Do You Need Professional Liability?

Over the past three decades, the delivery system for construction projects has undergone some fundamental changes.

Many of these changes sought to relieve the owner from the costs and challenges associated with attempting to assemble two independent, and somewhat adversarial (designer and contractor), parties to cooperate in delivering a quality project.

With these changes in methods, whether design build or construction management, exposures to contractors have also undergone fundamental change.

Under the traditional method of construction contracts, most of the professional liability will rest with the design professional, which historically has been a separate entity. However, contractors that perform work as design-builders assume not only the responsibility for design, but also the corresponding liability exposures.

It is clear that when contractors enter into design-build and construction management contracts, they take on certain responsibilities that require professional architectural and engineering expertise. Since coverage for professional liability is excluded under most contractors’ general liability insurance policies, contractors performing these services require professional liability insurance to protect their balance sheets.

Contractors who question their need for professional coverage might wish to evaluate the checklist of exposures as prepared by the International Risk Management Institute:

a) Does your firm enter into explicit design-build or construction management contracts?

b) Does your firm perform services for a fee that involve no “hands on” construction work?

c) Could failure to exercise the appropriate degree of skill and care cause harm to others?

d) Does your firm employee licensed professionals-primarily architects or engineers-or does your firm contract directly with these professionals for services?

If the answer to any of these questions is “yes,” the contractor should look further into procuring professional liability insurance.

Recognizing professional exposures requires understanding the scope of services provided on a project, how the contractor is defined by the project parties and the project agreement and scope. The following chart summarizes the responsibilities:

General Liability Exclusions

General liability (GL) and professional liability policies typically have specific exclusions relating to professional acts or omissions. While contractors with incidental or limited exposure may be able to arrange adequate coverage by modifying these policies, contractors who execute design-build contracts will need separate professional liability coverage. 

The Insurance Services Office (ISO) Commercial General Liability policy and the typical policies underwritten by Umbrella/Excess underwriters have specific restrictions related to professional liability coverages. The 2007 Insurance Services Office (ISO) GL coverage (CG 00-01-12-07) form excludes professional liability coverage under the Exclusions-Contractual Liability through the definition of an “insured contract.” While the GL coverage form is intended to provide coverage for bodily injury and property damage arising out of an “insured contract,” the definition of such “insured contract” explicitly removes any coverage for damages that might arise out of the rendering or failure to render professional services.

Additionally, insurance companies who underwrite general liability policies for construction firms will also attach various endorsements to exclude professional liability coverage, such as CG 22-43-07-98. This particular endorsement will exclude all coverage, including losses that might arise out of “supervision, inspection, architectural or engineering activities.”

From a construction standpoint, this exclusionary endorsement does create ambiguity in coverage that might arise out of traditional construction activities, such as supervision or inspection of the work. For that purpose, the ISO has produced endorsements (CG 2279 and CG 2280) that provide “means and methods” coverage, meaning that while such activities are indeed excluded as an architect or engineer, such exclusion would not apply to operations with construction work performed as a contractor. This is accomplished through the definition of “professional services” to not include: means, methods, techniques, sequences and procedures employed as a construction contractor.

Risk Management Strategies

A contractor has three basic strategies for handling its design-build professional liability exposures. First, it can transfer as much of the risk as possible contractually, by requiring design firms to hold it harmless for liability arising out of the design of the project, and requiring proof of insurance as evidence of their ability to pay such costs. It should be noted that the contractor should evaluate the state statutes regarding Anti-Indemnity Laws regarding the enforceability of such agreements. However, such indemnity to the designer may not be enforceable to the degree that the contractor is fully protected and such protection is limited to the amount of liability insurance maintained by the designer. (An indemnity’s value is limited to the firm’s ability to respond financially, i.e., assets, insurance, etc.)

Secondly, the contractor should procure its own professional liability insurance. For design-builders, utilizing in-house architects or engineers is obvious, but when outside architectural/engineering (A/E) firms are retained, the contractor needs professional liability coverage to protect itself from the contingent liability of design as the prime contractor.

Finally, contractors should practice aggressive risk management with respect to design liability. This includes quality selection of the design firm, past experience in such projects, workload and capabilities to work as part of a design team. Below will outline some additional risk management strategies for contractors with professional exposure to consider:

• Evaluate all project participants, including the owner.
• Examine the project scheduling, focusing on delay exposures.
• Work with the design team closely to ensure that the design is functional and can be completed at the contracted price.
• Attempt to negotiate a limitation of liability and relief for consequential damages, including force majeure.
• Require the design firm to indemnify the contractor for damages arising out of the design, including environmental and geotechnical work.
• Construction subcontractors should hold the design builder harmless from liability arising out of their work.
• Require that the design firm provide evidence of liability.
• Specify that any design documents become the property of the contractor once the preliminary design is accepted by the owner. (If this is not feasible, it is recommended that a “reuse” agreement be executed with design firm.)
• Arrange other insurance coverages, such as builder’s risk to include delayed completion and loss of income. General liability and umbrella/excess liability policies should be coordinated to provide means and methods coverage.
• Require that disputes be resolved through mediation or one of the other options of dispute resolution. Some insurers may be reluctant to allow “binding arbitration.”
• Have clear protocols on how change orders will be handled.

The Professional Liability Market

The insurance underwriting community was initially reluctant to write such professional policies for contractors, as the definitions of professional services were slightly blurry and many were accustomed to the A/E exposure.  However, over the past decade, insurers have risen to the challenge in providing adequate products to insure the changes in delivery exposures to contractors who engage in design-build or construction management.

Some of the markets who focus on professional liability coverage for contractors include: Zurich Construction, Catlin, Arch Specialty, XL Insurance, Lexington Insurance Company, and Travelers.  Coverages provided by these insurers vary significantly, for example, CM (at risk), indemnity coverage for the owner, definition of professional services, BIM, and limits or capacity available.

Professional liability policies are underwritten on a “claims-made” basis while most general liability polices are underwritten on an “occurrence” basis. These two coverage triggers are very different and require careful analysis. Additional terms, such as retroactive date, self-insured retention, breach of contract and limited contractual liability have special meanings in professional coverage.

Many contractors procure practice policies, which can include contractor’s pollution liability coverage as well. Project specific policies are also available that provides professional liability coverage for a given project, with dedicated limits and extended reporting periods.

Professional Claims

Typical allegations of professional liability claims for contractors include the following:

• Negligence in preparing plans, drawings, designs and specifications
• Errors involving site surveys, soil testing, subsurface conditions, elevations
• Failure to design consistent with building codes
• Negligence in selecting or recommending building materials
• Failure to detect faulty workmanship on the part of a subcontractor
• Suits relating to cost over-runs, estimates, supervision and specifications
• Hiring of specialty sub consultants for design, environmental, etc.)
• Providing constructability reviews
• Making field changes to designs
• Performing quality assurance inspections

A key area of exposure change is that under a traditional contracting method, the design firm does not warrant its work, but as a design-builder, the designer not only warrants its own work, but that of the construction contractor it hires to build the project, as well. 

With the growing interest in capitalizing on new forms of partnerships between the public and private sectors to plan, design, finance, build and operate the nation’s transportation infrastructure, contractor’s exposures to professional and other liabilities will continue to evolve.

Construction Business Owner, November 2008