Chinese Drywall: Builders and Subs Face Huge Uninsured Losses

General liability carriers specializing in contractor insurance for builders and drywall subs are "sweating it out" over the potentially massive claims dollars that could be paid out in litigation, settlement, and adverse jury verdicts arising from Chinese drywall.

However, due to the impact of little known policy exclusions, and evolving case law in many states, general liability carriers may escape liability for all or a significant percentage of claims leaving builders and trade subs facing huge uninsured losses and potential bankruptcy.

From the point of view of the homeowner, these claims will not likely be covered by homeowners property insurance. And, to the extent that the damages are not covered by the general liability policies of builders, subs, and distributors, homeowners will incur devastating out of pocket losses.

Per House Damage Could Be Astronomical

There is a lot at stake for all parties because the damages on a per house basis are likely to be astronomical. The lawsuit papers will allege that the fumes from the defective Chinese drywall have resulted in corrosion damages to all metal parts of the house including electrical systems, copper piping, HVAC and other metal fixtures. In addition, it will be alleged that the non metal parts of the house have been damaged by foul smelling and noxious sulfur dioxide fumes.

Some experts may claim that the drywall can be sealed, but this approach is questionable and unlikely to be accepted by home owners. Most lawsuits will likely ask for the total removal and replacement of all drywall and electrical systems as well as other building materials that may have been contaminated by the fumes.

Next, add damages for remediation or replacement to household contents for exposure to corrosive and foul smelling fumes. Top this off with the possibility of bodily injury claims due to adverse health consequences to occupants due to exposure.

Pollution Liability Exclusions

All contractor general liability policies include a standard exclusion for liability arising from the "actual, alleged or threatened discharge, seepage, release or escape of pollutants'," "Pollutants" are defined as any solid, liquid, gaseous, or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals, and waste. "Based on this broad definition, the carriers will take the position that the fumes released from Chinese drywall fall under the policy definition of "pollution."

Fortunately, the standard policy language includes an exception to the exclusion for pollution that results from the products or completed operations of an insured. In other words, the insurance carrier can't use the pollution exclusion to deny a claim when the pollution arises after the house has been sold.

Unfortunately, many general liability policies that are sold to contractors include a Total Pollution Exclusion that does not allow the exception that is mentioned in the above paragraph. The presence of the Total Pollution Exclusion (or similar exclusion) on a policy will allow the insurance carrier to take the position of denial of all damages and legal defense. The success of such a position will be determined by the allegations in a specific lawsuit as well as case law. The successful use of the Total Pollution exclusion, if upheld by the courts, will have a devastating impact on all defendants.

Property Damage Exclusions and Emerging Case Law

In the event that the Total Pollution Exclusion is not present on the general liability policy or if it is not ultimately upheld by the courts, the claims adjusters will have a fallback position in their quest to deny a significant percentage of Chinese drywall claims.

As a result of the construction defect crisis, most General Liability carriers specializing in builders insurance began to insert special policy exclusions around five years ago to escape liability for construction defect claims.

The most common exclusion entitled "Exclusion: Damage To Work Performed By Subcontractors On Your Behalf" (CG2294), virtually eliminates all property damage liability for damage to the builder's faulty work itself (drywall) and resulting damage to the builder's non faulty work (corrosion to electrical systems, copper piping, HVAC, and other metal fixtures).

Existing case law in many states has resulted in claim denials for construction defect under the theory that property damage to a builder's work is not considered to be an "occurrence" or accident and thus the policy should not act as a warranty. Therefore, the end result in these states is the same as the application of exclusion CG2294.

However, general liability coverage under the builder's insurance policy will still likely apply to property damage to contents and bodily injury claims by occupants. Since most lawsuit papers are likely to allege at least some covered damages, coverage will still be triggered for the entire legal defense for all claims at the expense of the insurance carrier.

As concerns drywall subcontractors, their general liability policies will not cover property damage to their work (drywall) but will cover resulting property damage to other parts of the house and contents. Their policy will also cover bodily injury to occupants. In addition, their policy will likely trigger a full legal defense of all claims.

