EXAMINING THE APPROPRIATENESS OF REQUIRING WARRANTY COVERAGE ON R-2000 HOUSES

Transcription

1 EXAMINING THE APPROPRIATENESS OF REQUIRING WARRANTY COVERAGE ON R-2000 HOUSES Prepared for Canadian Home Builders' Association Prepared by Holmen Enterprises Ltd. July 2005

2 INTRODUCTION In February 2004, the requirement for builders ofr-2000 houses to be members of a new home warranty program was removed from the license agreement between Natural Resources Canada (NRCan) and R-2000 builders. Other documentation issued by NRCan is inconsistent with this. For example, the web site in the public area states that R-2000 builders must provide new home warranty coverage (where available) or have another means ofliability insurance to cover the homeowner from losses due to faults in the construction practices and materials used in the home. This discrepancy, together with some questions about the appropriateness of the decision to remove the requirement for warranty coverage, led the Canadian Home Builders' Association (CHBA) and NRCan to commission a small study to examine whether R-2000 builders should be required to be members of a new home warranty company and provide warranty coverage for their R-2000 houses. This report documents the results of that study. APPROACH Identification of Critical Factors The following factors were identified as relevant to a decision on this issue: Rationales for providing warranty coverage. Alternatives to warranty coverage. Consequences of a decision to require warranty coverage on R-2000 houses. Tasks to Examine the Critical Factors The following tasks were carried out to examine each of the factors: Rationale for providing warranty coverage: Brief interviews were conducted with representatives ofr-2000 delivery agencies in Newfoundland, Nova Scotia, New Brunswick, Quebec, Manitoba, Saskatchewan, Alberta and, Northwest Territories (NWT). Interviews were not conducted with representatives in BC or Ontario because these provinces require warranty coverage on all housing. They were not conducted with representatives of First Nations delivery agencies since R-2000 houses on reserves is beyond the scope of this study, or with representatives who are staff ofnrcan (representatives for PEl and Nunavut delivery agencies). Contact could not be made with the representative from the Yukon Territory. The interviews checked representatives' opinions about some rationales and also asked an openended question to identify others. Alternatives to warranty coverage: This issue was examined by carrying out the following tasks: Review of selected documentation on warranties and various forms of insurance. Interviews with selected representatives from the new home warranty programs (in Atlantic Canada, Manitoba, Saskatchewan and Alberta), two insurance companies, representatives of five provincial housing organizations, two non-profit housing corporations, and CMHC officials in the national office and BC.

3 Consequences of a decision to require warranty coverage on R-2000 houses: This issue was assessed by estimating the number ofr-2000 builders who would likely stop building R-2000 houses and the resulting decrease in annual R-2000 housing production if the requirement for warranty coverage was reinstated. RATIONALE FOR AND AGAINST PROVIDING WARRANTY INSURANCE ON R-2000 HOUSES Rationales in Support of Mandatory Warranty Coverage ofr-2000 Houses The position of a number of delivery agencies on warranty coverage for R-2000 houses is illustrated by the fact that delivery agencies in four provinces where warranty coverage is optional (Newfoundland, Nova Scotia, Saskatchewan and Alberta) 1 require R-2000 builders to provide warranty coverage. The delivery agency representative in New Brunswick also supports mandatory warranty coverage for R-2000 homes but did not have a policy of requiring it. A major reason expressed by a number of interviewees in support of requiring warranty coverage on R-2000 houses was that these houses represent high quality (or superior or "elite") housing and should therefore have warranty coverage because of the benefits. In view ofwarranty coverage as a fairly common attribute of typical housing, not having warranty coverage on R-2000 housing suggests to some that it is inferior, at least in that respect. The following specific reasons in favour of requiring warranty coverage can also be identified: Consumer protection: New home warranties provide assurance that deficiencies in a home as defined by the warrantor will be remedied up to the limit of the warranty for a set period after construction completion if the builder fails to remedy the deficiency. The coverage offered by new home warranty programs varies but it can include the following: Material and workmanship warranty: This is the main protection provided by warrantors. Warranties typically focus on ensuring building code compliance and remedying structural defects for a period after construction completion up to ten years. Building envelop or water leakage protection warranty. Deposit protection. Construction completion warranty. Protection against unauthorized substitutions. Manufacturers warranties. Delayed closing coverage. Off-site living expenses. Transfer of warranty coverage. If warranty coverage is not provided, and if the builder is unable or unwilling to remedy deficiencies or warrant other requirements such as those noted above, the consumer is not protected. If warranty coverage were provided, the consumer would be protected to the extent of the warranty. 1 Warranty coverage is mandatory in BC, Ontario and Quebec. 2

