Construction Defect Claims: How to Break Them Down and Resolve Them

Here's what builders need to know to prepare for construction defect claims.

Construction defect claims and cases are scenarios wherein physical loss or damage is claimed to be related to defective building elements that will require repair or replacement.

Typical defect claims and cases will involve exterior building enclosures or the building structure. However, it is important to note they can also include other building systems such as electrical, mechanical or plumbing.

The cause of a defect can be related to design, use of incorrect or unapproved materials, defective materials, improper techniques, improper installation or poor workmanship.

In addition to repair or replacement of the defective building elements, the extent of the claim will likely involve repairs to other building elements that have been impacted by the defective elements or which will be impacted by the replacement or repairs.

Analysis of Construction Defect Claims

The proposed repairs to correct defective conditions can be extensive, including the replacement of the complete exterior enclosure system of the building (windows/glass, stucco, brick, etc.) and in some cases demolition and replacement of the entire building.

Jim Borders, managing director, Risk Practice, J.S. Held’s Builder

In many cases, inspections and/or tests have been performed at representative locations to determine the extent, if any, of the defect and resultant damage. The claimed defect should be supported by detailed engineering analysis as a basis for any failures related to the defects that have occurred.

The construction defect claims typically also include a repair estimate which should be supported by detailed quantities and unit prices. The basis for timing or age of the defect (or statute of limitations) can vary based on the location/state.

Depending on the defect issue and the claimed extent of damage, the construction defect claims can be quite broad and extensive, but the analysis of most defect claims will include an investigation of the defects and an analysis of the claimed costs.

Investigation

To properly review exterior construction defect claims, there are several parts of the claim that require thorough investigation. These key parts of the investigation include:

Verification of engineering basis for claimed defect, including cause of the claimed defect and original construction documents (if available). The investigation should also be conducted with an understanding of the construction techniques and industry standards that were acceptable during the timeframe in which the building elements were installed.
Inspection of the physical conditions may be required to verify original construction materials and methods of construction when construction documents are not available or lack sufficient detail.
Determination of the extent of the defect. Is it limited in its scope or are the defects widespread? Can defective parts be traced to defective batches and isolated to specific locations in the building? This portion of the investigation may include non-destructive investigation, destructive investigations, in situ testing of materials, and testing of removed materials.

Cost Analysis

In order to perform an analysis of the (estimated?) cost to mitigate the defect and damages, the following steps are typically performed:

Granger Stuck, executive managing director, Risk Practice, J.S. Held’s Builder

Verify proposed repair scenarios, including potential code upgrades, betterments, or repairs to elements that were not investigated/tested.
Verify repair estimate quantities for each element of the repair scope of work.
Verify repair estimate unit prices, markups, and contingency (if applicable).
Verify possible alternative reasons for the condition of the claimed defective elements including poor workmanship or lack of (or improper) maintenance and allocate those costs accordingly.

Additional Considerations

In some cases, if the engineering verification of the claimed defect results in a different or abbreviated repair scope of work, an independent repair estimate may be required to reflect this alternate scope of repairs.

If singular or multiple policy periods are related to the defect damage in question, an allocation of the repair costs related to the specific time period(s) may be required.

In the cost analysis of the claim, it is also important to consider segregating (into individual buckets) the costs for repairing defects, resulting damages, repairs related to betterments, code upgrades, industry standard upgrades, and repairs related to typical building maintenance.

Consider replacing with like kind and quality where possible; however, newer methods may be more cost effective even though they may otherwise be considered betterments.

Construction defect insurance claims require investigative and design data to allow for proper estimating.

The scope of repairs should be reviewed in detail to account for any betterments or upgrades in the proposed repair work. Detailed repair quantities should be developed in order to validate the amount of work for each repair element. &

Jim Borders is a Managing Director in J.S. Held's Builder's Risk Practice. Granger Stuck is an Executive Managing Director and J.S. Held's Builder's Risk Practice Lead. They can be reached at [email protected] or [email protected] respectively.

How a Carrier Partner Can Help Navigate a Challenging Management and Professional Liability Market

A combination of a choppy economy with increased claims frequency and severity could lead to rate increases in the Management & Professional Liability market.

By: Risk & Insurance | April 3, 2024

Rates in the management & professional liability (M&PL) markets were on the rise from 2020 to early 2023 and are now falling rapidly.

M&PL divisions manage a number of different insurance products including management liability (D&O), professional liability (E&O), employment practices liability (EPL), fiduciary liability policies, cyber, etc. In 2023 and into 2024, a big influence on the marketplace has been the extremely aggressive and softening public company D&O market.

Though these rates have been softening for management liability, that may change over the next few years as companies continue to adjust their business models motivated by economic uncertainty. Layoffs were up nearly 200% last year, Forbes reported, even as other recession indicators, like the inflation rate, improved. A recession could lead to an increased claim activity and force carriers to raise rates.

