Risk Spreading Management

Risk spreading management of claims under a commercial general liability (“CGL”) policy is a burgeoning aspect of construction defect litigation. Insurance carriers defending general contractors are highly incentivized to pursue secondary carriers in an effort to defray the costs of defense and increase the amount of indemnity dollars available for settlement or judgment. Tenders claiming additional insured (AI) status or indemnity under an insured contract are conventional vehicles used to spread risk across policies where the duty to defend or indemnify may exist. This article discusses the basic mechanics involved in such tenders in order to provide carriers with a fundamental understanding of how risk spreading is managed.

Identifying Policies Subject to Tender

The scope of policies subject to coverage theories based upon additional insured status or an insured contract is initially determined by how the policy is triggered.

There are four primary theories under which a CGL policy is triggered. Under a manifestation theory, the policy is triggered when the manifestation of the injury becomes apparent or readily identifiable. Since this trigger is limited in time, it usually captures a limited amount of policies.

A CGL policy is triggered under an exposure theory upon first exposure to conditions that cause the injury. This trigger is not often used in property damage cases.

A more common rule is the actual injury or injury in fact theory, which triggers the policy when an injury is thought to have actually occurred. This trigger theory poses questions of fact as to when damages occurred. Therefore, tender is made to all policies in which damages may have actually occurred.

Finally, there is the continuous trigger, in which coverage arises under all policies in effect at the time the injury exists. A continuous trigger can lead to a greater number of policies potentially subject to tender, given the occurrence exists over a longer period of time. Prompt tender to potentially triggered policies is important to avoid an insurer’s claim of unreasonable delay.

Describing an Occurrence

Once policies subject to a trigger theory have been identified, the next step is to describe an occurrence that elicits coverage. While an occurrence is typically defined as an accident involving serendipity or fortuity, continuous or repeated exposure to substantially the same general harmful conditions can give rise to an occurrence. It is fortuity that is the pivotal element in establishing an occurrence. Under standard convention, an occurrence does not result from an outcome that was intended or expected from the viewpoint of the insured. For example, bodily injury is typically unintended or unexpected.

For property damage, the primary school of thought is that faulty or improper construction lacks fortuity because the injury is considered a natural and ordinary consequence. Therefore, property damage should result from an event that occurs without the insured’s expectation or foresight to establish the fortuity required from an occurrence.

Several theories can be used to demonstrate fortuity in this context. For example, a general contractor named as an AI typically lacks the expectation or foresight to understand the natural and ordinary consequences arising from a subcontractor’s work. Another fortuity doctrine gaining traction is defective work that damages non-defective work, sometimes referred to as “rip and tear” damages. Fortuity exists because damage to non-defective work is not anticipated. While damaged non-defective work can establish an occurrence, coverage will not lie for defective work. Several states also have codified the definition of an occurrence to lend some clarity to determine whether property damage constitutes an occurrence.

Entitlement to Assert a Tender

Beyond the description of an occurrence during the policy period, a tender should include an explanation of why the party making the tender is entitled to a defense and indemnity under the policy.

If not a named insured, the primary vehicle used for claiming defense and indemnity under a CGL policy is AI status. Another basis for entitlement arises when a party is indemnified under an insured contract. Subcontractor agreements often require that a general contractor be named as an additional insured under the subcontractor’s CGL policy and agree to indemnify and defend a general contractor for the subcontractor’s allegedly improper work.

AI status is typically memorialized under an endorsement to the CGL policy. In some cases, policies and endorsements provide blanket coverage for persons or entities to which the subcontractor is contractually bound to provide additional insured status or indemnify.

However the entitlement arises, the tender will need to provide an explanation with supporting documentation. A carrier reviewing a tender for entitlement will rarely accept allegations of the basis for entitlement without supporting documentation. Certificates of insurance indicating an AI status rarely satisfy a carrier’s request for proof of entitlement. Production of the complete policy is often required. If this documentation is not found in project records or case disclosures, then a party may have to resort to the power of a subpoena to procure it.

