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How to Manage Risk to Protect Your Business

As almost everyone is painfully aware, there is an insurance crisis in the residential construction industry.

Construction defect claims and related litigation are on the rise. Insurance carriers — finding that residential construction is too risky and not profitable enough to insure — are withdrawing from the housing industry due to poor underwriting results.

“If you do find general liability insurance, you find huge voids in coverage,” said Jim McErlean, risk management and marketing director for HBW Insurance Services.

However, there is plenty builders can do to manage their risk and avoid tapping elusive, pricey general liability insurance (GLI) policies if something goes wrong during construction or after a house is sold. The trick is to prevent things from going wrong in the first place.

Risk Management Techniques

McErlean and John Hubbard, vice president of 2-10 Home Buyers Warranty’s Western region, gave custom builders, remodelers and other attendees of the recent Custom Builder Symposium in Indian Wells, Calif. strategies for safeguarding their assets in a presentation entitled “Protect Your Business Through Risk Management.”

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Here are four risk management techniques you can use to help offset the current insurance crisis:

Avoid Liabilities.  Avoiding liabilities is the best solution. It involves careful site planning and preparation, effective design and construction practices, careful project supervision and using quality materials. “Avoid letting your architect be your structural engineer,” McErlean advises. “Sometimes there’s a conflict between a project’s architectural and structural components.”

Minimize Liabilities.  This is the next-best solution. Minimize liabilities by putting protective provisions in your sales contracts, making sure the arbitration language in your contracts doesn’t conflict with language in other documents you use, using third-party warranty contracts, resolving customer complaints as quickly as possible and seeing to it that your sales staff receives effective training. You don’t want them to promise customers the moon or something you can’t build.

Shift Liabilities.  Another desirable solution is to shift liabilities. You can protect yourself by having contracts with all the parties involved in the construction process — designers, trade contractors, vendors, etc. Your contracts should include indemnification clauses and mandated insurance requirements.

Insure Liabilities.  Finally, certain liabilities can be insured — although this is the most expensive, and least desirable, solution. The insurance solution isn’t very predictable because of claim-handling practices and disputes about coverage.

Key Aspects of an Asset-Protection Program

To further protect your business, use the following steps to incorporate the strategies mentioned above into your operations:

• Maintain Good Documentation and Records

Documentation is critical to mounting a defense against construction defect claims. “In a lawsuit, the one with the most paper wins,” Hubbard pointed out.

Keep the following documents related to the planning and construction of each home in one place:

• Development, site and all construction plans
• Documents that describe and specify the use of quality materials
• Documented work-in-progress inspections and follow-up notes
• Copies of videos and photos used during inspections
• Signed sales contract and documentation of all conversations with home owners
• Signed change orders
• Lists of trade contractors and descriptions of the work each contractor performed
• Signed trade contractor agreements
• Certificates of insurance from all trade contractors
  
  
• Pay Close Attention to Site Conditions and Site Preparation

Most general liability policies do not provide coverage for construction defects related to soil movement. Insured warranties, such as a home warranty program that covers soil movement, may offer the only insurance against structural claims related to this issue.

In addition, pre-acquisition due diligence can reveal significant future problems and help steer you away from land you shouldn’t buy. Due diligence should address:

• Geotechnical issues such as expansive and collapsible soils and the presence of sulfites in the soil. Sometimes found in plant fertilizer, sulfites can weaken concrete by causing it to calcify. Documentation related to soil testing is crucial in the defense of subsidence claims ― those related to sinking ground — and litigation.
• Noise — traffic, airports and other sources of noise
• The use of adjacent parcels of land
  
  
• Transfer Risk to Trade Contractors

You should have signed subcontracting agreements with all trade contractors that include:

• A hold harmless/indemnity agreement
• Insurance requirements that provide financial backing to indemnity agreements
• A waiver of subrogation
• An arbitration agreement

Writing contracts with your trades may seem formal, but it’s necessary. Business done with a handshake won’t protect you if a claim arises on a home you’ve built.

“Unless you have a contractual relationship with your trade contractors, it becomes a finger-pointing situation, and that finger-pointing can become a lawsuit,” McErlean said. He recommends working with a construction attorney who is well-versed in construction law to develop a trade contractor agreement.

In addition, obtain certificates of insurance from your trade contractors before work begins on each house, implement OSHA safety programs and require each of your trade contractors to carry minimum general liability insurance limits of $500,000 ― the preferable limit is $1 million.

• Make Sure Your Sites Are Well-Supervised

Selecting, training, retaining and managing knowledgeable, dependable job site superintendents or supervisors is an important part of a risk management and loss control program. A superintendent’s role includes:

• Overseeing and managing your company’s on-site risk-management program
• Verifying the quality of workmanship and building materials, and ensuring that they meet contract stipulations.
• Ensuring that job site safety standards are met.

