No matter whether it is designed to protect owners, architects, engineers or general contractors, the securing of project professional liability coverage can be complicated. Professional liability exposure exists for the construction period plus the applicable Statute of Repose, often meaning a total of 10 or more years. Ensuring compliance and affordability over an extended period is difficult. Unfortunately, over the past few years this process has become even more difficult, especially for applications surrounding the design and construction of commercial condominiums and other “habitational” projects.
The math is simple. The increased number of catastrophic professional liability claims, coupled with inadequate rates, have resulted in today’s tight market and the poor underwriting profits of the project professional liability insurance marketplace. Subsequently, various alternatives were developed to confront the problem. Some have been practiced for years, while others consist of fairly new insurance products that are still not understood by many in the industry. Although variations exist, these alternatives are available to protect various entities from professional liability on construction projects. Ordered by cost, rather than the degree of protection, each provides benefits based on the specific risk appetites of individual owners, design professionals, design builders and/or contractors.
1. Requiring No Professional Liability Insurance
While simplistic, contractual risk transfer via indemnity agreements offer an actual alternative. Many disagree, but there are owners who have chosen to move forward with design professionals or design builders who do not offer evidence of insurance, let alone the appropriate limits. This includes owners or contractors engaged in simple, “low-rise” or “cookie-cutter” projects and/or believe there is no need for anything beyond the contractual transfer of risk or to back up contractual indemnities with external financial mechanisms.
Other reasons often include the ill-placed belief that architects or engineers will financially rectify problems of their own accord. That said, there really aren’t too many owners who would willingly take this route. That’s because most owners and contractors realize the variety of professional liability exposures that can be faced during the course of even the simplest projects. For instance, the fast-paced nature of design-build delivery methods inherently involve exposures surrounding the ongoing compression of construction schedules, as well as expanded standards of care of the professionals involved. In addition, construction-management-at-risk (CMAR) projects have been known to advance general contractor and construction manager professional risks by increasing their reliance on subcontracted services, not to mention the expanded scope of services in a common CMAR contract. Also, the very definition has been debated among carriers for years. Some consider CMAR a pure “professional service,” while others view it as an extension of a general contractor typical scope of work, creating even more confusion when challenges arise. But it’s not that black and white.
2. Evidence of Professional Liability from Design Professionals
Under current market conditions, the requirement of design professionals or design builders to evidence a specific limit of professional liability insurance is probably the most prominent option. However, this alternative is often inadequate. It’s difficult to explain why the owners of a $3 million structure would allow a design professional to evidence only $1 million in professional liability insurance. Even if the entire design team, usually comprised of five or six firms, carries $1 million in limits, that only leaves—well, just do the math. Not much for a structure of that size. To compound the issue, often owners can’t even be sure that the limits requested in the contract will be available when needed. In fact, there are a variety of reasons why the coverage may not even exist:
- Impairment or exhaustion of the evidenced limits due to claims on other, unrelated projects
- Coverage restrictions in the form of exclusions around specific services or projects, such as habitational, along with contractual and/or mold/fungus/bacteria exclusions. This is further compounded when design professionals need only provide a simple certificate of insurance (COI) to evidence coverage. Quality of coverage varies greatly among the more than 50 facilities providing professional liability coverage.
- Securing COIs for a 10-year period is often impracticable, and there is no guarantee the A&E will be able to secure the required coverage. Variables, such as claim activity, acquisitions and insurer appetite must be considered. These concerns are further compounded by the lack of professional liability insurance purchased by many design professionals. In fact, the American Council of Engineering Companies (ACEC), a trade association representing approximately 600,000 engineers, architects, land surveyors and other construction professionals, annually surveys members on the limits of professional liability insurance (PLI) they purchase. While nearly all said they buy PLI, the average per claim limit of PLI purchased was around $2.6 million. Furthermore, the average claim PLI limit for geotechnical and structural engineers was only $2.5 million and $1.9 million, respectively. Of course, ACEC is comprised of many small to large engineering firms, so perspective must be applied.
Design professionals that carry inadequate practice limits can often secure a Specific Project Excess (SPE) endorsement to increase their limit to meet contractual requirements. But for the reasons discussed above, there is no guarantee this option is available or affordable over the required time period.
