Professional liability insurance is often an afterthought for large-scale construction projects. With builders risk, general and excess liability, and workers compensation risks to be addressed, professional liability often does not require the immediate attention of owners and contractors that are responsible for insuring the work on these projects and may not be considered until the process of insuring other risks is well under way.
With new project delivery systems including design-build and public private partnerships (also known as 3P projects), the lines between design and construction are becoming blurred, and professional liability risks are becoming more difficult to insure adequately. This article discusses the alternative measures available for insuring claims arising out of the work of design professionals on construction projects and offers comments on the strengths and weaknesses of each approach.
Professional Liability Risks Associated with Construction Projects
Most professional liability claims are made by owners against architects and engineers they have hired to provide professional services related to the design and construction of a building. Claims may arise out of the alleged negligent acts, errors, or omissions of the design professionals in rendering services related to the project where failures of structural components, major building subsystems (i.e., curtain walls, roof assemblies, etc.), or equipment result in losses or damage to the owners and third parties.
Claims by owners may also allege breach of contract where design professionals have failed to meet the terms or conditions of the written contracts for professional services. Breach of contract typically must be resolved in accordance with the provisions of the contract itself and involve principles of contract law and is not addressed by professional liability insurance. Errors and omissions in rendering of professional services may involve bodily injury or property damage, but these are often the subject of general and excess liability insurance rather than professional liability coverage.
Damages other than bodily injury and property damages associated with professional errors and omissions may be economic in nature and may include the cost of redesigning portions of a project that fail to meet professional standards and delay in completion of the structure (and associated loss of anticipated rental or sales income). These economic damages are the most common losses that give rise to professional liability claims against architects and engineers working on construction projects.
Alternative Insurance Mechanisms Available
There are four alternative methods for owners to insure professional liability claims associated with the design and construction of a building or other structure.
Rely on Design Professionals' Own Insurance
The lowest cost option is to require that design professionals provide specified limits of insurance and rely on their coverage for protection. This is also the least effective option in providing complete protection to the owner. Each architect and engineer in contract with the owner is required to provide professional liability insurance that meets specified requirements. Coverage features include limits, deductibles or self-insured retentions, ratings of insurers, and the term of coverage and completed operations periods.
In the simplest form of this option, the design professionals rely on their practice policies to satisfy the insurance requirements established by the owner and described in the contract for services. These policies insure all of the work performed by the insured architects and engineers during a policy year as well as the completed operations exposures for previous years or even decades.
This creates two problems for the owner. First, the limits of the design professional's insurance may be reduced or depleted by claims unrelated to the subject project. Second, practice policies are purchased on an annual basis, and it is not possible to guarantee that the insurance will be available on the original terms and conditions for the entire period of construction or for the completed operations period.
Since most architects and engineers maintain professional liability insurance, the cost of using their insurance as a means of protecting the owner of a project is typically charged as a component of their contract cost. Removing the requirement for professional liability insurance from the contract may not change the cost of professional services since the premiums are typically not audited for exposure at the end of the policy year, at least for larger design firms.
Other disadvantages of an owner relying on the professional liability policies of design firms include the following:
- Limits on policies carried by these firms may be inadequate to address the risks associated with larger projects.
- Policies can be canceled or not renewed by insurers, and the design professional may not be able to secure replacement coverage.
- Completed operations coverage is dependent on the design professionals continuing to renew their practice policies after the work on the subject project has been completed and the owners no longer have leverage to compel compliance.
- There is no guarantee of the quality of the coverage provided since each policy will have its own unique coverage terms and conditions.
- In the event of claims, several policies may be triggered, and their limits may be used to resolve disputes related to who caused a loss rather than to indemnify the owner for economic losses it has experienced.
The use of the design professionals' practice professional liability policies is a common means of providing protection to owners of construction projects and is reasonably effective where the architects and engineers are reputable and have substantial professional liability insurance limits. Where design professionals are hired for exceptionally low bids for their services, owners sometimes find that they are provided much less protection against professional liability claims by the practice policies of the most competitive firms.
A variation of this option (relying on practice policies of design professionals) requires the architects and engineers to provide the specified professional liability coverage on project-specific policies that are written for the terms of the work plus completed operations periods. The cost of this type of insurance is much higher than where practice policies are utilized, and a better approach is to purchase a project-specific policy that covers claims arising out of the work of all design firms providing services for the project.
Rely on Design Professionals' Policies and Purchase an Owners Professional Protective Indemnity (OPPI) Policy
If the owner is concerned about the quality, quantity, and availability of the protection afforded by the practice policies of design professionals working on its project, the owner can purchase an OPPI policy. This insurance provides two types of coverage: (1) additional limits over the practice policies of the design professionals hired for work on the project; and (2) protection against professional liability claims made directly against the owner.
OPPI insurance is usually purchased on a project-specific basis but can also be placed for a group of projects undertaken by a single owner. The protection applies to all design professionals providing services for an insured project. Since the owner is the named insurance on the policy, it can tailor the coverage to meet the risk requirements of a project (from the owner's point of view). The OPPI policy is triggered by a claim made by the owner against the professional liability policy of a design firm in contract with the owner. The owner gives notice to the OPPI underwriter at the same time it files a claim for errors and omissions against the design professional.
Policy terms of up to 10 years can be written to cover both the terms of the work and completed operations periods. This solves the problem of not being able to ensure professional liability coverage for the term of the work and for claims that arise after buildings have been completed. Limits are also dedicated to the insured project(s), eliminating the concern about coverage being eroded by claims on other projects being worked on by the design professionals.
