Whether you are an owner of a construction project, architect, engineer, design-builder, general contractor, insurance broker, or are involved in any way with the construction industry, you have probably run into the hassle of attempting to secure project professional liability insurance.
Where coverage was once somewhat available, insuring professional liability on construction projects has become an extremely difficult task to accomplish over the past few years. If your project involves the construction of commercial grade condominiums or other "habitational" buildings, the task gets even tougher.
This has led many of us to investigate various alternatives to project professional liability insurance. Some have been practiced for some time, while others consist of fairly new insurance products still not known or understood by many in the industry. This article is an overview of four alternatives for protecting a construction project from professional liability (each of us may have our own version or combination of the alternatives discussed). For simplicity sake, these alternatives are in order of the cost to create such programs rather than the degree of protection provided. Each provides certain benefits based on the specific risk appetite of each individual owner, design professional, design builder and/or contractor.
Alternative 1: Requiring No Professional Liability Insurance—"Do Nothing"
While simplistic, doing nothing other than contractual risk transfer via indemnity agreements is an actual alternative. While many may disagree with this logic, many owners have the option to simply not require a design professional or design builder to provide evidence of insurance, let alone carry insurance limits specifically for a project. Owners or contractors who may be engaged in simple "low rise" or "cookie-cutter" design (retail stores and the like) and construction may not see a need to do anything more than contractual transfer of the risk. Maybe there is just no need to back up any contractual indemnities with an external financial mechanism? Maybe the architect or engineer is financially solvent with substantial assets to back the indemnity? Maybe.
With that said, I don't think I could find many who would take this route. When you look at the professional liability exposures associated with the typical construction projects, it's obvious that this alternative may not be the prudent alternative.
While the initial cost to this alternative is attractive, it can end up being the most expensive alternative in the event of a design flaw or some other error on the part of the design professional.
Alternative 2: Evidence of Professional Liability from Design Professionals
Under the current market conditions, simply having the design professional or design builder evidence a specific limit of professional liability insurance is probably the most prominent alternative. However, this alternative may be on the verge of being abused. You see, I'm an educated man, but I'm afraid I will never be able to explain why we still see owners designing and building $300 billion and $400 billion structures with the selected prime design professional carrying only $1 million in professional liability insurance. Even if the entire design team, usually comprised of 5 or 6 firms, carries $1 million in limits, that doesn't leave much for an indemnity payment even if you find negligence on the part of every design firm. Not much for a structure of that size!
To compound the issue, you can never be sure that the limits you requested to be evidenced in the contract will be there when you need it. There are a variety of reasons why that coverage may not even exist.
Impairment or exhaustion of the evidenced limits due to claims on other projects. Does your due diligence or subcontractor prequalification process require you to investigate the DP's claims history?
Coverage restrictions in the form of exclusions such as habitational, contractual, and/or mold/fungus to name a few. This is further compounded with the simple fact that the only thing the design professional needs to do for evidencing coverage is provide a simple certificate of insurance (COI) that lists the insured, insurer, policy number, policy term and limit. Who knows what other limitations exist in that policy.
Annual renewals on the design professional's policy can bring about changes in their professional liability insurance program. Are you consistently notified of these changes?
The programs are structured to be straightforward—they protect the design professional only! The intent is not to protect the design professional and the owner/client, design builder, or general contractor.
Does the design professional hold all contracts for design services on the project including mechanical, electrical, plumbing (MEP) services, fire protection services and the like? In many cases, the MEP contractor performs both design and construction under contract. Do you know if the MEP is carrying professional liability insurance?
These concerns are further compounded by the lack of professional liability insurance being purchased by design professionals. In the past 2 years, two prominent professional associations for architects and engineers produced studies to identify the type of professional liability insurance being purchased by the membership. One association released staggering results—nearly half of its members didn't even purchase professional liability insurance. The other organization revealed that of the nearly 500 members surveyed, approximately 85 percent of those design professionals generating annual fees/revenues of $15 million or less only purchased $2 million or less in professional liability limits. Of the firms generating in excess of $15 million in fees, approximately 50 percent purchased less than $5 million in limits.
