Contractors Professional Liability Update
August 2007
Contractors professional liability (CPrL)
is a third-party liability policy providing coverage for acts, errors, and omissions
in performing professional services. In addition, CPrL provides coverage for
vicarious liability arising out of professional services subcontracted by the
construction firm.
by Jeff
Slivka
New Day
Underwriting Managers
CPrL is available for all types of construction firms performing professional
services—design-builders, construction managers (at-risk and agency), general
contractors (involved in various pre-construction consulting), specialty trades
such as mechanical/electrical/plumbing (MEP) contractors who typically perform
both design and installation, and environmental engineering/remediation firms.
Additional first-party coverage or protective coverage can be added to the
typical CPrL. The protective coverage, offered by few insurers, provides coverage
for the named insured for damages incurred as a result of negligent acts, errors,
and omissions arising from professional services performed by sub-design professional
(DP). The coverage sits excess and difference in coverage of the underlying
professional liability of the design professional and pays out when the underlying
DP's policy is exhausted.
CPrL is offered on both practice/blanket as well as project policies. However,
many insurers will only offer CPrL on a project policy if it is currently insured
with that insurer. This puts a tremendous burden on those contractors who are
required to carry CPrL via contract but have no practice program in place. Terms
for practice programs are annual, while project terms range between 3 to 5 years
with extended reporting periods (ERPs) available up to 10 years. However, the
common practice is to limit the total program to 10 years, construction period
plus ERP.
Marketplace
Today, there are approximately 15 domestic and foreign insurers willing to
offer various forms of CPrL coverage. Insurer appetite varies dramatically.
For example, one insurer may only offer CPrL to environmental firms, while another
only offers it to construction managers, design/build firms, and other non-environmental
construction firms. Others only offer coverage to smaller or middle market specialty
trade contractors. In addition, some may only be willing to take an excess position,
while most will offer terms on a primary basis. With so many differences in
risk appetite and coverage, it becomes increasingly difficult to navigate through
the marketplace.
It is estimated that annual CPrL premiums are in the $250 million range and
growing at a rate of about 15 to 20 percent each year. Each insurer offers its
own unique policy form, so careful attention must be given in reviewing each
form for accuracy, depending on the delivery method and professional services
offered by the construction firm.
It is expected that the number of insurance insurers will remain stable with
the possibility to see a few new entrants, especially entertaining the middle
market CPrL business.
Capacity
Combining all domestic and foreign markets, the available capacity for CPrL
remains approximately $150 million each claim/aggregate limit, with the maximum
limit any one insurer can offer remaining at $25 million on each claim/aggregate.
The major insurers continue to have access to the reinsurance marketplace for
facultative capacity above the $25 million.
A question that is often asked of brokers by their clients is what limits
should be purchased when considering CPrL coverage. In my opinion, the matrix
presented below provides a guideline for discussion with the contractors. Limits
required or purchased can change with numerous variables. Variables that need
to be considered are types of structures, geography, experience level, and risk
appetite.
MATRIX
EXHIBIT
Medium to larger size contractors take higher retentions—$100,000 each loss
or $250,000 each loss and combine the CPrL with the CPL to offset the cost of
the higher limits and sacrifice neither program because of price. This tracks
with the logic in purchasing CPrL—it is a catastrophic coverage so insure for
the single claim that will have the potential to threaten the existence of the
organization.
Retentions
Minimums remain at $10,000; however, most firms will purchase higher retentions
to offset the cost of coverage. CPrL insurers offer both self-insured retentions
and deductibles. Typically, deductibles have to be negotiated prior to policy
inception.
Premiums
The average minimum premium of all the markets is around $10,000 for the
$1 million per loss/aggregate limit of liability.
Market Trends
There are two reasons motivating CPrL buyers—contract requirements and asset
protection. Contract requirements for CPrL are on the rise. Although it is difficult
to apply a percentage increase, it is certain that there has been a dramatic
increase in the number of owners or general contractors (GCs) requiring CPrL
coverage. This is a factor of an increased awareness of exposures more so than
any changes in the marketplace. Owners and GCs are becoming more aware of the
professional liability exposures they face and try to transfer that exposure
via CPrL requirements.
As for asset protection, this can be further broken down into several factors,
all interrelated and all driving factors leading contractors to the purchase
of CPrL to finance professional liability loss. They include:
- An increase in education or awareness on the issue
- Availability of coverage—insurers catering to all types and sizes of
construction firms
- Softening of the standard casualty lines making funds available to purchase
CPrL
- Increased interest in Construction Management At-Risk and Design-Build
Discussions with underwriters revealed that the marketplace saw an average
of 20 percent new buyers to the marketplace, driven by one or all of the above
motivators.
Project Delivery Methods
Although design-bid-build continues to be the predominant delivery method
selected by many owners in the Untied States, according to a recent edition
of Engineering News Record (ENR) the Construction Management At-Risk (CM At-Risk)
delivery method has now surpassed Design-Build as the second most popular choice.