Coverage is typically written on an excess and difference-in-conditions basis, so protection may be afforded for claims that are excluded in the practice policies of the design firms. If the underlying coverage is not available (due to depleted limits or canceled and not replaced coverage), the OPPI policy responds as primary coverage but may be subject to a deductible.
The disadvantages of the OPPI policy are the limited number of underwriters that offer such coverage and the limited appetites of some insurers for certain types of projects (i.e., some will not write industrial projects, and others do not like multi-family residential construction). This makes it difficult to structure coverage programs with limits of more than $25 million, which may be inadequate for some of the largest projects.
An OPPI policy is a cost-effective means of providing more robust limits for professional liability claims arising out of work on a construction project. Pricing is based on the dollar value of the construction work and may run from 0.25 to 0.50 percent of those values for a limit of $10 million and a construction term of 2 years plus a completed operations period of 5 years or longer.
Purchase Project-Specific Professional Liability Insurance
Project-specific professional liability insurance is purchased by the owner and insures claims arising out of the work of all design professionals providing services related to the project. It replaces the insurance provided by the individual practice policies of the architects and engineers and insures subcontracted work of any design professional in contract with the owner.
The policy is written for the term of the work and for a completed operations period following issuance of a certificate of occupancy, with a combined term of up to 10 years. Policy limits and the deductible are selected to meet the needs of the owner, and uniform protection is provided to all parties engaged in work on the project. The limits are dedicated to the insured project and cannot be depleted by claims arising from other work performed by the insured design professionals. The policy cannot be canceled once the premium is paid, and a separation of insured provision allows coverage for innocent parties even if coverage is denied to an insured firm as a result of fraud or intentional illegal acts.
A project-specific professional liability policy also eliminates disputes among the insured professionals, preserving limits for the payment of economic damages. Joint defense provisions also make the claims management process more efficient than where an owner relies on the practice policies of individual architects and engineers.
There are two problems for owners utilizing project-specific professional liability policies to address claims arising out of the work of design firms. The first is the relatively high cost of this insurance. This is driven by the limited number of insurers willing to write such coverage as well as the relatively poor loss experience of those underwriters that have continued to offer project-specific policies. As a result, premiums may be as high as 1 percent of the project costs. Limits offered may also be inadequate for the risks associated with larger projects. The forms offered by some underwriters for project-specific professional coverage may also contain terms and conditions that are unacceptable to owners (i.e., material variation endorsements in some policies allow the underwriters to rethink their terms and conditions if there are major changes in the project during execution of the designers' plans).
Obtain Contractors Protective Professional Indemnity (CPPI) Insurance
This insurance is similar to the OPPI policy, but it is purchased by a design-build contractor or construction manager at risk rather than the owner. The named insured is typically the prime or general contractor on the project or the construction manager at risk (as contrasted with a construction manager working on behalf of the owner). Policies are usually written for a specific project or group of projects built by a single design-builder.
The CPPI policy provides two types of coverage: (1) excess indemnity for claims brought by the insured contractor against the professional liability policies of design firms in contract with the contractor or design-builder; and (2) coverage for professional liability claims brought against the design-builder directly. The policy requires that design firms in contract with the named insured maintain specified limits on their practice policies. Where underlying limits are not provided or depleted, the CPPI policy will respond excess of a deductible or drop down depending on why the primary coverage does not respond.
Rates for CPPI policies are slightly higher than for OPPI coverage since the insured design-builder typically has a higher risk of professional liability claims than the owner in a traditional design/bid/build project. Premiums range from 0.30 to 0.70 percent of project costs for a limit of $10 million and a project term of 2 years (plus 5 years of completed operations). Pricing may be influenced by the type of project, the quality of the professional service firms, and the amount billed for architectural and engineering services.
As with OPPI coverage, there are a limited number of underwriters willing to offer this form of insurance. Some insurers are also unwilling to provide CPPI coverage for certain types of projects (i.e., power plants, paper mills, refineries, etc.). In some cases, the insurers will only write CPPI coverage where they insure the professional liability of the named insured on an annual practice policy. The common interests of the insureds allow for joint defense in the event of a claim and eliminate disputes among design firms that are engaged in work on the insured project.
Any of the professional liability insurance options can be utilized with an owner-controlled insurance program (OCIP) or a contractor-controlled insurance program (CCIP) purchased for protection from general liability and workers compensation claims associated with construction projects. Obviously, an OPPI policy is typically purchased where an OCIP program is used to insure construction risks, while a CPPI policy is appropriate for CCIP insurance programs. The other alternatives can be used for either "wrap-up" insured projects or projects where conventional insurance programs are utilized.
With a growing percentage of new construction projects utilizing design-build or "3P" delivery systems, professional liability risks are among the most difficult to insure for project owners, contractors, architects, and engineers who are at risk for claims arising out of the acts, errors, or omissions of design professionals. Given the limited capacity for professional liability insurance and the selective appetites of underwriters for these risks, it is important to get an early start in planning to manage professional liability risks for construction projects.
Careful drafting of contracts is required to allocate these risks to the appropriate parties, and early investigation of risk management alternatives is important in developing cost-effective solutions. The counsel of experienced lawyers, brokers, risk management consultants, and underwriters can help to sort out the issues and make sure that the solutions developed are the most appropriate solutions available for the work on such projects.