All that being said, it should be strongly noted that much of the above concerns or risks can be greatly mitigated by the quality of design professional selected for the project.
Alternative 3: Professional Protective Insurance
"Protective" policies have gained much momentum over the past 3 years with the price of project professional skyrocketing. Offered to owners ("owners protective") of construction projects as well as design-builders and general contractors ("contractors protective"), the "protective" policies simply provide first party indemnity for damages, which are excess of the design professional's professional liability insurance, that the named insured incurs as a result of negligence of the design professional. The "protective" sits excess of the design professional's professional liability insurance limit of liability and there is a minimum insurance requirement, that acts to qualify the coverage, placed upon the design professional by the insurer offering coverage. This requirement varies greatly upon the type of project and the design team performing services. Furthermore, the underlying design professional's professional liability policy must be exhausted before the policy will provide the indemnity.
Benefits of the "protective" policy include the following.
The policy provides an owner or contractor with a cost-effective alternative to costly project insurance. Typically, "protective" policies are priced 40-60 percent less than project professional liability policies with the same limits, retentions, and policy term. Of course this depends on the type of project.
All the benefits of having an owner or contractor controlled program exist such as primary protection for the named insured, consistency in coverage and reduced cost to administrate the program.
The policy supplements the design professional's professional liability program with providing direct benefits to the named insured.
The policy offers difference in conditions (DIC) coverage above the underlying professional liability policy extending coverage to the named insured in the event the underlying policy is deficient in coverage. Some good examples include mold, habitational, construction management, or contractual liability exclusions.
Defense costs for third-party claims arising out of the design professional's services are provided to the named insured.
Contractor's pollution coverage can be included providing the named insured with excess coverage for pollution claims—including mold.
Coverage can be provided for the liability of the owner's professional services in the event the owner has an engineering/construction entity on staff.
The policy is offered on a project-specific basis for up to 10 years (the extended reporting period or ERP is included in that term) and annually for all construction ("blanket" coverage) of the named insured.
In the event the underlying design professional's policy is intact (limits and coverage) at the time of claim payment, the self-insured retention under the "protective" policy does not apply.
May be an effective alternative for those owners requiring design builders and general contractors to secure professional liability from their design professionals.
Limits of liability can be secured up to $25 million with one single insurer. Higher limits may be obtained through use of multiple insurers.
There are only a few carriers offering "protective" policies and not all offer them to both owners and contractors. Coverage terms and conditions vary greatly so it is imperative that a sound understanding of the contractual relationship between the named insured and the design professional exists prior to pursuing the coverage.
Alternative 4: Project Professional Liability Insurance
The project professional liability policy will typically provide the broadest coverage for all design firms on a construction project as long as it is structured properly. The operative phrase is "structured properly." As already discussed, there can be a variety of contractual arrangements with those providing professional services on any given project. In most instances, the lead design professional will hold contracts with the entire design team. In these instances, the policy structure is simple—all entities are named accordingly. However, in other instances it may not be that simple. Maybe the owner is contracting directly with the structural engineering firm or the geotech firm? Maybe the general contractor is contracting with the MEP contractor—who just happens to be providing the design on that work as well. There could be a variety of reasons why; in any event, it is imperative to have a clear understanding of the contractual arrangement for professional services to ensure proper coverage is provided.
When creating the structure of the program do not forget about the various insured versus insured exclusions attached. While you may be able to secure coverage naming the owner, general contractors, and the design team, the insured versus insured exclusion may preclude those entities from the original intended coverage. The intent here is to provide coverage for the third-party claim from the owner and not get involved in counter and cross-claims of the design and construction team which precludes the primary intent of coverage. In addition, you have to understand the effects project professional liability policies have on the named design professional's practice program—there are exclusions for separately insured projects. Some of those exclusions are fairly far reaching, excluding separately insured projects regardless of whether the claim is "covered" or not. This could actually lead to the design professional having coverage under neither project policy nor their practice program.
