SIRs, Deductibles and the Armstrong Elections

Transcription

1 SIRs, Deductibles and the Armstrong Elections How Will Contractors and Their Subs Survive in the Future of Construction Defect Cases? By David Stern and Deborah Wities Orange County Bar Association Construction Law Section October19, 2006 The Windham Hotel 3350 Avenue of the Arts Costa Mesa, California

2 Speakers Bios David Stern, RPA Vice President Dave joined West Coast Casualty Service in 1993, and presently serves as its Vice President. Dave has over twenty-six years of diverse experience spanning the insurer, self-insurer, third party administrator and independent adjusting arenas. Since coming to West Coast Casualty Service, Dave s central focus has been on the investigation of all aspects of construction defect claims. He has been involved in the creation of innovative methods for the reduction of claims handling expenses to include joint defense ventures, joint destructive testing and facilitated mediation strategies. In addition, Dave is often called upon to testify as an expert in construction defect and insurance related litigation and has been asked to be a consultant on articles involving construction featured in the Los Angeles Times, the Boston Globe and the Orange County Register. Each year Dave coordinates our annual Construction Defect Seminar, the premier and most highly attended construction defect event in the United States. He also speaks at and conducts seminars discussing vital issues facing the insurer and self-insurer communities. Dave serves as Secretary of the Construction Defect Claims Managers Association (CDCMA). In addition, he is a member of the Registered Professional Adjusters Program, the Society of Insurance Trainers and Educators, the National Association of Insurance Litigation Managers and the National Association of Professional Specialty Lines Officers where he also served on the Industry, Communication and Public Relations Committee (1999 to 2001). Dave is on the President Circle of Habitat for Humanity and also serves as Secretary/Treasurer of the Malibu Lost Hills Sheriffs Booster Club and is an advisor to the Thousand Oaks Police Charitable Foundation. Deborah Wities, CPCU Deborah has been a claim adjuster for 22 years. She trained with Aetna Casualty & Surety back in the days when full-scale classroom and field training were the norm. She began handling construction defect cases 16 years ago in Northern California long before Type I Indemnity and AI endorsements drove the litigation. Deborah enjoys cases involving insurance coverage issues and contract language. In addition to CD, she s handled litigation arising out of advertising injury, copyright and patent infringement, wrongful eviction, wrongful death and serious injuries involving peculiar risk and product liability allegations. During her eight years with Fireman s Fund in Northern California, she worked as an adjuster, a supervisor and a trainer. As a trainer, she conducted classes in general liability, homeowners, trucking, personal and business auto policy interpretation and claim investigation and evaluation. She then spent six years with Chubb Insurance, which transferred her to Southern California. Deborah later worked for a number of national insurers and third-party administrators. As a result, she has a broad knowledge of the policy forms and endorsements, claim handling practices and internal workings of many of the carriers now providing coverage to the construction community. She has also represented individual subcontractors in non-insured matters. Table of Contents Page No. 2

3 Table of Authorities 4 Introduction 6 The Changing Environment 7 The Self-Insured Retention and Deductible Involvement 8 Is There A Difference Between Deductibles and SIRs? 10 The Involvement of Wrap-Up Insurance Programs 10 The Scope of SIRs 11 Is Self-Insurance... Insurance? 12 Kinds of Self-Insurance 13 Satisfying the Retention Per Claim, Per Occurrence, or In the Aggregate 14 The Armstrong Election in Progressive Loss Cases 16 Will Other States Follow Armstrong Elections in Progressive Loss Cases? 17 The SIR and the Duty to Defend and/or Indemnify 19 Can One Exhaust a SIR Through Payments Made by Another Insurer? 20 Satisfying SIRs When Coverage Under More Than One Policy Year is Triggered 21 Bankruptcy, Insolvency and the Self-Insured Retention 22 Claims-Made versus Occurrence Policy Type Exclusions 24 Defense Cost Exclusions 24 Self-Insurance Considerations 25 Advantages 25 Disadvantages 26 Conclusion 27 Exemplar Self Insured Retention Endorsements 28 Copies of Power Point Slides 36 3

4 Table of Authorities CA Aerojet-General Corp. v. Transport Indemnity, 17 Cal. 4th 38, 70, n. 20 (1997) CA General Star Indemnity Ins. Corp. v. World Oil Company, 973 F. Supp. 943, (1997) CA General Star Indemnity Company, et al. v. Superior Court, et al. (Hard Rock Cafe America L.P. real parties in interest), 47 Cal.App.4th 1586, 55 Cal.Rptr.2d, 322 (1996) CA Foster-Gardner, Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa. 18 Cal. 4th 857, 879 (1998) CA Montrose Chemical Corp v. Admiral Ins. Co., 10 Cal. 4th 645, 671 (1995) CA EOTT Energy Corp. v. Storebrand International Insurance Co., 45 Cal. App. 4th 565, (1996) CA Foster -Gardner, Inc. v. Nat. Union Fire Ins. Co. (1998) 18 Cal.4th 857, 879 CA Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. (1996) 45 Cal.App.4th 1 CA California Pacific Homes, Inc. v. Scottsdale Ins. Co., 70 Cal. App. 4th 1187 (1999) CA The Vons Companies, Inc. v. U.S. Fire Insurance Company, 78 Cal. App. 4th 52 (2000) CA Alpha Therapeutic Corp. v. Home Ins. Co., 90 Cal. App.4th 1330, 1335 (2001) CA Community Redevelopment Agency v. Aetna Cas. & Surety Co., 50 Cal. App. 4th 329, 339 (1996) CA Montgomery Ward & Co., Inc. v. Imperial Casualty & Indemnity Co., 81 Cal. App. 4th 356 (2000) CA California Pacific Homes, Inc. v. Scottsdale Ins. Co., 70 Cal. App. 4th 1187 (1999) CA Syntex Corporation, et al, v. Lowsley Williams & Companies, et al, 98 DAR CA Beaumont-Gribin Von Duil Management Co, et al, vs. California Union Insurance Company, et al. 66 Cal.App 3d 617 (1976) CA Whitaker Corporation, et al. vs. Allianz Insurance Company, et al. 11 Cal.App 4 th 1236, 1241 (1992) CA Bay City Paving & Grading, et al. vs. Lawyers Mutual Ins. Company, et al. 5 Cal.App 4 th (1993) CA Haerens v. Commercial Cas. Ins. Co. (1955) 130 Cal.App.2d Supp. 892, CA State Farm Fire & Casualty Co. v. Elizabeth N. (1992)9 Cal.App.4th 1232, [12 Cal.Rptr.2d 327 CA City of Oxnard v. Twin City Fire Ins. Co. (1995) 37 Cal.App.4th 1072, CA Stonewall Ins. Co. v. City of Palos Verdes Estates (1996) 46 Cal.App.4th 1810, 1853 IL The Home Insurance Company of Illinois, et al. vs. Carl Hooper, et al. Il.App, 6 th No (1998) IL Missouri Pacific R.R. v International Insurance Co. (MoPac), 288 Ill App 3d 69, 679 NE2d 801, appeal denied 174 Ill 2d 567, 686 NE2d 1164 (1997) IL Hartford Accident & Indemnity Co. v. Chicago Housing Authority, 12 F.3d 92, 96 (7th Cir. 1993) Table of Authorities (cont d) 4

5 IL Hudson Insurance Co. v. Gelman Sciences, Inc., 921 F.2d 92, 95 (7th Cir. 1990) IL John Burns Construction Co. v. Indiana Insurance Co., 189 Ill. 2d 570 (2000) IL American National Fire Ins. Co. v. National Union Fire Ins. Co., 343 Ill. App. 3d 93 (2003) IL Institute of London Underwriters v. Hartford Fire Ins.Co., 234 Ill. App. 3d 70, 599 N.E.2d 1311 (1st Dist. 1992) IL Bituminous Casualty Corp. v. Royal Insurance Co., 301 Ill. App. 3d 720, 704 N.E.2d 74 (3rd Dist. 1998) IL Dearborn Ins.Co. v. Internat l Surplus Lines Ins. Co., 308 Ill. App. 3d 368, 719 N.E.2d 1092 (1st Dist. 1999) IL Alcan United, Inc. v. West Bend Mutual Insurance Co., 303 Ill. App. 3d 72, 707 N.E.2d 687 (1st Dist. 1999) IL American Country Ins. Co. v. Kraemer Brothers, Inc., 298 Ill. App. 3d 805, 699 N.E.2d 1056 (1st Dist. 1998) KS Atchison, Topeka & Santa Fe Railway Co. v. Stonewall Ins. Co., 275 Kan 698, 71 P3d 1097 (Kan 2003) MI Associated Indem. Corp. v. Dow Chemical Co. (E.D.Mich 1993) 814 F.Supp. 613, 623 MN Minnesota Mining & Mfg. Co. v. H&W Motor Express Co., 507 N.W. 2d 622, 625 (Minn Ct of App 1993) NY Michaels v. Mutual Marine Office, Inc. (S.D.N.Y. 1979) 472 F.Supp. 26, 29 TX Transport Ins. Co. v. Lee Way Motor Freight (N.D.Tex. 1980) 487 F.Supp. 1325, 1329 US 9 th Cir. Chemstar, Inc. v. Liberty Mut. Ins. Co. (9th Cir. 1994) 41 F.3d 429, 433 US 9 th Cir. Mead Reinsurance v. Granite State Ins. Co. (9th Cir. 1988) 873 F.2d 1185, 1188 US 9 th Cir. Appalachian Ins. Co. v. Liberty Mut. Ins. Co., supra, 676 F.2d at p. 61 * * * Cal. Prac.Guide. Insurance Litigation, The Rutter Group } 7397 at pages 7A/82 and 7A/83 Ostrager and Newman s Handbook on Insurance Coverage Disputes (8 th ED.) } 13.13(a) at page 629 * * * Introduction As the explosion of construction defect lawsuits, which began in the mid-eighties, continues to spread throughout the United States and abroad, all sides of these specialized claims have been at odds on the 5

6 best way to resolve them. The key factor that is seriously impacting both builders and insurers is the increased level of construction defect litigation initiated by the plaintiffs' bar. Insurance companies are paying defense costs, attorneys' fees, and settlements and passing these expenses on to builders in the form of increased premiums or, in some areas of the country, pulling out of the residential construction market altogether. Further, most (if not all) of the exclusions currently included in commercial general liability (CGL) policies are often the result of litigation. The bottom line is that insurers consider builders to be a class which is unprofitable, undesirable and very costly. Further, this kind of litigation is spreading nationwide and is fueled by heavy media coverage and large jury verdicts. It remains common knowledge that homes cannot be built without contractors having affordable insurance coverage, and if traditional construction defect litigation is allowed to continue, insurers may abandon this marketplace in its entirety. But one thing has remained constant, the cost and availability of commercial general liability has skyrocketed, if insurance is available at all. To say that contractors commercial general liability insurance coverage is currently in a crisis mode for construction in many areas due to a number of issues would be stating the current situation mildly. Contractors are seeing significant premium increases for this coverage ranging from as high as 600% to 1,000% on a year-over-year basis in some states, but none so high as those seen in the western United States due to the high amount of construction defect claims located in the western states. The cost of this insurance is the second highest insurance cost for contractors behind only workers compensation coverage. Moreover, significant policy exclusions are currently prevalent, including exclusions for project types, such as condominiums, apartments, and master-planned developments that include a homeowners association. The increasing prevalence of construction defect lawsuits has led to the exclusion of various exposure types of construction from CGL policies. At present, California s insurance industry has begun a full retreat from covering construction of condominiums and townhomes as well as most of the residential construction. In 2004, there were only three or four insurers for tract construction in California, down from a decade earlier. Today, only one is willing to cover condominium construction under very restrictive coverage limitations. Specialty subcontractors, roofers, concrete and trim contractors are laying off workers as their insurance premiums skyrocketed as much as 1,000 percent. Of concern is that more companies are winding up their corporate entities and restarting under a different corporate entity. One of the primary reasons for this is the cost of general liability insurance or the complete unavailability of such insurance. Homebuilders are paying a $500,000 to $700,000 premium with a minimum $500,000 self- insured retention for $1 million dollars of primary general liability coverage. In the western United States, insurance costs for housing construction were running between $20k and $80k per unit. Education about these emerging CGL trends is essential, since mistakes here can and, in fact, have led to the bankruptcy of contractors and insurance companies alike. Good risk management and the proper placement of losses regarding construction is a key element in business success and ultimately the survival for contractors and their insurers. While traditional risk management can take many forms, including subcontracting to shift risk to others, contract modifications, avoiding extreme-risk projects, subcontractor bonding, and insurance requirements, there are many things a contractor can do to control loss exposure, even after the loss has been reported. The focus of this paper will be on current construction issues in contractors commercial general liability insurance coverage with a special emphasis on the proper use of self-insured retentions. Generally, CGL policies provide coverage to contractors for damages arising out of both their ongoing and completed construction operations. For a general contractor, a roof leak that damages a two-year old office building, due to an omitted flashing detail by the roofing subcontractor, would have the water damages covered under the CGL policy. Depending on the nature of the leak, the policies covering the periods during or after the construction, or only at the time of the leak, would provide coverage. The 6

