Association of Defense Counsel of Northern California and Nevada

1. Association of Defense Counsel of Northern California and Nevada Sacramento, California February 29, 2008

2. Wrap-Up Policies, Current Policy Concerns, and Insurance Trends Presented By: CRAIG M. HOUCK INTERWEST INSURANCE SERVICES, INC. 3636 American River Dr., 2nd Floor Sacramento, California 95864 GEORGE D. YARON YARON & ASSOCIATES 601 California Street, 21st Floor San Francisco, California 94108

3. Insurance IssuesCalifornia Residential Construction Industry

4. What�s Going On In the Industry? The evolution of construction defect and mold claims Factors Influencing the overall CA Construction Insurance marketplace Today�s �Hard� Market Attached & Tract Housing Projects Wrap-Up Programs Current Trends

5. Evolution of Construction Defect Claims The frequency of CD claims & litigation increased sharply in the early 1990�s. The increased frequency was directly associated with building boom of the 1980�s. Large Master Planned Communities / HOA�s Large Condominium & Townhouse Projects Apartment / Condominium Conversion Projects Plaintiff CD attorneys became experts at tracking, canvasing and soliciting HOA�s. Plaintiff CD attorneys became experts at exploiting the traditional coverage structure utilized in the construction insurance industry.

6. Evolution of Construction Defect Claims The Construction industry�s relatively unsophisticated risk management, quality control and customer service practices in the early 1990�s significantly contributed to the rise in CD claims. Much of the early construction defect litigation originated in So. California, however it soon migrated to the North. 1995 Montrose Chemical vs. Admiral Insurance Co. Application of continuous coverage trigger for CD claims Cost & complexity of CA CD claims increase significantly Hardening effect on CA construction insurance marketplace In early 2000�s the CD Claims Industry spreads to Nevada, Arizona and beyond. Construction and insurance industry begin to experience dramatic increase in mold claims alleging bodily injury and property damage.

7. Factors Influencing CA Construction Insurance Marketplace Two decades of CD Claims Escalating Defense Costs Montrose Decision (continuous coverage trigger) Carrier Insolvencies, consolidations & withdraw�s September 11, 2001 Introduction of Mold claims (BI & PD) Stock Market-Investment Income Declines Poor Underwriting Results Acceptance Insurance v. Syufy Enterprises (1999) 69 CA4th 321

8. Today�s �Hard� MarketResidential Builders & SubcontractorsAttached & Tract Housing Highest rate of CD Claims Fewer Carriers (Non-Admitted) Historically High Premiums Historically High Deductible / SIR�s Restrictive Coverage Prior Work Exclusions Defense Costs Inside Policy Limits Montrose Exclusions Subsidence Exclusions Condo / Townhouses Exclusions Residential Tract Exclusions Mold / Fungus, EIFS, Lead, Silica Exclusions A/I Form CG 2010 11/85 Discontinued for Residential contractors Excess Liability increasingly cost prohibitive Insurance Industry adopts Wrap-up programs as: A cost effective alternative to traditional insurance coverage for attached housing and tract residential construction An effective coverage structure to combat construction defect litigation.

9. Wrap-Up ProgramsOCIP / CCIP

10. What is a Wrap-Up? Definition of Wrap-up A wrap-up is a single policy/program, purchased by the contractor or developer, that covers all participants of a construction project. Types of Wrap-up Owner Controlled Insurance Program (OCIP) Contractor Controlled Insurance Program (CCIP) Coverage General Liability only GL and WC combined GL, WC, Builder�s Risk and occasionally some forms of E&O combined Who is Covered? Owner / Developer General Contractor Subcontractors Sub-Subcontractors Consultants

11. What is a Wrap-Up? Insurance requirements still needed by subcontractors. Subcontractors still need to carry and provide the owner/builder with Certificates of Insurance for auto liability and workers� compensation. Subcontractors still need to carry and provide proof of Commercial General Liability insurance for their own construction activities away from the project site.

12. When Are Wrap-Ups Used? Commercial Wrap-ups �for over 50 years Predominantly for large ($100M) public works or private, single purpose projects General Liability, Workers Compensation and Builders Risk Residential Wrap-ups � for 5-10 years Condominium / Townhouse Projects Large Tract Residential Developments General Liability and occasionally some form of limited (B.I. & P.D.) professional Liability.