Assuming that both the builder and drywall sub have general liability insurance in force continuously from the completion of the job to the filing of the lawsuit papers, their combined policies won't likely cover the cost to tear out and replace the drywall. Such a repair job represents a huge undertaking and will be very expensive.

U.S. Suppliers and Chinese Manufacturers

U.S. suppliers of Chinese drywall will undoubtedly participate in these lawsuits with both builders and drywall subs. Plans for class action lawsuits are already under way. Under a worst case scenario, some U.S. suppliers may run out of general aggregate limits under their general liability policies and it is unlikely that Chinese manufacturers will share in these claims due to the difficulties in enforcing judgments against foreign manufacturers.

Builders Can Protect Themselves

Builders are advised to protect themselves from future construction defect and pollution claims by implementing the following practices:

• Implement mandatory subcontractor agreements with all subs including insurance requirements for general liability, hold harmless/indemnification provision, and a requirement for all subs to participate in arbitration proceedings.
  
• If the builder's general liability policy includes the Exclusion-Damage To Your Work Performed By Subcontractors On Your Behalf (CG2294) or a similar exclusion, find out if the insurance carrier provides a buyback for an additional premium charge.
  
• Ask the insurance agent if any insurance carriers are available that don't use exclusion CG2294 or have a less severe version that covers resulting property damage to the builder's non faulty work.
  
• Purchase a Pollution Liability policy.

By John Sadler

Survey: Buyers Prefer Agents When Purchasing Medical Insurance

A recent online survey of more than 1,000 consumers found that those who purchased individual medical (IM) insurance through a professional agent were significantly more satisfied with their health plans than those who bought IM insurance online.

The independent study was commissioned by Milwaukee-based Assurant Health, a national provider of Individual Medical, Small Group and Specialty health insurance products. Some of its other key findings included:

• 64 percent of those who bought through agents used the word "helpful" to describe their experiences while only 36 percent of online purchasers used this term.
  
• 91 percent of those who purchased through an agent bought the plan their agent recommended.
  
• 31 percent of those shopping online described the experience as "time-consuming."
  
• Despite the recent proliferation of Web-based insurance brokerages, 62 percent of the survey respondents bought their insurance through an agent.
  
• In addition, consumers who purchased through an agent were significantly more satisfied in regard to how easy it was to understand their options and choose a plan that gave them the best coverage tailored to their needs than those who purchased online.
  
• After being presented with information on how agents can help, and advised that purchasing through an agent does not increase their costs, nearly one out of four of those who purchased online reported that, if they were going to purchase IM insurance today, they would buy it through an agent.

Independent insurance agents play a vital role in educating consumers and helping them make informed decisions about their health plans, said Don Hamm, president and CEO, Assurant Health. "It also shows that consumers greatly value agents' personalized services and recommendations."

The research commissioned by Assurant Health was conducted in May/June 2009 by the Chicago firm of Beall Research & Training Inc. Some 1,003 consumers who purchased individual medical (IM) insurance within the past two years were surveyed about their shopping and purchase experiences. The respondents were recruited from a representative online panel of Americans. All differences noted are statistically significant at the .05 level.

Securities Class Actions Decline; More Foreign Firms Targeted

Federal securities class action activity declined in the first half of 2009, with a particularly significant decline in the second quarter.

According to Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research, a total of 87 federal securities class actions were filed in the first half of 2009, a 22.3 percent decline from the 112 filings in both halves of 2008.

Only 35 filings were observed in the second quarter, the lowest quarterly total since the first quarter of 2007.

Financial services firms are defendants in 66.7 percent of these filings, an increase over the 50.0 percent share of all filings in 2008.

The data come from the most recent annual report, Securities Class Action Filings: Mid-Year Assessment, which introduced a new metric that measures the number of securities class action filings in U.S. federal courts against defendant corporations headquartered outside the U.S..