7 determination of which policy or policies apply to a construction defect loss remains an issue to be evaluated under both fact and law. The roofing subcontractor itself has coverage under its own CGL policy only for the resultant and/or consequential failure of its work, but not for the work itself. An individual contractor s CGL policy will not cover their own defective work, but instead only the resultant damage. In the case of a leaking roof, the general contractor s insurance carrier would look to the roofing subcontractor s insurance carrier for compensation for the water damages. Under the above scenario, the roofing subcontractor would still be responsible to pay out-of-pocket for installation of the omitted flashing detail. Similarly, a customer of a restaurant who suffers an injury at the establishment, due to a construction defect, will seek recovery from the restaurant owners, who in turn will cross-claim against the general contractor and as well as any responsible subcontractor. If the customer tripped on a poorly-constructed concrete step, the ultimate responsibility for the personal injury costs would be covered by the concrete subcontractor s CGL policy. The subcontractor would have to pay out of its own pocket for corrections to the step itself. This is the standard type of claim that a CGL policy provides for, whether it is for injuries to persons and/or damage to property, occurring after a construction operation is completed, but attributed to that operation. The Changing Environment Given that both construction defects and the commercial liability insurance for them are not new, what are the reasons that contractors must pay close attention to significant changes in the commercial liability insurance environment and their own responses to them? In general, the reason these significant changes in the CGL environment have arisen is due to the prevalence of class-action construction defect lawsuits and aggressive marketing by a few plaintiffs firms that specialize in CD litigation. Generally, many states have made it very easy for homeowners to bring claims against developers of mass produced homes over a vast period of time since statute of limitations for construction defects can run for up to years after completion of the home. Developers of mass produced homes are strictly liable to the homeowners for the defects. Strict liability against developers is not new. Strict liability against developers began in New Jersey in The western United States did not see strict liability imposed against developers until Subcontractors generally cannot be charged with a strict liability standard. Claims against subcontractors are generally negligence-based or through a contractual liability theory (usually from the developer and/or its general contractor through the subcontractor s contract). Projects, such as condominiums, apartments, and any development with a master-plan format and a homeowners association, provide a significant opportunity for a plaintiff s attorney in a lawsuit against the project s contractors, if defective construction is present in the project. Flaws in the design, construction, and/or project management on these types of projects contributed to project problems. As an example, trade sequencing improperly coordinated by the developer/general contractor, such as the intersection of a balcony deck with an exterior stucco wall result in water damage to interior surfaces. Instead, if the balcony deck-waterproofing contractor would have been scheduled before exterior stucco installation, defect avoidance would be the result. Subcontractor s personnel may be unfamiliar with a particular new construction material or existing materials may be used in an improper application. In both cases, missed application steps may take place. The resultant defect may not be apparent until long after the project construction is completed. The laymen would assume that the developer/general contractor is either fully or partially at fault for this oversight, as would many of the subcontractor trades who work on these projects. However, due to the increasing use of contractual language and obligations cast upon subcontractors by developers in the subcontractors agreements, much, if not all, of the liability is shifted to the 7

8 subcontractor through the indemnity portion of the contract. Add to this the laws which impose joint and several liability onto several trades whose work interfaces with the work of another trade. Under the doctrine of joint and several liability, the laws in most states allow an injured plaintiff (in the construction defect context, this generally refers to the homeowner) to recover all their damages from one or any combination of defendants. It is only used when there is more than one wrongdoer; innocent parties are never held responsible for harm caused by others. Joint and several liability ensures that the innocent victim is fully compensated in cases where one or more wrongdoers are not able to pay their share of the compensation. In many cases, a small subcontractor, who only played a small part in the construction of a project, but interfaces with a larger, more responsible party could end up paying the lion s share of a settlement in which it had no more than 1% liability, just because its work interfaced with that of the larger, more responsible party and that party is uninsured or otherwise cannot pay its allocated percentage of damages. In a 200 or 300 unit condominium project, an investment by every condo owner of $500 results in a starting legal fund of $100,000 or $150,000, respectively. Or an attorney may decide to take the case on a contingency basis for a 40% contingent fee of any recovery. The successful litigation case awards can be substantial. In one recent 2002 condominium defect case in Nevada, a jury awarded $12 million on a project whose initial construction costs were $8 million. At the time, despite a $12 million verdict (when the plaintiffs only asked for $8 million) the condominium owners plaintiffs attorneys sought an additional $8.9 million in legal fees. The legal fees were more than the original cost of construction twelve years earlier. In some areas, the vast majority of projects such as condominiums, have ended up in litigation especially in the case of San Diego County in California, where 100% of these projects have seen construction defect claims and litigation. Due to the increasing trends toward more construction defect litigation and the rising costs associated with these cases, insurance companies have been overrun by claims. Their reaction has been to substantially change their past approach to commercial general liability policies in the construction arena by either not underwriting coverage or limiting the coverages by not providing the same or similar coverage previously offered in the past. Combined with less coverages, substantial premium increases have occurred, in some cases on the order of 600% to 1000%. The Self-Insured Retention and Deductible Involvement In an effort to continue underwriting in the construction arena, and to control claims costs, CGL carriers are rapidly applying self-insured retention (SIRs) limits on most, if not all, new policies they issue instead of continuing the use of liability deductibles on their CGL policies. An SIR is a provision wherein the insured agrees to be responsible for paying an amount called the Retained Limit. That amount is set forth in the policy. SIR refers to the portion of a risk or potential loss assumed by an insured that must be satisfied before coverage under the policy is triggered. See Vons Companies, Inc. v. United States Fire Ins. Co. (2000) 78 Cal.App.4th 52, Therefore, the stated policy limits are in excess of the SIR. The amount of money that satisfies an SIR for a given loss or series of losses varies, depending on the policy language used. Some SIRs are on a per claim (or per unit ) basis. Others are on a per occurrence basis or based on aggregate claims or occurrences for purposes of satisfying the SIR. The choice of which term to include for purposes of SIR satisfaction can have varied implications for the insured. This is another reason why it is so important for the terms of every SIR provision to be expressly negotiated and agreed to among all the parties, in order to avoid the pitfalls created by litigation between many parties. SIRs have moved from relatively minor sums of $5,000 to $10,000 to current levels seen in some instances of $25,000 to $250,000. One Arizona-based residential roofing contractor, with multi-state 8

9 operations, has a current SIR of $75,000 in one state and is paying CGL premiums of $1,000,000 per year. Another Nevada-based residential concrete slab foundation and exterior flatwork contractor has a $25,000 deductible and is paying $1,000,000 in CGL premiums. By way of example, let s say that claims in a 200 unit condominium project result in a successful damage award against the Arizona roofing contractor of $5,000 per unit, or a total award of $1,000,000 against the roofer. If the roofer s SIR is on a per unit basis and given the previously-cited $75,000 per occurrence SIR, none of the award would be covered by insurance. With a 5% net margin before taxes, the roofing contractor would have to do $20,000,000 in additional work to make up for this single claim. SIRs in some instances have reached as high as $100,000 per house. Some insureds have argued that per claim deductibles or SIRs should apply to an entire project as one claim. As aforementioned, SIRs have increased greatly and the policyholder s participation has also expanded greatly. The same can apply to defense costs, which may also be subject to a per claim or per occurrence deductible or SIR. SIRs may cover defense costs, but only after a $25,000 or more SIR is reached. A contractor sued on five separate projects or five units in an industrial park may end up paying $125,000 in defense costs, rather than just a $25,000 SIR. The purpose of this review and analysis is to discuss the continuing problems associated with the funding of the settlements of third party claims made against policyholders where multiple insurers are involved in progressive property damage and/or construction defect claims. The policies that have been triggered may include a variety of deductibles and/or self- insured retentions that may be interpreted differently by policyholders, their carriers and co-insurers, which causes difficulty in funding settlements and deductible recovery of the underlying third party claim against the policyholder. The following is a sample SIR provision, others can be found at the end of this material as exhibits: The insurer shall be liable only for the Amount of Loss arising from a claim which is an excess of the retention amount stated in the Declarations Page... The retention amount (a) shall apply to occurrences under this policy; and (b) shall apply separate to each such occurrence and (c) shall include all amounts under the Supplementary Payments section of this policy. The Insured s bankruptcy, insolvency or inability to pay the retention shall not increase the Insurer s obligation under this policy. In contrast, a deductible is a payment required of an insured for each claim paid by its carrier. It is basically a contribution an insured must make in accordance with the specific policy terms set forth. A review of the definition of the term deductible is discussed in the Cal. Prac.Guide. Insurance Litigation, The Rutter Group } 7397 at pages 7A/82 and 7A/83 defines a deductible as follows: Refers to that portion of the loss for which the insured is responsible. Often it is a specific sum that the insured must pay before the insurer owes its duty to indemnify the insured for a covered loss. The deductible relates to the damage for which the insured is indemnified, not defense cost. The insurer is fully responsible for defense cost regardless of the deductible amount as long as there is potential for coverage under the policy. Ostrager and Newman s Handbook on Insurance Coverage Disputes (8 th ED.) } 13.13(a) at page 629 defines deductibles as follows: 9

10 It is clear that a deductible does nothing to abrogate an insurance carrier s duties to defend its insured. Rather an insurer whose policy contains deductible will provide for the defense of an insured and, subject to policy limits, the insurer will pay on behalf of the insured the amount of any judgment or settlement of a covered claim, billing the insured for the amount of the deductible. Is there a Difference Between Deductibles and SIRs? The two main differences between deductibles and SIRs deal with:(1) policy limits and (2) the carrier s duty to defend. Under an SIR, the policy limits apply in addition to the amount paid by the insured, whereas a deductible reduces the total policy limit. As a brief example, if the insured had a $1,000,000 policy limit with a $100,000 deductible, the insured should expect to pay $100,000 and the carrier will pay the remaining $900,000 of the policy limit. In contrast, with an SIR, the insured should still expect to pay $100,000 but the carrier would pay the full $1,000,000 policy limit. In other words, the insured can expect to receive the full limits of the policy. An SIR is a portion of each claim where the insured is not covered until the SIR amount is satisfied. Accordingly, the carrier is under no duty to defend or pay a claim until the SIR is satisfied. Gen. Star Indemnity Co. v. Super. Ct. (1996) 47 Cal.App.4th 1586, However, under a deductible, the insurer has an immediate obligation to respond to a claim whether or not the deductible has yet to be paid. In reality, insurers sometimes agree to defend their insured to avoid a default. This raises the question as to whether the insurer, has waived the SIR requirement for its insured and/or its additional insureds. The Involvement of Wrap-Up Insurance Programs Wrap-Up insurance programs were developed to overcome the problems that developed in the construction defect litigation context, when multiple insurance carriers were expected to remedy a claim. Regarding Wrap Ups and SIRs generally under a wrap-up, a single policy is purchased to cover all or most project participants. The intent is that it will result in the efficient resolution of claims, mitigating litigation costs. However, allocation issues arise when the participants to a construction project disagree that they should be bound by all or part of an SIR or deductible amount. If a dispute arises, then the intent of the Wrap-Up to respond simply to claims is largely dissipated. The use of SIRs on a larger basis has in part nullified the efficiency that Wrap-Ups were intended to promote. For example, if an insured has to first satisfy a large SIR amount, the chance that the claim will be settled without ever involving the carrier is greater. The remedy to SIRs in Wrap Up programs is the need for all participants in a construction project to clearly outline their duties and responsibilities toward allocation of risk, deductibles, SIRs, and other provisions in contracting with each other. An attractive alternative for the builder or owner of a construction project is to estimate the amount of money likely to be paid out during the duration of the project by adding to the total premium to be paid by the participants. That way, the builder/owner can, himself, satisfy an SIR or a deductible, having already collected the resources from the participants as a general cost of insurance before a dispute as to allocation or apportionment can develop. 10

