COMMITMENTS AND CONTINGENCIES

Warranty Claims

The Company provides its homebuyers with warranties for defects in structural elements, mechanical systems and other construction components of the home. Warranty liabilities are established by charging cost of sales for each home delivered based on management’s estimate of expected warranty-related costs and by accruing for existing warranty claims. The Company’s warranty liability is based upon historical warranty cost experience in each market in which it operates and is adjusted to reflect qualitative risks associated with the types of homes built and the geographic areas in which they are built. The estimation of these costs is subject to a high degree of variability due to uncertainties related to these factors. Due to the high degree of judgment required in establishing the liability for warranty claims, actual future costs could differ significantly from current estimated amounts, and it is not possible for the Company to make a reasonable estimate of the possible loss or range of loss in excess of its warranty liability.

Changes in the Company’s warranty liability during fiscal 2018 and 2017 were as follows:



	September 30,
	2018			2017
	(In millions)
Warranty liability, beginning of year	$	143.7		$	104.4
Warranties issued	81.6			69.7
Changes in liability for pre-existing warranties	49.3			30.0
Settlements made	(72.6		)	(60.4		)
Warranty liability, end of year	$	202.0		$	143.7

The change in liabilities for pre-existing warranties was $49.3 million and $30.0 million in fiscal 2018 and 2017, respectively. These amounts reflect the Company’s ongoing efforts to improve its customer service and relations, which in many cases results in the performance of warranty service after the original warranty period has expired. The Company has increased the amount of its warranties issued as a percentage of home cost of sales to reflect this increase in warranty costs.

Legal Claims and Insurance

The Company is named as a defendant in various claims, complaints and other legal actions in the ordinary course of business. At any point in time, the Company is managing several hundred individual claims related to construction defect matters, personal injury claims, employment matters, land development issues, contract disputes and other matters. The Company has established reserves for these contingencies based on the estimated costs of pending claims and the estimated costs of anticipated future claims related to previously closed homes. The estimated liabilities for these contingencies were $408.1 million and $420.6 million at September 30, 2018 and 2017, respectively, and are included in accrued expenses and other liabilities in the consolidated balance sheets. Approximately 99% and 98% of these reserves related to construction defect matters at September 30, 2018 and 2017, respectively. Expenses related to the Company’s legal contingencies were $41.0 million, $87.8 million and $49.6 million in fiscal 2018, 2017 and 2016, respectively.

The Company’s reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. As of September 30, 2018, no individual existing claim was material to the Company’s financial statements. The Company has closed a significant number of homes during recent years and may be subject to future construction defect claims on these homes. Although regulations vary from state to state, construction defect issues can generally be reported for up to ten years after the home has closed in many states in which the Company operates. Historical data and trends regarding the frequency of claims incurred and the costs to resolve claims relative to the types of products and markets where the Company operates are used to estimate the construction defect liabilities for both existing and anticipated future claims. These estimates are subject to ongoing revision as the circumstances of individual pending claims and historical data and trends change. Adjustments to estimated reserves are recorded in the accounting period in which the change in estimate occurs.

Historical trends in construction defect claims have been inconsistent, and the Company believes they may continue to fluctuate. Housing market conditions have been volatile across most of the Company’s markets over the past ten years, and the Company believes such conditions can affect the frequency and cost of construction defect claims. If the ultimate resolution of construction defect claims resulting from the Company’s home closings in prior years varies from current expectations, it could significantly change the Company’s estimates regarding the frequency and timing of claims incurred and the costs to resolve existing and anticipated future claims, which would impact the construction defect reserves in the future. If the frequency of claims incurred or costs of existing and future legal claims significantly exceed the Company’s current estimates, they will have a significant negative impact on its future earnings and liquidity.

The Company’s reserves for legal claims decreased from $420.6 million at September 30, 2017 to $408.1 million at September 30, 2018. The increase in reserves during fiscal 2018 was less than the prior year was due to a decrease in known and expected future claims. Changes in the Company’s legal claims reserves during fiscal 2018 and 2017 were as follows:



	September 30,
	2018			2017
	(In millions)
Reserves for legal claims, beginning of year	$	420.6		$	423.5
Increase in reserves	46.4			91.0
Payments	(58.9		)	(93.9		)
Reserves for legal claims, end of year	$	408.1		$	420.6

In the majority of states in which it operates, the Company has, and requires the majority of the subcontractors it uses to have, general liability insurance which includes construction defect coverage. The Company’s general liability insurance policies protect it against a portion of its risk of loss from construction defect and other claims and lawsuits, subject to self-insured retentions and other coverage limits. For policy years ended June 30, 2006 through 2019, the Company is self-insured for the first $10.0 million to $17.5 million of aggregate completed operations indemnity claims incurred, depending on the policy year. After the aggregate self-insurance limits have been satisfied, the Company’s excess loss insurance coverage begins. However, the Company must still pay $0.25 million of any indemnity claim and a portion of the legal fees incurred for each claim occurrence.