13. When Are Wrap-Ups Used? Project Specific Wrap-ups (Commercial & Residential Projects) Normally, single locations Dedicated limits (Primary & Excess) Works Well for: Public Work or Private Commercial Projects ($100M +) Hi-Rise � steel and concrete condominiums Wood frame attached housing project Conversion of apartments to �for sale� condominiums Mixed use (residential and commercial) projects

14. When Are Wrap-Ups Used? Highlights � Project Specific Wrap-Up Multi-Year Policies � usually one set of dedicated limits per policy term and �statute extension�. Defense costs inside policy limits $5,000,000 to $50,000,000 or more in limits Subsidence usually covered with acceptable soils report Some carriers mandate use of third-party peer review for quality control. Some carriers will provide limited (B.I. & P.D.) for Consultants errors & omissions Typical Exclusions Mold (separate pollution liability policy including mold coverage available) Professional Liability EIFS, Lead, Silica, Asbestos, Employment Practices Liability

15. When Are Wrap-Ups Used? Rolling Wrap-Ups (Detached Single Family Homes) Annual renewable policy with �statute extension� built in Usually on a �close of escrow� form Home Builders with annual revenue of $100M and do more than five projects per year Builders may pick and choose which projects to include in wrap-up State-by-State Project-by-Project Works Well for: National or large regional home builders with annual revenues of $100M

16. When Are Wrap-Ups Used? Highlights � Rolling Wrap-Up Builder may pick and choose which Subs to include in Wrap-up. Defense costs inside policy limits Limits Available: $5,000,000 to $200,000,000 �Subsidence� usually covered Bodily Injury and property damage arising from Consultants errors or omissions included in some cases. At least two carriers offer combination GL / warranty programs. Typical Exclusions Mold (separate pollution liability policy including mold coverage available) Professional Liability EIFS, Lead, Silica, Asbestos, Employment Practices Liability

17. Why Wrap-ups have been adopted for Residential Construction Subcontractors unable to meet Builders� insurance requirements No proper Additional Insured Endorsements (CG 2020 11/85) No �attached� housing coverage (Condo/Townhouse) No Subsidence coverage Cost prohibitive premiums & deductible Adjusting claims under �traditional� insurance simply too cumbersome and inefficient Too many attorneys involved Too many expert witnesses, forensic investigators, claims adjusters Adversary relationship exists between Subs and Builders Exposure and percentage of liability must be allocated between all insureds � time consuming and expensive

18. How Do Wrap-Ups Solve ProblemsCreated by Traditional Insurance? Eliminate Adversarial Relationships One policy/program covers all participants One defense � single defense firm and single adjuster One �pot of gold� for the plaintiff attorneys Cross-Suits are eliminated, reducing disputes and litigation expenses. Policy extended to provide coverage for (statute of limitations) Eliminates need to determine liability Legitimate claims paid sooner!

19. Wrap-up Problems and Pitfalls Proper Policy Construction Remove Exclusion �L� (damage to �your work�) Confirm completed operations coverage extension for full statute period Warranty / Repair Extension Environmental / Mold Coverage Enrollment & Administration Procedures Carrier Solvency Best�s Financial Rating Admitted vs. Non-Admitted Adequacy of Limits Must protect interest of Owner/Developer, General Contractor & Subcontractors of every tier for full status period Defense cost are always inside policy limits Deductible / SIR Allocation Methodology

20. The Concept of Wrap-Up Administration The administrators synchronize the roles of the builder, insurance carrier and broker. The aim is to provide consistent support to the insured and set the proper foundation for the wrap-up program.

21. Wrap-Up AdministrationServices to Look For On-site, interactive wrap-up orientation training for the builder. A project-funding model to determine allocation of insurance premium contributions from participants. Suggested contract language and provisions for indemnity agreements in accordance with the wrap-up program. Contract/bid specifications that mandate wrap-up participation for trade contractors and design professionals. Orientation materials for all project participants on the concept and scope of the wrap-up program. (Includes comprehensive wrap-up insurance manual for the project.)

22. Wrap-Up AdministrationServices to Look For On-call service to answer coverage questions from all participants during the course of the project. Enrollment of each construction participant into the program. (Subcontractors, builder and the wrap-up insurance broker each receive a copy of the enrollment certificate.) Ongoing evaluations and troubleshooting of the wrap-up program.

23. Wrap-Up AdministrationAllocating Wrap-Up Premiums Premium allocation is the art of obtaining reimbursement of wrap-up premiums form subcontractors and design professionals. We refer to premium allocation this way because it requires precision in negotiating, balanced with the awareness that doing business in construction is largely based on relationships and reputations that exist between contracting parties and subcontractors.