11 The Scope of SIRs Having outlined a general overview of recent developments and trends in the insurance aspect of construction claims, and how the use of deductibles, SIRs and Wrap-Up insurance programs interact and have become more prevalent, it is now necessary to discuss in detail the scope of SIRs and their impact on construction defect litigation. It is critical to carefully review each contract and subcontract, including the SIR provision and other relevant language, as policy language may vary and meaningfully impart how the SIR and the policy are interpreted. As previously introduced, an SIR can be exhausted on one of three basis: (1) per claim, (2) per Occurrence, or (3) in the Aggregate. In the context of an insurance contract, the term claim, generally refers to a demand for money due. Foster -Gardner, Inc. v. Nat. Union Fire Ins. Co. (1998) 18 Cal.4th 857, 879. The term occurrence generally refers to the event that triggers the insured s obligation to satisfy the SIR amount in order to trigger coverage. This can include repeated exposure to the same harmful conditions, which California courts will treat as constituting a single occurrence. Montrose Chemical Corp. v. Admiral Ins. Co. (1995) 10 Cal.4th 645, 671. The difference in the language can result in either no coverage or complete coverage for an insured once the SIR amount is satisfied. For instance, if an insured is responsible for the occurrence of an accident which results in multiple individuals filing separate claims against the insured, coverage for the insured might not ever be triggered, if the exhaustion of the SIR is on a per claim basis. As long as the none of the individual claims exceeds the per claim SIR retention amount, the excess insurance will not ever be triggered. An insured will be responsible for satisfying the SIR amount with respect to each individual claim brought against him. In contrast, if the SIR amount is exhausted on a per occurrence basis, the insured pays the SIR amount only once, thus, triggering the excess insurance for the balance of all the claims. This is because all of the individual claims resulted from a single occurrence. One final way in which SIRs can be exhausted is by aggregating the claims or occurrences. If there is such a provision, payment by the insured may be aggregated until the aggregate limit is exhausted. Upon exhaustion, the excess policy covers the rest of the insured s liability claimants. The result of the inclusion of these terms in individual policies can result in significant monetary benefit or detriment to the insured. It serves as further illustration of the importance of clear, express language in contracts, so that all of the contracts participants understand to what extent they will be financially liable. Is Self-Insurance... Insurance? The California Supreme Court some years ago was presented with the question of defining what constituted self-insurance. Its common sense answer was a simple one; it is not insurance. In a strict sense, self-insurance is a misnomer.. Quite frankly, self-insurance means no insurance. Insurance is a contract whereby one undertakes to indemnify another against loss, damage or liability arising from a contingent or unknown event. (Ins. Code 22.) Self insurance... is equivalent to no insurance.... If insurance requires an undertaking by one to indemnify another, it cannot be satisfied by a self-contradictory undertaking by one to indemnify oneself. Aerojet-General Corp. v. Transport Indemnity, 17 Cal. 4th 38, 70, n. 20 (1997) 11

12 Accordingly, self-insurance exists if the policyholder is ultimately indemnifying itself. When talking about self-insurance, one usually refers to an SIR. (Self-insurance may also come in the form of a deductible which, in some circumstances not relevant here, differs from a SIR. General Star Indemnity Ins. Corp. v. World Oil Company, 973 F. Supp. 943, (1997) In the case of General Star Indemnity Company, et al. v. Superior Court, et al. (Hard Rock Cafe America L.P. real parties in interest), 47 Cal.App.4th 1586, 55 Cal.Rptr.2d, 322 (1996), the court found that the carrier, despite its duty to defend language, did not owe such a duty until only after the claim exceeded the self-insured retention which was exhausted by the payment of the retention by the insured. In essence, the court found that although the policy did include the duty to defend, the policy, which on its face appeared to be a standard CGL form (or primary policy), was actually an excess policy covering only those amounts in excess of the policyholder s self-insured retention. In the Minnesota Court of Appeals case of Minnesota Mining & Manufacturing Co. v. H&W Motor Express Co, the court held that the retained limit is not coverage. The Kansas Supreme Court, on the other hand, in Atchison, Topeka & Santa Fe Railway Co. v Stonewall Insurance Co., 275 Kan 698, 71 P3d 1097 (Kan 2003), found that the self-insured retentions were "other insurance" that must be exhausted before the excess insurance policies must assume an obligation because the only insurance policies issued to the railroad were excess insurance policies which, by their nature, assume that there is primary coverage. The Kansas Supreme Court concluded: The SIRs are other insurance under the policies, and thus primary insurance. We further recognize that primary coverage attaches upon the happening of an occurrence An excess policy covers the loss over and above that provided by the primary insurance. the insured must exhaust its SIRs per annual policy period. We cannot ignore the stated terms of the policies, nor the reality of SIRs as primary insurance where the expectation and intent is to provide excess coverage. Similarly, the Illinois Court of Appeals in Missouri Pacific R.R. v International Insurance Co. (MoPac), 288 Ill App 3d 69, 679 NE2d 801, appeal denied 174 Ill 2d 567, 686 NE2d 1164 (1997), the Illinois trial court concluded as a matter of law that the claims arose from a single occurrence and that Missouri Pacific was required to horizontally exhaust all self-insured retentions for implicated policy periods before looking to the insurers for coverage. The Illinois Court of Appeals did not consider whether a self-insured retention is a deductible because it held that the SIR is the equivalent of underlying insurance coverage. The Illinois court reasoned that exhaustion of the self-insured retentions was required by the "other insurance" policy provisions. A significant number of other jurisdictions follow the view that self-insurance does not constitute insurance within the meaning of a liability policy. Courts have, and continue, to look at various factors in choosing whether to follow the majority or minority rule of the various states. It has been noted that since insurance is a mechanism for the transfer of risk from one person or organization to another different entity, that self-insurance while resembling traditional insurance, may not be what a layperson s understanding is. Such examination also has to involve a review of statutory rules; legislative history and public policy considerations, which all come into play. Consequently, it is extremely difficult to predict how a jurisdiction that has not decided the issue might rule. Kinds of Self-Insurance Basically, there are several self-insurance schemes presently in use in construction projects: 12

13 o Pure self-insurance. This is the complete absence of any type of insurance. The entity is considered bare. As a practical matter, most companies cannot afford to face catastrophic losses and significant litigation that can result in serious financial loss and bankruptcy; therefore, this is not usually used. o Self-insured retention. Under this concept an entity agrees to be responsible for all the amount of the claim up to a specified sum and thereafter various layers of insurance become involved. o Fronting Policies. Under this plan there is a complete retention of the risk by the entity. The obligations of the insurer come into play when the entity is unable to pay a loss sustained by a third party. Up until that point the insured fulfills the function of an insurer, adjusts the loss and agrees to pay the insured for any payment it makes. These policies are required by many states in order for the self-insured to meet governmental insurance requirements. o Retrospective Rated Policies. A program of this nature operates on the insured s loss history. Based upon the insured s claims experience during the prior year, the insurance company retrospectively sets the premium charged. This can result in either a rebate to the insured where the actual losses are less than the estimation or an additional premium if the losses exceed the estimation made by the insurer. In California, a fronting policy has been determined to be one when an insurer issues a policy of insurance but the policy also contains a deductible in the amount of the policy limits. This effectively results in the insured agreeing to indemnify the insurer, just the opposite of real insurance: A fronting policy has been described as one which does not indemnify or, apparently, defend the insured but which is issued to satisfy financial responsibility laws of various jurisdictions by guaranteeing to third persons who are injured that their claims against the insured will be paid. Aerojet, supra, 17 Cal.4th at 49, n.3. However labeled, SIR, retention, deductible or fronting policy, self insurance constitutes a threshold amount which must be exhausted before an insurer s obligation to pay is triggered. There are three major issues involving exhaustion of SIRs that a policyholder should be aware of: First, how is the SIR satisfied: on a per claim, per occurrence, or aggregate basis? Depending upon the language used under the same set of facts, the amounts one pays to exhaust an SIR can vary greatly. The second issue concerns the insured s ability to use monies paid out by other insurance to exhaust its SIR, for instance when the insured is listed as an additional insured on another entity s policy. Whether this is permissible depends upon the policy language of the excess insurance. The third major issue involves how many SIRs an insured must exhaust to reach its excess insurance when a single continuous occurrence extends out over more than one policy year. For example, suppose an occurrence causing bodily injury claims continues for five years and the policyholder has a $500,000 self-insured retention for each year. Whether the insured must pay a single $500,000 self-insured retention or five retentions totaling $2,500,000 before it triggers its excess coverage can make a big difference to the bottom line. Satisfying the Retention -- Per Claim, Per Occurrence, or In the Aggregate 13

14 The amount of money that satisfies a SIR for a given loss or series of losses varies greatly depending upon the policy language used. Some SIRs are on a per claim basis. Others are on an per occurrence basis. Still others are aggregate claims or occurrences for purposes of satisfying the deductible. What does all this mean? The word claim, when used in an insurance contract, generally refers to a demand for money due. (See Foster-Gardner, Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa. 18 Cal. 4th 857, 879 (1998). In contrast, the term occurrence is usually defined in a policy as an accident, including continuous or repeated exposure to the same general harmful conditions. (See Montrose Chemical Corp v. Admiral Ins. Co., 10 Cal. 4th 645, 671 (1995). Many occurrence policies also contain a so-called funnel clause stating that all claims arising from the same accident or exposure to the same conditions constitute a single occurrence. Even without such a funnel clause, a California court has found that 653 separate incidences of theft, none of which individually exceeded a policy s $150,000 per occurrence deductible but all resulting from the same cause, constituted a single occurrence. Accordingly, the policy s $150,000 per occurrence deductible was satisfied and the insurer was liable for the balance of the insured s $1,500,000 loss. See EOTT Energy Corp. v. Storebrand International Insurance Co., 45 Cal. App. 4th 565, (1996). The different meanings of claim and occurrence as applied to SIRs can result in large differences to an insured, from a monetary standpoint, in determining when and to what extent underlying selfinsurance is exhausted and excess insurance triggered. For example, suppose an insured has a policy with a $2,000,000 per occurrence limit excess of a $100,000 SIR. A significant accident occurs during the policy period that injures twenty (20) different people. All 20 individuals file separate claims against the insured. The insured is then found liable in the amount of $100,000 to each of the twenty claimants, with a total resulting liability of $2,000,000. If exhaustion of the $100,000 SIR is on a per claim basis, the insured must pay the entire $2,000,000 in liability itself. This is because none of the individual claims ever exceeds the per claim $100,000 SIR. Accordingly, the excess policy is never triggered. In contrast, if the $100,000 self-insured retention is exhausted on a per occurrence basis, the insured pays only $100,000, with the $1,900,000 balance paid by the excess insurer. This is because the 20 individual claims all resulted from a single accident i.e., a single occurrence, and the $100,000 per occurrence SIR is exhausted once the insured s liability exceeds that amount. The $2,000,000 excess policy is triggered and must pay any liability, here $1,900,000, which exceeds the $100,000 retention. Many self-insured policyholders believe that all progressive losses which include construction defect claims arise from a single occurrence. The events causing them to continue over a period of time are due to actions beyond the control of policyholder and/or its insurers and strictly in control of those who bring the claims and litigation and the judiciary who for the expedience of justice consolidate these claims into class actions. Due to conflicts in law regarding progressive property losses which policyholders believe are a single occurrence, such claim or allegations of multiple contribution(s) are permitted to exist. Thus, an insured can be repeatedly charged multiple deductible(s) and/or SIRs arising from the same single occurrence when clearly, only one deductible and/or one SIR should apply per loss. Policyholders also believe that the pursuit of multiple deductibles and/or SIRs by various carriers is not permissible where such demand for the payment of a deductibles and/or SIRs arise from the same occurrence or where deductibles are being asserted by carriers with a per occurrence or per claim deductible for the same loss. Such assertion is both afforded and supported by various appellate courts in that an insurer in progressive property losses must bear all sums as they relate to their payment obligations on behalf of, or in favor of, the policyholder. In Aerojet and in the appellate case of Syntex Corporation, et al, v. Lowsley Williams & Companies, et al, 98 DAR 11562, the insurer must bear the burden of all sums to which the insured would be found legally liable under the insuring agreement. In Aerojet it was found that each carrier would have a separate and distinct duty to the insured under an all sums argument which may cancel out each individual carrier s deductible. Additionally, in the case of Beaumont-Gribin Von Duil Management Co, et al, vs. California Union Insurance Company, et al. 66 Cal.App 3d 617 (1976), the court rejected the insurance carrier s position 14

