THE CURRENT STATE OF INSURANCE COVERAGE LACKS GLOBAL COVERAGE
While Owner and Contractor Controlled Insurance Programs alleviate some of the issues with adequate coverage, the state of the industry and the rising costs of projects and claims have created a clear deficiency in adequate comprehensive coverage.
Background
Projects used to be primarily one dimensional. You had office, industrial, retail, residential and so on. If you combined office and retail, you were avant garde.
At some point in the not too distant pass, residential joined the “mixed use” party. But the retail component was typically a very small component.
Project cost was significant but not NYC high rise significant. Most of the coverages provided by the A/E team as well as the contractors and subcontractors were adequate.
Things have changed.
Current State of Development
While there are still many one-dimensional projects, these are often relatively small and not the types of projects that are addressed in this article.
Most of our clients are developing complicated student housing, mixed-use projects and cities. They include not just retail and residential or commercial but entertainment and multi-purpose and use components. In addition, the design is not your typical brick and mortar cinder block box.
New materials and methods of constructing these projects are emerging creating unique and compelling environments. The traditional design/bid/build structure has given way to a growing number of design commingled with the construction process. For instance, “design/assist” has become more common, and there really is no such thing as a project that doesn’t include some design/build component. Take fire, life, safety and other common components designed by subcontractors to the general contractor. Many (if not most) of these projects are fast tracked meaning that some portion of construction will commence before all the necessary permits allowing for the complete project to proceed are obtained. There are also deferred submittals meaning that various components of the building assembly will be designed after the notice to proceed is issued to the contractor and thus design plans, drawings and specifications submitted for building department approval down the road. While this has become the norm and somewhat necessary to get the project built before market conditions “adjust”, it also adds risk.
We have seen a substantial climb in construction claims in the past few years. As project costs climb and delays thus become even more costly, the level of finger pointing has risen to unprecedented highs. Commingling and deferring design contribute to the rise and complexity of claims. No matter your role in the project, you will likely be the target of a finger point. If you are the owner/developer, you will be the subject of multiple finger points. Unless the project is a true design/build project, most of the claims we see ultimately find their way to the owner/developer.
Current State of Insurance Coverage
When you consider the fact that coverage is somewhat static no matter the project delivery method, you have to scratch your head.
Most project still follow something like the following:
Owner carries general liability, and often builders’ risk policies with workers compensation coverage for its employees. There are likely some other forms of coverage not specifically related to the project (for example, employee dishonesty and officer liability).
A/Es’ carry their own GL, workers comp and typically some amount of professional liability. You might find it interesting that some are reducing the amount of PL coverage on the theory that the less coverage carried, the less likely the firm will be a target. I guess you can call this a form of “risk management.” The PL coverage is written to cover all the design professional’s projects, is typically a “burning limits” policy (meaning that members of my bar will get paid from the policy limits before anyone else does thereby depleting the available coverage), and requires the owner/developer to make a claim against the one it’s contracted with (commonly, the architect) in order to trigger any coverage. This can be problematic if the purported culprit has been engaged by the architect as a sub-consultant (e.g., the structural engineer) which is common. In addition, most A/E professional liability policies will not allow the owner/developer to be a named additional insured to any of the sub-consultant policies so this “system” relies on the architect (as the one contracted with the owner/developer) to make the claim against the sub-consultant.
We have seen some reluctance to do this in recent claims involving complicated allegations of negligence and lots of greenbacks.
Besides the typical primary design policies carried by the A/E’s, there are three other options:
Option No. 1:
Obtaining a project specific excess endorsement attached to the design professional’s base PL policy;
Option No. 2:
Project Insurance: and
Option No. 3:
The Owner Protective Liability Policy.
I will discuss these options in more detail below.
Contractors and their subcontractors and suppliers carry general liability policies as well as workers compensation policies. Policies carried by these participants also include vandalism and theft policies for their equipment and tools, as well as auto and pollution coverage. In some instances, the general contractor will carry a form of subcontractor default insurance that is billed to the owner/developer to cover losses caused by a defaulting subcontractor. These “premiums” include the deductible that would be due if a claim is made. You might find it interesting that at least one of the issuers of this type of policy offered a well above market interest rate on the “premium” collected by the owner/developer and maintained by the insurer for the duration of the project before being “refunded” to the contractor. Many large projects look to an Owner or Contractor Controlled Insurance Program (commonly referred to as an “OCIP” or “CCIP” respectively).
These policies typically just cover general liability. The intent is to “wrap” all general liability coverage under one “umbrella”. While a worthy intention given the duplicative general liability coverage on these projects and the associated costs, as well as the otherwise litigation prone journey to trigger coverage, the administration of the process for achieving these worthy goals leaves a lot to be desired. As discussed, these policies are narrow in scope and leave the owner/developer left to manage the balance of necessary coverage. I won’t dwell on the process for dealing with defects, delays and other claims and the associated costs that are often occur. I want to focus on something more positive. But first, we need to understand the problem.
The Weak Link
While there usually is enough (if not too much) general liability coverage given the many policies and readily available high excess limits, obtaining adequate design professional coverage is another story. Additional options must be considered given that the professional liability polices maintained by the design professional (a) are written on a claims made basis meaning that the claim must be made during the policy period, (b) provide no guarantee that the design professional will continue to maintain coverage, (c) do not typically provide adequate limits to respond to a significant claim, (d) do not address the fact that significant claims are on the rise, (e) are subject to claims from all projects that the design professional is involved with, (f) are vulnerable to eroding limits as legal fees are paid first on any claim, (g) are set up to be adverse to any claim, and (h) have no process for involving the owner in determining the quality of the A/E’s coverage especially considering that certain forms include exclusions related to habitational and heavy civil projects as well as structural/soils engineering services mold and other pollution conditions. While most A/E contracts contain contractual indemnity provisions in favor of the client, most also contain a limitation of liability provision limiting the design professional’s liability to a fraction of its fee or to available insurance coverage in place at the time of the claim.
