Construction Defect Claims on the Rise: Understanding the Trends and Impacts

When it comes to managing construction defect claims, insureds should be looking for an insurance partner that has a sharp eye on the market and is keeping pace with today’s trends.

By: Autumn Demberger | April 17, 2024

Topics: Claims | Construction

Construction projects are booming.

That’s because demand is returning to its pre-pandemic levels, no longer impeded by mass closures, supply chain stalls or a lack of labor. Businesses and homeowners are looking to build, and the industry is more than happy to oblige.

“The pre-COVID building boom, combined with lower interest rates and affordability, continues to drive residential, except single family new sales, and commercial construction, including infrastructure, hospitals, medical facilities and warehousing,” said John Posa, SVP Nationwide E&S Brokerage Construction.

One report noted the collective value of construction projects at play today equals close to $500 billion. Reuters reported earlier this year that construction spending “shot up 11.3% on a year-on-year basis in November [2023].”

It’s an exciting time for the construction industry. However, massive growth can mean equally substantial risk. Now is the time for risk professionals to review their exposures and get the right construction risk mitigation partners in place.

Construction Defect Claims Trending

Perhaps the biggest challenge the industry faces (after worker safety) is construction defect claims. These types of claims stem from any defect in a build that deviates from what was promised — leaky plumbing, cracks in the foundation, mold and more.

“The tail on construction defect claims are increasingly being filed by plaintiff attorneys right up against the deadline set by the statute of repose, which can be as far out as 10 years from the completion of the project or the issuance of the certificate of occupancy,” said Posa.

Several factors are coming into play in construction to drive up defect claim activity.

John Posa, SVP Nationwide E&S Brokerage Construction

For one, Posa noted, there’s been an overall increase in municipality claims, “which can be attributed to the $1.2 trillion infrastructure bill passed in 2021,” he said. “As the funds from this bill are being allocated, we’re starting to see a corresponding rise in claims activity, particularly in states like Texas.”

Construction defect claims are also being triggered by an increase in high-end custom house projects, which are valued at $10 million to $15 million each — and sometimes more.

“This trend, fueled by current economical factors such as interest rates, is triggering a number of new construction defect claims,” Posa said.

“Additionally, we’re seeing delays or abandonment of properties as part of larger construction defect claim activity. Factors such as mechanical liens, failure to pay and increases in adjustable interest rates are contributing to these claims. In some cases, people walk away from projects, leading to allegations of construction defect claims being filed in retaliation against general contractors who have left a site,” Posa shared.

Added to the increase in claims is the increase in nuclear verdicts plaguing construction. Juries are awarding larger and larger awards to plaintiffs, especially if they perceive some injustice has been inflicted in the process.

“This phenomenon of social inflation and nuclear verdicts does indeed apply to construction, whether they involve bodily injury, property damage or construction defect claims,” Posa said.

How the Market Is Responding

Property values have doubled in some places over the past few years, directly increasing the cost of repairs and settlement values for construction defect claims.

Coupled with the types of builds on the docket, like medical facilities or high-end homes, “prominent plaintiffs’ firms and attorneys are now more selective in the construction defect cases they pursue,” Posa said, “focusing on those with high dollar values.”

This has had “a significant impact on carrier appetite in the construction defect insurance market.”

Carriers have pulled out of the market due to a number of factors. For example, unsustainable business practices or a lack of adaptability could easily deter a carrier and make the sector a less-than-ideal environment to operate in.

“Changes in distribution network relationships could stem from a misalignment of goals or a failure to foster mutually beneficial partnerships. It’s essential to cultivate strong, long-lasting relationships built on trust and shared objectives,” Posa offered as another example as to why some carriers have pulled back.

“Carriers need to adapt quickly to changes in their portfolios and risk appetites, taking into account the inflationary and economic factors we’ve witnessed over the past five years,” he added. “Pricing and risk assessment strategies must evolve to keep pace with the rapidly changing market conditions.”

Keeping Up with Construction Trends

Carrier appetite is one area construction risk professionals should review. For insureds, bolstering mitigation tools and managing risk in the current market environment require a multifaceted approach.

“The most important consideration for insureds is their own unique needs and circumstances,” said Posa. Every environment is different, therefore requiring a unique set of risk tools and covers to remain whole in the event that a construction defect claim comes their way.

Insureds should be looking for insurers that are keeping pace with today’s construction trends.

“As an insurance provider, our primary purpose is to serve our clients and ensure they have the coverage they require. That said, it can be beneficial for insureds to inquire about their carrier’s diversification. A well-diversified carrier is more likely to weather market fluctuations and maintain stability in their offerings,” Posa said.

Carriers are keen to maintain a diversified portfolio across various lines of business and geographies in order to spread risk and minimize the impact of construction defect claims in any single area.

Another key consideration is the use of data analytics and predictive modeling. Insureds will want to see insurers leveraging advanced analytics tools so they can better understand and quantify client exposures. By doing so, carriers can make more informed underwriting decisions and pricing strategies.

“Carriers must also focus on building strong relationships with their reinsurance partners,” Posa noted. “Reinsurance plays a vital role in managing risk by providing additional capacity and protection against large losses. Collaborating closely with reinsurers allows carriers to optimize their risk transfer strategies and ensure adequate coverage.”

Above all, insureds will want to make sure their carrier partners are prioritizing an efficient claims-handling process. When claims arise, proactive claims management goes a long way in preventing a claim from snowballing into litigious territory, cutting costs and keeping customers happy.

“Ultimately,” Posa said, “open communication between the insured and their carrier is crucial. Insureds should feel empowered to ask questions, voice concerns and work collaboratively with their provider to navigate the complexities of the current market while securing the protection they need.” &

Autumn Demberger is a freelance writer and can be reached at [email protected].

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.