expenses.

Once installed, equipment may undergo two forms of testing:

– Cold testing checks equipment under ‘dry run’ conditions.

– Hot testing operates equipment under actual working conditions, and includes the application of heat, fuel, feedstock, or connection of equipment to a grid or load circuit. The hot testing phase poses a high potential for breakdown.

Common Exclusions:

Two examples of common exclusions in builders’ risk policies are the exclusions for faulty materials, workmanship or design and for latent defect or inherent vice.

The faulty materials, workmanship or design exclusion states that the polices do not insure the cost of making good faults or defects; this exclusion will apply if the risk that caused the loss was in any way foreseeable and therefore preventable if the property had been properly designed or built.

The Supreme Court of Canada clarified the faulty workmanship exclusion in its 2016 decision, Ledcor Construction Ltd. v Northbridge Indemnity Insurance Co.

Station Lands Ltd. retained Ledcor Construction Ltd. to coordinate construction of Edmonton’s EPCOR Tower. The building’s windows were supplied and installed by a trade contractor. Another trade contractor, Bristol Cleaning, was retained by Station Lands to carry out an industrial clean on the windows. Bristol Cleaning damaged the windows by using inappropriate tools and methods. The glass had to be replaced at considerable expense, which Bristol Cleaning paid for.

Bristol Cleaning sought coverage but was rejected under Station Lands’ Builders' Risk policy, as the insurers asserted the windows’ damage was not covered due to the “making good faulty workmanship” exclusion. 

The trial court said the exclusion clause was ambiguous and ruled that the insurers were liable for the damage. The Alberta Court of Appeal reversed this decision, and devised and applied a new test – “physical or systemic connectedness” – to determine whether physical damage was excluded as the “cost of making good faulty workmanship,” or covered as “resulting damage” as per the policy wordings. The Appeal Court ruled that the damage was excluded from coverage because it was directly caused by the intentional scraping and wiping motions utilized by the cleaners, and was therefore not accidental or fortuitous. The damage to the windows was directly connected to the cleaning method employed by Bristol, and therefore fell within the parameters of the “cost of making good faulty workmanship”.

The Supreme Court of Canada, however, disagreed with the Appeal Court’s finding and found the insurers liable for the cost of replacing the windows. Justice Richard Wagner wrote: “The purpose behind builders’ risk policies is crucial in determining the parties’ reasonable expectations as to the meaning of the Exclusion Clause. In a nutshell, the purpose of these polices is to provide broad coverage for construction projects, which are singularly susceptible to accidents and errors … In my view, the purpose of broad coverage in the construction context is furthered by an interpretation of the Exclusion Clause that excludes from coverage only the cost of redoing the faulty work itself — in this case, the cost of re-cleaning the windows.” 

Redoing Bristol’s faulty work did not require Bristol to install windows in good condition.  The cost of the windows’ replacement therefore represents “resulting damage”, and is covered under the Policy.

Latent defect and/or inherent vice

Property insurance policies also exclude coverage for loss or damage caused by latent defect and/or inherent vice, although resultant damage to other property arising out of these defects is covered. A latent defect is a weakness or problem with the property, which is not readily observable and not discoverable on an examination by a reasonably skilled person; an inherent vice is an intrinsic condition in the insured property, which causes it to be damaged when exposed to normal conditions.

On December 19, 2016, the Alberta Court of Appeal unanimously maintained the exclusion for damages resulting from the latent defect or inherent vice in an insured’s building.

Clarence Roth, operating as Inter-City Collision Repairs Ltd., owned a building in Medicine Hat, which consisted of a steel frame main shop and an older wood frame building. In July 2012, heavy rainfall caused a storm sewer overflow, resulting in water damage to the wood frame building.

The City of Medicine Hat determined that the wood frame building was unsound and the cost to replace the building was estimated at $471,000. The parties (insured and insurer) agreed the storm sewer overflow, an insured peril, had resulted in the discovery of the pre-existing building code violations. The trial judge’s ruling, in favour of Roth and Inter-City Collision, was reversed on appeal.

“It cannot reasonably be suggested that either the insurer or insured would have anticipated recovery for pre-existing deficiencies in a building where the peril insured against (water damage, in this case) did not actually create the bylaw issue,” the Alberta Court of Appeal ruled. “Extending coverage in such cases would require that the insurer determine in each case whether the property complied with all relevant bylaws, as it would be responsible for the costs of remedying any and all deficiencies unearthed as part of subsequent damage insured against. Quite apart from the fact that this would be practically impossible in most cases, it would also effectively turn an insurer into a guarantor of construction defects and building code violations.”

The court also noted that the building deficiencies did not come about as a result of the water damage: “Compliance with by-laws is not an independent insured peril.”

Opportunities in Construction

Brokers have an opportunity to sell service and expertise instead of focusing on pricing, ENCON’s Raitanen says. This helps to ensure there are no gaps in expectations with clients. For example, builders’ risk and wrap-up liability policy wordings are not standardized—so to assume that all are equal may lead to unmet expectations in the event of a claim. “The devil really is in the details,” he says.

ENCON is also seeing more opportunities to offer contractor’s pollution coverage to clients. “I suspect this demand is being driven by astute risk managers, lenders & public/institutional owners who are aware of the risks involved with environmental hazards.”

Moving forward, Raitanen expects demand for builders’ risk and wrap-up liability insurance on smaller projects to increase, particularly in cases where these coverages may not have been required by contract, or ‘on the radar’ of the project owner in the past. 

For example, a professional such as a lawyer, dentist or doctor may rent a unit in a new building and undertake a “tenant fit up” project where they are essentially the “project owner”. There is a strong argument in favour of them controlling the insurance; they’ll benefit from uniform liability limits, deductibles, dedicated limits, and the coverage period will match project term, Raitanen says.


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