15 that a deductible should apply in each claim noting that regardless of whether or not the claimants acted together and brought one claim or each brought separate claims, only a single deductible applied. The court in Beaumont-Gribin rejected the insurer s claim that separate deductibles applied and that such demand was improper and should not be allowed under California law. (SEE ALSO, Eott Energy Co, et al. vs. Storebrand International Insurance Co, et al. 45 Cal.App 4 th 565, 577 (1996), Whitaker Corporation, et al. vs. Allianz Insurance Company, et al. 11 Cal.App 4 th 1236, 1241 (1992) and Bay City Paving and Grading, et al. vs. Lawyers Mutual Insurance Company, et al. 5 Cal.App 4 th (1993) ). Courts across the country have reached similar conclusions when faced with a fact situation involving a series of related acts which can be attributed to a single cause; and the same principle is applied whether the coverage involves property, liability or fidelity insurance. In Haerens v. Commercial Cas. Ins. Co. (1955) 130 Cal.App.2d Supp. 892, , the employee's scratching of numerous window panes gives rise to a single deductible, not one per window. Just by way of some brief examples, in State Farm Fire & Casualty Co. v. Elizabeth N. (1992)9 Cal.App.4th 1232, [12 Cal.Rptr.2d 327, it was found that repeated acts of child abuse resulted from the insured's continuing negligent failure over several months to monitor activities of her pedophile husband, thus triggering the "$100,000 per occurrence" liability limitation. In the case of Chemstar, Inc. v. Liberty Mut. Ins. Co. (9th Cir. 1994) 41 F.3d 429, 433, there were twenty-eight incidents of pitting involving twenty-eight different homes and multiple claimants, but caused by the failure of a lime plaster manufacturer to warn of limited application requirement, thus triggering only one deductible. In Mead Reinsurance v. Granite State Ins. Co. (9th Cir. 1988) 873 F.2d 1185, 1188, there were eleven separate lawsuits alleging excessive force by police, were founded upon alleged policy of condoning police brutality, and thus constituted a single "occurrence". In Appalachian Ins. Co. v. Liberty Mut. Ins. Co., supra, 676 F.2d at p. 61, the insured's pattern of employment discrimination constituted one "occurrence" even though it resulted in multiple claims over an extended period of time. Additionally, the cases of Associated Indem. Corp. v. Dow Chemical Co. (E.D.Mich. 1993) 814 F.Supp. 613, 623" revealed that damage to different buildings caused by same defect in building material constituted one "occurrence". Transport Ins. Co. v. Lee Way Motor Freight (N.D.Tex. 1980) 487 F.Supp. 1325, 1329 found that an insured's discriminatory policies constituted one "occurrence" despite insured operating from four separate trucking terminals. In Michaels v. Mutual Marine Office, Inc. (S.D.N.Y. 1979) 472 F.Supp. 26, 29, two hundred dents and holes caused by "grab buckets" dropped over nine-day period constituted one "occurrence". SIRs can also be exhausted by aggregating claims or occurrences together. Including an aggregate provision in the SIR policy language may provide an insured with a significant benefit. Without an aggregation feature, the SIR amount applies to each claim. The insured must exhaust that amount separately, over and over again as many times as there are claims. Before the insurer has any obligation on any single claim, the SIR must be exhausted for that claim. If, by contrast, there is an aggregation provision, payments made by the insured may be aggregated until the aggregate limit is exhausted. Thereafter, the insured will cover any additional claims from dollar one. An aggregation feature obviously provides added protection to an insured, and can therefore be expected to cost an additional premium amount. An aggregation feature is not essential to a self-insured retention, which can be fully operable without an aggregation feature. (General Star Indemnity Company v. Superior Court, 47 Cal. App.4th 1586, 1594 (1996). 15

16 Using the prior hypothetical with and without aggregates, one can see the effect an aggregate can have. Suppose the $100,000 SIR from the prior hypothetical was both per claim and in the aggregate. A single $100,000 claim therefore exhausts the $100,000 per claim/aggregate SIR, with the remaining $1,900,000 in liability covered by the excess policy. In comparison, without the aggregate, all $2,000,000 in liability is the insured s responsibility because no single claim ever exceeded the $100,000 SIR. The effect of adding an aggregate provision into a SIR can have a significant effect on when the SIR is exhausted. At a minimum, policyholders need to understand that the amount needed to exhaust the SIR can vary greatly depending upon which policy language is used and the nature and extent of a policyholder s losses. This presents a very important question. We know the SIR must be exhausted before an excess insurer becomes obligated to pay. Does it matter, however, where the funds used to exhaust the SIR come from? Put another way, can the payments made to exhaust the SIR come from a source other than the policyholder itself, such as another insurer? Careful consideration of SIR policy language often leads to the conclusion that it can. The Armstrong Election in Progressive Loss Cases When the California Supreme Court adopted the "continuous trigger" theory for progressive damage claims in California under Montrose v. Admiral Ins. Co. (1995) 10 Cal. 4th 645 ("Montrose II"), a new set of issues surfaced pertaining to the allocation of coverage for such claims. The California Court of Appeal tackled many of those issues in Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. (1996) 45 Cal.App.4th 1. With the Supreme Court's decision declining review of Armstrong, that opinion provides important guidance for contractors, owners, design professionals and suppliers on the allocation of general liability insurance coverage for construction-related damage claims. Several of the Armstrong rulings are now know as Armstrong Elections, or the selection by a policyholder to a specific policy, which would attach to a progressive property loss. The Armstrong case, which arises from a dispute over coverage for asbestos bodily injury and property damage claims, establishes much needed ground rules for the allocation of coverage for continuous trigger or continuous property damage claims. From the insured's perspective, the court concluded that each policy (and each insurer) has an independent obligation to respond "in full" to a claim up to the policy limits. This obligation by insurers provides insureds the flexibility to maximize their insurance assets by selecting the appropriate policy or policies to respond to a progressive damage claim. The insured's policy selection does not determine the final allocation of a claim because an insurer that pays a claim in full still has equitable contribution rights against any other carrier having the same obligation to pay the claim but for the selection by the policyholder. The picked insurer is entitled to seek contribution from other insurers based on the "other insurance" clause in its policy and a right of equitable contribution. Those insurers are still bound by their specific coverage language. The Armstrong court also approved the trial court's allocation based on policy limits and time on the risk, but cautioned that allocation methods must be determined from the specific language of the policies at issue in each case. Armstrong also addressed the insurers' contention that a policyholder with years of self-insurance or no insurance must share in responsibility for a risk spanning multiple policy periods. Following standard CGL policy language that obligates an insurer to pay "all sums" for which the insured is legally obligated to pay because of bodily injury or property damage, the court again found that each carrier has an independent obligation to respond to a claim in full, irrespective of other policies that contain deductibles or self-insured layers. 16

17 Similar to California Pacific Homes, Inc. v. Scottsdale Ins. Co., 70 Cal. App. 4th 1187 (1999), the most important ramification of Armstrong is that it dispels any notion that an insured must exhaust all applicable deductibles (or SIRs) before receiving benefits from any of several triggered policies. In fact, Armstrong seems to permit an insured to target policies with low levels of self-insurance when seeking coverage for a continuous damage claim. The Armstrong decision provides much needed guidance for insureds and insurers in unraveling the numerous coverage issues associated with progressive damage claims. In light of Armstrong, insureds are now better able to maximize insurance benefits for continuous damage claims and insurers can then equitably allocate the coverage between all applicable policies. Armstrong cites, albeit does not follow, the apportionment formula set forth in Ins. Co. of North America v. Forty-Eight Insulations, 633 F. 2d 1212 (6th Cir. 1980). Will Other States Follow Armstrong Elections in Progressive Loss Cases? Citing Illinois law, in contrast, the Illinois Supreme Court, in John Burns Construction Co. v. Indiana Insurance Co., 189 Ill. 2d 570 (2000), promulgated a "targeted tender rule" which allows the insured to select which concurrent primary insurer must respond to a particular suit or claim. However, unlike California and a number of other states, the targeted insurer in Illinois has NO right to contribution rights from the "deselected" insurers (even if the deselected insurers have notice of the claim and even if the targeted insurers' policy contain other insurance clauses). This rule has been criticized by Justice Quinn in his concurring opinion in American National Fire Ins. Co. v. National Union Fire Ins. Co., 343 Ill. App. 3d 93 (2003). In Illinois, whenever an insured has the luxury of being concurrently covered under two or more separate insurance policies for the same occurrence, that insured may choose which policy it wants to respond and "target" its tender of defense to that carrier. This has most frequently happened in the context of construction site bodily injury claims, but the practice has potential application to any situation in which an entity can claim concurrent coverage under more than one policy either because the entity qualifies as an "additional insured" under a policy that it did not purchase, or because it happened to purchase two or more policies that provide overlapping coverage. A "targeted tender" was first recognized in Institute of London Underwriters v. Hartford Fire Insurance Co., 234 Ill. App. 3d 70, 599 N.E.2d 1311 (1st Dist. 1992). There, Great Lakes Towing Company was covered as a named insured under its own Hartford policy and as an additional insured under an Institute of London policy. The Illinois Appellate Court held that Institute of London was not entitled to seek contribution from Hartford for one half of a settlement it paid on behalf of Great Lakes. The court found that Great Lakes did not tender the defense of the personal injury lawsuit to Hartford, though it had provided notice, since Great Lakes had specifically told Hartford s adjuster that it did not want Hartford to indemnify the settlement. Institute of London, 599 N.E.2d at In recognizing an insured s right to choose between two insurers whose policies each provide coverage, the court noted certain interests an insured may wish to protect by targeting only one insurer including the interest in reducing future premiums and optimizing loss history. Id., 599 N.E.2d at After Institute of London, "targeted" insurers attempted to avoid the "target" by seeking contribution from the other carrier that provided concurrent coverage through enforcement of "other insurance" provisions. However, this tactic was expressly disallowed in Bituminous Casualty Corp. v. Royal Insurance Co., 301 Ill. App. 3d 720, 704 N.E.2d 74 (3rd Dist. 1998). The Bituminous Casualty appellate 17

