Urban Legends Regarding Insurance – A Reality Check

real estate Aug 26, 2021

Proper insurance in all forms is one of the most important means to protect a property owner. But beware of the many myths regarding insurance. For the owner pursuing a major remodel, repair or reconstruction project, these urban legends, if believed, can have rather harmful consequences.

Myth: Builders and contractors are all insured, and have to be insured in order to build.

Unfortunately, this is simply not true.  A contractor is required by most municipalities only to show proof of workers compensation insurance.  This compensates only for injury to the builder's employees.  

Myth: Contractors have a state-mandated insurance policy in place.

Contractors are required by the Business and Professions Code to have a license bond.  This bond is maintained by contractors to compensate the victims of any violations of the Contractors Licensing Laws.  The bond is currently $7,500 - less than the cost of building a brick patio.   

Contractor license bonds permit recovery to claimants who demonstrate a contractor has violated one of the licensing laws.  Unfortunately, incompetent construction is not a violation of the licensing law, and so the bond will not pay for the repairs to correct it.

Myth: The contractor's insurance will finish the job and pay the subcontractors if they are not paid by the contractor.

Liability insurance issued to contractors does not cover breaches of contract, but only covers negligence. If one desires to insure the completion of a project, a "performance bond" is needed; for insurance against mechanics liens, and against non-payment of subcontractors and building material suppliers, a "payment bond".  These two bonds are typically sold in a package, and are usually not available from the liability insurance companies.  Such bonds add 2-3% to the cost of a contractor's work.  However, many contractors cannot qualify to be bonded—which is itself another good reason to insist upon a bond, if finances permit.

Myth: Insurance covers all negligent construction work.

Liability insurance typically covers only damages to persons or property from negligent construction which occurs during the policy period.  If the negligent work has not yet resulted in any damage to the property, the insurance policy does not deem it to be an insured event.

Furthermore, the insurance normally excludes damage to the insured contractor's own construction work.  Under the "work product exclusion", there must be damage to some part of the building other than that constructed by the negligent contractor.  

Myth:  We received a declarations page showing our vendor is covered by insurance, so we are protected.

A declarations page usually tells the insured only that at the time of issuance of the declarations page, the vendor was insured by that insurance company for the limits stated on the page.  However, it says nothing about exclusions.  Unfortunately, most insurance companies exclude work on common interest developments, and this exclusion may not be evident from the declarations page.  

Demand to see the policy and all exclusions and endorsements, to make sure your association is not excluded from coverage.

Insist upon receiving an “Additional Insured Endorsement”.  This also guarantees that if the policy for any reason is canceled or not renewed, your association, if named, will receive notice of this.

Myth: We had our contractor show proof of coverage when we had the construction three years ago, so we are covered now if anything goes wrong.

Contractors are usually issued insurance that covers the occurrence of loss during the policy period.  As mentioned above, the loss is not the negligent construction, but the damages caused by that construction.  Therefore, the policy in force during the construction project is not necessarily the policy that pays for damage caused by the negligent construction.  

If the contractor's insurance coverage has expired prior to the time the construction caused noticeable damage, the policy which was thought at the time of the construction project to protect the property owner may not be available.

Myth: If the owner does not collect from the original builder for the badly built roof, the owner’s property insurance will pay for the repair.

Most (if not all) general liability insurance policies have a Aconstruction defect exclusion@, in which the insurance company states that it will not cover damage caused by construction defects. 

Myth: Mold damage is not covered by insurance.

Since the explosion of mold damage claims in recent years, insurance companies have all written mold damage out of property coverage.  This has become so much the rule that many property owners and managers no longer even try.  

However, mold damage is often accompanied by a litigation threat, or may be caused by someone’s negligence (in which case a litigation threat should be made).  Threatened litigation is handled by a liability adjuster under the property owner’s general liability coverage, which is usually different than the ones who handle property damage claims.  In insurance parlance, first party mold claims are not covered, while third party claims may be.  The point here is that there is often hope for coverage, which otherwise is often overlooked.

 Written by Kelly G. Richardson

Kelly G. Richardson Esq., CCAL, is a Fellow of the College of Community Association Lawyers and a Partner of Richardson | Ober | DeNichilo LLP, a California law firm known for community association advice. Submit questions to [email protected]. Past columns at www.hoahomefront.com. All rights reserved®.