Expert Commentary

Dissecting the Contractors Professional Liability Policy

The longest uninterrupted economic expansion in US history will probably end with a recession in 2020, says a panel of more than 100 experts conducted by Zillow Research. However, while the market is likely to soften on other fronts, the North American construction marketplace is still trending upward and expected to post annual 4.2 percent gains through 2024, according to market intelligence and advisory firm Mordor Intelligence.


Design and Professional Liability
September 2019

Among the drivers will be the continued emphasis on new construction that starts within the institutional, manufacturing, and public works sectors, as well as the ongoing investment in sustainable green building practices and advanced technologies like 3-D modeling and self-driving vehicles. As a result, many knowledgeable contractors are confronting the future with questions: What is the efficacy and longevity of the market's latest and greatest new sustainable and recyclable building products? What happens when a project doesn't achieve the desired level of Leadership Energy and Environmental Design certification? What is an acceptable risk, and how do I prepare if something goes wrong?

According to a survey of RT Specialty's national environmental and construction professional liability practice's book of business, contractors professional liability (CPrL) claims rose by nearly 23 percent from 2014 to 2017. In fact, 60 percent of these claims were related to construction management issues ranging from safety challenges and the mismanagement of subcontractors to the poor inspection of work and misidentification of environmental hazards.

Subsequently, an increasing number of educated firms are now looking to protect themselves with CPrL policies that cover the damages arising from the negligent acts, errors, and omissions related to the professional services performed by or on behalf of the insured. This is especially true for construction professionals who are currently experiencing an uptick in severe claims within the civil, health care, commercial building, and habitational project arenas. Many of these firms are now even exploring the benefits of expanded terms that cover the following.

  • Professional liability (third-party) protection for liability arising out of negligent acts, errors, or omissions in the issuance of professional services performed by or on behalf of the insured.
  • Protective indemnity (first-party) protection for damages incurred by the insured (contractor) and legally entitled to recover from errors created by design professionals. Protective, however, is an excess coverage, meaning that it pays for the delta between the total damages and the damages paid by the professional liability limits available to the insured from the design professional.
  • Rectification/mitigation (first-party) pays for the expenses reasonably incurred during the mitigation or rectification of a negligent act, error, or omission arising from professional services (performed by or on behalf of the insured) that would otherwise lead to a professional liability claim. Rectification/mitigation coverage is a primary coverage.

Evaluating CPrL Coverage Forms

Unfortunately, CPrL policies can vary greatly, often reflecting the flavor and inclinations of the approximately 30 insurers representing this market. To help sort out the differences, here is a review of the prominent terms and enhancements broken down by each individual coverage part.

Professional Liability (Third Party) Coverage Part

CPrL definitions. The definition of professional services is the "portal" for evaluating CPrL coverage forms. "No-brainer" denials are often triggered by claims against insureds that fall outside the professional services definition. For example, the following is a typical generic definition.

"Professional services" means those services performed solely for a Project in the capacity as an architect, engineer, designer, planner, land surveyor, landscape architect, Leadership Energy and Environmental Design (LEED®) Green Associate, interior designer, construction manager, project manager, owners representative, environmental consultant, technical consultant, scientist and other related consulting services or as specifically listed by endorsement to this policy.

For the most part, this definition covers nearly all of the professional capacities where professional liability (PL) may arise, including construction management (CM), technical consultant, and "other related consulting services." Notice, it doesn't list specific services or preclude any specific project delivery methods. So, as long as the insured is performing these services, it doesn't matter what project delivery method is used.

Another approach to the definition is scripting during coverage negotiations. A bit trickier to create, they entail the detailed listing of any and all professional services performed by the insured. This approach has the potential to omit key services if not careful. Two examples are below.

Professional services rendered by the named insured in the discipline of construction management; and, by or on behalf of the named insured in the disciplines of architecture and engineering.

Preconstruction services

The definition of "professional claims" is another important definition. It is used to trigger the coverage when demands formally arise from third parties. That demand could be oral or written (in most cases, insurers require some type of written demand) and may include the obvious—lawsuits, complaints, petitions, or some type of regulatory action that asserts negligence. However, some insurers define professional claims in much broader terms, often only requiring a "demand for money to pay for damages" or "the correction of professional services." As a result, it is always important to clearly identify the events that trigger the liability coverage part.

In addition, there is still some confusion in the marketplace when it comes to the definition of "damages." For instance, it's not uncommon to find bodily injury (BI) and property damage (PD) exclusions in the typical miscellaneous professional liability policies for other professions like attorneys or accountants that insure against pure financial loss. However, if you have ever handled PL for construction professionals, such as architects, engineers, or contractors, then you know this can present a major setback because these events may not be covered by other policies. Consequently, you should make sure that ANY damages arising from the negligent performance of professional services are included within the coverage.

