Chapter 14 - § 14.12 • INSURANCE COVERAGE FOR FAULTY RESIDENTIAL CONSTRUCTION

• Jurisdiction: Colorado

§ 14.12 • INSURANCE COVERAGE FOR FAULTY RESIDENTIAL CONSTRUCTION

The two words homeowners do not want to hear following the (ostensibly) successful prosecution of a construction defect suit are "unsatisfied judgment." Construction lawsuits are expensive and time consuming, and often emotionally draining for homeowners. If, at the end of the day, a homeowner is left with a substantially unsatisfied judgment, one must ask whether the suit should have been brought in the first instance.

Whether against a solvent production builder or a potentially impecunious custom builder, liability insurance coverage issues must be considered at every stage of construction defect proceedings. Failure to maximize the availability of insurance proceeds by carefully crafting legal claims, dispensing with claims that may impair coverage, and informally coordinating coverage preservation efforts with defense counsel, may leave a very disappointing result. Prudent defense counsel will strongly urge their clients to notify all carriers of all claims and suits and to consult with experienced insurance coverage counsel if significant coverage issues arise. Defendants often retain coverage counsel to provide the first notice of potentially significant claims to their insurance carriers, since the content of the notice itself may affect the policyholder's rights.

Homeowners and builders engaged in hard-fought litigation appear to have little in common. However, if homeowners succeed or appear likely to succeed in proving their claims, homeowners and builders have a strong identity of interest in ensuring that the builder's liability insurer responds to any successful claims. Where the liability insurer selects and pays for a builder's defense counsel, both the builder and its counsel need to keep in mind that many potential conflicts of interest may arise between the builder and defense counsel, who has an ethical obligation to do nothing to prejudice the builder's coverage.²⁷¹⁵

The first half of this section concerns (1) how the insurance industry compiles commercial general liability policies; (2) how policy forms evolve; (3) how different lines of insurance coverage "dovetail" with one another; and (4) how these matters, when combined with well-accepted rules of policy interpretation, can help predict how courts will construe particular policy provisions with regard to construction litigation claims. The second half of this section discusses (1) standard commercial general liability policy coverages and exclusions; (2) supplementary coverages; and (3) coverage issues and exclusions most directly implicated by typical construction litigation claims.

§ 14.12.1-First- and Third-Party Coverage Distinguished

Liability insurance coverage is intended to protect a policyholder against legal liability due to injuries, damages, or other losses sustained by third parties arising from the policyholder's wrongful conduct.²⁷¹⁶ While one aspect of this coverage is the insurer's duty to indemnify the policyholder against liability covered by the policy, an equally critical aspect is the insurer's duty to pay for the policyholder's legal defense against such liability claims.²⁷¹⁷ Property or casualty insurance coverage is intended to protect policyholders against injury, damage, or loss to their own property.

While liability insurance often is referred to as "third-party" coverage and property insurance often is referred to as "first-party" coverage, these labels can be misleading, especially when analyzing the insurer's duties of good faith and fair dealing towards the policyholder. Where the policyholder has "ceded" some right to the insurer, such as control over the defense or settlement of third-party claims, the insurer generally is held to a heightened standard of care.²⁷¹⁸ However, where the policyholder has not ceded any rights to the insurer - for example, when a policyholder submits, and the homeowner's insurer simply refuses to pay, a property loss claim, or, perhaps, where an insured tenders the defense of a lawsuit to a liability insurer and it declines - a less stringent standard of care applies.²⁷¹⁹

Proper characterization of a person as first-party or third-party claimant may affect the availability of double damages and attorney fee remedies under Colorado statute.²⁷²⁰ The Texas Supreme Court has found that its "prompt payment" of first-party claims statute, which is similar to Colorado's "prompt payment" law, C.R.S. § 10-3-1115, applies to an insurer's wrongful refusal to defend.²⁷²¹ A Colorado district court held that C.R.S. § 10-3-1116's double damages first-party provisions apply to a liability insurer's failure to pay defense and indemnity benefits.²⁷²² C.R.S. § 13-20-808 states that an insurer's duty to defend is a "first-party" insurance benefit, strongly indicating that an insurer's failure to defend may implicate Colorado's prompt payment statute.

