US Homebuilder Industry

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1 US Homebuilder Industry Demand in Heightened Quality and Lower Costs Empowers Strategic Risk Management Practices October 2015 Lockton Companies The homebuilder industry continues to surge ahead as housing demand steadily increases. While keeping pace with the demand, US homebuilders must continue to build quality homes and implement state-of-the-art proactive quality assurance and customer service to reduce costly construction defects and differentiate themselves from their competitors. ERIC BROWN Vice President, Unit Manager Irvine, California JAMES KNOOP, ARM Senior Vice President, Unit Manager Lockton Construction Practice Irvine, California Homebuilders should continue to focus on process and quality. The quality of production homes delivered over the past 15 years has been tremendous as evidenced by the reduction in claims and claim values on a per-home basis. Training subcontractors to maintain this positive trend, and use newer technologies to catch field-related issues early and often, will create the distinction between good and great builders. L O C K T O N C O M P A N I E S

2 Job growth is the number one driver of new home demand. Four markets expected to add more than 250,000 new jobs over the next three years are New York, Los Angeles, Chicago, and Atlanta. Job growth in all three of the biggest Texas metros Houston, Dallas, and Austin is expected to slow due to the drop in oil prices. If the job growth projections hold, New York and Los Angeles will have added a combined total of more than 1.3 million jobs during the current economic expansion. Job Growth Projected Next Three Years Six of the top 17 job growth markets over the last three years were in California. The California markets added 926,000 jobs from 2012 through 2014, or one out of every eight new jobs in the country! Source: John Burns Real Estate Consulting, LLC One of the challenges facing homebuilders is a shift in workforce aging trade laborers combined with reduction in immigration from Mexico. According to John Burns Real Estate Consulting, there has been a 67 percent decline in immigration from Mexico, and many that have returned to Mexico may not return to the US construction industry because of: Significantly higher border patrol investments Acceleration in courtordered deportations over the last 7 years Implementation of E-Verify technology by employers Arizona s SB 1070 bill passing in 2010 Economic opportunity in Mexico 2

3 October 2015 Lockton Companies Green Construction The demand for green construction will continue to grow. The goal is for all new homes by 2020 to be zero net energy. The increase in construction costs will be passed on to consumers, forcing some builders to cut costs in other resources vital to the construction quality of the home. A zero net energy building is one that As we move toward energyefficient and Leadership in creates an amount of renewable energy Energy & Environmental equal to the amount Design (LEEDS)-certified it consumes. housing, there could be another round of litigation ensuing from the failure of the products to achieve the advertised or mandated results. Coverage for these types of claims will be challenging under a traditional general liability program, and professional liability will be a focus. There may also be defect claims that arise out of newly developed products and the increasing need for recall insurance. Litigation/Claim Challenges The number of single-family dwelling homeowners that sue builders for construction defects continues to increase due in large part to plaintiff firms using databases to canvass communities with mailers. For attached product, we are seeing HOAs more willing to work with the repair recommendations of the joint experts. The cost of defense of these cases now ranges from an early resolution potential of $5,000 per home to $30,000 per home on the threat of trial. As usual, the settlement value depends on the law firm representing the homeowners. Some law firms have the resources to prolong litigation and associated costs, and have experts that are able to assert high-dollar-value repairs (such as replacement of the slab) to achieve higher settlement values. California, Arizona, Nevada, and Florida are still the biggest drivers of construction defect exposure, with Washington and Texas in the mix. The exchange of information in those states is definitely an issue, and something we advocate addressing contractually and through the defense bar. In Nevada, AB 125 Homeowners Protection Act was signed into law, reforming construction defect laws and reducing the statute of repose to six years. Anti-indemnity statutes continue to be updated and revised in several jurisdictions. The statutes have also linked restrictions to additional insured endorsements and have made typical risk transfer solutions more challenging. These trends continue the validation of wrap-up insurance programs. Bill review and panel counsel are ways to further reduce the costs of litigation particularly within the self-insured retention (SIR). Depending on the size of the SIR, we believe that there is an opportunity to achieve savings by retaining those firms that have the competence and expertise but will charge the insurance defense rate. We encourage our builder clients to review the bills and better manage the process. Having an aggregated sense of what are appropriate results can yield substantial savings. Motivating homeowners to accept a fix rather than pursue costly litigation should be the focus of a quality homebuilder. We have had moderate success through the builders warranty and use binding mediation under the Federal Arbitration Act to cost-effectively adjudicate an acceptable fix in challenging cases. Thus far, the plaintiff bar and defense bar have not adopted this approach and continue to press for the case management order or mediation. 3