24. Wrap-Up EnrollmentA Step-by-Step Process Builder notifies the administrator of potential subcontract award and the contract amount. The administrator sends notice of the wrap-up policy to each subcontractor along with answers to frequently asked questions. The administrator works with each subcontractor to receive and review its current insurance coverage information for proper rate negotiation. The administrator calculates a change order amount for each subcontractor�s contribution toward the premium and notifies the subcontractor.

25. Wrap-Up EnrollmentA Step-by-Step Process The administrator negotiates the premium contribution with each subcontractor based upon any historical contributions and trend analysis for each trade. The administrator should follow a structured model to ensure consistent communication and timely negotiations with subcontractors. Once the premium contribution is agreed upon, the administrator notifies the builder to finalize the contract for this participant.

26. Current Trends 100% of attached housing projects (Condo/Townhouse) will continue to be insured on wrap-up programs. National & Large regional home builders will continue to utilize rolling Wrap-up programs to insure tract residential/subdivision construction. Traditional Insurance programs will continue to be widely utilized by: Small to medium size home builders Custom home builders Commercial Construction Subcontractors (Excluding Work insured under Wrap-up programs) As Wrap-Up administration cost and complexity improves, Wrap-ups will become more widely utilized by smaller builders and for smaller projects. If the quality, availability and affordability of traditional insurance continues to decrease, Wrap-ups will be increasingly utilized.

27. Wrap-Up / OCIP (Primary)

28. Wrap-Up / OCIP (Excess)

29. 1. A Brief Overview of Liability Insurance2. Wrap-Ups From A Legal Perspective3. Current Policy Concerns and Insurance Trends

30. A Brief Overview of Liability Insurance Anatomy of an Insurance Policy �Occurrence� (accident) �Property Damage�/�Bodily Injury� ��within the Policy Period.� Exclusions Insurers� Duties Duty to Defend Duty to Indemnify Exemplar CG 00 01 General Liability Form

40. Wrap-UpsFrom a Legal Perspective Basic Principles Trends Types of Wrap-Ups: OCIPs and CCIPs Scope of Coverage: They do not operate as a performance bond! Elimination of Exclusion L does not eliminate Exclusions J(5), J(6), K, M, or N, nor any of the limitations! Absent a waiver from the insurer, coverage limitations for the typical CD case will be present.

41. Wrap-Ups From a Legal Perspective Advantages of Using a Wrap-Up Cost Savings Attracting Subcontractors Adjusting Claims Through a Single Insurer Control Higher Limits Site Safety and Loss Control Benefits

42. Wrap-Ups From a Legal Perspective Disadvantages of Using a Wrap-Up Gaps in Coverage: Exclusions minus exclusion L still have bite Increased Administrative Costs: safety/loss control, claims management, bid-deduct process, wrap manual, etc. Depleting Shared Limits: more insureds = more claims; Discouraging Bids from large sophisticated subs who choose not to pay the �buy-in� profit center that owner or GC sets up. Claims Adjustment Issues: Conflicts among insureds due to gaps in coverage/express indemnity issues.

43. Wrap-Ups From a Legal Perspective Special Considerations for Drafting a Wrap-Up Express Indemnity: owner will create notwithstanding the policy Alternative Dispute Resolution: bind the insurer as well �Completed Operations� Coverage: extend to the Statute of Repose/Limitations period. Why Wrap-Ups Are Better for Large Construction Projects: They provide what the are designed to provide in that setting.

44. Current Policy Concerns and Insurance Trends General Contractor/Subcontractor Distinction Additional Insured Endorsements (AIE) Pre-1993 CG 2010 AIE Acceptance Ins. Co. v. Syufy Enterprises (1999) 69 Cal.App.4th 321 (CG 2010 11/85, providing coverage ��for liability arising out of your work��, provides broad coverage even for the GC/AI�s independent negligence/liability) Post-1993 CG 2010 AIE Valley Ins. Co. v. Wellington Cheswick LLC (W.D.Wash 2006) 2006 U.S.Dist.LEXIS 81049 (CG 2010 10/93, purporting to limit coverage for ��liability arising out of your ongoing operations��, held by this one court to be ambiguous

45. Current Policy Concerns and Insurance Trends General Contractor/Subcontractor Distinction �Your Work� Exclusion Subcontractor Exception Operations of the General Contractor/Subcontractor Hartford Casualty Insurance Company v. Mt. Hawley Insurance Co. (2004) 123 Cal.App.4th 278: Risk transfer from GC�s insurer to sub�s insurer via equitable subrogation enforcement of the express indemnity obligation, notwithstanding �other insurance� clause. Recall Crawford v. Weathershield issues (held GC entitled to �an immediate defense� from the sub under the express indemnity in the subcontract) are still with us!

