Insurance for Architect- and Engineer-Led Design-Build Projects
August 2000
This article reviews the liability insurance
typically purchased by architects and engineers, and examines how well it works
in design-build settings.
by David
H. Collings
Ames & Gough
Design-build project delivery is not new, but its recent growth continues
to impress. According to the Design-Build Institute of America, design-build
project delivery now accounts for 35 percent of all U.S. nonresidential construction,
up from 25 percent just 5 years ago. Even more remarkable, domesticdesign-build
revenue for the Engineering News Record Top 100 design-build firms grew over
30 percent last year (see ENR, June 19, 2000).
From an insurance and risk point of view, the challenge with design-build
is that it can take so many forms, as shown on the right. While most architect/engineer
(A/E) firms still do not act as the lead design-builders, it is an issue that
many are starting to address.
The purpose of this article is to review the liability insurance typically
purchased by A/Es and to examine how well it works in the design-build setting.
Design-Build Architect/Engineers Liability Insurance
Most A/Es maintain several basic types of insurance coverage, including the
following:
- General liability
- Auto liability
- Employers liability
- Workers compensation
- Umbrella or excess liability
- Professional liability
Taking the lead in design-build projects increases the amount of risk being
insured by an A/E's policies and, in some cases, it also changes how liability
insurance responds to a loss.
Commercial General Liability Insurance
General liability insurance is usually purchased by all of the parties in
the construction process. It is designed to protect the insured party against
liability arising out of direct bodily injury and property damage to third parties
caused by an occurrence (accident).
Generally, an A/E's normal operations do not generate a substantial loss
exposure for the risks covered by general liability insurance. Although A/Es
always purchase general liability insurance to protect against normal commercial
liability, the limits of this coverage (even with umbrella or excess coverage)
are frequently not high enough to meet the design-build contract requirements,
requiring the purchase of additional limits.
Graph
2
General liability coverage can cause some confusion in the design-build setting
because it does provide limited protection for losses arising from design error.
For example, an unamended general liability policy will insure against a loss
resulting from a design error, as long as the design error results in bodily
injury or property damage to a third party and is the result of an occurrence.
If the loss is purely economic (i.e., delay without bodily injury or property
damage), there is no general liability coverage.
To avoid overlapping with professional liability coverage, an A/E's general
liability policy includes the Insurance Services Office, Inc. (ISO), Form CG
22 43, "Engineers, Architects or Surveyors Professional Liability" endorsement,
which excludes any liability arising from professional services. For a pure
A/E, this does not present a problem, but for a design-build A/E, it can. As
with a contractor, the professional services exclusion needs to be clarified
so that excluded professional services will not include any activities included
within construction means or methods (ISO Form CG 22 79, "Exclusion-Contractors-Professional
Liability" endorsement).
Most insurers will not, however, delete the professional services exclusion
entirely or even use the "Limited Exclusion-Contractor-Professional Liability"
endorsement (ISO Form CG 22 80) that allows coverage for bodily injury or property
damage from professional design services in connection with a project the insured
is designing and constructing.
Another important coverage for design-build A/Es is contractual liability.
In the definition of an "insured contract," the 1998 edition commercial general
liability policy form CG 00 01 contains exclusions that affect design-build
contracts. Specifically, the policy states that coverage will not apply to contracts:
- That indemnifies an architect, engineer or surveyor for injury or damage
arising out of:
- Preparing, approving, or failing to prepare or approve maps, shop
drawings, opinions, reports, surveys, field orders, change orders or
drawings and specifications; or
- Giving directions or instructions, or failing to give them, if that
is the primary cause of the injury or damage; or
- Under which the insured, if an architect, engineer or surveyor, assumes
liability for an injury or damage arising out of the insured's rendering
or failing to render professional services, including those listed in 2.
above and supervisory, inspection, architectural or engineering activities.
This wording is rarely amended, or even considered, for its impact on design-build
risk. A design-build A/E should request that the wording be amended in two ways:
clarify that ordinary means and methods will not be considered a professional
service (similar to ISO endorsement CG 22 79) and amend the policy to confirm
that this wording will not apply to design-build joint ventures. Underwriters
are more likely to agree to the first change suggested but may resist on the
second.
The design-build A/E must also be concerned with completed-operations insurance
coverage. Completed-operations insurance covers bodily injury and property damage
caused by defects in the completed work, including losses arising from damage
that occurs during the operation of the finished product, usually provided for
a term of 1 to 3 years after substantial completion.
Owners must be aware that some design professionals do not carry completed-operations
coverage on their general liability policies. However, most general liability
insurers will agree to add completed-operations coverage without additional
charge.
Professional Liability Insurance
Typical A/E professional liability insurance provides broad protection for
liability arising from the rendering or failure to render professional services.
