Mitigation of Damages Coverage Helps with Design Defects
September 2011
The contractors professional liability
insurance (CPrL) marketplace is an evolving area of professional liability
insurance, familiar to few, so much so that many construction firms may not
be familiar with the various first-party coverages now available to them
under their CPrL program. From "protective" to mitigation of damages (MOD),
these coverages could preserve a construction project and prevent disaster.
by Jeff
Slivka
New Day Underwriting
Managers
With the desire for more advanced and innovative construction project
delivery methods, industry initiatives like integrated project delivery,
sustainable design and construction, public/private partnerships, and other
similar movements and the increasing demand that owners require of
contractors to deliver a project faster and cheaper, contractors of all
types, shapes, and sizes face professional liability exposure. These exposures range from vicarious liability from design or
architectural/engineering services to scheduling/sequencing errors to
mismanagement of subcontractors or the construction process. These exposures
can easily cripple a construction firm and create unwanted liability with
devastating results.
Some construction firms still do not recognize such risk exists.
Fortunately, many firms do understand the risk, manage it effectively, and
properly insure themselves to mitigate the financial impact it can have on
an organization. Many have purchased what is called CPrL insurance.
CPrL provides coverage for third-party liability arising out of negligent
acts, errors, or omissions in professional services performed by or on
behalf of the construction firm or named insured. These policies now
specifically address the professional liability exposures associated with
construction operations, not to mention providing specific coverage for
Leadership in Energy and Environmental Design and other sustainable
initiatives as well as building information modeling and integrated project
delivery.
Mitigation of Damages Coverage
Recently, there has been an increase in the number of insurers offering a
unique first-party coverage to those construction firms that contract with
design professionals (DPs). This coverage is referred to as "rectification,"
"mitigation of loss," or "mitigation of damages" coverage, depending on the
insurer. I'll refer to it as mitigation of damages or MOD coverage to keep
it simple. Generally speaking (keep in mind that the applicability of
coverage is different for each insurer), MOD coverage provides the insured
with first-party coverage for damages it incurs as a result of a design
defect discovered during the course of construction for defects that, if not
addressed, would result in a professional liability claim.
Advantages of MOD Coverage
MOD coverage is similar to contractors protective coverage in that it
provides a construction firm with an alternative to recoup the costs spent
to correct design defects that would otherwise come out of its pocket or
professional liability program, but it is very different in terms of paying
for the costs associated with a design defect. Whereas contractors
protective coverage supplements the DP's professional liability insurance,
MOD coverage essentially replaces the DP's insurance solely with respect to
the costs incurred by the named insured (design-builder) to rectify design
issues discovered during the course of construction that would otherwise
result in professional liability claims if not corrected.
In addition, while the protective coverage is an excess coverage, MOD is
primary coverage subject to a self-insured retention (SIR). In theory, MOD
coverage allows for the construction to proceed with funding for the
rectification costs coming from the insurer rather than the contractor. The
insurer may then subrogate back against the DP for expenses incurred.
MOD coverage can be added inclusive of the policy limits of liability or
in addition to the limits of liability. In addition, both can be offered on
a project-specific basis in conjunction with the base CPrL product. However,
most insurers will require that contractors purchase a practice program
(corporate program for all work/services) before they will offer project
coverage; otherwise, the cost of project insurance may rise substantially.
Because of the broad scope of MOD coverage, insurers offering this
insurance can control their limits by offering and managing their risk with
significant SIRs, usually starting at $250,000; coinsurance requirements;
and exclusions on internal cost and profits so both the contractor's and
insurer's interests are aligned to ultimately recover as much as possible
from the responsible party or DP.
An Illustration
Applying MOD coverage to a project scenario, a design-builder enters into
a contract with a DP on a mixed-use retail/condominium project. The
contractor carries a $5,000,000 CPrL program, including MOD coverage. During
the course of construction, it is discovered that the structure was designed
using the improper sized rebar. It is determined that the cost to rectify
the error is approximately $3 million. The policy would then indemnify the
named insured, starting from the time the error is discovered, for the total
of $3 million (subject to the SIR). The insurer would likely then subrogate
back against the negligent DP to recover its costs.
Disadvantages of MOD Coverage
While MOD coverage has great benefits, there is a downside. MOD coverage
can expose the CPrL program to a greater probability of loss and potentially
even impact the contractor's future insurability, regardless of whether the
insurer is successful in its subrogation action. One other important aspect
to note about MOD coverage is that, when it is attached to a combined CPrL
and contractors pollution liability form, MOD coverage applies to pollution
as well. The best example would be the first-party costs incurred to remedy
mold growing on a project during the course of construction.
Conclusion
As the CPrL marketplace continues to expand, there is no doubt that we
will see continual broadening of coverage to attempt to address the various
delivery systems being created and associated professional risk. Currently,
few insurers offer MOD coverage; however, that will likely change. In only 3
short years, the market has gone from one insurer offering MOD, and on an
extremely select basis, to at least five. I'm sure with time we'll see that
number increase.
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