46. Current Policy Concerns and Insurance Trends Montrose II Exclusions In Montrose v. Admiral Insurance Company (1995) 10 Cal.4th 645, the California Supreme Court adopted the continuous-injury trigger of coverage. Some insurance companies have modified their policies to exclude continuous or progressive injuries Exemplar Exclusions

47. Current Policy Concerns and Insurance Trends Exemplar Exclusion I. The coverage under this policy does not apply to �bodily injury,� �property damage,� �personal injury,� �advertising injury,� or any injury, loss or damage arising out of inadequate, improper, faulty or defective construction: 1. Which first occurred, began to occur, or is alleged to have occurred prior to, or is alleged to be in the process or occurring to any degree, as of the inception date of this policy; 2. Causing incremental, continuous or progressive damage arising from an occurrence which first occurred, began to occur or is alleged to have occurred prior to the inception date of this policy;

48. Current Policy Concerns and Insurance Trends Exemplar Exclusion p. Progressive, Continuous or Intermittent �Property Damage� which: (1) existed or commenced prior to the inception date of this policy, or (2) arose our of any damage, defect, deficiency, inadequacy or dangerous condition which existed prior to the inception date of this policy. This exclusion applies only to �property damage� included under the �Products-Completed Operations Hazard.�

49. Current Policy Concerns and Insurance Trends Manifestation Trigger An alternative way to contract around the Montrose II decision is to modify policy language to change the trigger of coverage from a continuous injury trigger to a manifestation trigger. These endorsements or modifications vary: some add definitions, others change the insuring agreement, and others add exclusions. Exemplar Policy Language Application of These Limitations

50. Current Policy Concerns and Insurance Trends Manifestation Trigger In Prudential-LMI Commercial Ins. v. Super. Ct. (1990) 51 Cal.3d 674, 699, the California Supreme Court stated that manifestation referred to �that point in time when appreciable damage occurs and is or should be known to the insured, such that a reasonable insured would be aware that his notification duty under the policy had been triggered.�

51. Current Policy Concerns and Insurance Trends Exemplar Definition �Occurrence� shall mean an accident, including continuous or repeated exposure to substantially the same general harmful conditions, causing �bodily injury� or �property damage� which first becomes manifest during the Policy Period shown in the Declarations.

52. Current Policy Concerns and Insurance Trends Exemplar Exclusion This insurance does not apply to and we have no duty to defend any claim or �suit� seeking damages because of �bodily injury� or �property damage� that is continuous or progressively deteriorating and which �manifested� prior to the inception or after the expiration of the policy period; * * * �Manifest(ed)� means: a. For �bodily injury� when injury, sickness or disease first becomes reasonably capable of medical diagnosis; and b. For �property damage� when the damage is first discovered by the person or organization who suffered such damage.

53. Current Policy Concerns and Insurance Trends Exemplar Exclusion A. This insurance does not apply to the following, which is added to the EXCLUSIONS: All �bodily injury,� �property damage,� �personal injury� or �advertising injury� that is continuous or progressively deteriorating, and that is first manifest prior to the effective date or after the expiration of this policy. This exclusion applies even if such injury or damage continues or deteriorates during the term of this policy. * * * C. Within the meaning of this endorsement, injury or damage is manifest when appreciable harm occurs that is or should be known to the insured, the person or organization harmed.

54. Current Policy Concerns and Insurance Trends Armstrong-Selections and Self-Insured Retentions Armstrong-Selections Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. (1996) 45 Cal.App.4th 1 (in a continuous loss/injury setting, wherein multiple consecutive policies may be triggered, insured may select which policy it wishes to respond to the claim) Issues: Still viable with the replacement of �all sums payable� language with �those sums payable�? Are non-selected insurers excused? (In Illinois, they are.) Multiple tenders equal multiple deductibles/SIR�s?

55. Current Policy Concerns and Insurance Trends Exemplar Endorsement As a condition precedent to our obligations to provide or continue to provide indemnity, coverage or defense hereunder, each insured upon receipt of notice of any �suit�, incident or �occurrence� that may give rise to a �suit�, shall first demand indemnity, coverage and defense from each other insurer that may provide indemnity, coverage or defense when any other insurer may also provide indemnity, coverage or defense to the insured. The insured waives any rights it may have to a targeted tender or any other right to select us as the insurer to provide indemnity, coverage or defense.

