Contractual Risk Transfer Is A House Of

AMERICAN RISK MANAGEMENT RESOURCES NETWORK, LLC
                     7780 Elmwood Ave., Suite 130 ~ Middleton, WI 53562 ~ 877-735-0800 ~ Fax: 608-836-9565

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 Contractual Risk Transfer Is A House Of
Cards For Most Contamination Risks Today
                                  By David J. Dybdahl December 2013

The introduction of exclusions for losses related to fungus/mold/bacteria/Category3 water in
virtually all forms of commercial property and liability insurance has changed the game for
contractual liability risk transfer in construction operations. Based on loss frequency, these
exclusions have increased the need for Contractors Environmental Liability (CEL) insurance at
least 1000-fold since the origins of the CEL product line in 1986. In spite of the plethora of CEL
insurance products available, the majority of contractors that need CEL do not have this
important coverage in place today. To further exacerbate the insurance coverage gap created by
expanding exclusions for contaminants, the environmental liability polices being sold today
have unacceptably high fundamental coverage defect rates for indoor environmental loss
exposures. This is because very few environmental insurance policies were designed to be
used for indoor environmental risks.

The need for insurance for indoor environmental risks can be demonstrated utilizing the
example of an actual sequence of events arising from the construction of a hospital lobby. The
loss involves wrongful death claims resulting from the exposure to bacteria living in a
decorative water feature in a hospital lobby. This situation illustrates why traditional contractual
liability risk management practices using insurance transfer in construction projects will turn
into a house of cards unless the effects of pollution/contamination exclusions in insurance
policies are addressed.

Toxic torts arising from the decorative water feature in a hospital lobby
A commercial interior design firm was contracted by the owner of a hospital to design and build an
attractive space for the hospital lobby. The design/build work performed under this contract included
furnishing the seating area, installing the wall and floor coverings and installing the decorative water
feature – a small waterfall.
A General Contractor with twenty years of experience was hired by the interior design firm to build out
the plan. The General Contractor then hired a plumber subcontractor to install the water feature.
Industry standard procurement contracts between the hospital and the interior design firm were
completed, whereby the design firm agreed to indemnify and hold harmless the hospital owner for
potential liabilities arising from the lobby project. The indemnity obligation of the design firm was
backed by General Liability insurance, which was specified to include contractual liability coverage
making the hospital owner an additional insured on a primary and non-contributory basis and to waive
all rights of subrogation against the owner.
Following custom and practice in the construction industry, the design firm passed on its contractual
indemnity obligations and insurance requirements to the General Contractor and the GC, in turn,
required the plumber subcontractor to indemnify the GC and back up that obligation with equivalent
insurance to that required of the General Contractor.
The construction of the lobby was completed to the hospital owner’s satisfaction.

AMERICAN RISK MANAGEMENT RESOURCES NETWORK, LLC
                     7780 Elmwood Ave., Suite 130 ~ Middleton, WI 53562 ~ 877-735-0800 ~ Fax: 608-836-9565