Normally, the scope of coverage includes all professional services offered by
the A/E, and coverage provides long-term protection as long as it is continuously
renewed by the A/E. In the design-build setting, however, A/E professional insurance
presents several problems.
- Third parties cannot be added as additional insureds.
- Insurers frequently add restrictive "design-build" endorsements.
- Low policy limits need to be shared by several parties.
- Coverage only applies to third-party liability.
The additional insured issue is not a problem from the A/E's point of view,
but can be frustrating to owners and/or contractors requesting additional insured
status similar to a general liability policy. The best resolution for this issue
is for each entity to buy its own coverage or for the owner or lead design-builder
to purchase project specific professional liability insurance (see IRMI.com, Project-Specific Professional Liability: Who Really
Pays for Design Errors? May 2000).
Both the design-build A/E and the project owner must also recognize that
many professional liability policies carry a design-build endorsement which
specifically excludes the "build" aspect of design-build services from coverage.
While these endorsements may vary in their particular wording, they are generally
similar in that they seek to exclude claims based on or arising out of faulty
workmanship and construction performed by both the insured design-build A/E
or its subcontractor.
There are several reasons cited in support of this exclusion. Some types
of faulty workmanship will be covered by the applicable general liability policy
or builders risk policy. Also, because design professionals are often in a position
to control and eliminate many of the situations and factors that can directly
cause faulty workmanship, the faulty workmanship exposure is often perceived
as an uninsurable risk with respect to design professionals.
The problem with some design-build endorsements is that they inadvertently
eliminate coverage for certain professional activities and/or losses (e.g.,
delay or review of shop drawings). As recommended in the comments about contractor
professional liability insurance, any exclusions added by the underwriter (or
included in the policy form) that are intended to limit coverage by excluding
construction activities should always be clarified by adding the phrase, "unless
such loss or liability arises from the rendering or failure to render professional
services."
Another key issue for design-build A/Es is how their insurance works when
they are leading a fixed price or guaranteed maximum price (GMP) project. For
example, consider the following scenario.
An Elm Street A/E agrees to design and build a $20 million commercial
building on a GMP basis. The expected profit from the job is $1 million.
During construction, a design error (committed by Elm Street) is discovered,
and it costs $2 million to repair and get back on schedule. As the design-builder,
Elm Street absorbs the increased costs and still completes the job on time
and within budget.
In the scenario described above, Elm Street gets no benefit from its own
professional liability policy because it was not sued by the owner or any third
party. One leading A/E insurer has verbally stated it will cover the type of
claim described above, but to date, this issue has not been addressed by the
insurance community. A/Es planning to lead design-build projects should discuss
this risk with their insurers and request "first-party" coverage to pick up
a loss that would otherwise be insured except for the structure of the design-build
contract.
Surety Bonds
The potential for exposure to liability for design problems makes some sureties
reluctant to issue bonds securing the performance of design-build contracts.
This reluctance is not diminished by the fact that the design-build team is
headed by a design-build A/E rather than a design-build contractor.
Even if the surety is confident that the language of the bond and the design-build
contract precluded a claim on the bond due to design defects, the surety may
still be hesitant to issue the design-build A/E a performance bond for the construction
portion of the project. The two fundamental elements considered by sureties
when determining whether to issue a bond to secure the performance of an entity
are (1) the capability of the bonded entity to perform the contract requirements,
and (2) the financial ability of the bonded entity to indemnify the surety if
the surety must pay a claim on the bond.
In this regard, the surety may harbor reservations about the design-build
A/E's ability to effectively manage and administer the construction aspects
of the project because the activities are beyond the scope of the design professional's
traditional expertise. Furthermore, many design and engineering firms do not
possess the financial capability to adequately indemnify the surety in the event
of a large claim. Taken collectively or individually, such factors could lead
to design-build A/Es encountering particular problems in securing a performance
bond for their design-build project.
A design-build A/E can improve its ability to procure a performance bond
in three ways.
- The design-build A/E should establish a relationship with a reputable
surety before the bond is actually needed and increase the surety's confidence
in its financial capability.
- The design-build A/E should procure smaller bonds while successfully
performing projects and prove that it is a good performance risk.
- The design-build A/E should procure bonds with the construction subcontractor
so that the surety can look to both entities for performance of the contract
and indemnity if the surety has to honor a claim on the bond.
Conclusion
Design-builders and owners using design-build construction techniques must
carefully consider the form of the design-build entity to determine the adequacy
of the insurance purchased for the project. Who leads the design-build team-a
contractor, a design professional, or a joint venture-will have an impact on
the insurance and bond coverages available. Thus, both owners and design-builders
must carefully analyze risks and insurance available for design-build projects.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.