56. Current Policy Concerns and Insurance Trends Self-Insured Retentions Stacking FMC Corp. v. Plaisted & Cos. (1998) 61 Cal.App.4th 1132 (held insurer could not stack multiple limits for a single occurrence; could go vertical up to the excess insurer above the selected primary) California Pacific Homes, Inc. v. Scottsdale (1999) 70 Cal.App.4th 1187 (held insurers could not stack consecutive SIR�s) Apportionment (where required, equity will apply)

57. Current Policy Concerns and Insurance Trends Self-Insured Retentions Satisfaction of the Self-Insured Retention Vons Cos. V. U.S. Fire Insurance Co. (2000) 78 Cal.App.4th 52 (held other insurer could satisfy the SIR unless the SIR policy prohibits such and required the insured, and only the insured, to pay the SIR) compares policy Exemplar Endorsement Insolvency of the Insured Public Policy Policy Interpretation: Condition 1. typically provides that �Neither the bankruptcy nor the insolvency of the insured will relieve us of our obligations under the policy�� Equity

58. Current Policy Concerns and Insurance Trends Arbitration, Forum Selection, and Choice-of-Law Provisions Unconscionability Effect on Third-Party Claimants Exemplar Endorsements

59. Current Policy Concerns and Insurance Trends Exemplar Endorsement If a Per Occurrence �self insured retention� amount is shown in the Schedule of this endorsement, it is a condition precedent to our liability that you make actual payment of all damages and �defense costs� for each �occurrence� or offense, until you have paid �self insured retention� amounts and �defense costs� equal to the Per Occurrence amount . . . . Payments by others, including but not limited to additional insureds or insurers, do not serve to satisfy the �self insured retention.�

60. Current Policy Concerns and Insurance Trends Exemplar Endorsement By accepting this policy or by presenting a claim which an insured contends is or may be covered under this policy, the Named Insured and any other insured submits themselves to the jurisdiction of the Superior Court of Cobb County, Georgia and agrees that such court shall have jurisdiction and venue for purposes [of] determining all rights and obligations under this agreement. Any insured expressly consents to the jurisdiction and venue of the Superior Court of Cobb County Georgia for any �suit� brought to interpret or enforce the provisions of this agreement. By contending that there is or may be coverage under this policy, each insured agrees to accept service of process by any legally recognized method available under Georgia law.

61. WRAP Exclusions Insured: Argue that they are nothing more than escape-type �other insurance� clauses, and, there, unenforceable. Nevada treatment of �other insurance� clauses is more pro-insured than California. Insurer: Argue that premium is based on contract values or revenue reported. If wrap project revenue is not reported, the insured is getting coverage for a project that was not reported or for which it never paid a premium to cover.

62. Current Policy Concerns and Insurance Trends Resolution Strategies Defending Insurer vs. Non-Defending Insurer Equitable Contribution Settle with Covenant Not to Execute Against the Insured and Set-Up Non-Participant Settling the Entire Action without the �recalcitrant� Safeco Insurance Co. v. Superior Court (2006) 140 Cal.App.4th 874 (held presumption of coverage under the recalcitrant policy if the recalcitrant violated a duty to defend)

63. Current Policy Concerns and Insurance Trends Resolution Strategies Defending Insurer vs. Non-Defending Insurer Settling Covered Damages Covered/Non-Covered Damages Camelot by the Bay Condominium Owners� Ass�n v. Scottsdale Ins. Co. (1994) 27 Cal.App.4th 33 Protecting the Insured Insured vs. Non-Defending Insurer: Johansen v. CSAA (1975) 15 Cal. 3d 9 (held insurer may not consider coverage defense in evaluating whether to accept a policy limits demand).

64. Pending Legislation � AB 2738 This bill would provide that all agreements for a residential construction project on which a wrap-up insurance policy is applicable, which require a subcontractor to indemnify, hold harmless, or defend another for any general liability claim or action, or workers' compensation claim or action are unenforceable, as specified. The bill would also provide that if an owner, builder, or general contractor obtains a wrap-up insurance policy or other consolidated insurance program for a work of improvement and requires that any subcontractor provide a credit or compensation for that policy to the owner or original contractor, the credit or compensation required and the coverage provided shall be clearly delineated in the bid documents, and the owner or original contractor may not require that the insured subcontractors under the wrap-up policy credit or compensate the owner or original contractor an amount greater than the amount the owner or original contractor paid to provide that subcontractor coverage under the wrap-up policy.

65. THANK YOU FOR PARTICIPATING� CRAIG M. HOUCK INTERWEST INSURANCE SERVICES, INC. GEORGE D. YARON YARON & ASSOCIATES G:\08 Year\ADC Presentation2