This could be for a number of reasons—owners want to create a more collaborative
team, centralize responsibility for construction, guaranteed maximum price (GMP)
contract, various state legislators now allowing CM At-Risk for public projects,
or perceived reduction of risk. CM At-Risk is probably the least understood
project delivery method by all insurance professionals, including brokers/agents
and underwriters. CM At-Risk continues to cause confusion when trying to get
perspective on the professional liability risk associated with the delivery
method.
It is fairly clear that during the pre-construction, design, and bid phases,
a construction firm may provide advisory professional management assistance
to the owner and, in some cases, the prime design professional, offering schedule,
budget, constructibility reviews, and a number of other services (depending
on the services agreed to in the contract). But what professional services and
associated liability, if any, arise during the construction phase? The CPrL
marketplace is still split on this issue.
Currently, some insurers specifically exclude CM At-Risk services, fearful
of providing coverage for general liability type exposures—construction means,
methods, techniques, scheduling, etc., and any resulting damages to subcontractors
as a result of these services. Others will provide CPrL coverage for professional
services offered via CM At-Risk as long as they are provided by a licensed design
professional or spelled out in a professional services agreement rather than
a construction contract. Lastly, there are some insurers that do not differentiate
between CM At-Risk and CM Agency, nor do they have any exclusionary language
for construction means, methods, sequencing, scheduling, etc.
Contractors need to understand their own professional liability risks and
the coverage afforded by the various coverage forms to obtain coverage that
will respond in the event of a claim. Any of the options above may be satisfactory,
and the requirement for a knowledgeable broker manifests itself in the process
of procuring appropriate coverage.
For 2007, I see little to no change with this issue. Education in all levels
of the industry needs to occur to truly understand and address the professional
liability exposures associated with CM At-Risk. The fact that there seems to
be several variations of CM At-Risk will not help the issue.
Professional Liability Insurance Requirements
Another trend affecting CPrL coverage is the owner's or general contractor's
requirement of a contractor to purchase CPrL, regardless of whether the firm
is providing professional services. Many public/private owners and GCs need
to take a harder look at what they are requiring of construction managers, design
builders, and/or general contractors, and reassess those requirements. No one
is advocating that owners or GCs should blatantly remove the professional liability
insurance requirements from the contract, but perhaps concessions on coverage
or limits can be made.
- Is it necessary to require $10 million of professional liability insurance
from a firm performing agency construction management on a $50 million project?
- Is it necessary to require the design professional under a design build
contract to have specified limits and overlook the $25 million the design
builder purchases?
- Is it appropriate for an owner to request $10 million in professional
liability from a general contractor/developer when they are not in contractual
privity with the design professional?
This is a difficult topic because liability cannot be capped, and owners
have a right to protect their asset and their project. To the other extreme,
I have seen many projects where the owner merely relies on the $1 million professional
liability coverage from the prime design professional on projects of $250 million
and higher. To address appropriately, the solution lies somewhere in-between
and should be determined on a project-by-project basis, based on the level or
type of professional services being offered by the construction firm.
For 2007, there was minor improvement in the availability of CPrL coverage.
Continued and sustained improvement will depend on continued education of the
exposures and a better understanding on the level of coverage offered in the
CPrL marketplace. Unnecessary CPrL insurance requirements lead to an increased
cost of the project. Some contractors may be able to secure CPrL coverage; however,
if they are not providing professional services, the likelihood that the CPrL
will provide any protection may be questioned.
Prudent contractors are aligning themselves with CPrL insurers now and buying
the coverage on a practice or blanket program. This allows them to bid projects
with CPrL requirements with efficiency, allocate costs, and protect the organization.
Rate Adjustments
The professional liability marketplace continues to move its way back to
profitability. Even though the past 3 to 4 years have been profitable for many
insurers, rates still appear to be increasing. CPrL rates will typically track
with standard professional liability market rates. It is anticipated that 0
to 10 percent rate increases for 2007 will occur on accounts performing well
for underwriters: little change in operation or project type and no significant
claims activity. For construction firms with significant claims activity, change
in operation, change in project type, or with delivery methods offered, rate
increases will vary based on the insurer.
Although rates will increase modestly, premiums will rise at a much higher
rate due to the increase in revenue or exposure base of many contractors we
have seen. In many cases, contractors are experiencing revenue growth, on average,
of 25 to 40 percent. Naturally, this will have a significant impact on the overall
cost of the CPrL program.
Project Professional Liability
Owners of construction projects, architects, engineers, design-builders,
general contractors, and insurance brokers all have experienced the same issues
and frustrations in attempting to secure project professional liability insurance.
Where coverage was once somewhat available, insuring professional liability
on construction projects has become an extremely difficult task to accomplish
over the past few years. Projects involving the construction of commercial condominiums
or other "habitational" buildings presents even greater issues.
The project professional liability policy will typically provide the broadest
coverage for all entities on a construction project as long as it is structured
properly. The operative phrase is "structured properly." There can be a variety
of contractual arrangements with those providing professional services on any
given project. In most instances, the lead design professional will hold contracts
with the entire design team. In these cases, the policy structure is simple—all
entities are named accordingly. However, in other instances, it may not be that
simple. Perhaps the owner is contracting directly with the fire protection engineering
firm. Maybe the general contractor is contracting with the MEP contractor—who
happens to be providing the design on that work as well. It is imperative to
have a clear understanding of the contractual arrangement for professional services
to ensure proper coverage is provided. All entities performing design services
or professional services should be named in the policy to optimize coverage.