Some CPrL policies also ONLY cover BI/PD and not the pure financial loss of third parties such as the economic damages related to delays, acceleration costs, lost income, remedial design, reconstruction, or any other expenses that can be directly tied to professional service errors. However, I must say that if you are buying or selling these types of CPrL policies, the ones that only cover BI/PD really don't constitute true professional liability insurance. Furthermore, one of the primary drivers behind the purchase of CPrL is contracts, especially when it comes to middle-market or smaller contractors. Usually when owners or general contractors require a contractor or subcontractor to evidence PL in a contract, even though they haven't specifically requested it, they are looking to protect themselves from the pure financial loss or economic damages incurred as a result of the services performed.

Another consideration is the "responsible insured" definition (and this can be referred to differently depending on the insurer), which is often tied to the knowledge and notice of claims provisions in the policy. The typical knowledge provision may be an exclusion or part of the insuring agreement that provides coverage for any claim, provided the responsible insured had no knowledge of the claim or incident. As for the notice to the insurer, the claim must be reported to the insurer as soon as possible or reasonably practicable once the responsible insured is made aware of the event or claim.

These are important provisions since they determine the timeline at which the insured knew about a claim or incident while also dictating the capacities or positions within the insured's business that can consider a claim as "known." So, the definition should always be as narrow as possible. The following is an example.

  • Some CPrL policies still tie the knowledge and notice provisions back to the insured, which includes the insured's employees. Under such terms, this could mean that the known condition clause could be triggered by the knowledge of a claim or incident by ANY employee.
  • Most insurers have restricted definitions surrounding directors, officers, general counsel, risk managers, and/or any employees responsible for the project's safety and environmental affairs, which is often too broad a definition given that almost ALL employees are responsible for these tenets in some way or form. In this case, it should be restricted to only the individuals designated to report and manage the claims, suits, or actions brought against the insured.

CPrL Exclusions

CM. When it comes to exclusions, there are several that should be considered carefully. In most cases, the current CPrL policies have been free of CM exclusions. However, there are a few insurers that still apply construction management at risk ([email protected]) exclusions in their policy forms. The key is the definition of "construction manager" or "construction management" in the policy form. Some allow CM agency and exclude [email protected] by definition and not actual exclusion. These exclusions or definitions should be modified to appropriately address the contractor's risk.

Construction means and methods (CMM). This is a different story. Ideally, there should be no exclusions for services performed within the realm of CMM because of the existing CPrL risks. Just because a structure is temporary, it doesn't mean that it can't have a design or engineering error that could delay the project. As a strong backup to a no exclusion policy form, you should always ensure the exclusion only applies to BI/PD. Maybe not ideal, but the approach still protects the insurer from being tied to the BI/PD that should be covered under the commercial general liability (CGL) policy via CG 22 79 or 2280, but at the same time applies coverage to pure economic damages that are not covered under the CGL policy.

Faulty workmanship exclusions. While these still exist, they are now most often applied to the insured's self-performed work. These exclusions should also include an exception for professional services to ensure the coverage (at minimum defense) is in effect in the event that the insured is required to monitor or inspect the work of subcontractors. This could simply result in allegations of negligent management asserted directly against the insured.

Something else to consider is coverage for the actual faulty work, including installations or product malfunctions, performed by the insured. While this may take the coverage beyond the CPrL policy realm, there are three or four insurers that are now offering this enhancement as part of their CPrL programs, either incorporated into the form itself or added via endorsement. This coverage could be a substantial benefit to smaller specialty trade contractors or general contractors that self-perform a high percentage of work.

Contractual liability exclusions. These exclusions are still currently in place when it comes to CPrL policies. In fact, the coverage does not exist for contractually assumed obligations, although it does not interfere with the coverage for common law tort negligence. This is important to note because some American Institute of Architects contracts on large/design-build/civil projects apply a higher or expanded standard of care on the design builder (DB) by requiring the DB to indemnify the owner for any acts, errors, or omissions regardless of negligence. Furthermore, those same contracts often require the DB's work as well as the associated design plans to be free from defect. Unfortunately, there is no "insurance" solution to this risk, so identifying these provisions and negotiating them out of the contract are the best methods of risk management.

CPrL Other Provisions

Claims reporting. Strict provisions usually require the prompt reporting of incidents or claims. In addition, most CPrL policies contain a circumstance or notice of potential claim provision, which allows for the reporting of an incident that may lead to a claim at some point in the future. As a result, it is imperative to report claims early and often to both the CGL and CPrL insurers. There are instances when insureds have made the mistake of not reporting claims to the CPrL insurer until it's obvious a CPrL element exists. At that point, the reporting provision may actually have been violated, thus nullifying the claim and potential coverage. It's always smart to report incidents to the CPrL insurer when you report to the CGL insurer.