18 court held that the insured could select one insurer to provide its defense and indemnification. The chosen insurer, Bituminous Casualty, could not seek equitable contribution from the other insurer, Royal Insurance, which was not designated by the insured. Bituminous Casualty, 704 N.E.2d at In reaching that conclusion, the court rejected Bituminous argument that the "other insurance" clauses found in both policies mandated contribution by both insurers stating: "It is only when an insurer s policy is triggered that the insurer becomes liable for the defense and indemnity costs of a claim and it becomes necessary to allocate the loss among co-insurers. The loss will be allocated according to the terms of the "other insurance" clauses, if any, in the policies that have been triggered. As discussed above, Royal s policy was not triggered and its obligation to defend and indemnify Johnson Construction was excused by the targeted tender to Bituminous." Id., 704 N.E.2d at 79. The above scenario may also present a danger to an insured or additional insured as that insured entity must "knowingly forego" one available coverage in order to effectively "target" its tender of defense exclusively to the other available concurrent coverage. In Dearborn Insurance Co. v. International Surplus Lines Insurance Co., 308 Ill. App. 3d 368, 719 N.E.2d 1092 (1st Dist. 1999), the insured was covered under both its own policy with ISLIC and as an additional insured under a co-defendant s policy with Dearborn. The co-defendant had already requested that Dearborn defend both insureds. Thus, a "targeted tender" to Dearborn was being attempted. However, the insured also provided notice to its own insurer, ISLIC. Dearborn, 719 N.E.2d at The appellate court concluded that this notice letter was enough to trigger ISLIC s duty to defend even though the insured did not specifically request a defense. Id., 719 N.E.2d at Moreover, the court held that the insured did not "knowingly forego" a defense by ISLIC because it did not specifically tell its ISLIC not to defend the action against it, rather it left the decision to ISLIC. Id. Under Illinois law, and insured can request the Deactivation of Tender of Defense. In this regard, Illinois appellate courts have expanded the concept of "targeted tender" to hold that if an insured discovers that it has additional coverage from a second insurer in the course of the lawsuit against it, the insured may "deactivate" its original tender and "de-select" the insurer it originally targeted, in favor of the newly-discovered insurer. In Alcan United, Inc. v. West Bend Mutual Insurance Co., 303 Ill. App. 3d 72, 707 N.E.2d 687 (1st Dist. 1999), Alcan initially tendered its defense of a personal injury suit to its own insurer, Reliance, before it discovered that it also had coverage as an additional insured under a West Bend policy issued to a co-defendant. Alcan then attempted to "deactivate" its tender to Reliance and target West Bend alone to defend and indemnify it. The court concluded that an insured should be permitted to deactivate coverage "when the deactivation occurs upon the discovery of other coverage not known to have been in existence at the time the first tender took place." Alcan, 707 N.E.2d at 695. In Illinois, insurance companies need to respond to this targeting so they began the process of utilizing "Anti-Target" Cooperation Clauses. The courts recognized this position as a limitation to a "targeted tender" by an insured. In American Country Ins. Co. v. Kraemer Brothers, Inc., 298 Ill. App. 3d 805, 699 N.E.2d 1056 (1st Dist. 1998) the "targeted" insurer s policy contained a cooperation clause that required any named insured or additional insured to tender the defense of a claim to "any other insurer which also has available insurance." When the additional insured failed to tender the defense of the claim to its own carrier, American Country denied the "targeted tender" on the ground that the additional insured breached this cooperation clause. The additional insured argued that such a requirement was against the public policy recognized in Institute of London and limited its freedom to select which insurer it wanted to defend. The appellate court sided with the insurance company and held that such a requirement in a cooperation clause was enforceable and was not against public policy. Id., 699 N.E.2d at Especially helpful to the court s decision was the fact that this particular policy language was included in endorsement forms that had been accepted by the Illinois Department of Insurance. The SIR and the Duty to Defend and/or Indemnify 18

19 As articulated above, an insurance policy which contains an SIR is treated as excess insurance, since coverage is not triggered unless and until the insured becomes legally obligated for a loss in excess of the satisfied SIR amount. Until that point, the insurer has no duty to defend or indemnify the insured. Gen. Star Indemnity Co. v. Super. Ct., supra, 47 Cal.App.4th 1586, Unless the policy provides otherwise, the insured must bear its own defense costs until the SIR is exhausted: As a self-insurer [Insured] was solely liable for its defense costs attributable to the extent of the SIR, just as a primary insurer is responsible for the defense expenses attributable to the extent of its coverage. City of Oxnard v. Twin City Fire Ins. Co. (1995) 37 Cal.App.4th 1072, Defense obligations of excess insurers arise only when primary insurance coverage is exhausted. (Id. at 1077.). In City of Oxnard, the City sued two of its liability insurers to contribute to the City s defense in an underlying action. Both policies expressly stated that only excess coverage was being provided and would only be triggered when The City of Oxnard became legally obligated for a loss in excess of its retained limit (SIR). The Second District Court of Appeal held that since the defendant insurers provided coverages that were excess over amounts of the insured s SIRs, and the SIR amounts were never exhausted in the underlying action, they had no duty of contribution to the insured s defense. (Id. at 1080.) The only exceptions are where the policy containing an SIR expressly requires the insurer to defend before the retention limit is exhausted, the insurer will be liable to the insured for defense costs incurred. Montgomery Ward & Co. v. Imperial Casualty & Indemnity Co., supra, 81 Cal.App.4th 356, 373. This is yet another example, of the importance of the contractual terms, which will always govern, unless contrary to public policy. In addition, where the insurer enters into a settlement agreement which refers to the insurer as a primary carrier, the insurer will not be treated as an excess carrier; it will be treated as a primary carrier: See Stonewall Ins. Co. v. City of Palos Verdes Estates, (1996) 46 Cal.App.4th 1810, Can One Exhaust an SIR Through Payments Made by Another Insurer? The benefit to a policyholder of having someone other than itself pay its deductible is self-evident. Courts applying California law, on at least two occasions, have found that monies paid by primary insurers can be used to exhaust an insured s SIR and trigger its excess coverage. In General Star National Ins. Group v. World Oil Company, 973 F. Supp. 943 (C.D. Cal. 1997) the insured, World Oil, had purchased insurance from General Star in excess of a $250,000 SIR. World Oil then purchased a primary policy from Hartford Insurance for purposes of covering the $250,000 SIR. Subsequently, an accident occurred which resulted in a $775,000 settlement of which Hartford paid its $250,000 and General Star the remaining $525,000. General Star then sued World Oil seeking reimbursement for the amount of the SIR, asserting that, under the terms of its policy, World Oil was prohibited from obtaining insurance for the amount of the deductible. The District Court, in rejecting General Star s position, held: The General Star policy nowhere states that the insured cannot purchase coverage for the amount of the deductible. If General Star intended the language and the requirements to which it points to prohibit the insured from obtaining separate coverage for the deductible, General Star failed to state this intention in unambiguous terms. World Oil, supra, 973 F.Supp. at 948. In The Vons Companies, Inc. v. U.S. Fire Insurance Company, 78 Cal. App. 4th 52 (2000), a California Court of Appeal, relying in large part on World Oil, found that Vons $1,000,000 SIR was exhausted by a $1,000,000 payment made by National Union on behalf of its named insured, Longs Drugs, and its additional insured, Vons, as part of a $1,540,000 settlement. The Court of Appeal in explaining its reasoning stated: 19

20 Nowhere does the SIR expressly state that Vons itself, not other insurers, must pay the SIR amount. Because the SIR was subject to the other insurance provisions, which also made the Vons policy excess if there were another policy covering the accident, Vons as a reasonable insured could read the policy as permitting the use of other insurance proceeds to cover the SIR amount. Vons, supra, 78 Cal. App. 4th at Because Vons was jointly and severally liable with Longs for the underlying liability, the $1,000,000 payment toward the settlement paid by National Union, Longs insurer on behalf of both Longs and Vons, exhausted Vons SIR, which was based upon Von s legal obligation to pay damages. Accordingly, under the terms of its policy, USF was obligated to pay the $540,000 balance of the settlement. Vons, supra, 78 Cal. App. 4th at The Vons court also referenced policy language it saw in the Longs policy (which contained a SIR that was previously satisfied) and hinted it would have required the insured, not some other insurer, to pay the SIR. Although our decision does not apply to the Longs policy, which is not at issue here, that policy also appears to have tackled the issue of other insurance, stating: In the event there is any other insurance, whether or not collectible, applicable to an occurrence, claim or suit within the Retention Amount, you will continue to be responsible for the full Retention Amount before the Limits of Insurance under this policy apply. Regardless, if USF wanted to make it clear that Vons was required to pay the SIR amount, it should have said so. Vons, supra, 78 Cal. App. 4th at 63, n.4. Taken together, World Oil and Vons stand for the proposition that an insured can use other insurance that applies to a given loss to exhaust its SIR(s) unless the policy contains language that expressly states it cannot. In a construction setting, the rule of law emanating from World Oil and Vons raises some interesting potential applications. Specifically, many major construction projects contractually require that the general contractor and subcontractors obtain liability insurance up to certain specified limits and name the owner as an additional insured on the policies. There is nothing preventing an owner from structuring these contractual insurance requirements so that they correspond with and can be used to satisfy the owner s SIR. Accordingly, an owner can use policies purchased by its general contractor or subcontractors and favorable SIR policy language in its own excess insurance to significantly reduce, if not eliminate, the use of its own funds to exhaust a SIR. The savings in such circumstances can run into the millions. Satisfying SIRs When Coverage Under More Than One Policy Year is Triggered On occasion, bodily injury or property damage can be continuous or progressive in nature and thereby trigger coverage under more than one policy year. (See Montrose Chemical Corp v. Admiral Ins. Co., 10 Cal. 4th 645, 689 (1995); Alpha Therapeutic Corp. v. Home Ins. Co., 90 Cal. App.4th 1330, 1335 (2001). Where an insured has primary insurance in each of these years, California courts have generally held that each of the primary policies must be exhausted, often referred to as horizontal exhaustion before any excess insurance is triggered. (See Also, Community Redevelopment Agency v. Aetna Cas. & Surety Co., 50 Cal. App. 4th 329, 339 (1996). If, instead of primary policies, the insured has SIRs sitting below the excess insurance for each policy year, how many SIRs must the insured exhaust before excess insurance applies arises? The significance of having to pay a single $500,000 SIR, as opposed to five $500,000 SIRs, is obvious and important to a policyholder. 20

21 Two California cases have addressed this issue, both holding that an insured need only exhaust a single SIR in order to reach excess insurance for each triggered policy year. In reaching the decisions, both courts relied upon policy language which distinguished between SIRs and insurance and prior California decisions holding that self-insurance is not the equivalent of insurance, See Montgomery Ward & Company Incorporated v. Imperial Casualty and Indemnity Company, 81 Cal. App. 4th 356 (2000); California Pacific Homes, Inc. v. Scottsdale Ins. Co., 70 Cal. App. 4th 1187 (1999). As stated in Montgomery Ward the Insurers policies state they are excess over a specifically described SIR and will cover a claim when that SIR is exhausted. 81 Cal. App. 4 th at 369. Consequently, as long as a policyholder s liability exceeds the amount of the largest applicable SIR, all SIRs are exhausted and the insurers policies triggered. Thus, if a policyholder has excess policy language similar to that found in Montgomery Ward, supra and California Pacific Homes, supra, which is likely because the language at issue in those cases is commonly used, a policyholder need only exhaust a single SIR to reach the coverage provided by its excess policies. Having to exhaust only a single SIR to trigger multiple years worth of coverage is a significant benefit to any policyholder. This raises yet another issue. Can other insurance be used to exhaust an SIR obligation in the continuous injury context discussed here. There are traditionally four types of other insurance clauses which need to be reviewed in conjunction with the loss and the policy(s) applicable: o Pro Rata Clause. Such a clause provides that if other insurance exists, the insurer will pay its pro rata share in relation to the insurers respective liability limits. In other words, this would be the proportion one insurer s policy limits bears to the aggregate limit of all other valid and collectible insurance. o Excess Clause. The insurer s expense is limited to the amount of the loss that exceeds all other valid and collectible insurance and its total exposure is limited by the limits of the policy containing the excess clause. o Escape Clauses. Simply stated this type of clause generally provides that the insurer is relieved from any obligation to the insured if other coverage is available. o Tailor-Made Clauses. It is extremely difficult to characterize these types of clauses because they are specifically drafted to cover specific types of risks and are meant to address specific requirements of an insured. Generally, this type of clause is a combination of the other three. While no published case has yet squarely applied the decisions in Montgomery Ward and California Pacific Homes in conjunction with those in World Oil and Vons, taken together, these cases stand for the proposition that multiple SIRs can be exhausted by means of monies paid out under a single primary policy that applies to the same continuous injury. Conceivably, this means that multiple years of excess insurance sitting above SIRs, which could each represent millions of dollars worth of coverage, can be accessed without the policyholder having to pay a single dollar. Bankruptcy, Insolvency and the Self-Insured Retention Policyholders and their insurers always have to be concerned about the problems of insolvency and/or bankruptcy of the policyholder and its effect on third party claims. In the case of a self insured policyholder, this remains especially important since the outcome of the claim may depend on the solvency of the policyholder. Generally, when a policyholder declares insolvency or goes bankrupt, it 21

