CGL Exclusions: Why Additional Insureds Should Worry About Construction Defects

The construction industry has a lot of costs. In addition to the fact that many projects are worth millions of dollars, lawsuits often accompany them.  In fact, according to Arcadis' 2020 Global Construction Disputes Report, the global average value of construction disputes was $30.7 million.
 
The rising number of construction defect lawsuits has also led to insurance premiums rising significantly. It is estimated that a typical insurance premium for construction projects could range from one percent to four percent of the total project costs. In a competitive market, higher premiums can force some contractors out of business or force others to make poor insurance decisions. A contractor may also have to rely more on his or her commercial general liability insurance policy because insurers are trying to pay less. 
 
A large number of policy exclusions have resulted from construction defect lawsuits. Generally, the named insured is left without coverage, as well as additional insureds. Moreover, this information is found too late, which leaves the named insured without coverage.
 
In this article, we’ll explore CGL policy gaps and the common exclusionary endorsements associated with them. A property owner, manager, or contractor who wishes to be an additional insured needs to be aware of the following policy limitations.

Residential Exclusion

Residential exclusions are rare, so it's important to read such exclusions carefully and compare them with the type of work done in the past and now.  Single-family homes, townhouses, condos, and other similar developments are exempt from certain requirements. Many states specifically exclude apartment buildings from residential requirements. In addition, there are other exclusions that may mean that buildings such as assisted living facilities, hotels, and dormitories are not covered. In some endorsements, all operations on residential properties are excluded, while other endorsements leave coverage intact as long as only repair or remodeling is done on the property.
 
Commercial or industrial properties that are converted to residential properties are another type of exclusion. Take ABC Contracting as an example: They built an office building a while back. Today the building will be converted into residential condominiums. ABC may not even know the renovation plan is in the works, but this type of exclusion could result in a loss of coverage on the original work from ABC.
 
This exclusion can generate lower insurance rates for the named insured subcontractor. However, a policy that doesn't align with the subcontractor's work scope could nullify the additional insured's coverage. 

Total Pollution Exclusion

Total Pollution Exclusion - eliminates virtually all coverage for pollution incidents, which are still covered in a standard CGL policy in spite of its "absolute" pollution exclusion. Under the three Insurance Services Office, Inc. (ISO), total pollution exclusion endorsements (CG 21 49, CG 21 55, and CG 21 65), all bodily injury and property damage losses resulting from pollution are excluded from policy coverage.
 
In particular, CG 21 55 provides an exception for smoke, heat, or fumes from an aggressive fire. According to CG 21 65, both hostile fires and BIs resulting from faulty equipment for heating buildings are covered. Any of these endorsements should be avoided by the insured, and any endorsement that is added should be negotiated to be CG 21 65 if required.

Subsidence/Earth Movement Exclusion

Many construction projects involve some earth movement, from excavation to site development to laying utility lines. If there is a lot of earth movement, the risk of a claim is higher. Moreover, subsidence and earth movement claims can create catastrophic losses and hinder a project to the point of failure. 
 
For the reasons above, this is why insurers will add an endorsement excluding property damage and bodily injury caused by earth movements. As a result, earth shifting, sinking, rising, landslides, and mudflow coverage is no longer available, leaving additional insureds exposed to a large amount of risk. 

EIFS Exclusion

Buildings both residential and commercial use EIFS, a multilayered exterior wall system that provides high energy efficiency. EIFS systems typically consist of an insulation board that is attached to the exterior wall surface with an adhesive, a coat of water-repellent base coat applied over the insulation, and a finish coat applied over the finish coat. Insurance companies began to pay attention to EIFS when claims arose alleging moisture damages. This led to liability claims against contractors as well as manufacturers of EIFS. 

Further, homeowners’ policies have been a source of many first-party claims. Many insurance companies have sought to limit their exposure to risks with a substantial exposure by excluding them from coverage or by refusing to cover risks such as those with EIFS (e.g., homeowners who have EIFS installed on their homes).

Mold Exclusion

There are many exclusions in homeowners insurance policies regarding mold, fungus, and wet rot. How can we determine whether these exclusions apply to mold? As a general rule, mold that grows over time is not covered by most insurance policies. Nonetheless, the insurance company may consider mold as covered in some instances. But, only if it’s the direct cause or result of the covered loss.

Mold may be covered in the event of a plumbing loss such as the rupture of a pipe. Burst water pipes are covered losses, so the mold may also be covered as an ensuing loss due to that.

A mold exclusion is expressly spelled out in certain policies. An "absolute" exclusion means the insurance company will not pay for any mold damage, regardless of how it may occur. Mold would usually not be covered by a policy under any circumstances. Applied to De Brun v. Superior Court, Farmers Insurance upheld its policy language and prohibited any claims arising from mold damage. Despite this, in De Brun, the Court also pointed out that language that excludes explanatory language could express an anti-public policy position if the efficient proximate cause is negated.
 
Upon discovering mold following a covered loss, you should check your policy and seek professional advice on whether any mold exclusions apply.

What Can You Do to Protect Yourself from Construction Defect Exclusions?

It’s common to find exclusionary endorsements. Finding where and when they occur, however, is the key to managing them.
 

• Ask about the "Exclusions Added By Endorsement" on your subcontractor's statement of work.
• Verify the language of the endorsement by requesting the actual document. Check to see that the exclusion does not affect the coverage of the additional insured or the scope of work.
• When negotiating a contract, including coverage limitations. The endorsements of active policies can be requested or removed by subcontractors.  
• Delete specific exclusionary endorsements from the contract. The revised version should be signed by all subcontractors and their coverage should be updated as needed. 
   
  

Last but not least, use TrustLayer before hiring your next subcontractors. Our platform can extract data from their COIs, compare it against compliance requirements that you set for different groups of subcontractors, and flag noncompliance. Digital COIs can save you hours compared to manual review. More than that, TrustLayer can send automated requests when the expiration dates are approaching, so you don’t have to set calendar reminders anymore! Take the headache out of third-party risk management by using TrustLayer for your next projects.