The Definitive Guide to Liability, Financial Protection, and Risk Management for Builders and Contractors

by John M. SadlerMaster Builder Instructor, Attorney, Builder Insurance Expert

How Builder Insurance Works and What You Must Do to Protect Yourself with the Right Policies and Coverage at the Absolute Lowest Cost

Start up builders often ask us what policies they need to carry at a minimum. We frequently get the same question from long term builders looking to trim their expenses.

Builders may need up to 9 different insurance polices and/or bonds depending on their situation, activities, and tolerance to take out of pocket risk.

At a minimum, almost all builders, regardless of how small or even if they’re a start up operation, will need Workers Compensation, General Liability, and Builders Risk.

Other policies that are commonly carried include:

  • Property
  • Business Auto
  • Excess or Umbrella
  • License and Permit Bonds
  • Performance Bonds
  • and Home Owners Warranty products

The percentages that are indicated on this page are a rough estimate of the percentage of our builder clients that purchase the respective insurance policy.

As you can see, it ranges from a low of 1% for performance bonds to a high of 100% for Workers Compensation and General Liability.

  1. Workers’ Compensation (100%)
  2. General Liability (100%)
  3. Business Auto (60%)
  4. Excess Liability / Umbrella (10%)
  5. Builders Risk (75%)
  6. Property (Building, Contents, Equipment, Crime) (90%)
  7. License And Permit Bonds (100%)
  8. Performance Bonds (5%)
  9. Home Owners Warranty (50%)

* Percentages indicate approximate percentage of builder clients that carry each policy type.

Why exactly are all of these policies possibly needed?

Some of these policies are required under state or local law such as Workers’ Compensation, Auto Liability, and License Or Permit Bonds. If you don’t carry these policies you face serious fines and sanctions.

The builder’s bank or lending institution will always require proof of Builders Risk to secure the value of the new start or project for which they have extended the loan. Also, banks want to make sure that they’re lending to a legitimate business as no legitimate business would operate without Workers Compensation and General Liability.

In the case of custom jobs, project owners want to make sure that the builder is a legitimate businesses man and is adequately insured with all of he customary policies including Work Comp, General Liability, Business Auto, and Builders Risk. In rare cases, a residential property owner under a custom contract may require a Performance Bond to guarantee that the job will be completed according to the terms of the contract. This is more common in commercial construction.

Many builders want to voluntarily carry these policies because it makes good business sense and they want to protect their assets in the event of worker injury, a lawsuit, or a property loss. Many want to go beyond what may be required by carrying an Excess Liability or Umbrella policy and a Home Owners Warranty.

Why Are The Various Policies Needed?

Some of these policies are required under state or local law such as Workers’ Compensation, Auto Liability, and License Or Permit Bonds. If you don’t carry these policies you face serious fines and sanctions.

The builder’s bank or lending institution will always require proof of Builders Risk to secure the value of the new start or project for which they have extended the loan. Also, banks want to make sure that they’re lending to a legitimate business as no legitimate business would operate without Workers Compensation and General Liability.

In the case of custom jobs, project owners want to make sure that the builder is a legitimate businesses man and is adequately insured with all of he customary policies including Work Comp, General Liability, Business Auto, and Builders Risk. In rare cases, a residential property owner under a custom contract may require a Performance Bond to guarantee that the job will be completed according to the terms of the contract. This is more common in commercial construction.

Many builders want to voluntarily carry these policies because it makes good business sense and they want to protect their assets in the event of worker injury, a lawsuit, or a property loss. Many want to go beyond what may be required by carrying an Excess Liability or Umbrella policy and a Home Owners Warranty.

Workers’ Compensation

Workers’ Compensation pays benefits to your employees and the employees of your uninsured subs who are injured on the job.

Benefits include payment of medical expenses (both past and future), lost wages (usually up to 66 2/3% of the average weekly wage for a maximum number of weeks as prescribed by state law), lump sum benefits for certain partial or total disabilities, disfigurements, and a death benefit that is prescribed by state law.

The benefits under Workers Compensation are extremely broad and can be paid out over a number of years.

The cost of this policy starts out at a minimum premium around $1,000 and total estimated premiums range upward depending on your projected annual employee payrolls and amounts paid to uninsured subs. Many of our smaller builder clients that use all insured subs pay less than $5,000 a year in premium whereas some of our larger builders pay over $75,000 a year. Since there are so many factors involved, the only way to know your likely cost is to get an actual quote.