22 will have little or no effect on the third party claim since insurance is coverage is generally not affected by the bankruptcy of the policyholder. In most jurisdictions, courts will look at the policy itself to make a determination as to the conditions of the coverage and the claim for which the coverage is made against to determine whether or not a bankruptcy will have an effect on the obligations of an insurer where a self- insured retention is involved. In January of 1998, the Illinois Court of Appeal undertook this question in The Home Insurance Company of Illinois, et al. vs. Carl Hooper, et al. The Home court addressed the issue of whether the trial court properly determined that the self-insured retention provision of the subject policy was a condition precedent and did not constitute a violation of the Illinois Insurance Code. Under Section 388 of the Illinois Insurance Code (215 ILCS 5/388 (West 1994)) it requires all liability policies to contain a provision which guarantees that the insolvency or bankruptcy of the insured will not release the insurer from payment of damages from injuries or loss occurring during the term of the policy. Specifically, the statute states in pertinent part: "No policy of insurance against liability or indemnity for loss or damage to any person other than the insured, for which any insured is liable, shall be issued or delivered unless it contains in substance a provision that the insolvency or bankruptcy of the insured shall not release the company from the payment of damages for injuries sustained 215 ILCS 5/388 (West 1994) The plain language of section 388 makes clear the legislative intent to prevent insurers from using the insured's bankrupt condition and resulting inability to make actual payment to satisfy a judgment or any portion thereof as grounds to avoid payment on a policy. Home asserted that under the express language of the policy actual payment of the $250,000 is a condition precedent to its obligation to pay damages in excess of the self-insured retention limit. The subject policy issued by Home also contained the following provision: "Bankruptcy or insolvency of the named insured shall not relieve the company of any of its obligations hereunder." However, the unambiguous language of the self-insured provision contained in the instant policy would release Home from the obligation of payment under the policy due to Lester's bankruptcy. Lester's pending bankruptcy petition will almost certainly make it impossible for Lester to pay the initial $250,000 of any judgment. The operative effect of the language of the self-insured provision is directly contrary to the public policy as declared by the legislative enactment of section 388. Home's characterization of the self-insured retention clause's requirement of "actual payment" by Lester of the retention amount as a condition precedent to its obligation to pay on the policy is also unavailing due to the same public policy considerations. The Home court declared that irrespective of the language contained in the subject policy, section 388 prevents Home from avoiding making payment of that portion of a judgment in excess of $250,000. Therefore, Home is obligated to pay any portion of an award to the Hoopers that is in excess of $250,000 up to the $1 million limit of the Home policy. In an endorsement of the policy at issue in this case, Home's liability is described as being limited to pay only those: 22

23 "Claims which resulted in the amounts cumulatively equaling or exceeding $250,000, such that the amounts paid or payable by the company, plus the amounts paid or potentially payable by the Named Insured, shall equal $1,000,000." The express language of the policy clearly defines Home's liability to pay claims in amounts cumulatively exceeding $250,000, such that the amounts paid or payable by the company, plus the amounts paid or potentially payable by the named insured, shall equal $1 million. Under the aforementioned provision, Home is obligated to indemnify Lester for that portion of the judgment or settlement exceeding $250,000, irrespective of Lester's inability to pay the claimed retention amount. Lastly, but certainly not least, the policyholder asserts that Home's coverage was required to drop down and pay the policyholder s self-insured retention if the policyholder became bankrupt or insolvent. In reviewing the language in the policy, it Home court determined that it was clear that there is no drop down provision requiring Home to pay the first $250,000 under these circumstances. In this case, Home's obligation is similar to that of an excess insurer's obligation to provide coverage when an underlying insurer has become insolvent. The Home court determined that Home retains the obligation to cover any judgment in excess of $250,000 but is not obligated for the first $250,000. While courts have held that an excess insurer has an obligation to provide coverage when an underlying insurer has become insolvent, with coverage beginning where the unpaid underlying insurance was to have left off, the excess insurer is not responsible for liability below limits contained in the excess policy. See Also, Hartford Accident & Indemnity Co. v. Chicago Housing Authority, 12 F.3d 92, 96 (7th Cir. 1993); Hudson Insurance Co. v. Gelman Sciences, Inc., 921 F.2d 92, 95 (7th Cir. 1990). Therefore it remains important for both a policyholder and its insurers to examine both the language of the bankruptcy and self-insured retention provisions of the policy when faced with a bankruptcy or insolvency issue while third party claims are pending. Claims-Made Versus Occurrence Policy Type Exclusions An important distinction with CGL policies is when the claim is filed versus when the CGL policy was in effect. Many contractors are unaware of the ramifications of this distinction, when purchasing insurance. Thus contractors may sincerely believe that since they have always had CGL insurance, they are covered from any claim. Nothing could be further from the truth, though, and contractors must understand this key insurance difference. CGL policies are written either on a claims-made basis or on a occurrence basis. Claims-made refers to the fact that the policy only covers claims made on the insurance policy during the policy period. Occurrence refers to the fact that the policy covers claims made on the insurance policy from events occurring during the policy period irrespective of when the claim is filed on the policy. The distinction is not important with many policies, such as a contractor s equipment insurance policy, since claims will be filed while the policy is in effect. However, a contractor may be faced with a claim on a project several years after construction completion especially since many of the claims discussed in this paper refer to construction defect claims and litigation. The occurrence policy provides important coverage for hidden or latent construction defects. The difficulty facing many contractors is that they typically may not stick exclusively with one insurance carrier for work over a five to ten-year period. Yet under most state laws, contractors are 23

24 often responsible for their work up to ten years or possibly more. A contractor switching from one carrier to another may also be changing policy types from a claims-made to an occurrence policy. Thus the contractor may be confronted with a gap in insurance coverage and possibly no coverage for the defect claim. A tail may need to be purchased for the claims made policy as a supplement to cover potential claims on past work. Defense Cost Exclusions Given that any litigation is expensive, many CGL carriers, in an effort to control their exposure, are excluding defense costs from policies. On a 200-unit condominium project, subcontractors being sued can expect to spend anywhere from $3,000 to $5,000 per month defending themselves over the 18- month to 24-month time frame of active litigation on this case. Thus defense costs are subject to a number of exclusions. An insurer may state in the policy that they have the right, but not the obligation to defend the contractor. Or it may simply state that the contractor will bear all defense costs for the insurer s attorneys in defending a CGL claim. A third type of defense costs exclusion is where a successful judgment is obtained against the CGL carrier that may exceed coverage limits. The CGL policy may state that defense costs are within the policy limits and thereby will act to reduce the amount of available coverage to satisfy an award against the policyholder. Self-Insurance Considerations The SIR differs from a deductible because the insured performs all the functions normally undertaken by an insurance company for losses within the SIR, including claims adjusting, audits, defending, funding and paying claims, as well as the possibility of complying with applicable state and federal laws and regulations (even though this may only be true of mandatory coverage issues like Workers Compensation). Under a self-insured retention plan, the insured may assume a designated portion of property, general liability, automobile and other losses. In most cases, the insured pays claims from its own funds up to the self-insured retention (SIR). Payments should include actual loss costs, investigative expenses and legal costs associated with the loss. As an insured, you can generally select an SIR on the basis of an occurrence, per claim and potentially make them subject to a cap, which is referred to as an aggregate limit, which will limit the total amount of self- insured retentions an insured will have to pay regardless of the number of claims made against the policy. However, given current underwriting and market conditions, some insurers may not offer an aggregate limit on self-insured retention payments. There are advantages and disadvantages with a program of this type of the self-insured retention plan which include: 1. Premium Savings Advantages: A major advantage may include significant premium savings. The savings depend in part upon the size of the self-insured retention and past loss experience. There is also the consideration of improved and less expensive coverage in the excess market. 2. Control of Claims Greater control, and a desire for improved handling of claims is an important reason for utilizing a selfinsured retention program. The insured is responsible for handling all aspects of claims that are less than 24

25 the SIR that applies to a single loss. The insured has the opportunity to control risk by accepting it under the self-insured policy and resolving the claim, or examining the potential of transferring that risk to another specific policy of insurance, (i.e. prior insurance coverage, other insurance coverage, under an additional insured endorsement etc.). The insured may elect to contract claims handling to an outside party or to adjust them itself. The policyholder gets the opportunity to control the defense and settlement of smaller claims thereby keeping them out of their experience rating. 3. Cost Predictability An important advantage associated with an SIR program is cost predictability, cost control and, hopefully, cost stabilization. The insurance marketplace is characterized by rate cycles in which prices are reduced periodically and then dramatically increased. These cycles cause substantial difficulties in budgeting from year to year. A SIR program does not eliminate these cycles, but it does reduce their impact as the percentage of change affects a much smaller premium base. 4. Risk Management Flexibility Self-funding increases flexibility in a Risk Management Program. The insured is in a better position to react to changes in the insurance marketplace, as well as to its own risk bearing capacity. For example, the self-insured retention levels can be raised or lowered by the insured to affect insurance and claim costs. This can be an invaluable tool in the budget process and in controlling costs to the insured 5. Direct Benefit from Loss Control Measures A self-insured retention program allows insureds to benefit directly from its efforts in loss control. Loss control involves loss prevention, which controls frequency, as well as loss reduction, which controls the frequency of claims, which causes the underwriter to pay for fewer losses and thereby increases profitability. Under a self-insured retention program, the insured pays only its actual losses, thus benefiting directly from any loss that is prevented. 6. Fraud Prevention /Loss Control With an insured directly involved in the claims handling process, it will know when a fraudulent claim is being made, based on the insureds direct involvement in the underlying activity leading up to the claim. Additionally, the insured will know if the claim is exaggerated giving the insured the ability to resist these types of claims thus controlling its ultimate exposure and claims payment(s). 7. Improved Public/Customer Relations With an insured directly involved in the claims handling process, it brings the insured in direct contact with many of its customers who many times are the claimant. While sometimes difficult in a claims context, business relationships can be improved when the claimant will know that the insured has a direct interest and concern regarding the claim. The satisfactory resolution of the claim may lead to an enhanced relationship leading to further business ventures. 1. Additional Risk Assumed Under SIR Program Disadvantages: The insured is responsible for many losses which were previously transferred to an insurance company. 25

26 2. Additional Administrative Cost, Time and Expense Insured personnel are actively involved in investigating, evaluating and settling claims. You assume all the cost for losses at your organization, up to a certain limit. The policyholder must assume responsibility for handling claims (or hire a TPA) for losses within the retention limits set in the policy. 3. Safety and Loss Prevention While strong safety and loss prevention procedures are important to any insurance program, they assume even greater importance in self-insurance programs. One of the Risk Management Department's prime responsibilities is the development, enforcement and monitoring of an effective safety and loss prevention program. Toward that end, insureds should welcome suggestions from the insureds employees as to how procedures and program may be improved. A self-insured plan may be the right insurance solution for organizations that want to assume more responsibilities for their own losses in exchange for more control over insurance costs. When deciding to accept more risk through deductibles or self-insured retentions, it will be necessary to conduct an analysis of your claims history to determine the level of retention that makes the most sense financially and/or to evaluate the credit an insurer may be offering for your acceptance of a self-insured retention. Detailed loss runs will be needed to conduct this analysis. In evaluating the cost-effectiveness of a selfinsured retention, loss runs including details on allocated loss expenses on a per claim basis may be extremely valuable.when evaluating small SIRs involving frequent, but low severity claims (where outside legal counsel will be rarely needed and other allocated expenses will be minimal) the need to know the allocated expenses in connection with past claims is not as important. Policyholders selecting a self-insured retention must be aware of the incident and/or claim reporting requirements in their insurance contracts. Some SIR endorsements actually amend the loss reporting requirements that are contained in the basic policy and these should be clearly understood. Often, a claim will need to be reported only if it appears that it will exceed the SIR or a stated percentage of it.whether considering a self-insured retention, there are enough differences among policy and endorsement provisions that a complete review of all contract language is essential before accepting either. Understanding the risks involved and the administrative responsibilities are critical to the success of any loss retention program. Conclusion A policyholder in construction defect cases may minimize and, in some cases, eliminate its obligation to exhaust a SIR while triggering its excess coverage. For currently pending and future claims, policyholders with self-insured obligations, SIRs, deductibles or fronting policies, should look at the relevant policy language to see if they are paying too much in these complicated cases. By focusing on the SIR policy language and using a little creativity and aggressive approaches, insureds can also structure their future self-insured obligations so as to minimize how much they might have to pay as well as maximize the benefits of their insurance coverage over the SIR. For policyholders, the bottom line is that an SIR should be used as a tool toward resolving claims in an efficient and effective manner, using the SIR only when needed, and tapping into any excess or other insurance coverage when necessary. 26