There are a wide variety of benefits to purchasing a project professional liability program.
It provides primary protection for the design professionals and consistency in coverage—not having to deal with inconsistencies in coverage from one design professional to another.
Provides financial security from professional liability throughout the life of the project.
Limit of liability that is dedicated to the specific project. Replaces the design team's professional liability programs allowing their programs to act as excess. The cost charged back to the owner or GC or DB should be reflected accordingly.
Contractors pollution liability (including mold liability) can be included to provide coverage for pollution conditions arising out of construction work. Defense costs are covered for third-party claims arising from the design team's errors.
The policy is offered on a project-specific basis for up to 10 years (the extended reporting period or ERP is included in that term) and annually for all construction ("blanket" coverage) of the named insured.
Limits of liability can be secured up to $25 million with one single insurer. Higher limits may be obtained through use of multiple insurers.
When it comes to cost, there is a simple rule of thumb—the broader the coverage, the higher the cost. Therefore, all things being equal, project professional liability, whether secured by the owner, design builder, or design professional, tends to be the most costly alternative in terms of premium. The irony is, as with nearly all types of insurance, it could end up being least costly in the event of a catastrophic occurrence.
One thing to remember with project programs—there is a greater potential of exhausting the limit of liability in the event of a claim or claims since coverage is extended to numerous insureds under the policy. The concern here would be that defense costs alone may greatly reduce the limit of liability left for compensatory damages.
Owner Requirements
One factor not mentioned but that should be considered is the owner's requirement of the design professional, design builder, or general contractor to purchase professional liability dedicated to a project. This may contribute a bit of mayhem to the process as well. Honestly, this issue could be an entire article on its own so I'll just have to summarize.
Quite frankly, many public and private owners need to take a hard look at what they are requiring of design professionals, design builders, and/or general contractors and reassess those requirements. No one is advocating that those owners should blatantly remove the professional liability insurance requirements from the contract, but maybe concessions on coverage or limits can be made. Is it necessary to require $10 million of professional liability insurance from a firm performing agency construction management on a $50 million project? Is it necessary to require the design professional under a design build contract to have specified limits and overlook the $25 million purchased by the design builder? Is it appropriate for an owner to request $10 million in professional liability from a general contractor/developer when they are not in contractual privity with the design professional? This is a tough topic because you cannot cap liability. Furthermore, owners have a right to protect their asset—their project; and who is to say those limits are outrageous anyway? Even with that last comment, it would seem that a better understanding of the pressures and complexities of the current professional liability insurance marketplace would help create other cost effective ways of protecting that asset than traditional methods.
One last thing to mention when it comes to insurance requirements is what I'll call the "pass-through" concept. This is when the general contractor subcontracts to a design professional under a design/build contract and "fulfills" the CPrL insurance requirement by having the design professional evidence professional liability. While this may be a solution to the contract, it may seldom be a solution to transfer the risk. At the end of the day you have to consider who holds the contract with the owner and who is ultimately taking responsibility for design or professional services being performed. When you start relying on this concept and the design professional's insurance as your risk financing alternative, you are putting your company in a position it really should not be in.
Conclusion
All alternatives described above have a place in the construction insurance industry. The key to selecting the alternative sounds simple—match the benefits with the entity or entities requiring the protection. Of course, who's to say that one alternative gets you to your goal. It may be that you will need some combination of alternatives and techniques to accomplish your task. As the need continues to rise, more alternatives may be created to protect all entities on a construction project from professional liability. For now, the above pretty much sums it up.
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.
Whether you are an owner of a construction project, architect, engineer, design-builder, general contractor, insurance broker, or are involved in any way with the construction industry, you have probably run into the hassle of attempting to secure project professional liability insurance.
Where coverage was once somewhat available, insuring professional liability on construction projects has become an extremely difficult task to accomplish over the past few years. If your project involves the construction of commercial grade condominiums or other "habitational" buildings, the task gets even tougher.