As you can imagine, when the policy is set up, the estimated payrolls and amounts paid to uninsured subs tends to be inaccurate. For this reason, the final premium is subject to an audit at the end of the policy year. The audit is necessary to determine your exact exposures so that a fair premium is charged.

The Workers Compensation policy is explained in much more detail in the “Workers’ Compensation for Contractors” main article section. This section includes the important issues of how to collect certificates of insurance from your subs, how to deduct from uninsured subs, and how to prepare for your audit.

General Liability

The General Liability policy protects the builder against certain claims and lawsuits alleging that the builder’s negligence resulted in bodily injury, property damage, or personal and advertising injury to a third party. A third party is someone such as a visitor, trespasser, neighbor, another contractor on the job, a competing builder, the buyer, or a subsequent purchaser.

The policy pays for the costs of legal defense, settlements, and adverse jury verdicts.

The policy does cover the individual business owners and employees in addition to the business entity.

Below is a very short list of potentially covered lawsuits examples that have actually happened to our builder clients. These are just the tip of the iceberg of the types of claims that have been reported to our office.

While you’re scanning over this list, please note that the insurance industry has eliminated important coverage for construction defect over the past five years. Your actual policy coverages for construction defect claims will depend on your carrier and the coverage options that you’ve selected.

* Examples of potentially covered lawsuits:
– jobsite injuries to visitors and trespassers during construction
– utility line severed during construction
– neighbors house burns down when worker throws cigarette in yard
– house burns down in future due to faulty wiring (coverage depends on policy terms)
– water damage occurs in future from faulty plumbing (coverage depends on policy terms)

The minimum premium for this policy starts out in the $750 to $4,000 range and the total estimated premium goes up from there depending on your annual projected payrolls, amounts paid to uninsured subs, and amounts paid to insured subs. Some of our smaller builders pay under $2,000 a year and a few of our larger builders pay over $50,000 a year. The only way to know your likely cost is to get an actual quote.

Just like with the Workers’ Compensation policy, these projections tend to be inaccurate and as a result the final premium is subject to audit at the end of the policy year.

General Liability is explained in more detail, including the important issues of construction defect litigation and contractual transfer of liability to your subs, in the main “General Liability for Contractors” article section.

Business Auto

Most builders are familiar with auto insurance and the various coverages such as liability, uninsured and underinsured motorists, and physical damage which consists of collision and other than collision.

Builders who own one or two vehicles sometimes purchase a Personal Auto policy which can be less expensive but provides more limited coverages.

Other builders that own three or more vehicles typically purchase a Business Auto policy because they qualify for fleet discounts. A Business Auto policy typically provides higher limits of coverage as well as the option to add Non Owned and Hired Auto Liability which is highly recommended.

Non Owned Auto Liability covers a builder’s vicarious liability for when an employee or subcontractor uses their personal vehicle to run an errand on behalf of the builder. In those situations, if the employee or sub is uninsured or only carries minimum limits under their own auto insurance policy, and if they get in a wreck and injure someone else, the builder can be shot gunned into that lawsuit. The builder must carry Non Owned Liability in order to be protected.

Hired auto liability protects the builder when he rents a vehicle while out of town on business or possibly when a special vehicle is rented for a particular job.

Non Owned And Hired Auto Liability can often be purchased on a stand alone basis for a charge of around $250 a year.

Excess Liability and Umbrella

Excess Liability and Umbrella policies are a major source of confusion among builders.

The terms “excess liability” and “umbrella” are almost interchangeable now in the insurance industry. Historically, an “umbrella” policy provided much broader coverage than an “excess liability” policy but that is no longer the case in most instances.

Many builders believe that the policy is a super duper catch all that covers all claims that are not covered by the other policies. This is just not true.

Also, many builders believe that their Personal Umbrella policy which supplements their Homeowners Liability and Personal Auto policy protects them if they are sued arising out of their business operations. This is not true either. You must have a Business Excess Liability or Commercial Umbrella to protect your business operations.

What the policy does is that it merely extends the limits of your underlying policies to a higher limit in increments of $1M. It can extend the limits of your existing Auto Liability, General Liability, and Employers Liability policies.