The report found that federal securities class action lawsuits against foreign firms have been rising for more than a decade and reached 31 filings (13.8 percent of total filings) in 2008, with an average of 18 foreign firms (9.4 percent of total filings) sued in each year since 1997. Thus far in 2009, 18 lawsuits have been filed against foreign firms, representing 20.7 percent of the total. Filings against foreign firms are concentrated in the financial sector, as 41.9 percent of the filings in 2008 and 77.7 percent of the filings in the first half of 2009 were against financial firms.

Disclosure Dollar Losses (DDL) totaled only $48 billion, well below the semiannual average of $69 billion.1 Two-thirds of these losses are generated by two mega-DDL cases with DDLs in excess of $5 billion each. According to the authors, this considerable decline in DDL, and its heavy concentration in two cases, likely reflects lower stock market valuations: prices are declining from a lower base, meaning that investors' losses at the time of disclosure are compressed.

Both average and median DDL were also lower in the first half of 2009, but were still higher than the semiannual average for the 12 years ending December 2008.

Maximum Dollar Losses (MDL), however, totaled $429 billion, a 22.2 percent increase from the second half of 2008 and 20.5 percent above the semiannual average. The median MDL was also 80.3 percent higher than the semiannual average. There were seven mega MDL filings—lawsuits with an MDL of $10 billion or more—that accounted for $376 billion of MDL in the first half of 2009 and represent 87.6 percent of MDL in the first half of 2009, the largest share in the prior 12 years.

The decline in DDL and the simultaneous increase in MDL can be explained by the fact that the MDL metric measures declines over the entire length of the alleged class period, which can often include higher stock prices because the class period may have begun before the recession, the report notes. In contrast, the DDL metric considers only the stock price decline contemporaneous with the corrective disclosure, which today typically occurs at lower valuations.

Professor Joseph Grundfest, director of the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research, said that class action lawyers, having already sued large firms, are shifting their attention to smaller firms.

"Securities litigation activity continues to be driven by claims against financial services firms, but all the large firms in the industry have already been sued. Plaintiffs are therefore filing claims against the smaller number of smaller financial services firms yet to be sued," said Grundfest. "Those facts, combined with the general decline in stock market valuations, help explain the decline in the number of companies sued and in the dollar amounts at risk in recent litigation, as measured by the DDL."

Class action lawyers are also expanding into foreign territory.

"A disproportionate number of recent claims against foreign firms target the financial services sector. The uptick in litigation activity against foreign firms can therefore be viewed as a side-effect of the larger trend to sue financial services firms, wherever they are headquartered. The key question for the plaintiffs is whether they can get jurisdiction in the U.S. courts," he said.

The rise in suits against foreign firms reflects the global economy, according to the researchers.

"The continued rise in securities class action filings against foreign firms, as presented in the report's new metric, underscores the interconnected nature of the credit crisis and the global reach of securities class action litigation," said Dr. John Gould, vice president of Cornerstone Research.

Gould also said that a possible explanation for the decline in filings thus far in 2009 may be the reduced stock market volatility. "The market was much more volatile in the second half of 2008, when filings were rising, compared to the first half of this year, when filings dropped off. Moving forward, greater market stability may signal a reduced number of securities class action filings," he said.

Key Findings

• If the filing rate for the first half of the year continues, then 174 securities class actions will be filed this year, a 22.3 percent decrease from 2008 and an 11.7 percent decrease from the annual average for the 12 year period ending December 2008.
  
• About half of the filings so far in 2009 were driven by the credit crisis, with 42 filings in the first half of the year containing allegations related to the credit crisis.
  
• The dramatic decline in the number of class action filings is contemporaneous with a 43.7 percent decline from the fourth quarter of 2008 to the second quarter of 2009 in stock market volatility as measured by the Chicago Board Options Exchange Volatility Index (VIX).
  
• The Litigation Heat Map, a recent addition to the report, show that 2.8 percent of companies that represent 7.5 percent of market capitalization in the S&P 500 index were defendants in filings in the first half of 2009. Financial firms were hit hard as 12.8 percent of companies in the S&P 500 classified by Bloomberg as financial were named as defendants, accounting for 41.2 percent of the market capitalization of that sector.
  
