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!
< p>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.