27 Knowledgeable contractors can avoid, or at the very least, minimize losses in construction defect cases by placing themselves in a position to control the claim rather than having the claim control the selfinsured policyholder. Special Notation; The materials contained within this publication have been prepared to highlight certain complex issues of construction insurance related matters. It is not meant to provide legal advice which should always be sought from competent legal counsel specializing in the specific area of law being sought. This material is for informational and educational purposes only and is not to be utilized in any litigation. This copy of SIRs, Deductibles and the Armstrong Elections, How Will Contractors and Their Subs Survive in the Future of Construction Defect Cases? is the written material associated with the Orange County Bar Association s Construction Law Section originally presented at the Windham Hotel on October 19 th, 2006 The authors makes no warranty or guarantee as to the cases and opinions cited. This handout material article is protected under copyright laws of the United States of America and others nations affording protection for written materials. Comments regarding this publication should be directed to David Stern, c/o West Coast Casualty Service, Inc., 1445 East Los Angles Avenue Suite 205 Simi Valley California or by to; [email protected] Self Insured Retention Endorsement (Defense Costs in addition) THIS ENDORSEMENT CHANGES THE CERTIFICATE. PLEASE READ CAREFULLY This endorsement modifies insurance provided under the: Commercial General Liability Coverage Part SCHEDULE Self Insured Retention Amount $ Per Occurrence Level of notification of potential penetration 50% of the Self Insured Retention Amount The insurance provided by this policy is subject to the following additional provisions, which in the event of conflict with any other provisions elsewhere in the Certificate, shall control the application of the insurance to which this endorsement applies: I Self Insured Retention and Defense Costs Your Obligations The self insured retention amount stated in the Schedule of this endorsement applies as follows: 1. You shall be responsible for payment of all damages and "loss adjustment expenses" for each occurrence or offense, until you have paid damages equal to the self insured retention amount shown in the Schedule. In no event shall the payments made by any other insurer, having an obligation to respond to the same claim, satisfy the "self insured retention amount" of this Certificate, 2 The self insured retention amount is the maximum amount you will pay for all damages, exclusive of "loss adjustment expenses", for bodily injury, property damage, personal injury, advertising injury, medical payments or any other coverages which may be included in this insurance as the result of one occurrence or offense, regardless of the 27

28 number of persons or organizations making claims or bringing suits because of the occurrence or offense. 3 Except for any "loss adjustment expenses" that we may elect to pay, you shall pay all such "loss adjustment expenses" as they are incurred until you have paid damages, in accordance with paragraph 1. above, equal to the self insured retention amount. If any final judgment or settlement, excluding "loss adjustment expenses", is less than the self insured retention amount, we shall have no obligation to reimburse you under this insurance. II. Self Insured Retention and Defense Costs Our Rights and Obligations A) In the event of your refusal to respond to your obligations for the payment of any self insured retention amount or "loss adjustment expenses" for any reason, the insurance provided by this Certificate shall not make payments for you, nor in any event shall we be required to substitute for you as respects your responsibility for payment of any such self insured retention amount or "loss adjustment expenses". B) We shall be liable excess of the self insured retention amount up to the applicable Limits of Insurance shown in the Declarations of this Certificate. C) Settlement of Claims 1 We shall have the right, but not the duty, to defend any claim seeking damages as the result of any occurrence or offense which would, except for the amount thereof, be covered by this insurance, regardless of whether the damages appear likely to exceed the self insured retention amount. 2 You may not settle or offer settlement of any claim or suit which exceeds the self insured retention amount without our written permission to do so. If you fail to obtain such written permission, we shall have no obligation to provide coverage for that claim or suit under this insurance 3 We shall have, at our option, the right to negotiate the settlement of any claim we deem expedient both within and in excess of the applicable self insured retention amount, but we shall obtain your consent prior to entering into the settlement of any claim which is equal to or less than the self insured retention amount. If however, you refuse to consent to any settlement recommended by us within the self insured retention amount and you elect to continue with any legal proceedings in connection with such claim, our liability for that claim shall not exceed the amount determined by subtracting the self insured retention amount, and "loss adjustment expenses" incurred to the date of such refusal, from the amount for which the claim could have been settled. We shall have no liability with respect to such claim if that difference is zero or negative 4 In the event that you tender your "self insured retention amount" to us (with accompanying payment) in respect of an occurrence or offense, then we shall have the duty to defend any valid claim under this Certificate arising from such occurrence or offense. 28

29 5 With respect to any claim under this insurance which has been notified in accordance with section IV below and which may exceed the self insured retention amount, we may pay any or all of the self insured retention amount and "loss adjustment expenses" on your behalf to defend or to effect settlement of such claim. Such amount paid by us shall be reimbursed promptly by you. In the event we incur any "loss adjustment expenses" in the exercise of our right to defend any claim, you shall not be liable to reimburse us for those "loss adjustment expenses". III Authorized Claim Service Provider 1 You shall employ a claim service provider acceptable to us for the purpose of providing claim services for the negotiation and settlement of losses within the self insured retention amount. You shall pay all fees, charges and costs of the claim service provider in addition to the self insured retention amount, without any reimbursement from us. 2. In the event of cancellation, expiration or revision of the claims service contract between you and the claim service provider, you shall notify us within (10) days of such change and shall replace the claim service provider with another claim service provider that is acceptable to us. IV Notification of Potential Penetration C 1 You or the authorized claim service provider must promptly notify our Claims Administrator (as identified in the Certificate of Insurance) of any occurrence or offense which may result in a claim under this insurance. Notice must include: A) How, when and where the occurrence or offense took place. B) the names and addresses of any injured persons and witnesses; and C) The nature and location of any injury or damage arising our of the occurrence or offense. 2 You or the authorized claim service provider must promptly notify our Claims Administrator, per paragraph.1. above, in the event of any occurrence or offense, without regard to liability, which results in any of the following:- A) Death B) Brain Damage C) Paraplegic or quadriplegic impairment; D) Amputation or serious functional impairment of any major limb E) Severe burns involving more than 25% if the body or causing serious disfigurement F) Sensory impairment (sight, hearing, taste or smell) G) Severe internal body organ damage or loss H) Multiple fractures involving more than one body part I) Permanent and total disability J) Sexual abuse or molestation; or K) Significant psychological / neurological involvement L) Potential exposure which equals or exceeds the Level of notification of potential penetration shown in the above Schedule; M) Establishment of any loss reserve which equals or exceeds the said Level of notification of potential penetration ; 29

30 N) Potential judgment, if the claim prevails, which equals or exceeds the said Level of notification of potential penetration ; O) The receipt or filing of a suit, in which event we shall have the right to appoint defense counsel, even if the amount claimed in the suit is unspecified or less that the self insured retention amount 3. It is a condition precedent to our liability under this insurance that you undertake to ensure that you, any other involved insured and your authorized claim service provider will fully co-operate with us, our Claims Administrator or any legal representative we may appoint, as respects the reporting or investigation of any claim, suit or occurrence which may be covered by this insurance. Such co-operation shall include, but not by way of limitation, reasonable access to employees, witnesses and your records during normal business hours. IV Definitions Self insured retention amount the amount or amounts which you or any insured shall become legally obligated to pay as compensatory damages because of bodily injury, property damage, advertising injury, personal injury, medical payments or any other coverage included in this Certificate sustained by one or more persons or organizations as the result of an occurrence or offense. Such amount or amounts shall apply separately to each separate occurrence or offense. Such amount or amounts shall be exclusive of all "loss adjustment expenses". 30

31 Self Insured Retention Endorsement (Defense Costs Included) THIS ENDORSEMENT CHANGES THE POLICY. PLEASE READ CAREFULLY This endorsement modifies insurance provided under the: Commercial General Liability Coverage Part SCHEDULE Self Insured Retention Amounts $ Per Occurrence $ Per Claim Aggregate $ Periodic Reporting Requirement Quarterly Level of notification of potential penetration - % of Self Insured Retention The insurance provided by this policy is subject to the following additional provisions, which in the event of conflict with any other provisions elsewhere in the policy, shall control the application of the insurance to which this endorsement applies: 1. Self Insured Retention and Defense Costs Your Obligations A. The self insured retention amounts stated in the Schedule of this endorsement apply as follows: 1.If a Per Occurrence self insured retention amount is shown in the Schedule of this endorsement, you shall be responsible for payment of all damages and defense costs for each occurrence or offence, until you have paid self insured retention amounts and defense costs equal to the Per Occurrence amount shown in the amount is the most you will pay for self insured retention amounts and defense costs arising out of any one occurrence or offence, regardless of the number of persons or organizations making claims or bringing suits because of the occurrence or offense. 2. If a Per Claim self insured retention amount is shown in the Schedule of this endorsement, you shall be responsible for payment of all damages and defense costs for each claim until you have paid self insured retention amounts and defense costs equal to the Per Claim amount shown in the Schedule, subject to the provisions of A.3. below, if applicable. The per claim amount is the most you will pay for self insured retention amounts and defense costs sustained by any one person or organization as a result of any one occurrence or offense. 31

32 Schedule, subject to the provisions of A. 3. below, if applicable. The Per Occurrence Countersigned 3. If an Aggregate self insured retention amount is shown in the Schedule of this endorsement, the Aggregate amount is the most you will pay for all self insured retention amounts and defense costs incurred under this policy. This amount applies separately to each consecutive annual period and to any remaining period of less than 12 months, starting with the beginning of the policy period shown in the Declarations of this policy. If no entry appears in the Schedule of this endorsement as Aggregate, then your obligation for payment of "self insured retention amounts and defense costs applies in accordance with the Per Occurrence or Per Claim self insured retention provisions, as applicable. 4. Except for any defense costs that we may elect to pay, you shall pay all such defense costs as they are incurred until you have paid defense costs and damages for bodily injury, property damage, personal injury, advertising, medical payments or any other such coverage s which may be included in the policy, equal to the applicable self insured retention amount. If any final judgment or settlement and defense costs is less than the self insured retention amount stated above, we shall have no obligation to reimburse you or pay defense costs under this policy. Settlement of Claim You may not settle any claim or suit which exceeds any self insured retention amount indicated in the Schedule of this endorsement without our written permission to do so. If you fail to obtain such written permission, we shall have no obligation to provide coverage for that claim or suit under this policy. Authorized Claim Service Provider 1. You shall employ a claim service provider acceptable to us for the purpose of providing claim services for settlement of losses within the self insured retention amounts. You shall pay all fees, charges and costs of the claim service provider in addition to the self insured retention amounts, without any reimbursement from us. Claim service provider that is acceptable to us. Notification of Potential Penetration 1 You or the authorized claim service provider must notify us promptly of an occurrence or offense which may result in a claim under this policy. Notice must include: A) How, when and where the occurrence or offense took place. B) the names and addresses of any injured persons and witnesses; and C) The nature and location of any injury or damage arising our of the occurrence or offense. You or the authorized claim service provider must notify us promptly, per D.1. above, in the event of any occurrence or offense without regard to liability, which results in any of the following injuries. A) Death B) Brain Damage C) Paraplegic or quadriplegic impairment; D) Amputation or serious functional impairment of any major limb E) Severe burns involving more than 25% if the body or causing serious disfigurement F) Sensory impairment (sight, hearing, taste or smell) G) Severe internal body organ damage or loss H) Multiple fractures involving more than one body part I) Permanent and total disability J) Sexual abuse or molestation; or K) Significant psychological / neurological involvement 2 Your or the authorized claim service provider must notify us promptly of any: A) potential exposure which equals or exceeds the level of penetration of the self insured retention amount show in the 32

