Residential builders in the Pikes Peak region say construction defect lawsuits, especially those being brought in California, are to blame for the fast-rising costs of liability insurance.

Chris White is a project manager for Mahler GC, a general contracting company in Colorado Springs. Mahler GC was awarded a contract to build between 200 and 300 homes as part of a low-income housing project in Falcon. Because Mahler GC is mainly a commercial contractor, White said he was unaware of the exorbitant cost of liability insurance incurred by residential builders. To carry out the contract, White said his company is having to create a subsidiary to manage the Falcon project.

Without the subsidiary, he said, Mahler GC would lose its insurance carrier.

Larry Lawrence, owner of Equity Custom Homes, has been building high-end homes since 1986 in northern El Paso and Douglas counties. Scott Dittman is company’s chief financial officer. He said the number of class action lawsuits filed against builders and subcontractors during the past few years – mainly in California – have wreaked havoc with liability insurance rates for builders in Colorado. “If it’s happening in California, it’s coming here,” he said.

Dittman said the problem begins when lawyers tell a homeowners association that they are filing a class action suit against the builder because a homeowner discovered a defect, such as a water leakage or mold. If it is a production home-built neighborhood, like Falcon’s Woodmen Hills, the lawyers seek out other homeowners who belong to the association to join the class, Dittman said. The association is then forced to support the lawsuit because of its fiduciary responsibility to the homeowners. If the association chose not to, it could be sued for failing to respond. “Our liability insurance rates have gone up in the past few years strictly due to the lawsuits,” Dittman said. “These guys are like ambulance chasers, and the threat of the lawsuit is just as damaging to the insurance company as the actual lawsuit because of the high cost of defending the case.”

Equity Homes’ insurance increased from $10,152 in 2001 to $27,000 in 2003 to $34,000 this year.

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The cost of liability insurance, which is based on the cost of construction, is about $10 per $1,000 of the total sales price, Lawrence said. “If the house is a million-dollar house, the liability insurance tacked onto the home is about $10,000,” he said. “We used to absorb the cost when the liability insurance rates were reasonable, but now those costs are passed on to the homebuyer, which accounts for an additional 1 percent increase to the homebuyer for the cost of construction. “In the past few years, we couldn’t compete against resale homes. And people wonder why there is no such thing as affordable housing.”

Most professional builders take care of their problems, Lawrence said. However, the unexpected occasionally happens.

Andy Cobb is a senior vice-president of Van Gilder Insurance Corp. He has been in the insurance business for 32 years and said the California lawsuits, which started increasing in the mid- to late 1990s, have had an “extreme impact on liability insurance costs to general contractors.”

The high liability rates are also a result of insurance carriers withdrawing from the market, he said.

“The expense of defending the lawsuits is the key issue, and insurance companies tried to fight individual and class action suits in the beginning but they lost time and again,” Cobb said. “Today, the insurance companies almost always settle.”

Cobb said Colorado is one of seven western states – the others are California, Arizona, Utah, Nevada, Oregon and Washington – that are being impacted by the lawsuits.

“The premiums have gone up by several 100s of percentages, and it’s even worse for the builders that have previous claim activity,” he said. To make matters worse, the coverage is more restrictive and insurance companies have fled the residential liability market. Cobb said liability policies were routinely offered through carriers such as Travelers, American Family and State Farm. But those companies and others have pulled out of Colorado, leaving only three insurers that offer liability coverage to Springs residential builders.

Jan Merriman is the chief financial officer for Classic Homes, one of the Springs largest production builders. Merriman said the company’s liability rates started soaring in 2001 because of the construction litigation. He said Classic Homes changed its liability coverage to a wrap program, which is an owner-controlled program, similar to a self-insured plan. Under the wrap program, all of Classic’s subcontractors are rolled into one insurance premium, and Classic collects the premiums from the individual subs.

Merriman said part of the problem with the construction litigation is that the claims filed include not only the main builder but also the dozens of subcontractors, who each have their own attorneys and insurance companies. To save costs, insurance companies began offering the subcontractor inclusive coverage.

Even with the wrap program, Merriman said, Classic’s liability rates increased 400 percent in 2001. Merriman said Classic has been locked into those rates for three years; in July, the company will renew again with a 45 to 50 percent increase. Classic is faced with high premium rates and self-insurance retention deductibles of $100,000 to $150, 000 per home, Merriman said. If there is a defect in the home, the insurance will not kick in until the deductible is met.

There is hope on the horizon for Colorado residential builders.

House Bill 1161 allows builders time to rectify a construction defect before a lawsuit can filed. Cobb said the bill protects builders and developers but leaves out the homeowners. He is not convinced that HB 1161 is an “equitable solution.”

Cobb, Merriman and Lawrence agree that it will take several years to determine the bill’s effect on litigation. Cobb said a grassroots movement is under way to counter the bill through a November ballot issue. Meanwhile, liability rates are increasing and construction defect litigators are splashed all over the Yellow Pages.

Dittman thinks there has to be a better solution than litigation. “Where’s the common sense in all of these lawsuits?” he asked.