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. These are discussed briefly below.
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
(discussed below).
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 discussed above, 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.
Conclusion
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.