• The number of filings against unique issuers on major U.S. exchanges decreased in the first half of 2009 on an absolute level and as a percentage of total filings. This decline was driven by a large number of filings related to non-exchange-traded securities and private companies in the first half of 2009.
  
• There were 15 filings related to Ponzi schemes thus far in 2009. The majority of these lawsuits, 11 filings, were on behalf of investors in Madoff funds, with most suits targeting so-called feeder funds, hedge funds, and other financial intermediaries that invested their clients' money with Madoff.

U.S. Reinsurers Post $26.4B in Net Premiums for 2008

For 2008, the U.S. reinsurers reported net premiums written of $26.4 billion, premiums earned of $25.9 billion, according to the Reinsurance Association of America's "Reinsurance Underwriting Review: 2008 Industry Results."

The report includes industry aggregate data and summarizes underwriting experience, operating results, ceded reinsurance and recoverables, reserve development and leverage, and the invested assets of 36 organization.

The report also showed loss and loss adjustment expenses for U.S. reinsurers at $18.2 billion, commission and broker expenses of $5.4 billion, and other underwriting expenses of $2.6 billion.

The figures indicate a weighted loss ratio of 70.3 percent, commission and broker ratio of 20.3 percent, and other underwriting expense ratio of 9.7 percent, resulting in a combined ratio of 100.4 percent.

As a group, the reinsurance companies reported policyholders' surplus of $69.0 billion. This same group of reinsurers reported a return on equity of 3.9 percent, an investment yield of 3.8 percent, net-net reinsurance exposure that was 9.9 percent of surplus and net leverage of 198.1 percent.

The RAA has reported the underwriting results of the nation's major property/casualty reinsurers in its annual Reinsurance Underwriting Review since 1980.

Congress Warned Reforms Could Hike Health Care Costs 'Significantly'

Congressional Budget Office director Douglas Elmendorf told lawmakers Thursday legislation to expand health care coverage would increase federal healthcare costs "to a significant degree" and revenue will need to be found to keep from increasing the deficit.

Asked by the tax-writing House Ways and Means Committee about his remarks to a Senate committee earlier Thursday that the legislation would not hold down healthcare costs, he said, "The point I made earlier this morning is that it raises future federal outlays more than it reduces future federal outlays."

Elmendorf told the panel, "The coverage proposals in this legislation would expand federal spending on health care to a significant degree and in our analysis so far we don't see other provisions in this legislation reducing federal health spending by a corresponding degree."

He said ways to pay for the healthcare programs could include further savings from the Medicare health program or changes to the current exclusion from taxes of employer-paid insurance premiums.

The nonpartisan budget analysis arm of Congress has not yet estimated the cost of the full House healthcare legislation working its way through three House committees.

The House bill pays for the roughly $1 trillion 10-year cost of the healthcare overhaul with a combination of estimated savings in health costs and taxes worth $587 billion over the period. It sets up a government-run health plan to cover many of the uninsured and expands coverage in other government health programs.

The Senate Finance Committee is considering other options, including a tax on health insurers and a tax on employer-paid premiums. Chairman Max Baucus, a Democrat, said their task was not helped by President Barack Obama's opposition to counting the value of employer-paid premiums as income.

Republicans seized on the CBO director's comments as evidence the legislation should be rejected or at least more time should be taken to examine it. Obama has urged Congress to pass it out of each chamber by August.

"Today's CBO testimony should be a wake-up call," Senate Republican Leader Mitch McConnell said. "Instead of rushing through one expensive proposal after another, we should take the time we need to get things right -- especially at a time when hundreds of thousands of Americans are losing jobs every month."

Backers of the House bill disputed this assertion. "It is true that we don't know how much reform will bend the cost curve (slow the increase in healthcare spending); but we know it is better than doing nothing," Jonathan Gruber, a Massachusetts Institute of Technology economist who backs the House bill said on a call organized by backers of the bill.

House Speaker Nancy Pelosi told reporters that she hoped the formula for paying for healthcare reform could change. Instead of half of the more than $1 trillion in costs being covered by savings program spending and the other half from new revenues, Pelosi said, "I hope that we can change that percentage" and "squeeze more savings."