Choice of law. Hard to believe, but there are jurisdictions or states that favor some insurers over others, while also legislating on the side of the insured. Most insurers apply New York State laws because they typically favor the insurer when there is a dispute between the insurer and the insured. Generally speaking, it may be better to have this provision removed. But this determination is usually made by the insured and based on where they are domiciled and the services performed.

Contractors Protective Indemnity Coverage Part

Protective indemnity definitions. Protective claim or loss definitions are most important when assessing protective indemnity coverage. The definition typically applies to the damages that the insured is legally entitled to recover from a design professional under contract with the insured. Limitations of liability (LoL) provisions that some contractors sign with the design professionals or engineers can have an adverse impact on this coverage since the insured may contractually limit their recovery to an LoL that is below the minimum insurance requirement under this coverage part. If there's an enforceable LoL provision in the contract, let's say $500,000, that may be the only amount the insured is "legally entitled to recover." That's why it is so important to understand how insureds handle LOL provisions. The same can be said about waivers of consequential damage (CD) provisions—in these situations, if the insured is barred from making a claim against the design professional for purely CDs, it may prevent the insured from triggering the policy altogether.

Another key definition is design professionals insurance because it can often be written in a variety of ways. Even though the intent is to sit excess of the design professional's (DP) professional liability (PL) insurance, some insurers include "all liability insurance" or all of the insurance available to the DP under this definition, which is often far too broad and in need of modification.

When it comes to the definition of professional services—believe it or not, this definition can vary under the liability coverage part, which quite frankly is unacceptable. These definitions should be uniform from one coverage part to the next.

Protective Indemnity Exclusions

One additional exclusion that applies separately to the protective coverage part is the default judgment. This exclusion pertains to any amount awarded by default judgment or any other proceeding in which the DP failed to respond or defend itself. However, the coverage still applies if the insured cooperates with the insurer to determine the damages that would have been recovered had the DP responded.

What else is excluded? The actual cost of a claim instituted against the DP. This includes attorneys' fees and any other costs incurred during the filing of the claim against the DP.

Lastly, always remember that all other exclusions included within the insured's policy apply, which can cause a problem if they're more restrictive than the DP's PL insurance. Remember, this coverage part is excess but not follow form, so what I am saying to those that are used to follow form excess programs is the terms of the protective may vary more greatly than those of the underlying DP's professional liability insurance. Not much can be done about this. It's just important to understand it.

Other Protective Indemnity Provisions

Some people refer to the minimum insurance requirement (MIR) as an attachment point. The MIR is not the attachment point. It is simply the minimum at which the protective will attach so if the DP has $5 million available and the MIR is $1 million, the protective attaches at $5 million.

Self-insured retention (SIR) provision. The following are still two schools of thought under the protective coverage.

  • SIR doesn't apply—simple excess of whatever is available to the insured from the DP's professional liability insurance
  • SIR applies—only if the MIR is not met

LOL provision. Typically, there is a provision that does not allow for the acceptance of LOL provisions with the DP. The following are two exceptions.

  • Unless liability is limited to insurance proceeds of the DP
  • LOL endorsement whereby the insurer attaches excess of a given dollar amount. If the LOL is below the dollar amount, the insured is responsible for the delta. If it is above, the insurer attaches above the LOL.

Typically, either one may suffice.

Before we leave protective indemnity, one more thing has to be said, and it's about timing of payment. Remember, this excess coverage only pays when the underlying action has been settled or the underlying DP's PL policy has paid. However, there is one insurer as an example that provides what is often called a proactive claim resolution provision. If the damages exhaust the underlying coverage and reach into the protective layer, the insurer will not wait for the underlying action to settle. It will pay the obligated amount without the underlying payment being made. However, this decision is the sole decision of the insurer.

Rectification Coverage Part

Rectification coverage (or mitigation coverage, depending on the insurer) has been offered commercially since 2011. Over this time, it's been used to provide coverage for the damages incurred by the insured to remedy or "rectify" design errors or errors in professional service that would otherwise lead to a PL claim. Whereas protective is excess coverage, rectification or mitigation coverage is a primary subject to an SIR. So, it actually circumvents the DP's PL insurance with the idea that the insurer will subrogate back against the negligent DP.

Rectification Definitions

Professional services. This is where insurers vary. Some definitions only cover design, while others cover "all professional services" as defined by the policy. The definition may also be written to apply to the errors performed by the named insured and not subcontractors or subdesign professionals. Ideally, the definition should apply to the following.

