Expert Commentary

Mitigation of Damages Coverage Helps with Design Defects

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.


Design and Professional Liability
September 2011

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.


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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