HONOLULU—A controversial ruling in Hawaii that damage resulting from construction defects does not constitute an occurrence triggering coverage under a commercial general liability policy has prompted some insurers to alter policy language to make it clear that they intend to pay such losses.

Hawaii's Intermediate Court of Appeals further concluded in its May 19 decision in Group Builders Inc. and Tradewind Insurance Co. Ltd. vs. Admiral Insurance Co. that breach-of-contract claims based on allegations of shoddy performance are not covered under CGL policies and that tort-based claims derivative of such breach of contract claims also are not covered.

The Hawaii court upheld a lower court ruling that Admiral had no obligation under a CGL policy to defend or indemnify its policyholder, Honolulu-based Group Builders Inc., a subcontractor that installed insulation during construction of the Hilton Hawaiian Village's Kalia Tower in 2001.

A year after the tower opened, Hilton was forced to close 21 floors after discovering extensive mold in guest rooms. Hilton sued Group Builders and other defendants, alleging, among other things, that the subcontractor's shoddy work caused construction defects that led to property damage.

The ruling stated that an investigation “revealed numerous material defects in the design and construction of the tower. Some of these defects substantially contributed to or caused the mold growth.”

The court acknowledged that the mold damage and loss of use of the facility qualified as property damage, but it ruled that the construction defects were not an occurrence triggering coverage under a CGL policy.

In upholding the lower court ruling, the appeals court relied on prior federal court opinions, including one by the 9th U.S. Circuit Court of Appeals. That court ruled that to allow recovery for disputes between parties in a contractual relationship over the quality of work would essentially convert a CGL policy into a professional liability policy or performance bond.

The pro-insurer ruling surprised brokers and policyholders, who feared it could mean their claims for property damage resulting from construction defects caused by poor-quality work would be denied routinely by insurers in Hawaii and elsewhere.

The Hawaii decision is the latest of several such cases, with courts split on whether defects are an occurrence and thus trigger CGL coverage.

The case is the “most recent adverse decision” for policyholders, said Frank Armstrong, Tampa, Fla.-based senior vp, national director of Willis Construction Claims, a unit of Willis Group Holdings P.L.C. A Sept. 30 ruling by the Supreme Court of Indiana in Sheehan Construction Co. Inc. vs. Continental Casualty Co. ruled that construction defects constitute an occurrence under a CGL policy, he said.

“The adverse cases tend to get more attention, as they should,” Mr. Armstrong said.

“I've had several calls on this case,” said Paul Primavera, senior vp in Washington for Lockton Construction Services Group, a unit of Lockton Cos. L.L.C. “Periodically, we see cases that find an occurrence and cases that do not...In my mind, it's not different from other cases,” he said of the Hawaii ruling.

Warren C. Perkins Jr., vp-risk manager at Boh Bros. Construction Co. L.L.C. in New Orleans, said the Hawaii case is especially troublesome because the court did not consider policy language after deciding a defect does not constitute an occurrence.

“It basically says that if it's not an occurrence, it doesn't matter” what the policy says and there is no need to investigate the policy wording,” Mr. Perkins said. Still, it is “promising” that insurers are clarifying their coverage intent, he said.

Among insurers modifying policy language, Swiss Reinsurance America Corp. added an endorsement to its CGL policy in Hawaii stating that poor workmanship is not in and of itself considered an occurrence, but resulting property damage would be treated as a triggering occurrence, said Brian Evans, senior vp of the Overland Park, Kan.-based company.

The reinsurer last year also added the endorsement to CGL policies in Pennsylvania, where a court ruled that defects are not occurrences.

“From our perspective, this was the intent of the policy all along” and Swiss Re decided to re-evaluate its policy wording based on client feedback, Mr. Evans said.

Zurich North America also changed wording in its CGL policies to ensure that defects are considered occurrences, “especially in light of the ruling in Hawaii,” a spokesman for the insurer confirmed.

Other insurers are making similar moves, said Bob Dixon, Los Angeles-based senior vp at Aon Risk Solutions' construction services group.

“There are a number of insurers that write coverage in the Hawaiian market,” Mr. Dixon said, and nearly all have made coverage changes to assure policyholders that construction defect claims related to shoddy work would be covered.

Willis' Mr. Armstrong pointed out that there are some differences in how larger construction general liability insurers and those in the middle market approach coverage regarding construction defects from an underwriting and claims standpoint.

In light of the Hawaii ruling and others, some larger underwriters have been willing, if asked, to negotiate terms that essentially amount to an “underwriting clarification” that for policyholders presents a more favorable coverage view toward faulty work constituting an occurrence, while that's not necessarily the case among smaller insurers, he said.

Lockton's Mr. Primavera said he believes most of the market's large insurers always intended to cover property damage resulting from poor workmanship.

Admiral's attorney said the concerns are an overreaction and the ruling upheld policy language that rightfully protects insurers from exposures they didn't intend to cover.

“I have been contacted by contractors who have Chicken Little concerns that the sky is falling,” said Allen R. Wolff, New York-based attorney with Olshan Grundman Frome Rosenzweig & Wolosky L.L.P. “At the end of the day, the question comes down to: What is it that an insurance company agrees is the risk it has insured against?” Mr. Wolff said. “I think it arguably can be said that the insurer agreed to take on the risk of accidents. But an insurance company does not take on the risk of the quality of the training programs you have for your employees.”