Acme Construction, a home building company, constructed 20 homes in 2003. It hired subcontractors to perform the concrete work, plumbing, wiring, and roofing. One year later, it received complaints from two of the homeowners about cracks in their foundations. Acme notified its Liability insurance company. When the homeowners eventually sued Acme, the insurance company provided legal defense and set up reserves to pay for any resulting settlements.
Fast forward to 2005 when Acme built 35 homes to meet the demands of an active housing market. Other than the subcontractor who did the concrete work in 2003, Acme hired the same group of subs to work on these homes. When snow started melting after the winter of 2007, complaints started to come in about leaking roofs. Eventually, seven homeowners determined that they had to replace their roofs completely, and sued Acme for the faulty work. Acme again notified its insurance company. This time, however, the company denied the claims, saying that the insurance policy did not cover them. Acme had to pay for its own legal defense and liabilities.
What changed between 2005 and 2007? The insurance company added to the policy an endorsement that created a significant coverage gap: ISO form number CG 22 94 10 01, Exclusion-Damage to Work Performed by Subcontractors on Your Behalf.
This endorsement modifies an important exclusion contained in the ISO Commercial General Liability coverage form. Without this endorsement, the exclusion states that the insurance does not apply to damage to the insured’s work if the damage arises out of it or any part of it and if the damage occurs after the insured has finished the work. However, the provision gives coverage back if the damage arose out of work performed by a subcontractor working on the insured’s behalf. In the 2005 incident, Acme had hired a subcontractor to build the foundations for the new homes. Because the subcontractor had done the faulty work, Acme’s CGL policy covered the resulting defense costs and liability.
Endorsement CG 22 94 strips that coverage give-back from the policy. With it attached, the policy does not cover liability for damage to the insured’s work and arising out of it, even if another contractor actually performed the work. Accordingly, Acme’s policy did not cover its liability for the defective roofs. Without the attachment of this endorsement, Acme would have had coverage.
An insurance company might add this endorsement to a policy in the belief that faulty construction is a business risk, not an insurable one. Accidents such as slips and falls, unintentional fires, and injuries suffered while using a product are all examples of insurable risks. Performing work improperly, mismanaging cash flow, and making poor strategic business decisions are examples of business risks. Insurance companies feel they cannot insure business risks because to do so would remove an incentive to reduce those risks. If a carpenter knows he can collect insurance if he does a sloppy job building a house, he has less of an incentive to build it well. When a company attaches CG 22 94 to a policy, it is transferring the risk of a subcontractor’s poor performance back to the insured.
Almost all contractors subcontract at least some of their work, so this is an issue to take seriously. Review their Liability insurance with our agents to determine whether you have this endorsement. Since it can present a very significant coverage gap, discuss alternatives, such as negotiating with the company to remove it or seeking another company that is willing to leave it off. Even if it means paying an additional premium, removing the endorsement could save a lot of expense in the long run.