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.
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.