When creating the structure of the program, consideration should be given
to the various insured versus insured exclusions attached. While coverage may
be secured, naming the owner, general contractors, and the design team, the
insured versus insured exclusion may preclude those entities from the original
intended coverage. Also, keep in mind there are project exclusions that exist
on contractor's and DP's professional liability policies. Some are as broad
as excluding coverage regardless of whether the project policy "covers" the
claim." It's excluded for the mere fact that a project policy exists. This may
be a very significant drawback to project policies—rather than having various
limits under all contractor and DP policies, you now have a single limit with
the project policy.
Lastly, there is a greater potential of exhausting the limit of liability
in the event of a claim or claims since coverage is extended to numerous insureds
under the policy. The concern here would be that defense costs may reduce the
limit of liability remaining for compensatory damages. In addition, the practice
programs of the many design professionals covered under the project policy will
have a project exclusion on the policy, making the project policy the only policy
for the project.
When it comes to premium cost, there is a simple rule of thumb: the broader
the coverage, the higher the cost. Therefore, all things being equal, project
professional liability—whether secured by the owner, design builder, contractor,
or design professional—tends to be the most costly alternative. It may, however,
be the least costly in the event of a catastrophic occurrence.
A sound alternative to the project policy continues to be the owner's protective
policies. The protective policies have gained momentum over the past 3 to 4
years as the pricing of project professional liability insurance has skyrocketed.
Offered to owners ("owners protective") of construction projects, design/builders,
and general contractors (contractor's protective), the "protective" policy provides
first-party indemnity for damages, which are excess of the design professional's
professional liability insurance, that the named insured incurs as a result
of negligence of the design professional. The "protective" sits excess of the
design professional's professional liability insurance, and there is a minimum
insurance requirement placed on the design professional by the insurer offering
coverage. This requirement varies greatly, depending on the type of project
and the design team performing services. Furthermore, the underlying design
professional's professional liability policy must be exhausted before the policy
will provide the indemnity.
There are only a few insurers offering "protective" policies, and not all
offer them to both owners and contractors. Coverage terms and conditions vary
greatly, so it is imperative that a sound understanding of the contractual relationship
between the named insured and the design professional exists prior to pursuing
the coverage.
The protective type programs will continue to gain attention in the CPrL
marketplace in 2007 and beyond.
Combined Professional Liability and Pollution Liability Forms
When discussing "combined" policy forms, we are referring to a CPrL combined
with contractors pollution liability (CPL). Some insurers only offer pollution
liability arising from professional services. While that product has its place
in the marketplace, any firm performing actual work is not adequately insured
for pollution liability under those forms. If contractors are performing actual
work, confirm that the CPL component of coverage is being purchased and not
just pollution liability coverage under the professional liability insuring
agreement.
Combined CPrL and CPL programs were created to offer a cost-effective financing
solution to those contracting firms that possess both professional liability
and environmental liability exposures. Rather than purchasing two separate policies,
this combined form offers the ease of providing both coverages without the issues
of two premiums and two retentions.
In 2006 New Day performed an informal study of 35 construction firms with
approximately $250 million in annual revenue that purchase some form of CPrL
and/or CPL coverage. This study was launched to confirm a trend that New Day
believed has gained momentum over the past 3 years—the utilization of a combined
form versus buying separate CPrL and CPL policies to optimize premium dollars.
It was confirmed that with the general cost of insurance, exposures with both
professional and pollution liability rising in the construction industry, contractors
are finding the combined form to be a cost effective alternative to buying separate
programs or, more importantly, sacrificing neither coverage for the other because
of cost.
Most contractors feel both coverage parts are extremely important to the
existence of the organization. Of the 35 firms surveyed, 28 purchased a combined
CPrL/CPL program while 7 maintained separate programs. While the population
surveyed was limited, there is a trend in which contractors are buying or moving
to a combined CPrL/CPL versus separate monoline policies. New Day expects interest
in the combined form will continue into 2007 and beyond.
Pollution/Mold Exclusions
Some insurers continue to apply some form of a pollution exclusion, i.e.,
silica, lead, and asbestos to their CPrL policies. This limits the effectiveness
of the coverage since the intent of the exclusion is to exclude pollution conditions
arising from professional services. With so many different activities being
performed by construction managers, general contractors, design builders, and
specialty trades, there is a potential that pollution may result from professional
services being offered. There is no expected change from the markets with CPrL
programs structured with pollution exclusions. It would be prudent when pursuing
CPrL coverage to ensure there is no such pollution exclusion that restricts
coverage.
Although mold and fungus concerns seem to have stabilized over the past 2
years, they are still an issue for many insurers offering CPrL. From one insurer's
standpoint, mold is excluded, and there is no alternative to buy back the coverage.
For others, it is fairly easily secured, provided the construction firm can
evidence a mold prevention or water intrusion mitigation program. Most insurers
will still offer up to $10 million with additional limits being available on
a case-by-case basis.
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