In some states where the Company believes it is too difficult or expensive for its subcontractors to obtain general liability insurance, the Company has waived its normal subcontractor general liability insurance requirements to obtain lower costs from subcontractors. In these states, the Company purchases insurance policies from either third-party carriers or its 100% owned captive insurance subsidiary and names certain subcontractors as additional insureds. The policies issued by the captive insurance subsidiary represent self-insurance of these risks by the Company. The Company is self-insured under its captive policies for up to $25.0 million in aggregate completed operations indemnity claims per policy year and for the first $0.25 million for each claim occurrence. For all policy years after April 2007, the captive insurance subsidiary has $15.0 million of excess loss insurance coverage with a third-party insurer. For policy years 2017, 2018 and 2019, after consideration of the aforementioned $15.0 million of risk transfer, the Company is self-insured under these captive policies for up to $10.0 million in aggregate completed operations indemnity claims, plus defense costs, per policy year and for up to $0.25 million for each claim occurrence.

The Company is self-insured for the deductible amounts under its workers’ compensation insurance policies. The deductibles vary by policy year, but in no years exceed $0.5 million per occurrence. The deductible for the 2017, 2018 and 2019 policy years is $0.5 million per occurrence.

The Company estimates and records receivables under its applicable insurance policies related to its estimated contingencies for known claims and anticipated future construction defect claims on previously closed homes and other legal claims and lawsuits incurred in the ordinary course of business when recovery is probable. Additionally, the Company may have the ability to recover a portion of its losses from its subcontractors and their insurance carriers when the Company has been named as an additional insured on their insurance policies. The Company’s receivables related to its estimates of insurance recoveries from estimated losses for pending legal claims and anticipated future claims related to previously closed homes totaled $54.6 million and $74.4 million at September 30, 2018 and 2017, respectively, and are included in other assets in the consolidated balance sheets.

The estimation of losses related to these reserves and the related estimates of recoveries from insurance policies are subject to a high degree of variability due to uncertainties such as trends in construction defect claims relative to the Company’s markets and the types of products built, claim frequency, claim settlement costs and patterns, insurance industry practices and legal interpretations, among others. Due to the high degree of judgment required in establishing reserves for these contingencies, actual future costs and recoveries from insurance could differ significantly from current estimated amounts, and it is not possible for the Company to make a reasonable estimate of the possible loss or range of loss in excess of its reserves.

Land and Lot Option Purchase Contracts

The Company enters into land and lot option purchase contracts to acquire land or lots for the construction of homes. At September 30, 2018, the Company’s homebuilding segment had total option deposits of $401.1 million, consisting of cash deposits of $397.4 million and promissory notes and letters of credit of $3.7 million, to purchase land and lots with a total remaining purchase price of approximately $6.5 billion. The majority of land and lots under contract are currently expected to be purchased within three years. Of these amounts, $48.0 million of the option deposits related to contracts with Forestar to purchase land and lots with a remaining purchase price of $522.2 million. A limited number of the homebuilding land and lot option purchase contracts at September 30, 2018, representing $82.1 million of remaining purchase price, were subject to specific performance provisions which may require the Company to purchase the land or lots upon the land sellers meeting their contractual obligations. Of the $82.1 million remaining purchase price subject to specific performance provisions, $34.7 million related to a contract between the homebuilding segment and Forestar.

During fiscal 2018, Forestar reimbursed the Company’s homebuilding segment $21.2 million for previously paid earnest money and $15.2 million for pre-acquisition and other due diligence costs related to land purchase contracts whereby the homebuilding segment assigned its rights under contract to Forestar.

At September 30, 2018, Forestar had total option deposits of $4.2 million to purchase land and lots from third parties with a total remaining purchase price of approximately $32.7 million.

Other Commitments

At September 30, 2018, the Company had outstanding surety bonds of $1.5 billion and letters of credit of $128.5 million to secure performance under various contracts. Of the total letters of credit, $107.2 million were issued under the homebuilding revolving credit facility and $4.5 million were issued under Forestar’s revolving credit facility. The remaining $16.8 million of letters of credit were issued under secured letter of credit agreements, of which $1.4 million related to homebuilding operations and $15.4 million related to Forestar. These agreements require the deposit of cash as collateral with the issuing banks which is included as restricted cash in the consolidated balance sheet.

The Company leases office space and equipment under non-cancelable operating leases. At September 30, 2018, the future minimum annual lease payments under these agreements are as follows (in millions):



2019	$	16.8
2020	12.0
2021	6.8
2022	3.8
2023	2.1
Thereafter	0.8
	$	42.3

Rent expense was $27.8 million, $26.3 million and $24.7 million for fiscal 2018, 2017 and 2016, respectively.