4 A Few Things to Watch For The use of materials manufactured outside of the US, such as Chinese drywall, Chinese cast iron pipes, Schnell panels, and Pex and Kitec plumbing fixtures, should be analyzed and tracked. The quality control in place will need to be monitored, and it is still not certain how claims would be prosecuted against such international companies. For California exposures, under California Civil Code Section 895, there are a number of claims being made for building code violations; carriers may assert these are not covered. Drainage, particularly with smaller lot developments, has always been an issue that can result in costly exposures, particularly when homeowners alter (over time) the grade established by the builder. Adopting the philosophy that the foundation of a home is critical to the remaining structure and ensuring that all commercially reasonable steps are taken with regard to the concrete pours including monitoring the mix from quarry to jobsite, pouring with the correct water ratios, and appropriate cure time. Homebuilders taking personal information of prospective homebuyers (and/or processing the mortgages for buyers). While not a trend specific to homebuilders, it is a trend with retailers and financial institutions which leaves homebuilders an obvious target for cyberattacks. The best defense is a good offense. Providing warranties on new homes against defective materials and faulty workmanship is an efficient way to reduce litigation and improve homeowner satisfaction. The broader the warranty, the better it will deter class action litigation. What role does insurance play? The Home Builders Protective Program (HBPP) was a warrantydriven general liability policy introduced in 1997 designed for homebuilders with revenues in excess of $100 million. The HBPP was unique because it allowed the homebuilder to utilize their home warranty to define the term loss. This much broader definition allowed the homebuilder to be proactive rather than wait for a construction defect to result in covered damages and lawsuits, as would be required in a traditional wrap-up program in order to trigger coverage. This gave the homebuilder the ability to address a homeowner s concern much more effectively and efficiently, therefore deterring class action litigation and improving the overall cost of a claim by up to 50 percent to 60 percent. The traditional general liability wrap-up policies now recognize the advantages of mandating quality assurances, such as peer review and an insured warranty, or the homebuilder-formulated warranty that is approved by the carrier. The coverage trigger remains the same, requiring actual damage and subsequently filing a claim. 4

5 October 2015 Lockton Companies Here is a comparison of the main differences of the warranty and non-warranty policies: Coverage Feature Non-Warranty (Standard E&S Markets) Contractors Liability Insurance Occurrence Form - No Amendments Warranty Liability Insurance Policy Occurrence Form Coverage Trigger Close of escrow Certificate of Occupancy Performance failure Close of escrow Performance Failure Completed Operations Coverage Extension Trigger Completed Operations Extension Applies to BI & PD N/A Completed operations coverage provided during policy period as per definition of products/completed operations hazard. There is no exclusion to your work or your product. Base form offers property damage only; standard endt. to extend BI for 10 years from completion/sale of the work if the policy is not renewed. Provides warranty coverage arising from construction failures and preventive costs to mitigate further property damage or a property damage claim. Under products completed operations hazard, you become legally obligated to incur or pay repair costs for home performance failure(s) arising from a Home Performance Agreement on homes or common elements which have transferred control during the policy period and claims for property damage in the PCO Hazard. Extend BI & PD for 10 years from completion/sale of the work if the policy is not renewed or extended. Repair Work Premises Extension No Yes, covered through full statute of repose. (after expiration) Mold Exclusion Yes, separate CPL coverage required Property damage as a result of mold Mandatory Arbitration Applies Yes, but can be negotiated to mediation No Subcontractor Repair Costs Exclusion N/A First 12 months SIR/Deductible Subject to SIR or deductible SIR(s) is based on the number of homes in a single location and aggregated (same as SIR or higher depending on the risk). This comparison of liability programs is provided as a summary and guide only. It does not provide complete information about coverage, conditions, endorsements, and exclusions. You must refer to the actual policy for complete and accurate information. Conclusion As homebuilders continue to grow, they will need a broker that understands the technical nuances of their business and is equipped to deliver the highest level of product knowledge and services to assure the optimum insurance program. Lockton Insurance Brokers is a leader in residential construction in both the US and London markets, providing our clients comprehensive program design, project administration, contract review, quality control consulting, safety, and claim consulting. As the world s largest privately owned insurance broker, Lockton has been at the forefront in the development and design of homebuilder insurance programs. 5

6 Our Mission To be the worldwide value and service leader in insurance brokerage, risk management, employee benefits, and retirement services Our Goal To be the best place to do business and to work RISK MANAGEMENT EMPLOYEE BENEFITS RETIREMENT SERVICES Lockton, Inc. All rights reserved. g\white paper\knoop, brown\2015\knoop, brown_us homebuilder industry_oct15.indd: 11916