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Two years after the completion of the project there was an outbreak of deadly Legionnaires Disease in
the county where the hospital was located. Within days, public health officials determined that all of the
infected people had recently walked past the decorative waterfall feature in the hospital lobby.
Eight people became very ill from the pneumonia-like symptoms caused by the legionella bacteria living
in the lobby water feature. The deadly bacteria had been released into the air by the aerosolized falling
water in the hospital lobby. The airborne bacteria were inhaled into the lungs of the passing visitors
causing infections and the untimely deaths of two exposed victims.
Within months the hospital and the vendors it had hired to design and build the lobby were sued by the
eight injured parties, including the families of the deceased.
Per the terms of its contract, the hospital owner demanded indemnity from the design firm who had
arranged for the construction of the water feature. Part of the indemnity demand was for the design
firm’s General Liability insurer to defend the owner as an additional insured under the policy.
The design firm mirrored the demand for indemnification by the General Contractor under the indemnity
provisions in their contract with the GC and, of course, the GC demanded indemnification from the
plumber subcontractor who built the waterfall.
The hospital was located in a state where bacteria “contamination” has been determined to fall within
the definition of a “Pollutant” in the ISO standard Pollution Exclusions. California, Wisconsin and
Indiana all have insurance coverage case law designating bacteria as a ‘contaminant’. Therefore, claims
in which the proximate cause of the loss was exposure to bacteria fall within the ISO standard definition
of a “Pollutant” in insurance policies. Additional states could follow this precedent in coverage
litigation, as the logic is very simple to exclude bacteria as a contaminant. (See Revealing the Dark
Secrets of Category 3 Water Exclusions in IRMI)
In addition to the ‘standard’ pollution exclusions, the GL policies sold to all of the stakeholders further
excluded losses related to fungus/mold/bacteria by endorsement. The exclusions for
fungus/mold/bacteria also contained anti-concurrent causation language, which can take precedence
over any other provisions in the insurance policy if even a speck of the excluded materials is involved in
an otherwise covered loss. In this situation, the loss was caused by direct exposure to legionella
bacteria, so there was little dispute over which part of the loss may or may not have been caused by
bacteria.
The insurance vendor for at least one of the defendants in this toxic tort case had not informed its client
about the effects of the new exclusionary endorsements for fungus/mold/bacteria in its liability
insurance policies. Nor had the insurance vendor offered its client CEL coverage to fill the liability
coverage gaps created by universal pollution/contamination exclusions. The insurance vendor would not
be alone in these omissions. The vast majority of insurance vendors and underwriters have no
understanding of the effects of pollution/contamination exclusions in indoor environments or of the use
of environmental insurance to fill the resulting coverage gaps.
It’s All A House of Cards
In the face of wrongful death and toxic tort claims for millions of dollars against the stakeholders in the
lobby project, how did the sophisticated indemnity agreements and General Liability insurance coverage
specifications respond for the design firm and the other stakeholders?
A claim for defense costs was submitted to the design firm’s General Liability insurer for both the
design firm and for the hospital owner as an additional insured. The claim for both parties was promptly
denied by the insurance company under the fungus/mold /bacteria exclusion.

AMERICAN RISK MANAGEMENT RESOURCES NETWORK, LLC
                      7780 Elmwood Ave., Suite 130 ~ Middleton, WI 53562 ~ 877-735-0800 ~ Fax: 608-836-9565

www.armr.net

Litigation over the fungus/mold/bacteria exclusion in the design firm’s GL policy ensued, with the
design firm losing its case on appeal. The courts determined that the proximate cause of the loss was
bacteria contamination and that the fungus/mold/bacteria exclusion clearly and unambiguously applied
to the claim on the General Liability insurance policy. The national trend in coverage litigation over the
meaning and effect of this exclusion follows the same findings.
There was another level of GL exclusions that could have been triggered in this case. The Total
Pollution exclusions in the stakeholders’ GL policies would also apply if their GL policies were
purchased in the state where the hospital was located. In that state, bacteria is a “Pollutant” in ISO based
insurance policies, as determined by prior insurance coverage case law. However, with the anti-
concurrent causation fungus/mold/bacteria exclusion endorsement in place on all of the stakeholders,
there was no reason for their GL carriers to be denying the loss under either the traditional pollution
exclusion f. or the Total Pollution exclusion endorsements. Although that was an option.
The exclusionary endorsements for fungus/mold/bacteria are much broader than standard ‘Pollution’
exclusions” in the basic policy forms. One important differentiator is that, under the exclusionary
endorsement for fungus/mold/bacteria, the insurance company can eliminate the obligation to defend a
claim arising from fungus/mold/bacteria. This was the actual situation for some of the defendants in this
example - no coverage and no defense costs either.
A similar claim for defense costs was denied for the General Contractor, although that denied claim was
not litigated.
Without liability insurance, the GC and its subcontractors are forced by their indemnity obligations to
indemnify the upstream parties without insurance to reimburse them for these costs.
The hospital’s General Liability insurance policy had the same exclusions as its vendors for
pollution/contamination/fungus/mold/bacteria related losses.

Traditional Contractual Risk Transfer Is a House of Cards For Environmental Risks
It turned out that none of the General Liability policies purchased by the stakeholders responded to this
loss. Not even defense costs were covered by the GL policies in the above scenario because of the
operation of the anti-concurrent causation based fungus/mold/bacteria exclusions.
There is one common denominator for all of the stakeholders defending themselves without the benefit
of insurance. Everyone involved ignored the existence and effects of pollution/contamination exclusions
in their risk management strategies. It turned out that all of the contractual risk transfers were a house of
cards because there was no environmental insurance in place backing up the indemnity obligations.
A proactive approach to serving the environmental risk management needs of the stakeholders would
have been a better solution for all the parties, including their insurance vendors.