Option No. 1: Excess on Primary
We have used this option in the past to obtain additional coverage and to make that coverage specific to our client’s project. We have, however, encountered situations where the design professional’s PL carrier will only allow so many projects to be afforded this option. Recently, a large multi-family architect informed us that it could no longer offer this option. In another case, the architect wanted a significant premium on an insignificant increase over its primary billable each year for the duration of its contractual liability. Some carriers stipulate minimum premiums for each additional $1,000,000 in limit deployed for a specific project. Many A/E carriers write the policy on admitted paper so are unwilling or unable to deviate from base rates to accommodate heightened limits on smaller sized projects. The other drawback to this option is that it the excess is written on the same term as the primary; typically a one year term. This doesn’t mean that it will be in place for the first year of your project; rather, from inception of the policy which may have been elven and a half months before the claim is discovered on your project.
This option is also less attractive when you consider that the additional premium is compounded throughout the full project term and subsequent mandated amount of years in which the design professional is contractually obligated to maintain the coverage in place. If additional limits are requested of sub tier A/E consultants to the architect, the additional charge is assessed against each individual prime.A/E.
Option No. 2: Project Insurance
This coverage protects the design team against liability arising from their own negligence and replaces the design professionals practice policy. All members performing design services under the architect are named insureds and thus covered by the program. While there are around four or five carriers that will actually name multiple A/E firms or even the design/builder/contractor and other design professionals in a joint venture structure, the premium is typically prohibitive. Owners should request to be endorsed as an indemnified party so that the carrier indemnifies the owner for damages and claim expenses incurred by the owner resulting from the covered design professional’s negligence. While the policy is project specific, and the owner may make a direct claim against the policy, the policy creates an inherent conflict of interest because the carrier is defending the covered design professionals. This has resulted in protracted litigation with the policy limits going to pay for the defense of the design professional thus eroding the available coverage; a frustrating situation for the owner who effectively pays for the policy.
Costs of coverage has fluctuated wildly in the past five years given the amount of claims and losses that have been experienced. Current rates vary from a five to fifteen percent rate on line for less risky projects to fifteen to thirty percent or more for more complex or high risk projects such as habitational/condominium, heavy civil or entertainment types of projects. Current available coverage from a single market is $25,000,000. The marketplace has been stagnant with only three or four carriers entertaining projects requiring $10,000,000 or more in coverage. Another factor to consider is that the premium is audible so that rates may increase if the design fee – or project construction value increases. Also, there are exclusions and limitations that should be evaluated such as no coverage for construction delays – which is one of the leading causes of economic damages suffered by project owners and subsequently, professional liability claims against contractors and A/E”s.
Option No. 3: Owner’s Protective
This policy protects the owner from catastrophic loss resulting from the design professionals’ negligence. The policy supplements the practice policies provided by all design professionals as well as design builders and specialty trade contractors performing design services such as the fire life safety subcontractor.
The policy thus acts as an excess policy over the design professionals’ practice policies but the named insured in this case is the owner. Because the amount of the underlying practice policy will impact the price and underwriting of the Owner’s Protective policy, there is a minimum insurance requirement (MIR) that the carrier will impose on the design professionals’ practice policies ranging from $1M to $5M.
The policy is project specific – but can be provided on a blanket/rolling basis over a certain term for multiple projects. The making of a claim by the owner triggers the claim process whereby the design professional is required to submit the claim to its practice carrier. The amount paid to the owner on the claim is the total damage less the design professional’s practice liability limit subject to the protective policy limit. Because losses are shared between multiple carriers, the claim process should be more expedient. Defense coverage is also provided to the owner – for third-party claims against the owner alleging damages as result of design services (covering the owner for their vicarious design exposure due to their contractual relationship with the A/E). Thus, when the contractor claims that the plans are deficient and makes a claim against the owner, the owner should tender the claim to the carrier. Costs have increased over the past five years but not as greatly as the project policy. Costs are forty to fifty percent less on average depending on the variables. Single market limits are currently at $50,000,000 with around eight to ten markets available as of this date.
The Future
The current “system” of placing coverage on current projects does not account for the many changes and climate created by the nature of current claims. While the Owner’s Protective Policy attempts to allay many of the concerns, it is still only a piece of the complicated puzzle that must be meticulously managed on a project to project basis.
While there are options that can be piecemealed to mitigate losses, only a global program incorporating strategic quality control from pre-project planning to design and ultimate construction coupled with a truly comprehensive insurance program can effectively mitigate the substantial growing risks of the project portfolio of the contemporary developer owner.
We are working with innovative firms to evolve coverage to its current needs.
We highly recommend working closely with your risk management team to address the specific needs of your projects, and the current programs available at this time as well as what can be assembled if requested of your insurance broker.
The material in this article is not intended to offer or provide legal guidance. It is merely intended to offer a perspective on current insurance issues. You should seek guidance from your risk managers before altering or adopting any risk management strategy.
For further information, contact Josef M. Rodarti at rodarti@constructionriskmanagers.com
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