Contractor Pitfalls Around Insurance
There exist several key pitfalls that contractors can easily fall into with insurance.
While most contractors are focusing on supply chain issues and labor challenges, there continue to be missed opportunities regarding contractor’s insurance. Contractors, as an industry, continue to be battered by “new” challenges: COVID-19 issues, supply chain disruption, and now inflation. However, insurance pitfalls can have far more catastrophic effects on a general contractor, even if they are not as trending of a topic. Insurance for contractors presents great variability in coverage options, with drastically different impacts.
The nature of contractors to “bid” on almost everything they do often drives them to ask for insurance bids as if they are a commodity. Every penny counts. The challenge is there are so many variants of coverage, that comparing apples-to-apples is hard and most general and artisan contractors have neither the time nor skills to truly evaluate insurance. Contractors are experts in construction, not insurance.
One area that is often misunderstood is the coverage for “completed operations.”
The entire purpose of a contractor’s general liability policy is to respond to a claim when someone is physically injured or has property damage caused by the contractor. If that injured party could sue to recover damages from the contractor, the insurance policy will step in, defend the contractor, and pay out any damages.
However, if you look deeper into liability protection, there are actually two types of coverage, separated by time. These apply to all types of contractors: general, plumbing, electrical, or any other type – just as long as you are being paid to do construction activities on a building. The types are Ongoing Operations and Completed Operations.
Ongoing Operations provides coverage while work is going on. This part of the policy insures activities while contractors are on the job, during the course of construction.
Completed Operations provides coverage once the job is finished. Once the contractor’s work is “complete” and they are no longer on the job site, this section of coverage continues to insure against injuries or damage the building might cause.
Many general contractors, artisan contractors, development companies, and property owners focus on the ongoing operations type of coverage. They think of insurance in terms of being “on the job” and the injuries or damage that can occur while construction is ongoing. During construction, the focus is on the “here and now” and when and how the project is going to get done. Thinking about the exposure of the building five years after it is completed becomes an afterthought.
Here is a phone call I sometimes receive: “Hello, Shane, I’ve finished the job at 123 Main St. Can we just let the insurance lapse now and get some of my money back?”
The pitfall is that the policy also covers all the work the contractor has previously done, not just the job at 123 Main St. As soon as the policy is cancelled, or allowed to lapse, all coverage for the prior work done everywhere, including, 123 Main St. ends.
Assume, for example, that two months after the contractor finishes, a ceiling tile falls and hits the head of an occupant. After an investigation, it was determined the ceiling tile wasn’t properly attached. It is possible for the contractor that built the building to be dragged into a suit, but now they have cancelled insurance (even if they had it when the building was under construction). They likely have no coverage, and worse yet, they don’t have defense coverage even to pay an attorney to defend them.
That scenario could be expanded to an infinite number of far more disastrous scenarios. Take the case of an improperly wired light fixture that starts a fire and does significant damage to the building, the neighbor’s building, and even folks who were inside. There would be no defense or claim coverage if the contractor allowed the policy to lapse.
There are two typical solutions to this “completed operations” gap.
The first solution is to ensure your contractor’s general liability insurance doesn’t lapse. Even in times between jobs, don’t cancel the policy. Keep in mind the premium you are paying isn’t just for the work you are currently doing, but also the work you have already completed. This works well for contractors that are in continuous operation, have multiple jobs, and continue from year-to-year. In many cases for larger contractors, there isn’t a gap in projects, so insurance is continuously left in place – which is good. But, for smaller contractors that have fewer jobs, it can mean having to pay money even during a slow period. This is still money well-spent. The premium might eat a few dollars into your savings, but it has the potential to prevent you from being permanently bankrupted by a claim from a completed operation just sitting out there.
An important warning to those who rely on this method of insuring completed operations: Make sure your policy does not have an exclusion for prior work. Some carriers insert this type of exclusion specifically, so they aren’t on the hook for work you did many years ago. It takes a competent insurance agent to navigate these exclusions.
The second solution is to pre-pay for a completed operations endorsement that lasts into the future. A contractor can pre-purchase, for example, ten years of completed operations coverage on a specific project, even after the policy is canceled. This type of endorsement allows the contractor to cancel a policy when the project is finished while having an automatic ten years (or however many years is purchased) of completed operations coverage for a specific building. This is really great coverage for smaller contractors that tend to work on a one-off basis and start/stop policies based on jobs they have. This also works well for single-purpose entities where a partnership might be formed by two contractors for the purpose of building just one project together. Since they anticipate breaking up after the one project, there isn’t a desire to purchase annual ongoing coverage. This “one-off” policy with an embedded endorsement to cover the future protects the partners even after they disband. The insurance term for this endorsement is “extended completed operations.”
A question I often get asked is “what length of time should I purchase the extended completed operations for?” While it is always up to the client, typically I recommend linking it to your state’s legal Statute of Repose. A Statute of Repose is the length of time that a party can bring suit against the contractor after the contractor finished its work.
While similar to a Statute of Limitations, there is a difference between the two. A Statute of Limitations is the length of time an injured party can bring an action after they are injured or know about an injury. A Statute of Repose is the length of time a contractor can be liable after the contractor finishes a job. In many states, a typical Statute of Repose is ten years.
Fundamentally, selecting the proper insurance requires time and insurance expertise that many contractors don’t possess. There are many nuances to coverage that, if not addressed, could leave a contractor exposed to significant liability. This also means contractors shouldn’t focus on just choosing the cheapest policy. A skilled insurance broker can help contractors navigate pitfalls such as “completed operations.” Coverage matters because a few extra dollars for the right coverage might prevent being completely bankrupted in the future.