This has led many of us to investigate various alternatives to project professional liability insurance. Some have been practiced for some time, while others consist of fairly new insurance products still not known or understood by many in the industry. This article is an overview of four alternatives for protecting a construction project from professional liability (each of us may have our own version or combination of the alternatives discussed). For simplicity sake, these alternatives are in order of the cost to create such programs rather than the degree of protection provided. Each provides certain benefits based on the specific risk appetite of each individual owner, design professional, design builder and/or contractor.
Alternative 1: Requiring No Professional Liability Insurance—"Do Nothing"
While simplistic, doing nothing other than contractual risk transfer via indemnity agreements is an actual alternative. While many may disagree with this logic, many owners have the option to simply not require a design professional or design builder to provide evidence of insurance, let alone carry insurance limits specifically for a project. Owners or contractors who may be engaged in simple "low rise" or "cookie-cutter" design (retail stores and the like) and construction may not see a need to do anything more than contractual transfer of the risk. Maybe there is just no need to back up any contractual indemnities with an external financial mechanism? Maybe the architect or engineer is financially solvent with substantial assets to back the indemnity? Maybe.
With that said, I don't think I could find many who would take this route. When you look at the professional liability exposures associated with the typical construction projects, it's obvious that this alternative may not be the prudent alternative.
While the initial cost to this alternative is attractive, it can end up being the most expensive alternative in the event of a design flaw or some other error on the part of the design professional.
Alternative 2: Evidence of Professional Liability from Design Professionals
Under the current market conditions, simply having the design professional or design builder evidence a specific limit of professional liability insurance is probably the most prominent alternative. However, this alternative may be on the verge of being abused. You see, I'm an educated man, but I'm afraid I will never be able to explain why we still see owners designing and building $300 billion and $400 billion structures with the selected prime design professional carrying only $1 million in professional liability insurance. Even if the entire design team, usually comprised of 5 or 6 firms, carries $1 million in limits, that doesn't leave much for an indemnity payment even if you find negligence on the part of every design firm. Not much for a structure of that size!
To compound the issue, you can never be sure that the limits you requested to be evidenced in the contract will be there when you need it. There are a variety of reasons why that coverage may not even exist.
These concerns are further compounded by the lack of professional liability insurance being purchased by design professionals. In the past 2 years, two prominent professional associations for architects and engineers produced studies to identify the type of professional liability insurance being purchased by the membership. One association released staggering results—nearly half of its members didn't even purchase professional liability insurance. The other organization revealed that of the nearly 500 members surveyed, approximately 85 percent of those design professionals generating annual fees/revenues of $15 million or less only purchased $2 million or less in professional liability limits. Of the firms generating in excess of $15 million in fees, approximately 50 percent purchased less than $5 million in limits.
All that being said, it should be strongly noted that much of the above concerns or risks can be greatly mitigated by the quality of design professional selected for the project.
Alternative 3: Professional Protective Insurance
"Protective" policies have gained much momentum over the past 3 years with the price of project professional skyrocketing. Offered to owners ("owners protective") of construction projects as well as design-builders and general contractors ("contractors protective"), the "protective" policies simply provide first party indemnity for damages, which are excess of the design professional's professional liability insurance, that the named insured incurs as a result of negligence of the design professional. The "protective" sits excess of the design professional's professional liability insurance limit of liability and there is a minimum insurance requirement, that acts to qualify the coverage, placed upon the design professional by the insurer offering coverage. This requirement varies greatly upon the type of project and the design team performing services. Furthermore, the underlying design professional's professional liability policy must be exhausted before the policy will provide the indemnity.
Benefits of the "protective" policy include the following.
There are only a few carriers offering "protective" policies and not all offer them to both owners and contractors. Coverage terms and conditions vary greatly so it is imperative that a sound understanding of the contractual relationship between the named insured and the design professional exists prior to pursuing the coverage.
