It's A Wrap
Proper insurance coverage helps condo developers reduce risk.
While condominium demand outpaces supply in many markets, some lenders
are starting to tighten their financing parameters in anticipation of a
possible market slowdown. To maximize their opportunities in this changing
environment, commercial real estate developers must carefully manage potential
Increased Condo Risk
The increase in condominium construction in recent years likely will
lead to an increase in construction litigation. To minimize risk associated
with litigation and safeguard their projects, condominium development teams
should purchase adequate insurance coverage.
Unfortunately, many traditional insurance carriers in the industry are
unwilling to insure condominium projects due to the high risks associated with
them. Condominium projects attract litigation proceedings for three reasons.
First, courts often view condominiums as a series of "manufactured
goods" making them subject to strict liability standards rather than
negligence standards generally applied to other construction types. Second,
many condominium owners who previously lived in single-family homes often are
disappointed with condominium projects' increased density and less private
living conditions, making them more likely to litigate against the development.
And finally, plaintiffs' lawyers usually assert construction defect cases on a contingent-fee basis, which makes it easier for condominium owners to
sue. With fewer carriers in the marketplace, premiums are higher, and many
subcontractors and design professionals also struggle to find condominium
insurance, thereby limiting the number of qualified professionals who are able
to bid on these projects.
"Wrap" insurance is one solution condominium developers can
use to fill the insurance void. The owner or general contractor purchases a
project-specific policy to cover the development team, including the general
contractor, subcontractors, and sometimes even the design professionals,
although the latter usually are covered only for bodily injury and property
damage. Wrap insurance policies often are divided into owner-controlled
insurance programs and contractor-controlled insurance programs. OCIPs and
CCIPs for commercial projects generally include workers' compensation and
general liability coverage.
While often more expensive, OCIPs and CCIPs offer advantages over having
each development team member purchase individual insurance coverage. First, by
combining the insurance into one project-
specific policy, the development team can increase its purchasing power
for expanded lines of coverage. A skilled broker can utilize the pooled funds
to buy coverage that the individual development team members may not be able to
obtain on their own.
In addition, placing all of the workers' compensation coverage under one
project-specific policy with no prior loss history may provide premiums lower
than if each team member purchased coverage. By maintaining one policy, the
owner and contractor can ensure that the policy is not canceled or materially
modified as opposed to gathering renewal certificates and endorsements from the
entire development team to assure that the policies remain in effect. Utilizing
OCIPs or CCIPs also allows one insurance company to cover all members of the
development team. With one carrier, claims should be more efficiently managed
While some insurance policies are self-depleting, meaning each dollar
spent defending a claim reduces the policy amount, OCIPs and CCIPs have much
higher policy limits to absorb self-depletion. For instance, if a developer
with a $1 million self-depleting policy is sued and the defense costs are $1
million, no money is left to satisfy any judgments or settlements in the case.
However, with a wrap policy, it is typically recommended that defense costs be
handled inside the deductible or self-
insured retention and outside the general liability policy limits to
prevent the limits from being
eroded. For example, a $1 million policy would remain entirely available
to satisfy judgments or settlements if defense costs were handled through
deductibles or self-insured retentions.
Lastly, by maintaining one project-specific policy, the owner or the
contractor can ensure that the OCIP or CCIP is renewed for the entire length of
the statute of limitations or statute of repose for construction defects. If an
OCIP or CCIP is not utilized on a large project, as many as 100 smaller
insurance policies may need to be monitored to ensure that they remain in force
for the entire statute of limitations period. This can be an impossible burden
that may require owners to purchase tail coverage, which is expensive and
difficult to obtain. If tail coverage is purchased, the carrier assures that
the insurance coverage remains in force for a specific number of years. In the
case of claims-made policies, tail coverage extends the time for reporting
events that occurred before the claims-made policy period expired.
Condominium developers, owners, and contractors must explore other
issues before electing to utilize an OCIP or CCIP wrap program, including the
overall insurance costs, the cost of administering an OCIP or CCIP, the
uncovered risks for off-site work, and the use of credits to capture the
amounts that individual development team members would have spent if not for
the existence of the OCIP or CCIP. To capture insurance credits to offset the
OCIP or CCIP costs, the broker should gather detailed insurance cost
information from each contractor, design professional, and subcontractor and
assure that if an OCIP or CCIP is utilized on the project, each covered entity
reduce its contract amount by the cost of each unneeded individual insurance
policy. In addition, many carriers and brokers may offer to return a portion of
the premiums if claims are below a certain threshold for a project. However,
developers should not rely on receiving a return on premiums since construction
defect claims are likely to occur on most condominium projects.
Condominium projects can be very rewarding and lucrative investments for
commercial real estate professionals who know how to manage the risks
associated with them. Developers should consult a qualified construction
attorney and insurance broker to perform a detailed cost/benefit analysis
before engaging in wrap insurance or other risk management strategies.