High Deductible Liability Insurance Policies Pose Potential Problems for Policyholders and Claimants

Construction Law Report Spring 2013

05/01/2013

Kevin S. Mapes

In recent years, the construction industry has seen an increase in the number of commercial liability insurance policies that are subject to significant deductibles or self-insured retentions. In some cases, the increased deductibles represent an effort by the policyholder to reduce the costs of insurance premiums. In others, the large deductibles or self-insured retentions are required by carriers issuing project-specific “wrap-up” insurance policies. In either case, however, large deductibles can have negative consequences when claims arise, both for the policyholder and for claimants looking to collect on insurance proceeds.

While deductibles and self-insured retentions serve similar purposes, and can have similar impacts, they have important differences. A deductible represents an amount that the insured must pay as part of a covered claim. Typically, where a deductible applies to a covered claim, the insurer will pay for defense and indemnity costs; the policyholder then has a contractual obligation to reimburse the insurer for the amount of the deductible. A self-insured retention, in contrast, represents an amount that the policyholder must pay before the insurer has any obligation under the policy, including any duty to defend. Both self-insured retentions and deductibles can be written on a per-occurrence or a per-claim basis.

Deductibles and self-insured retention, by design, will always impact the policyholder when an insured (or potentially insured) claim is asserted. Large deductibles or retentions will magnify that impact and can also pose a significant problem for claimants who are looking to the proceeds of an insurance policy to compensate them for their loss. In many instances, an insurance policy is the defendant insured’s only significant asset. Where that insurance asset is subject to a large deductible, a claimant’s ability to collect on a judgment may be limited. Moreover, even where an insurer is providing a defense, claimants may find it significantly more difficult to reach an insurer-funded settlement where a large deductible or self-insured retention is in play.

These issues can be especially pronounced in the context of residential construction defect claims. A $100,000 deductible or retention can present a major financial burden to many insureds, especially if the insured’s financial condition has changed for the worse since the time the policy was underwritten and issued. In the case of a single-purpose developer entity, the insurance policy may be the insured’s only remaining asset. A claimant may obtain a judgment against such an entity, only to be faced with an insurance company that refuses to pay based on the insured’s failure or inability to satisfy the deductible or retention. In the case of multi-unit residential construction, the impact of large retentions or deductibles can be magnified, as insurers often take the position that that the deductible or retention applies separately to each individual unit. Even an otherwise financially viable insured may find itself unable to satisfy a large deductible twenty, fifty, or a hundred times over.

In the case of project-specific “wrap-up” insurance policies, large retentions or deductibles can impact the primary named insured (typically the owner/developer or the general contractor), prospective claimants, and enrolled subcontractors. Wrap-up policies are intended to insure all of the project participants under a single policy, covering the developer, the general contractor, and the project’s subcontractors. Such policies are also often subject to large deductibles or retentions. Responsibility for the retention or deductible can be addressed in various ways, but most commonly falls to either the owner/developer (an “owner-controlled” wrap policy, or “OCIP”) or to the general contractor (a “contractor-controlled” wrap policy, or “CCIP”). What happens, however, when the developer is responsible for the retention or deductible and cannot pay it? Unless the enrolled subcontractors are prepared to step in and fund a large sum, the parties to the wrap-up insurance policy may be left without any coverage; in the case of a large self-insured retention, the parties may even be left without an insurer-provided defense.

Large deductibles or self-insured retentions can be attractive to insureds looking to reduce their insurance costs. Policyholders should, however, carefully consider the potential impact on future insured claims before purchasing a policy that is subject to a significant deductible or retention. Similarly, potential claimants should be aware of the fact that large deductibles or self-insured retentions could impact their ability to successfully execute on what otherwise appears to be adequate and available insurance coverage.

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