If you have a promising superintendent who could use more training, send him or her to Home Builder Institute’s Residential Construction Academy. Students take classes at local home builders associations. They receive a Residential Construction Superintendent (RCS) designation after mastering eight core competencies. For a course schedule and other details, visit the RCS Web site.

• Implement Job Site Safety and Security Procedures

“Even if a customer owns the land, you own the site,” said McErlean. And you are responsible for everything on that site — including personal safety.

Reduce the chance of job site injuries by:

• Properly covering and barricading excavated areas from visitors and workers at the end of each work day
• Making sure all open areas above ground have sturdy temporary railings or are covered with sturdy materials
• Posting warning signs indicating that no one is allowed on the job site. Signage with phrases like “Private Property — Unauthorized Entry is Prohibited” will help get the message across.
• Giving home owners and vendors written notice that site access is not allowed without an appointment. “Put this in your sales contract with home owners,” McErlean advised. “That way, if they go on the site at night without your authorization and get hurt, they can’t easily file a claim against your GLI policy.”
  
  
• Use a Comprehensive Sales Contract with Every Home Owner

Managing customers’ expectations goes a long way toward preventing lawsuits later on. A sales contract can help you do that. In particular:

• Have your attorney draw up the sales contract to ensure that you are fully protected.
• The sales contract must have strong waiver and arbitration provisions.
• Any changes to the original sales contract must be made in writing and must be signed by the builder and the home owner.
• Keep a copy of the sales contract in the project manual so it can easily be consulted during construction.
  
  
• Use an Insured Third-Party Warranty Program

“If you are a home builder, you are the warrantor of that home for 10 years,” said Hubbard. “It’s how you transfer that risk that makes the difference.” Supplied by a regional or national warranty company, an insured third-party warranty program replaces a builder’s own warranty program. It protects the builder by:

• Defining the builder’s legal responsibilities for 10 years
• Clearly defining home owner responsibilities
• Stipulating mandatory and binding arbitration
• Providing insured structural defect protection
• Coordinating home owner claims, complaints and disputes

In a sense, an insured third-party warranty program acts as a filter. Without one, there Is not much to stop home owner claims from tapping your GLI policy or turning into a lawsuit. “In an arbitration situation, the last thing you want to do is go to court,” said Hubbard.

• Implement a Comprehensive Warranty Program

The following pointers can help reduce risk and protect your assets if you decide to have your company take care of warranty service:

• Prioritize customer service in your company.
• Make sure your employees who handle warranty requests have strong decision-making skills.
• Provide comprehensive warranty training.
• Consider using software that tracks customers’ service requests and trade contractor work orders and monitors outstanding requests and work orders.
• Create and use consistent warranty service forms and documents. For example:
  • Request for service forms, which the home owner must submit in writing
  • Work orders for work to be performed by trade contractors. To get paid, the trade contractor must sign the form after the work is performed and obtain the home owner’s signature acknowledging that the work was completed satisfactorily.
• Document all warranty service requests, whether accepted or denied. Provide reasons for denied requests.
• Keep copies of all paperwork related to warranty service in each property’s document file.
• Take proactive action on all repetitive repair requests. If something keeps on breaking, find out why.

It may seem costly and time-consuming to put an asset-protection program in place. However, “an asset-protection program costs far less than the cost of being taken to court for a construction claim,” said McErlean.

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Mark Your Calendar for the 2005 Custom Builder Symposium

The 2005 Custom Builder Symposium 2005 is scheduled for Nov. 11-13 in New Orleans. Mark your calendars. For more information, e-mail the NAHB Business Management Department, or call 800-368-5242 x8388.

NAHB Has More Than 170 Resources to Help You Run Your Business More Profitably

Go to NAHB's Business Management Tools Web pages for instant access to more than 170 timesaving, moneymaking and cost-cutting business resources to help you run your business more profitably. Get guidance on accounting and financial management, business strategy, computers and information technology, customer service, human resources and more. 

Resources are added weekly, so bookmark www.nahb.org/biztools to go directly to these vital business management resources.

Local and state associations, link directly to www.nahb.org/biztools from your Web site and give your members instant access to these resources. It will make your HBA's Web site the place to go for the information and guidance they need to succeed.

The NAHB University of Housing Offers ‘Risk Management and Insurance for Building Professionals’ Course

The NAHB University of Housing offers a course on risk management designed to give building professionals an overview of strategies they can implement to avoid risks, minimize risks, transfer risks and, where possible, buy insurance and make insurance claims. For a list of current offerings, click here.

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