The Colorado Supreme Court held that C.R.S. § 10-3-1116 permits an insured whose claim for payment of benefits was unreasonably delayed or denied to recover two times the covered benefit, and does not require that award to be reduced by the amount unreasonably delayed but eventually paid by the insurer.²⁷²³ The general rule against double recovery for a single harm does not prohibit an insured from recovering both damages for breach of contract and a statutory award for unreasonable delay or denial of benefits.²⁷²⁴ Attorney fees and costs awarded under C.R.S. § 10-3-1116 are actual damages, and, therefore, are properly considered when measuring how much can be awarded as punitive damages under C.R.S. § 13-21-102(1)(a). These claims are also assignable, and survive the plaintiff's death.²⁷²⁵ Moreover C.R.S. § 10-3-1116's remedies appear to be mandatory so long as the insured proves the insurer violated C.R.S. § 10-3-1115. The one-year statute of limitations for penalty actions does not apply to a cause of action for an unreasonable delay or denial of insurance benefits under C.R.S. § 10-3-1116.²⁷²⁶

Licensed professionals such as architects, engineers, and real estate brokers often carry errors and omissions coverage, usually written on a "claims made" rather than "occurrence" basis. This coverage is triggered at the time the insured receives notice of a claim rather than when the injury occurs. Some of these policies contain "self-depleting" or eroding (Pac-Man^® ) liability limits that decrease pro tanto as defense costs accrue.²⁷²⁷ Under such policies, it is in the policyholder's best interest for the carrier to evaluate claims early and settle high exposure claims quickly.²⁷²⁸ In two related rulings that may affect all Colorado insureds, the Douglas County district court found the policy at issue to be an eroding limits policy where a supplementary payments provision provided that defense cost payments reduced the liability limits, even though the defense clause in the coverage grant said that the insurer's duty to defend lasted until the limits were exhausted by payment of settlements or judgments, and the coverage grant said that the supplementary payments provision described the insurer's monetary obligations in addition to those described in the coverage grant.²⁷²⁹ However, in the one published opinion addressing the issue, the New York Appellate Division held that that the coverage grant's broad duty to defend language trumped any argument that defense costs reduced the policy's liability limits under the supplementary payments provision.²⁷³⁰

§ 14.12.2-Liability Insurance Policies

Liability insurance policies generally are derived from standardized policy language first compiled by insurance rating bureaus, the successor to which is a property-casualty industry policy writing group, the Insurance Services Organization (ISO).²⁷³¹ The ISO is an umbrella organization owned by insurance companies, originally formed in 1971 when 11 predecessor insurance rating bureaus consolidated.²⁷³²

The ISO drafts insurance forms, files them with state insurance commissioners for approval, develops underwriting guidelines, and publishes explanatory circulars describing the intent and effect of policy provisions.²⁷³³ The standard insurance forms changed significantly in 1955, 1966, 1973, 1985, 1998, and 2001, and additional changes are always being discussed by ISO drafting committees. These changes do not necessarily limit coverage; they often clarify coverage in response to developing case law or expand coverage in reaction to market demands.

The insurance industry gravitates towards the use of standard forms for three main reasons:

1) Marketing. Generic forms make it easier for a policyholder to analyze and compare prices of insurance "products" (i.e., the so-called standard coverages). Generic forms also make it easier to market insurance, because agents and brokers may have to explain coverages less as policyholders become more familiar with these forms over time.
2) Better Risk Prediction. Generic forms make it easier to evaluate and underwrite the risk insured. This risk is not simply whether a covered loss will occur, but includes the risk that a court will say that a covered loss has occurred in light of specific policy language. Using the same language from policy to policy leads to greater certainty regarding how courts likely will interpret and apply policy provisions and, thus, greater certainty in assessing potential losses.
3) Acceptance. The various state insurance commissioners may be more inclined to accept the use of a particular insurance product in their state if a generic form has been previously approved for use by an insurance commissioner from another state.

Although standardized insurance contracts and sharing information to set premiums seems to implicate antitrust laws, the McCarran-Ferguson Act²⁷³⁴ exempts insurers from certain federal antitrust laws and helped pave the way for creation of the ISO and its work. The insurance industry's exemption from antitrust...