Gain a better understanding of this complex and often misunderstood type of construction insurance.
Editor's Note: This article is part of a contractor's insurance series by Steven Davis. To read his other articles in this series, click here.
The exposures that contractors face have become more complicated as a result of changes in project delivery systems over the past 20 years. This has forced construction executives to examine professional liability coverage—a complex and often misunderstood type of coverage.
In the past, an unendorsed Commercial General Liability (CGL) policy gave contractors a good option for insuring their general or operational liability risks. But the dynamics of coverage changed dramatically once the policy included the professional services exclusion, leaving contractors to sort through exposures arising out of their operations. Over time, an added endorsement, ISO CGL 2279, closed this coverage gap and restored coverage for bodily injury or property damage (BI/PD) in connection with the design of their means and methods.
The CGL policy covers physical activities that result in BI/PD, but the source of professional liability claims often come from issues relating to faulty design, cost overruns or a delay in completing the project due to professional negligence.
In construction litigation, professional negligence is usually defined as failure to perform duties according to the rules or standard of care or practice that would have been expected of another professional performing a similar task in the same region or location.
A professional is defined as someone who possesses specialized skills and experience and a higher level of competence resulting from acquired learning. A crane operator may have specialized skills and experience, but operating a crane would not be considered a professional service. It would be considered “means and methods.” Similarly, if a contractor uses detailed design for the temporary foundation of the crane and performs studies of the load bearing or handling capacity of the crane, these activities are considered means and methods and speak exactly as to the intent of coverage afforded to them by ISO CGL 2279. On the other hand, an engineering firm could potentially incur professional liability if the firm designs the supporting structures for the crane or offers opinions about the crane’s operating capacity but do not actually operate the crane as they would be acting within the capacity of a “professional.”
Professional Liability Coverage for Contractors
A professional liability policy broadly covers design claims, but the coverage works differently for cost overruns and delay claims. A major source of cost overruns or delay claims against construction managers, whether at agency or at risk, arise from bad sequencing or coordination of the work. To the extent the construction manager acted negligently, they incur professional liability, and a professional liability policy should at least afford them a defense, absent the policy having an affirmative exclusion for cost overruns or delays or any work altogether as a construction manager at risk.
In determining the ultimate liability that a professional carrier has with complicated professional cost overruns or delay claims, certain pertinent restrictions in the policy need to be considered, such as: contractual, profits, offsets, overhead and betterment exclusions. Since the majority of construction manager at risk delay or cost overrun claims are negotiated in advance by contract, only the most complicated claims involve professional policies. However, a construction manager at agency usually does not price for these claims in their service and historically benefits the most from this coverage.
Professional liability policies are defensive in nature, but coverage like protective indemnity and mitigation of damage have made them proactive in practice. Contractors should purchase protective indemnity coverage if they enter a design-build contract and provide design and construction services while subcontracting the design portion of the work.
In design-build projects, owners demand that a contractor provide full assurance about the project’s completion and costs, and any problems should be resolved in a contractual claim (i.e., if the contractor pays the agreed per diem liquidated damages for a delayed project or if the project has design problems, the contractor must fix the problems in accordance to the contractual agreements.) If the project costs increase or if there are any design problems, the contractor has no recourse but to deliver the project at a loss and fix the problems.
If the design firm is at fault and their professional liability insurance is not adequate, protective indemnity coverage will pay the contractor for such a loss in excess of the designer’s availability insurances. Such insurance is essential in design/build as it may be the only recourse available to help the contractor defray the costs of fixing the project. Since protective indemnity only pays for established losses, it typically takes some time to vet out its value.
Mitigating damage is a more proactive insurance coverage for a project, especially for design claims discovered during the course of the construction or warranty period. The coverage looks at the significant project design problems early on. If the problems require immediate attention, the coverage brings all parties to the table without litigation, while potentially providing immediate funds to remedy the design problems.
The issue of fault can be resolved later after the project meets the owner’s satisfaction. Once full design liability has been established through mediation or litigation, the contractor and his or her insurer jointly look to recover mitigation of damage advance payments that have been made from the negligent third-party designer.
A contractor who subcontracts design or provides design-build or construction management services should purchase a professional liability policy. The CGL policy does not cover the risks involved in these contracts.
In some cases, design liability is inadvertently assumed on an indirect basis (e.g., fire protection, life safety/lighting, signage, roofing, mechanical, electrical, curtain walls, etc.) when the contractor subcontracts the activity to a non-professional entity. This entity may also subcontract design services. Claims have arisen when a critical part of the job had a design-build component that resulted in a professional liability loss despite the fact that the contract for work was a general construction lump sum agreement.
Since a broad spectrum of professional liability coverage is offered in the competitive construction marketplace, contractors must spend time understanding their professional liability risks and how these risks differentiate from operational liability.