4 A voiding potential liabilities to the R-2000 Program in the absence of warranty coverage: One possibility is that an R-2000 homeowner could name the R-2000 Program or NRCan in an action if the builder failed to remedy a deficiency. This scenario could arise because the Program or NRCan would be the only significant authority/organization associated with the R house. It could arise even if the deficiency was not related to an R-2000 feature (this prospect was reinforced by comments from one representative of a delivery agent who noted that R-2000 homeowners ascribed and reported all problems with their houses to the R-2000 Program regardless of the nature of the problem). While NRCan would probably be able to defend itself in an action that dealt with deficiencies not related to the R-2000 Program, the experience would be needlessly expensive and result in negative publicity. Warranty coverage would likely eliminate this potential liability to the Program. A voiding a potential negative image of the R-2000 Program: Even in the absence of legal action, if a problem with an R-2000 house was not resolved due to the absence of a warranty, negative publicity could occur and this could result in a negative image of the Program with the public. This could in tum adversely affect the production ofr-2000 housing and have a negative effect on R-2000 builders not directly involved with the original problems. On the other hand, warranty coverage would likely avoid this negative image and publicity. Marketing advantage: In addition to the benefits of warranty coverage noted above, the unqualified requirement for warranty coverage could be a marketing benefit for the Program. Representatives of the delivery agents from the five provinces listed above who were interviewed were not aware of the rationale for NRCan's decision to remove the requirement for warranties on R-2000 housing. One speculated that it was to encourage more builders to participate in the R-2000 Program. However, this rationale should be juxtaposed against the reported position in support of warranty coverage ofr-2000 houses by R-2000 builders in a number of the provinces where warranty coverage is optional. Rationale Against Mandatory Warranty Coverage of R-2000 Houses The representative of the R-2000 delivery agent in Manitoba (Manitoba Hydro) explained that a number of small-scale builders in rural areas who build a variety of products and a small number of R-2000 houses reportedly think that the cost of warranty coverage is high relative to the volume of their R-2000 work. A decision to require warranty coverage might result in some of these builders deciding against building R-2000 houses. He noted that the delivery agent in Manitoba might not support mandatory warranty coverage on R-2000 houses. If a deficiency in an R-2000 house occurs and it pertains to an R-2000 feature, Manitoba Hydro works with the builder and homeowner to remedy the deficiency as a matter of policy. Formal alternate forms of coverage are not in place. ALTERNATEFORMSOFCOVERAGE Objective and Scope The main interest in the review was to identify types of coverage that could provide protection similar to that provided by new home warranties. The review examined the following types of coverage: 3

5 Various types of insurance used by new home builders and renovators: This included the following types of insurance: Builders' risk insurance (also known as course of construction insurance). Comprehensive general liability (CGL) insurance. Post construction insurance. Contractors' professional liability insurance. Wrap-up insurance. Bonds, including performance bonds, and labour and material bonds. Types of insurance used by non-profit housing corporations. Arbitration: This measure was included because it was used by one delivery agent in the past and has been mentioned as a possible type of protection. Conclusions about Insurances Used by New Home Builders and Renovators The forms of insurance used by new home builders and renovators has been examined and documented in other recently published CHBA reports. They are therefore only described briefly in this repon; in Appendix 1. The main conclusions about these forms of insurance are as follows: These forms of insurance are intended to provide protection for new home builders and renovators. They are not designed to provide consumer protection, as new home warranties do 2. Builders' risk insurance, comprehensive general liability insurance and wrap-up insurance can pay for damages but not for the correction of deficiencies, as new home warranties do. Perfommnce bonds provide some protection for the owner, i.e., they help to ensure project completion. This feature is similar to one feature in the coverage of some new home warranties but the owner in a bond agreement is typically not a homeowner. Bonds do not contain provisions to correct deficiencies discovered after construction completion which is a predominant feature of new home warranty programs. Conclusion about Insurance Used by Non-Profit Housing Corporations The review concluded that the main form of insurance used by non-profit housing corporations is essentially self-insurance. This type of insurance does not provide consumer protection and is not relevant as an alternate type of coverage for consideration in this study. Conclusion about Arbitration Arbitration is the process of settling a dispute between two parties by an independent third party - the arbitrator. If an arbitrator makes a decision in favour of the homeowner, and the builder does not have the capacity to remedy thedef).ciency, the decision will not benefit the homeowner. This is precisely the circumstance where new home warranty coverage is a benefit: it is a "back-up" service that remedies deficiencies when the builder fails to meet its obligations 3. 2 New home wananties also provide protection to new home builders, but their distinguishing feature in this context is that they provide consumer protection. 3 A wanan:ty company would remedy the deficiency only if it was a deficiency as defined by the wanantor. 4