  • Professional services as defined by the policy—inconsistencies should not exist among the differing coverage parts.
  • Services performed by or on behalf of the named insured—if not, the coverage is far too narrow.

Damages—rectification expenses or mitigation costs. Most definitions are similar. Insurers will pay the reasonable and necessary costs deemed necessary in order to minimize or prevent the liability and subsequent claims. This coverage can be offered either by endorsement or as a separate coverage part in the actual policy. Either way, there are several exclusions that typically pertain to rectification/mediation (R/M) terms and conditions.

The first is temporary structures. Personally, I'm not a fan of these exclusions since it shouldn't matter if the structure is temporary or permanent. If there is a threat of a delay that results from a temporary structure, and the action taken by the insured can reduce the overall liability of the insurer, what difference does the type of structure make? Fortunately, there are insurers that do not apply these exclusion types.

Also, most insurers require the insured to seek written consent from the insurer before they begin rectifying errors. A couple of insurers, however, will offer a 10-day "grace" period in emergent situations that allow the insured to respond or act and then report within the 10-day time frame. This is ideal.

Sublimits and supplemental limits. In some cases, insurers will apply sublimits or supplemental limits. Honestly, these sublimits are slowly disappearing with the realization of many insurers that, regardless of the type of claim—R/M or liability—the root cause of loss is similar or the same.

Secondary CPrL Coverages

Contractors pollution liability (CPL) is now a widely accepted CPrL coverage part. It protects against the pollution conditions resulting from the insured work (or work performed on their behalf), transportation, disposal liability, and owned premises of the insured. Nearly all insurers offer some form of CPL coverage as part of their overall program. The CPL afforded in a CPrL policy cannot be inferior (for example, some will only offer claims-made CPL where occurrence CPL is much more common) to what is available in the marketplace. Some insurers will cut back on the scope of CPL coverage merely because they feel they are not the insured's CPL insurer. That doesn't make much sense.

Technology coverage is another supplemental policy form that has impacted contractors by insuring against the negligent acts, errors, and omissions resulting from the performance of technology services per the definition of professional services or by endorsement. Typically covered are the following.

  • Data hosting/warehousing/hosting
  • Software programming and support
  • Network management and training
  • Internet services
  • Consulting

A fairly new type of enhancement that is becoming increasingly prominent in recent CPrL policies is cyber liability or network security coverage. Usually a separate coverage part and not necessarily tied to a negligent act, error, or omission, it protects against the damages arising from security breaches when the insured is performing typical professional or construction services. Particularly important is the element of mitigation coverage (under some policies) whereby the insurer provides coverage for certain investigative, notification, or remedial costs to the third parties associated with the breach. While it's not truly comprehensive cyber coverage, since it doesn't afford first-party coverage for the insured's data or information, it does offer the insured some element of liability protection.

Supplemental Coverages

All of the following can range from $5,000 to $50,000 and will not erode the base limit.

  • Crisis management. To assist the insured in managing the media and developing a public relations plan in a crisis situation
  • Subpoena expenses. To pay for the counsel's fees and expenses related to the response to subpoenas
  • Regulatory proceedings. To assist the insured in defending regulatory or administrative actions brought under the Americans with Disabilities Act of 1990 or the Fair Housing Act
  • Building information modeling (BIM) extra expense. The additional expense arising from the loss of or damage to information as a result of the inherent malfunction of any software used in connection with any BIM system

Other CPrL Considerations

  • Defense and settlement. The important aspects to identity here are "hammer" provisions. Most will continue with the defense, but some insurers may discontinue this coverage if the settlement offer is not accepted. Others may also agree to pay 50 percent of the defense costs above the settlement offer, softening the "hammer" substantially.
  • Assumption of liability. Most insurers do not want their insureds to admit or assume liability or agree to pay anything until they've given their consent. This is a strict policy term that must be followed at the risk of nullifying the policy. As a best practice, to ensure that you do not violate any reporting provisions or assumption of liability provisions, it is prudent to report any claim that you report to the CGL insurer and to the CPrL insurer in the event professional liability is uncovered during discovery.
  • Subrogation. Each subrogation provision should always contain an exception whereby the insurer will not subrogate back against the insured's clients to preserve their relationships.

Conclusion

In closing, our professional lives would be so much easier if we could simply and definitively highlight the insurers with the best CPrL offerings. But here's the fact, just like I'll swear Sasquatch isn't lurking in every forest nationwide until proven otherwise, there is no perfect CPrL policy. There is also no clear-cut favorite, although some are absolutely better than others. The only option is to do the math, explore the market, and consult the experts to determine the best-possible solution available in today's marketplace.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do 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.

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