Ongoing Versus Completed Operations

Two common endorsements for AI coverage are the CG 20 09 and CG 20 10, authored by the Insurance Services Office, Inc. (ISO). The CG 20 09 provides the additional insured coverage in connection with its supervision of the named insured’s work even though the subcontractor has no contractual obligation to name the general contractor as an additional insured. This endorsement is no longer a current ISO form and usually appears in older policies.

The CG 20 10 replaced this endorsement to limit AI coverage to occurrences that arise during the course of the named insured subcontractor’s work. The CG 20 37 10 01 removes this limitation and provides the AI coverage for occurrences arising out of the named insured subcontractor’s completed work.

Some jurisdictions have circumvented the completed operations limitation by finding coverage for damages as the natural and probable consequence of ongoing operations. Ongoing operations arise when the work has yet to be completed or put to its intended purpose. The distinction between completed and ongoing operations can become blurred when a general contractor is terminated prior to completion of the project or where some limited portion instead of the entire project is put to its intended purpose.

Indemnity Owed Under an Insured Contract  

A tender also may be made if a party is indemnified under an insured contract. An insured contract is one in which the named insured assumes the liability of another party to pay for an injury for which the named insured would be liable regardless of the existence of a contract.

A CGL policy is intended to provide coverage for unforeseen liabilities as opposed to business risks. However, it is not considered a business risk if the insured would be liable for damages in the absence of any contract or agreement. Damages must arise after the parties enter into the insured contract. If the insured contract contains a prevailing party provision, a defense may also be available under this theory of coverage.

Many states have enacted anti-indemnity statutes to incentivize a party to exercise due care rather than shift the risk of its conduct contractually to another party. These statutes have the potential to nullify insured contracts. For the most part, these statutes bar a claim for indemnity based on the sole negligence of the indemnified party, but they do not restrict contractual terms for obtaining insurance for the negligence of the indemnified party because the risk is transferred to an insurer that is not a party to the contract.

A Duty to Defend?

Any doubt in evaluating the insurer’s duty to defend is resolved in favor of the insured. A determination of the insurer’s duty to defend is based on the four corners of the complaint. If the allegations contained within the complaint arguably come within coverage, the insurer is typically required to provide a defense.

Oftentimes, a carrier’s response will assert that there is no duty to defend because the claim might result in a judgment that is not covered. However, the analysis on the duty to defend is not determined by whether the claim might result in a judgment that is not covered. Rather, if the claim can result in a judgment covered by the policy, a duty to defend arises.

If the carrier seeks to avoid this obligation, usually it must issue a reservation of rights and defend on all claims until a declaratory judgment is entered on the issue of whether the duty to defend and indemnify exists.

Incentives and Deterrents to Accepting or Rejecting a Tender

The duty to defend is often considered broader than the duty to indemnify such that a carrier must provide a defense for all claims, not just those that it deems subject to policy indemnity. This doctrine contravenes the concept of additional insured coverage, which is calculated to limit coverage under the policy to damages arising out of the scope of work performed by the named insured.

Where claimed defects have very little to do with the work of the named insured, a carrier has little incentive to provide a defense under an additional insured tender to defend a general contractor subject to a broad scope of claims.

If the named insured has significant exposure to claimed defects, then the AI carrier might consider sharing in the defense under the AI tender in an effort to defray defense costs with another carrier participating in the defense. Given a majority of jurisdictions hold that each insurer is jointly liable to the insured for the cost of the complete defense, a substantial advantage can be gained by cooperating with other insurers in the defense. The insurers that participate in the defense then have the equitable right of contribution or subrogation against those carriers that decline a tender. This right is considered to arise independently of any insured claim and, therefore, cannot be released as part of the underlying litigation.

It can be argued that an insurer that does not timely interpose a reservation of rights on all disputed policy provisions has waived the right to interpose further coverage disputes at a later time. An insurer’s failure to provide a timely coverage position can also expose a carrier to a claim of bad faith.

Future of Risk Spreading Management

Risk spreading management is a strategy that is gaining traction in the industry. It can yield highly favorable results to carriers that bear a substantial burden in defending and indemnifying under a CGL policy. As new regimes intent on spreading risk proliferate throughout the industry, these theories will continue to evolve. Considering how rapidly case law is developing in this area, carriers should be especially cognizant of these concepts so they can effectively deal with spreading their risks.