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. Below 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 below). 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 discussed above,
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 above 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.