Where Are the Insurance Brokers In This Mess?
The sky is not falling on insurance brokers for selling policies with major coverage gaps for
fungus/mold/bacteria related losses. The reasons for this vary from state to state based on the required
standard of care for insurance intermediaries in each state. Most states set low standards of care for the
quality of insurance products sold. Insurance buyers are primarily responsible for the insurance they
choose to buy - so buyer, beware!
Another saving grace for insurance producers is that insurance coverage litigation is very expensive. It’s
normally pursued only by firms that have the resources to defend themselves from a denied liability

AMERICAN RISK MANAGEMENT RESOURCES NETWORK, LLC
                     7780 Elmwood Ave., Suite 130 ~ Middleton, WI 53562 ~ 877-735-0800 ~ Fax: 608-836-9565

www.armr.net

insurance claim, while paying another set of lawyers to sue their insurance company hoping for a judge
to decide there is coverage under the insurance policies they purchased. In most denied pollution loss
scenarios, insurance buyers do not have enough money to pay two teams of lawyers for years, not to
mention a third team of lawyers alleging malpractice by their insurance vendor for failing to cover such
an obvious loss exposure, and providing no advice to insure it.
When a substantial liability claim is denied, as it was in this case, even firms with tens of millions of
dollars in sales can simply go out of business due to unfunded liabilities. The good news in all of this for
the insurance vendors servicing the stakeholders is that, if there is not enough money to pursue
insurance coverage litigation, the insurance buyer probably doesn’t have enough money to pay lawyers
to sue the insurance broker for professional malpractice either. But there is still a downside for the
insurance vendors. If the client does have the money to hire multiple sets of lawyers to pursue not only
coverage litigation for a denied claim but also professional malpractice allegations against their
insurance vendors one thing will be certain, the claim being made against the insurance vendor will be
for big dollars.
There is no reason for insurance vendors to be betting the farm on uninsured environmental risks in their
customer base. There is a glut of environmental insurance availability. Specially modified environmental
coverage for indoor loss exposures, including coverage for fungus and mold, was introduced by Zurich
Insurance Company in September, 2003. By October, this coverage could have been found on the first
page of an internet search by typing ‘mold insurance’ into Google. Coverage for bacteria as a pollutant
appeared in 2008, when coverage for Microbial Matter as a pollutant was introduced.
The fundamental flaw in contractual liability risk transfer for contamination risks is not a dearth of
environmental insurance product availability. The house of cards is created by fundamentally defective
insurance specifications commonly used by property owners, contractors and their lenders. An
insurance specification supposedly backing up an indemnity agreement is fundamentally flawed if it
ignores the existence of environmental/contamination loss exclusions in the requested coverage.

Correcting Contractual Environmental Liability Risk Transfer Design Flaws
It is simple to correct for the universal exclusions of claims associated with pollutants/contaminants in
property and liability insurance policies if stakeholders understand and correct for the effects of various
pollution/contamination exclusions in insurance policies.
 In this case:
   1. The hospital, design firm and GC should have specified modified Contractors Environmental
      Liability Insurance in their procurement contracts. A more complete set of sample CEL
      insurance specifications for indoor environmental risks can be found on ARMR’s website at
      www.armr.net, search ‘insurance specifications’. A summary of stakeholders’ environmental
      insurance needs can be found in the 2008 IRMI Risk Report entitled Environmental Risks,
      Insurance and Pitfalls

   2. The hospital owner needed a specially modified Environmental Impairment Liability insurance
      policy to address the gaps in the property and liability insurance policies caused by exclusions
      for pollution/contamination/fungus/mold/bacteria in virtually all of the insurance policies a
      hospital would purchase.

AMERICAN RISK MANAGEMENT RESOURCES NETWORK, LLC
                     7780 Elmwood Ave., Suite 130 ~ Middleton, WI 53562 ~ 877-735-0800 ~ Fax: 608-836-9565

www.armr.net

Conclusion
The continuously expanding scope of exclusions related to various contaminants can convert traditional
contractual liability risk transfer strategies into a house of cards. Fixing the problem is as simple as
correcting for the environmental exclusions in property and liability policies through enlightened
insurance specifications and procurements made by informed insurance vendors.

David Dybdahl CPCU, ARM, MBA is the President of American Risk Management Resources
Network, LLC. a insurance brokerage, consulting and expert witness firm. He specializes in
environmental a risk management and insurance and is a regular contributor to IRMI publications. He
can be reached at dybdahl@armr.net or 608 836 9590.