6 CONSEQUENCES OF A DECISION TO REQUIRE WARRANTY COVERAGE ON R-2000 HOUSES The estimated consequences are decreases in the numbers ofr-2000 houses built as a result of a decision to require warranty coverage on R-2000 houses. Based on comments by the delivery agency representatives, as reported above, the only jurisdiction where mandatory warranty coverage may not be supported is in Manitoba. A representative of the delivery agent there estimated that about one-half of the approximately 55 registered or licensed R builders might stop building R-2000 houses if warranty coverage became mandatory. Most of these build in rural areas. He further estimated that this would result in a production decrease of about one-third, i.e., a decrease from an estimated normal production of about 40 to 50 R-2000 houses per year to about 30, or a decrease of about 15 R-2000 houses annually. The same number would apply on a national scale, i.e., 15 fewer houses nationally. CONCLUSIONS The review of three factors identified as a reasonable basis for making a decision on mandatory warranty coverage ofr-2000 houses suggests the following conclusions: Representatives of most delivery agencies where warranty coverage is optional favour mandatory warranty coverage on R-2000 houses. Four delivery agencies in provinces where warranty coverage is optional require warranty coverage on R-2000 houses. R-2000 builders in a number of provinces where warranty coverage is optional reportedly favour mandatory warranty coverage on R-2000 houses. Lack of warranty coverage ofr-2000 houses results in lack of consumer protection and could result in liabilities and negative images for the R-2000 Program. A requirement for warranty coverage could avoid these possibilities and could also provide a marketing advantage. The delivery agency for R-2000 in Manitoba may not support mandatory warranty coverage of R-2000 houses. An estimated 50% (approximately) of the R-2000 builders in Manitoba may stop building R houses if warranty coverage is mandatory and this could result in an estimated decrease in production of about 15 R-2000 houses annually. Forms of coverage that provide coverage similar to that of new horne warranty programs do not exist. 5

7 Appendix 1 SUMMARY OF MAIN TYPES OF INSURANCE USED BY NEW HOME BUILDERS AND RENOVATORS Builders' Risk Insurance (also known as Course of Construction Insurance) The type of insurance indemnifies builders for loss of or damage to a building under construction from causes such as fire, accidents, vandalism and mischief. The insurance pays for repairs to or replacement of physical damage to a building. This type of insurance will not pay for correcting deficiencies (as does warranty coverage), and usually excludes damage due to design errors, faulty workmanship, latent defects, wear and tear and mechanical breakdown. This type of insurance can be purchased for a specific building or on a blanket basis covering all projects undertaken in a year by a builder. Comprehensive General Liability Insurance This type of insurance pays for liabilities due to bodily injury or death to third parties, and for damage to the property of others due to policyholders' actions for a period of coverage determined by the payment of premiums. Payment under this type of insurance can pay for emergency and surgical expenses, investigation expenses, defences expenses, etc. This type of insurance will not pay to correct deficiencies (as does warranty coverage), but only for the costs of the damage caused. Post Construction Insurance This type of insurance protects builders against claims from personal injury or property damage after construction completion (specifically the period between the expiry of construction insurance and the date when the statutes oflimitations takes effect) resulting from problems caused by people involved in the construction project. Contractor's Professional Liability Insurance This type of insurance is comprehensive liability insurance for contractors that carry out designbuild projects. It is similar to errors and omissions insurance. Wrap-up Insurance This type of insurance provides protection against liability due to bodily injury and property damage for all parties involved in a project. It is usually held on a project basis. This type of insurance will not pay to correct deficiencies (as does warranty coverage), but only for the costs of the damage caused. Bonds Bonds and insurances are fundamentally different. The objective of insurance is to protect the policyholder against loss. A construction bond is a three-party agreement between the owner, contractor and bonding company in which the bonding company agrees to indemnify the owner if the contractor fails to fulfill its obligations to the owner.

8 ~ I ' " Appendix 1 Bonds can be of various types, i.e., performance bonds, bid bonds, and labour and materials bonds. Performance bonds are the most widely called-for construction bonds. They protect the owner in the event that the contractor cannot complete the contract so the bonding company will either complete it or get another contractor to complete the work up to the amount of the bond. Bid bonds ensure a client that a contractor will be capable of performing a given piece of work for an agreed price. Labour and material bonds ensure payment to workers and suppliers. Bonds are usually used by large companies for large projects. They are not frequently used in the residential construction sector. While the provision in performance bonds to ensure project completion is similar to a provision in some new home warranties, performance bonds do not correct deficiencies after construction, which is a predominant provision of new home warranty programs. 2