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.
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.
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.
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.
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.
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.
The average minimum premium of all the markets is around $10,000 for the $1 million per loss/aggregate limit of liability.
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.
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.
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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