33 2. In the event of cancellation, expiration or revision of the claims service contract between you and claim service provider, you shall notify us within (10) days of such change and shall replace the claim service provider with another schedule of this endorsement for per occurrence or per claim, whichever applies; B) loss reserve established which equals or exceeds the level of notification of potential penetration of the "self insured retention amount show in the schedule of this endorsement for Per Occurrence or Per Claim, whichever applies; C) potential judgment, if the claim prevails, without regard to liability, which equals or exceeds the level of notification of potential penetration of the self insured retention amount shown in the schedule of this endorsement for Per Occurrence or Per Claim, whichever applies; or D) suit, in the event a suit is files, and we shall have the right to appoint defense counsel, even if the amount claimed in the suit is unspecified or less that the self insured retention amount shown in the schedule of this endorsement for Per Occurrence or Per Claim, whichever applies. E Reporting Self Insured Retention 1 You must report on claims or suits per the following: You or the authorized claim service provider must monitor the cumulative self insured retention incurred amounts and defense costs sustained during the policy period and report those total amounts to us in accordance with the frequency of report indicated in the Periodic Reporting Requirement of the Schedule of this endorsement. However, if the total of all incurred losses and defense costs should at any time during the policy period attain a total amount equal to 75% of the Aggregate Self Retention amount, you are required in that event to make an immediate report to us as to total incurred losses and defense costs sustained at that time. The Periodic Report that you send to us must be in a format that is acceptable to us, and include an accounting of all individual and defense costs incurred as of the date of the Report. 2. Within forty-five (45) days after the end of the policy term, you must give us a listing of all existing claims or suits within the Self Insured Retention Amounts. At a minimum, such listing will include the following for each claim or suit: i a description of each claim or suit 3. Quarterly thereafter, you are required to give us an updated listing of the status of all claims or suits, both paid and reserved, until all claims or suits for the reporting period are closed or settled. 4. Compliance with the reporting requirements set forth in this endorsement is a condition precedent to coverage. You acknowledge that in the event of non-compliance, we shall not be required to establish prejudice resulting from the non-compliance, but shall be automatically relieved of liability with respect to the claim. F Representatives By acceptance of this policy you agree that you will not procure insurance for all or any part of the self insured retention amounts shown in the schedule of this endorsement. If such insurance is procured, there will be no coverage under this policy. II. Self Insured Retention and Defense Costs Our Rights and Obligations A) In the event of your refusal to respond to your obligations for the payment of self insured retention amounts or defense costs for any reason, the insurance provided by this policy shall not make payments for you, nor in any event shall we be required to substitute for you as respects your responsibility for payment of these self insured retention or defense costs amounts. B) We shall be liable only for the amount of damages and defense costs in excess of the self insured retention amounts as applicable, shown in the schedule above, up to the applicable Limits of Insurance shown in the Declarations of this policy. C) Settlements of Claims 1. We shall have, at our option, the right to negotiate the settlement of any claim we deem expedient both within and in excess of the applicable self insured retention amount, but we shall obtain your consent prior to entering into any settlement of any claim which is equal to or less than the self insured retention amount. If however, 33

34 ii the date of the occurrence or offense you shall refuse to consent to iii the amount paid and reserve for future payments for loss and defense costs and Iv the current status of the claim or suit any settlement recommended by us within the self insured retention continue with any legal proceedings in connection with such claim, our liability for that claim shall not exceed the amount determined by subtracting the self insured retention amount from the amount for which the claims could have been settled including defense costs incurred with our consent to the date of such refusal. And we shall have no liability with respect to such claim if that difference is zero or negative 2 With respect to any claim under this insurance which has been tendered to us and which may exceed the self insured retention amount shown in the schedule of this endorsement for Per Occurrence or Per Claim, whichever applies, we may pay any or all of the self insured retention amount and defense costs on your behalf to defend costs or to effect settlement of such claim. Such amount paid by us shall be reimbursed promptly by you. Regardless of whether the damages for bodily injury, property damage, personal injury, advertising injury, medical payments or any other such coverage s or defense costs for which coverage is provided under this policy appear likely to exceed the self insured retention amounts stated above, we shall have the right, but not the duty, to defend any claim seeking damages for which coverage would be provided under this policy in the absence of the self insured retention amount. In the event we incur any defense costs in the exercise of our right to defend any claim, you shall not be liable to reimburse us for those defense costs, amount and shall elect to contest the claims or in the event of a midterm cancellation of this policy, the self insured retention amount shown in the Schedule of this endorsement as Aggregate is not subject to any pro rata reduction. Such Aggregate amount will apply as if the policy term had not been shortened. IV Definitions A. Self Insured Retention means; The amount or amounts which you or any insured must pay for all compensatory damages which you or any insured shall become legally obligated to pay because of bodily injury, property damage, advertising injury, personal injury, medical payments or any other such coverage included in the policy sustained by one or more persons or organizations. B. Defense costs means; Expenses directly allocable to specific claims and shall include but not be limited to all Supplementary payments as defined under the policy(ies); all court costs, fees and expenses; costs for all attorneys, witnesses, experts, depositions, reported or recorded statements, summonses, service of process, legal transcripts or testimony, copies of any public records; alternative dispute resolution; interest; investigative services, medical examinations, autopsies, medical costs containment, declaratory judgment, subrogation and any other fees, costs or expenses reasonably chargeable to the investigation, negotiation, settlement or defense of a claim or a loss under the policy(ies). 34

35 Copies of Power Point Slides 35

36 Slide 1 SIRs, Deductibles and the Armstrong Elections How will Contractors and their Subs Survive in the Future of Construction Defect Cases? By Deborah Wities and David Stern Slide 2 The Changing Environment Prevalence of class-action construction defect lawsuits Easy for homeowners to bring claims against developers Statute of limitations for construction defects years Developers strictly liable to homeowners for the defects 36

37 Slide 3 The Insurance Involvement Continue underwriting Control claims costs Deductible Self-insured retention Slide 4 Self-Insured Retentions: Generally, A SIR is a provision wherein the insured agrees to be self-insured up to the Retained Limit set forth in the policy It refers to the portion of risk assumed by an insured that must be satisfied BEFORE coverage is triggered Amount satisfying a SIR depends on policy language: Per Claim or Per Occurrence or Aggregate Slide 5 Sample SIR Provision The insurer shall be liable for the Amount of Loss arising from a claim which is an excess of the retention amount stated in the Declarations Page The retention amount (a) shall apply on to occurrences under this policy; and (b) shall apply separate to each such occurrence and (c) shall include all amounts under the Supplementary Payments section of this policy. The Insured s bankruptcy, insolvency or inability to pay the retention shall not increase the Insurer s obligation under this policy. 37

38 Slide 6 Deductibles A deductible is a payment required of an insured for each claim paid by its carrier It is a contribution the insured must make in accordance with the specific policy terms Slide 7 Deductibles and SIR s What s the Difference? Two Main Differences: 1. Policy Limits 2. Carrier s Duty to Defend Slide 8 I s S e lf -I n s u r a n c e..., I n s u r a n c e? In s u r a n c e is a c o n tr a c t w h e r e b y o n e u n d e r ta ke s to in d e m n ify a n o th e r a g a in s t lo s s, d a m a g e o r lia b ility a r is in g fr o m a c o n tin g e n t o r u n kn o w n e ve n t. (In s. C o d e 2 2.) S e lf in s u r a n c e... is e q u iva le n t to n o in s u r a n c e.... A e ro je t-g e n e ra l C o rp. v. T ra n s p o rt In d e m n ity, 1 7 C a l. 4 th 3 8, 7 0, n. 2 0 ( ). 38

39 Slide 9 Is Self-Insurance..., Insurance? Accordingly, self-insurance exists if the policyholder is ultimately indemnifying itself. When talking about self-insurance, one usually refers to an SIR. (Self-insurance may also come in the form of a deductible which, in some circumstances not relevant here, differs from a SIR. General Star Indemnity Ins. Corp. V. World Oil Company, 973 F. Supp. 943, (1997) Slide 10 Is Self-Insurance..., Insurance? The retained limit is not coverage. Minnesota Mining & Manufacturing Co. v. H&W Motor Express Co, Minnesota Court of Appeals Slide 11 Is Self-Insurance..., Insurance? The SIRs are other insurance under the policies, and thus primary insurance. We further recognize that primary coverage attaches upon the happening of an occurrence We cannot ignore the stated terms of the policies, nor the reality of SIRs as primary insurance... Atchison, Topeka & Santa Fe Railway Co. v Stonewall Insurance Co., 275 Kan 698, 71 P3d 1097 (Kan 2003) 39

40 Slide 12 Is Self-Insurance..., Insurance? Policyholder required to horizontally exhaust all self-insured retentions for implicated policy periods before looking to the insurers for coverage. The Illinois Court of Appeals did not consider whether a self-insured retention is a deductible because it held that the SIR is the equivalent of underlying insurance coverage. Missouri Pacific R.R. v International Ins Co. 288 Ill App 3d 69, 679 NE2d 801 Slide 13 Kinds of Self-Insurance Pure self-insurance This is the complete absence of any type of insurance. The entity is considered bare. Self-insured retention Under this concept an entity agrees to be responsible for all the amount of the claim up to a specified sum and thereafter various layers of insurance become involved. Slide 14 Kinds of Self-Insurance Fronting Policies. Under this plan there is a complete retention of the risk by the entity. The obligations of the insurer come into play when the entity is unable to pay a loss sustained by a third party. Up until that point the insured fulfills the function of an insurer, adjusts the loss and agrees to pay the insured for any payment it makes. These policies are required by many states in order for the self-insured to meet governmental insurance requirements. 40

41 Slide 15 Kinds of Self-Insurance Retrospective Rated Policies A program of this nature operates on the insured s loss history. Based upon the insured s claims experience during the prior year, the insurance company retrospectively sets the premium charged. This can result in either a rebate to the insured where the actual losses are less than the estimation or an additional premium if the losses exceed the estimation made by the insurer. Slide 16 Duty to Defend / Indemnify Insurer has no duty to defend or indemnify the insured until the SIR is satisfied Gen. Star Indemnity Co. v. Super. Court. (1996) 47 Cal.App.4th 1586, 1594 Unless the policy provides otherwise, the insured must bear its own defense costs until the SIR is exhausted City of Oxnard v. Twin City Fire Ins. Co. (1995) 37 Cal.App.4th 1072, Slide 17 Duty to Defend / Indemnify Exception: Where the policy containing an SIR EXPRESSLY REQUIRES the insurer to defend before the retention limit is exhausted, the insurer will be liable for defense costs incurred Montgomery Ward & Co. v. Imperial Casualty & Indemnity Co. (2000) 81 Cal.App.4th 356,

42 Slide 18 Duty to Defend / Indemnify Where the insurer enters into a settlement agreement which refers to the insurer as a primary carrier, the insurer will not be treated as an excess carrier but a primary carrier Stonewall Ins. Co. v. City of Palos Verdes (1996) 46 Cal.App.4th 1810, 1853 Slide 19 The Armstrong Election in Progressive Loss Cases Armstrong World Industries, Inc. v. Aetna Casualty & Surety Co. (1996) 45 Cal.App.4th 1. Armstrong Elections, are the selection by a policyholder to a specific policy, which would attach to a progressive property loss. The picked insurer is entitled to seek contribution from other insurers based on the " other insurance" clause in its policy and a right of equitable contribution Slide 20 Will Other States Follow Armstrong Elections in Progressive Loss Cases? The Illinois Supreme Court promulgated a "targeted tender rule" which allows the insured to select which concurrent primary insurer must respond to a particular suit or claim. However, the targeted insurer in Illinois has NO right to contribution rights from the "deselected" insurers (even if the deselected insurers have notice of the claim and even if the targeted insurers' policy contain other insurance clauses. John Burns Construction Co. v. Indiana Insurance Co., 189 Ill. 2d 570 (2000) 42

43 Slide 21 Can One Exhaust a SIR Through Payments Made by Another Insurer? Courts applying California law, on at least two occasions, have found that monies paid by primary insurers can be used to exhaust an insured s SIR and trigger its excess coverage. General Star National Ins. Group v. World Oil Company, 973 F. Supp. 943 (C.D. Cal. 1997) The Vons Companies, Inc. v. U.S. Fire Insurance Company, 78 Cal. App. 4th 52 (2000) Slide 22 Can One Exhaust a SIR Through Payments Made by Another Insurer? Nowhere does the SIR expressly state that Vons itself, not other insurers, must pay the SIR amount. Because the SIR was subject to the other insurance provisions, which also made the Vons policy excess if there were another policy covering the accident, Vons as a reasonable insured could read the policy as permitting the use of other insurance proceeds to cover the SIR amount. Vons, supra, 78 Cal. App. 4th at Slide 23 Bankruptcy, Insolvency and the Self-Insured Retention The Home Insurance Company of Illinois, et al. vs. Carl Hooper, et al. Is the self-insured retention provision of the subject policy a condition precedent? Violation of the State Insurance Code? Examine both the language of the bankruptcy and self-insured retention provisions of the policy 43

44 Slide 24 Conclusion Talk to the insured, what do they want to do? Look at the relevant policy language Use a little creativity and aggressive approaches Structure future self-insured obligations Maximize the benefits of their insurance coverage SIR should be used as a tool toward resolving claims 44