“Whenever there is a meaningful downturn in the economy, we tend to see claim frequency pop up,” said George Schalick, Jr., senior vice president of the Management and Professional Liability Division at Philadelphia Insurance Companies (PHLY).

With continued fiscal uncertainty, businesses potentially already burdened with pandemic-related claims should seek a carrier with a long history in M&PL products. They will provide much-needed risk management guidance and be better positioned to support their insureds during market fluctuations.

Why Insureds Might See an Uptick in M&PL Claims

George Schalick, Jr., Senior Vice President of the Management and Professional Liability Division, Philadelphia Insurance Companies

The current soft market might come as a bit of a surprise as it does not track with previous underwriting cycles and economic conditions. Afterall, many privately held and non-profit organizations struggled during the early days of the pandemic with shutdowns and rapidly declining revenues. But the Government assistance programs, like the Paycheck Protection Program loans, helped keep many afloat during the tough times.

“During COVID many organizations stopped doing business until they were able to sort out all of the health and safety challenges,” Schalick said. “They were forced to lock down, but then all the government assistance programs allowed them to keep people employed. The increased volume of claims we anticipated we would see coming from the lockdowns and restrictions that were imposed upon businesses in the U.S. didn’t manifest at first.”

“Just because there wasn’t an onslaught of reported claims at the beginning of the pandemic, doesn’t mean the circumstances that would give rise to a claim being reported didn’t occur. Courts and the judicial system were closed or slowed and now that they are back open, we’re starting to see the circumstances that occurred during the COVID lockdowns becoming claims today,” Schalick said. “Litigation is progressing.”

Added to the delayed pandemic litigation is a concern over newer claims that might be filed as the country inches toward an economic downturn. Though a recession was avoided in 2023, experts think a soft dip could occur in 2024, with 76% of economists saying there’s a 50% or less chance of an economic downturn this year — that almost always results in more management liability claims.

“During the Great Recession in 2008, we saw an almost immediate spike in claims because of the economic conditions and the pressure it placed on organizations. They were making personnel changes with significant belt tightening almost immediately.” Schalick said.

What’s in Store for M&PL Policy Rates in 2024?

Despite an uptick in claims and increased economic uncertainty, management liability rates haven’t increased, resulting in market-wide pricing levels that may not meet the increased pressure of rising settlements and jury verdicts.

“Rates are going the other direction and settlement values are not falling,” Schalick said.

The mismatch between rates, claim frequency and severity is, in part, because carriers experiencing the dramatic soft market in the public D&O market are seeking premium gain in the private and non-profit market.

“In the public company market, the rates have been decreasing significantly. The rates were increasing in the private, not-for-profit market, and rightfully so, but there’s a desire to supplement overall mid-size D&O for carriers who also write private not-for-profit, and they see that as an opportunity to aggregate premium,” Schalick said. “So the always competitive landscape in the private, not-for-profit market has dramatically increased in the last 18 to 24 months.”

Still, companies of all sizes and types should be concerned about management liability rates in the future. Legal system abuse is resulting in increases in both the amount of litigation and the size of verdicts plaintiffs are receiving.

Certain areas of the country are particularly vulnerable to this type of legal system abuse. As a result, insureds in these localities are likely to be vulnerable to rate increases.

“The environment is so positive for the plaintiff that forces premium increases so carriers are able to stay in that market long term,” Schalick said.

Why a Tenured Carrier Partner Can Help Insureds Navigate An Uncertain Market

It’s clear that insureds are facing an uncertain M&PL market over the next few years. Fortunately, carriers with a long history in the M&PL space will be there to offer stability.

Philadelphia Insurance Companies has been supporting this market for 35 years. PHLY is committed to offering long-term rate stability, even as economic and claims trends start to push premiums upwards. They have an appetite for all sorts of companies, large and small, for-profit and nonprofit alike.

“We’ve been at this game for a long time and are one of the most tenured underwriters in this space,” Schalick said. “We like to stay very consistent.”

PHLY has worked with both for-profit and non-profit on management liability policies. With dedicated M&PL teams throughout the company’s 13 regions, PHLY provides the support agents and brokers are looking for on behalf of their clients. The teams know their regions well and can respond to local trends. They’re also dedicated to making the renewal process as easy as possible for their partners and policyholders.

“We have real confidence in our results, so we focus a lot on making the renewal experience as painless as possible for all agents and insureds,” Schalick said.

The company is also investing in tools to help insureds avoid losses. Earlier this year, they launched a new online risk management platform, PHLYGateway, which offers resources for insureds on how to create an employee handbook and trainings on issues such as recognizing workplace sexual harassment and discrimination.

If insureds have questions, they can consult a Best Practices Help Line, provided via the platform. That way, they can get on the spot risk management guidance to help them prevent claims.

To learn more, visit: https://www.phly.com/mplDivision/managementLiability/default.aspx.

This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Philadelphia Insurance Companies. The editorial staff of Risk & Insurance had no role in its preparation.