Alternative 4: Project Professional Liability Insurance
The project professional liability policy will typically provide the broadest coverage for all design firms on a construction project as long as it is structured properly. The operative phrase is "structured properly." As already discussed, there can be a variety of contractual arrangements with those providing professional services on any given project. In most instances, the lead design professional will hold contracts with the entire design team. In these instances, the policy structure is simple—all entities are named accordingly. However, in other instances it may not be that simple. Maybe the owner is contracting directly with the structural engineering firm or the geotech firm? Maybe the general contractor is contracting with the MEP contractor—who just happens to be providing the design on that work as well. There could be a variety of reasons why; in any event, it is imperative to have a clear understanding of the contractual arrangement for professional services to ensure proper coverage is provided.
When creating the structure of the program do not forget about the various insured versus insured exclusions attached. While you may be able to secure coverage naming the owner, general contractors, and the design team, the insured versus insured exclusion may preclude those entities from the original intended coverage. The intent here is to provide coverage for the third-party claim from the owner and not get involved in counter and cross-claims of the design and construction team which precludes the primary intent of coverage. In addition, you have to understand the effects project professional liability policies have on the named design professional's practice program—there are exclusions for separately insured projects. Some of those exclusions are fairly far reaching, excluding separately insured projects regardless of whether the claim is "covered" or not. This could actually lead to the design professional having coverage under neither project policy nor their practice program.
There are a wide variety of benefits to purchasing a project professional liability program.
When it comes to cost, there is a simple rule of thumb—the broader the coverage, the higher the cost. Therefore, all things being equal, project professional liability, whether secured by the owner, design builder, or design professional, tends to be the most costly alternative in terms of premium. The irony is, as with nearly all types of insurance, it could end up being least costly in the event of a catastrophic occurrence.
One thing to remember with project programs—there is a greater potential of exhausting the limit of liability in the event of a claim or claims since coverage is extended to numerous insureds under the policy. The concern here would be that defense costs alone may greatly reduce the limit of liability left for compensatory damages.
Owner Requirements
One factor not mentioned but that should be considered is the owner's requirement of the design professional, design builder, or general contractor to purchase professional liability dedicated to a project. This may contribute a bit of mayhem to the process as well. Honestly, this issue could be an entire article on its own so I'll just have to summarize.
Quite frankly, many public and private owners need to take a hard look at what they are requiring of design professionals, design builders, and/or general contractors and reassess those requirements. No one is advocating that those owners should blatantly remove the professional liability insurance requirements from the contract, but maybe concessions on coverage or limits can be made. Is it necessary to require $10 million of professional liability insurance from a firm performing agency construction management on a $50 million project? Is it necessary to require the design professional under a design build contract to have specified limits and overlook the $25 million purchased by the design builder? Is it appropriate for an owner to request $10 million in professional liability from a general contractor/developer when they are not in contractual privity with the design professional? This is a tough topic because you cannot cap liability. Furthermore, owners have a right to protect their asset—their project; and who is to say those limits are outrageous anyway? Even with that last comment, it would seem that a better understanding of the pressures and complexities of the current professional liability insurance marketplace would help create other cost effective ways of protecting that asset than traditional methods.
One last thing to mention when it comes to insurance requirements is what I'll call the "pass-through" concept. This is when the general contractor subcontracts to a design professional under a design/build contract and "fulfills" the CPrL insurance requirement by having the design professional evidence professional liability. While this may be a solution to the contract, it may seldom be a solution to transfer the risk. At the end of the day you have to consider who holds the contract with the owner and who is ultimately taking responsibility for design or professional services being performed. When you start relying on this concept and the design professional's insurance as your risk financing alternative, you are putting your company in a position it really should not be in.
Conclusion
All alternatives described above have a place in the construction insurance industry. The key to selecting the alternative sounds simple—match the benefits with the entity or entities requiring the protection. Of course, who's to say that one alternative gets you to your goal. It may be that you will need some combination of alternatives and techniques to accomplish your task. As the need continues to rise, more alternatives may be created to protect all entities on a construction project from professional liability. For now, the above pretty much sums it up.
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.