3. Professional Protective Insurance
“Protective” policies have gained a great deal of momentum over the past 3 years. Offered to construction project owners (owners protective or OPPI), as well as design-builders and general contractors (contractors protective or CPPI), these policies provide first-party indemnity for damages, excess of the design professional’s professional liability insurance, that the named insured incurs as a result of negligence of the design professional. It supplements the design professional’s PLI with the added benefit of the owner or contractor as the named insured. Unlike relying on the subconsultants practice policy, the protective excess policy is dedicated to the project. As you would think with excess insurance, the underlying design professional’s professional liability policy must be exhausted before the policy will provide the indemnity.
In addition, this coverage part is designed to provide owners and/or contractors with a cost-effective alternative to costly project specific professional liability placements. Depending on the project type, “protective” policies are typically priced 40 to 60 percent lower than project professional liability policies with the same limits, retentions and policy terms. There should be no mystery surrounding the reduced cost as the protective is an excess coverage and contemplates the underlying design professional’s PLI will pay a portion of the loss.
Protective also provides the benefits of an owner or contractor controlled program that includes dedicated protection for the named insured—consistency in coverage, and reduced administrative costs on a project-specific basis for 10 or more years. Other advantages include the ability to offer, cover or supplement the following:
- IDifference in coverage, difference in limits (DIC/DIL) above the underlying professional liability policy in the event the underlying policy is deficient in coverage, or the underlying has been eroded from an unrelated claim
- Defense costs for third-party claims arising out of the design professional’s services
- Limits of liability secured up to $25 million with one single carrier. Higher limits may be obtained through use of multiple carriers
- Excess coverage for pollution claims, including mold and bacteria
- Rectification coverage, depending on the primary named insured (predominantly offered only the lead contractor). Rectification or mitigation coverage is another first party coverage for damages incurred by the named insured to remedy a design error or error in professional services. It differs from protective indemnity because it is a primary insurance subject to a self-insured retention, rather than sitting excess of the design professional’s PLI. It is typically purchased as part of the CPrL program similar to protective indemnity.
4. Project Specific Professional Liability Insurance
Project-specific professional liability (PSPL) policies often replace all the annual practice policies of the design and possible construction team, making it a true dedicated primary protection for projects. But as primary professional liability coverage, PSPL is the most expensive alternative for insuring projects. Although dedicated to the project, a third party can make a claim against this policy, possibly eroding limits intended to protect the project owner.
Properly structured PSPL policies often provide the broadest form of protection for design entities involved in construction projects. Although contractual arrangements and the services rendered can vary greatly, the lead design professional will often hold the contracts for the entire design team. In these instances, the policy structure is simple—all entities are named accordingly. However, life in the construction world is not always that simple. Sometimes owners will contract directly with the geotechnical engineering firm, structural engineering firm or even the fire protection engineering firm. Other times, the general contractor may contract with the MEP contractor, who happens to also provide design services. Nonetheless, the proper coverage of all services and events is dependent on a clear understanding of contractual arrangements across the various service fronts. Other benefits include:
- Joint defense for the design team, limits potential finger pointing.
- Dedicated project limits with extended reporting periods (ERPS) as long as 10 years. This is designed to preserve the design team’s professional liability insurance (which should sit excess of any project placement)
- Financial security for duration of project
- Primary protection for all design and/or construction entities
- Continuity of coverage throughout project and ERP
- Rectification coverage may be available for damages incurred by the named insured to correct or remedy a design errorDB or owner may be indemnified by policy for design team’s services
- Contractors Pollution Liability (including mold/bacteria) coverages, which can be included to provide coverage for pollution conditions arising out of construction work
- Coverage of third-party defense costs arising from design team errors
The key to selecting the proper professional liability alternative for a specific project entails matching program benefits with the entity or entities requiring protection. It’s very possible that no one form meets all the necessary goals, though. For example, proper protection for a mega project may require a combination of the above options, such as PSPL with a protective excess policy sitting above.
Plus, the process is often further convoluted by the fact that few carriers offer PSPL. There are more options for protective policies, but that list shrinks when considering rectification/mitigation coverage. In addition, coverage terms and conditions can vary greatly. So, it is imperative to establish a sound understanding of the contractual relationship between the named insured and the design professional well before the policy is enacted.
As a result, it may take a combination of alternatives and techniques to provide the proper amount and coverage type needed to protect the necessary parties from project problems. There is no cookie-cutter approach to construction risk management. Due diligence must be performed in every instance. If not, catastrophe should also be added to the list of alternatives.