Insider Q&A hears from construction-quality expert
Don Neff is president of La Jolla Pacific Ltd., an Irvine-based consulting firm that advises homebuilders on ways to improve the quality of their construction and avoid construction-defect claims. The firm operates in 10 states and claims to have assisted 1,000 clients in the building of more than 50,000 homes. Register reporter Jeff Collins spoke with Neff (not related to prior Insider Q&A guest Doug Neff of IHP Capital) about the state of the housing market and the current quality of homebuilding.
This question and answer session is interesting on a number of levels. La Jolla Pacific provides quality assurance and quality control risk management services to builders. The key to understanding such a firm is that risk management component. Risk is the quotient upon which the entire insurance industry is built upon. Insurance carriers are almost universally responsible for financing the construction defect litigation industry. If a developer/general contractor is sued by a group of homeowners or a homeowner association, usually the first thing that happens is that the builder’s insurance company is notified. The insurance company (after checking that the policy is still good!) hires a law firm to represent the builder. The law firm representing the builder then hires a team of experts and at the same time, files cross-complaints against the subcontractors that worked on the project in question. Now there are certainly exceptions to the rule, but that is the general method of operation in the CD industry.
From the moment the case is filed against the builder, their insurance company begins paying out money. Defense attorney firms bill by the hour. The experts designated bill by the hour. Documents have to be copied and organized and submitted. Even if the case is settled out of court, and even if the subcontractors and their respective insurance carriers pay the lion’s share of the settlement amount, the carrier for the builder will pay substantial amounts of money to their lawyers and experts. If the case goes to trial, the trial preparation costs for defending the builder will often run well over $100,000 alone. The only time that the builder’s insurance carrier recoups any of those costs is in the rare occasion that a jury finds in favor of the defense. So how does the insurance company remain solvent and return a profit to shareholders? Pretty easily, actually.
The insurance carrier reduces pay out on claims by reducing risk in the first place. One way of reducing risk is to insure builders with excellent track records – not unlike auto insurers providing better rates to drivers with fewer accidents. In construction, the high cost of litigation has prompted the carriers to go a step farther. On larger developments (more risk), the carriers are requiring better quality control/assurance (QA/QC) and are sometimes even requiring third party consultants to assist in that process. The cost of such services is prohibitively expensive to smaller developers, but the offset in insurance premiums is advantageous to the larger builders. (Builders that have seen numerous construction defect claims pay much higher premiums and as a result, some developers have resorted to insuring themselves.)
So what does this have to do with the article? Don Neff is asked by the reporter to weigh in on the relationship between the real estate market slow down and the potential for construction defect litigation. Mr. Neff asserts that even though the profit margin is decreasing due to significantly less demand, the construction quality overall will be better. He insists that builders will be more likely to spend more money for better quality control (i.e.: hiring firms like his) even though the profit is less. Economics must not have been offered at his school. History has shown us time after time that when profits go down, companies cut costs in order to boost the profit margin. The U.S. auto industry responded to decreased demand for domestic vehicles by cutting jobs – tens of thousands of jobs. Without such cutbacks, many of those companies would probably not be in place today. The auto industry did not increase quality control practices which would therefore increase labor costs and charge more to the consumers.
I guess we shall see whether Mr. Neff’s optimistic outlook is correct or not.
28 July 2007 | Business, Construction, Construction Defect, Construction and Law, Experts, Litigation | Comments
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