The reason you would want to carry an Excess Liability or Umbrella policy would be if there is a serious big dollar claim and the limits of coverage of your underlying policies are not high enough to take care of the damages. In this case, you would have to come out of pocket to pay for the difference and this could result in bankruptcy.

The additional limits provided by an Excess Liability or Umbrella policy can provide peace of mind for a relatively inexpensive cost.

Builders’ Risk

The Builders Risk policy is sometimes referred to as “course of construction insurance”.

It’s a temporary property insurance policy that protects the new housing start or other job in the event of damage while the job is in progress.

It protects against perils such as fire, theft, vandalism, wind, hail, and collision with auto.

The builder should insure each job for an amount equal to the replacement cost value of materials, labor, overhead, and reasonable profit.

Coverage ends when the job is completed, sold, or occupied by a tenant. When coverage ends, a permanent property insurance policy should be taken out by the new owner.

Rates for coverage vary depending on the state and the territory of coverage within the state. A typical rate for inland territories in South Carolina is .23 per $100 of completed value.

Property Insurance Coverages

Property insurance covers the property that is titled in the name of your business such as building, contents, and equipment.

Coverage limits for building and contents should be set based on their replacement cost value and should protect against perils such as fire, theft, vandalism, wind, and hail.

A special Contractors Equipment policy should be taken out to cover the value of your equipment that leaves your premises and travels to the job site. This policy can be customized to extend to rented and leased equipment as well.

In addition, a Crime policy should be taken out to protect against embezzlement of funds or other theft of equipment or materials by you own employees.

License And Permit Bonds

License and permit bonds are required by state governments or municipalities such as towns, cities, or counties to guarantee that your construction will comply with the applicable building codes and regulations.

If the authorized building official finds that your construction is not in compliance, a demand for correction can be requested and if you don’t fix the problem, the bonding company will step in your shoes and can hire another contractor to correct the problem or can pay up to the bond limit. Then the bonding company will file a lawsuit against you to get reimbursement for their expenses. As a result, the bond really doesn’t protect you, it only protects the owner and governmental entity.

In South Carolina, the state requires all residential builders to carry a bond limit of $15,000 and the cost for this bond for one year from the various bonding companies can range from $100 to $225 and even higher if your credit rating is poor. Other states may require higher limits of coverage and if so, the cost of the bond will be higher.

Also in South Carolina, the municipality where the construction occurs typically requires its own bond limit of $2,000 or $2500 and the cost for a three year bond with a leading bonding company is $250. This is typical of the requirements and bond cost in other states.

Performance Bonds

A different type of bond called a performance bond will be often be required by the project owner in commercial construction. Sometimes, on rare occasions, a residential home owner will require a performance bond on a large custom job.

This type of bond guarantees that the work will be completed in accordance with the contract terms. In the event that the bonded contractor does not complete the job due to lack of finances, death, or other problems, the bonding company will find another contractor to complete the job and will look to the original bonded contractor for reimbursement.

If you’re a home builder, it’ll be difficult for you to qualify for this type of bond, especially if you build spec homes which are considered by the bonding companies to carry a high financial risk. In addition, the application process is exhaustive with the requirement to complete multiple financial statements for your business and individual owners as well as a work in progress report. This type of bond usually requires personal indemnification by the individual business owners and may require spousal indemnification as well.

The cost of a performance bond ranges from $10 to $30 per $1,000 of bond amount depending on your financial strength. So for example, if the bond amount for a job is $750,000, the cost of the bond would range from $7500 to $22,500..

Home Owner Warranty

Home Owner Warranty products are typically used for new home construction but products are now available for remodeling jobs and some commercial construction.

The warranty provides protection to the home owner in the event the builder goes out of business or retires and is not able to correct construction problems. It provides a mechanism for the warranty company to address construction grievances and to correct them if necessary.

It protects the builder by superseding implied warranties under state law and replacing them with a written warranty.

It also protects the builder by forcing construction disputes into binding arbitration which can be less expensive and more favorable to the builder under many circumstances. However, not all warranty contracts force disputes into binding arbitration as arbitration may be voluntary with some providers.

The typical warranty terms provide protection against construction defects for workmanship for one year from the sale, major structural systems for two years, and structural defects for ten years.

The cost of the home owner warranty to the builder can range from $2.00 to $3.50 per $1000 of sales price depending on the state where the home is located and the quality of the terms of protection under the contract.