Design & Construct Professional Indemnity Insurance
Design & Construct Professional Indemnity (D&C Pl) policies indemnify the contractor for claims made against them by third parties during the policy period arising out of a breach, error or omission in the provision of professional services performed by them directly and/or their consultants and subcontractors for whom they are vicariously liable.
The Professional Services under most Professional Indemnity (PI) policies are usually described within the Policy Schedule, however, under D&C PI policy, the list of professional services covered is normally spelt out in detail under the Definitions section of the policy.
his list of professional services usually include:
• Technical advice
• Feasibility studies
• Quantity surveying
• Technical specification
• Programming and time flow management
• Project Management
• Construction Management
Whilst the professional services are generally pre-described within the policy, it is important that your insurance broker cross-reference these against the services actually performed by or on behalf of the contractor.
Types of Policies
Australian construction contractors that perform any of the above professional services and/or deliver projects under Design & Construct (D&C) style contracts will generally maintain an annual D&C PI policy. These policies are designed to cover the civil liabilities of the construction contractor for professional services performed on all current and previous projects (unless specifically excluded) after the retroactive date.
As the insuring clause trigger under PI policies are on a “claims made” basis (as opposed to an occurrence basis), these policies should ideally have an unlimited retroactive date; being the date after which cover is provided for the specific professional service performed that led to the claim. These policies should also be maintained (or placed into run-off if the policy is no longer required) for a period preferably aligned with the statute of limitation in the States or Territories in which the insured operates; normally a minimum of 6 years in most jurisdictions in Australia.
Annual D&C Pl policies are usually the most cost effective way of procuring this type of insurance. The coverage and extensions available under annual policies are normally broad and deductibles lower.
Project Specific Policies
Project specific PI policies have become popular with principals and financiers, particularly for large privately financed and government infrastructure projects, as they offer a guaranteed ring-fenced policy limit for their specific project. Project specific policies are usually procured on a multi-year basis (normally up to 10 years) ensuring that coverage is maintained on the same terms and conditions for the entire policy period.
Contractors should also consider project specific Pl policies when undertaking new or unusually complex projects and/or when operating in joint ventures (JV) with other companies to protect their annual policies from claims under these projects.
These policies are also appropriate for projects delivered under 'no blame' alliance style contracts. Due to the non-adversarial nature of these types of contracts, traditional third party policy triggers are not fully effective. Professional Indemnity policies for alliance style projects require specialised drafting to ensure that first-party costs associated with rectifying losses arising from professional acts, errors or omissions are covered.
Limits of Liability
Notwithstanding the type of policy procured, the limit of liability under PI policies is always an aggregate limit; meaning that the maximum amount the insurer will pay will be capped for both each claim and for all claims during period of insurance. The aggregate limit will either be specifically described on the policy schedule or as “reinstatement(s)” within the policy wording.
When determining the adequacy of the aggregate limit under a D&C PI policy, the contractor should consider the following:
• number of current and historical projects for which professional services were performed by or on your behalf;
• contract value of each of project;
• technical complexities and/or risks associated with each project; and
• (for project specific policies) the period of the policy.
The drafting of D&C Pl policy wordings can vary dramatically between insurers. Whilst all offer various automatic and optional coverage extensions; the inclusion of a specific policy extension in one policy wording does not necessarily mean that broader coverage is being afforded by that insurer. Most policy extensions are simply 'writebacks' in cover specifically excluded elsewhere in the policy; accordingly, the absence of the same exclusion (and policy extension) in another policy wording is likely to actually offer broader overall coverage.
Some of the standard extensions offered under most D&C PI policies include:
• Advancement of Defence Costs
• Inquiry Costs
• Vicarious Liability (Consultants, Subcontractors and Agents)
• Joint Venture Liability
• Loss of Documents
The following policy extensions are often optional under D&C PI policies, some of which can be subject to an additional premium; however, these extensions can provide real value to contractors depending on the nature of their projects and business activities.
All construction contracts include indemnity and hold harmless provisions that extend the liabilities of the contractor beyond what would normally attach under common law. Examples of these clauses include but are not limited to:
1. performance warranties;
2. hold harmless provisions; and
3. consequential loss agreements.
Although a commercial reality, contractors should check if and to what extent cover is being provided under their D&C Pl policy for these contractual liabilities.
Most standard D&C Pl policies include a broad contractual liability exclusion which limits the indemnity provided by the policy to losses that would attach under common law only. A contractual liability extension ensures that the contractors' liability to pay losses under such indemnity or hold harmless provisions of a contract are covered so long as the liability results from the performance of their or their consultants/agents professional services.
Limitation of Liability Contracts
Good quality construction contractors will always seek to mirror, as much as possible, the contractual provisions they have accepted under their head contract with the consultants and subcontractors they have engaged for the project. However, the reality is that this is not always commercially possible and in many case these consultants/subcontractors will actually seek to limit their liability in contract with the contractor.
Examples include limiting liability for:
a) an agreed insurance limit;
b) the value of the contract; or
c) a percentage of the contract value.
Whilst accepting these provisions is often a commercial reality, such agreements can have a significant impact on the D&C Pl policy of the contractor engaging these consultants and subcontractors. Standard D&C Pl polices contain a condition requiring the Insured not prejudice the insurer's actual or potential rights of recovery against other parties who may have caused or contributed to a loss covered by the policy.
Depending on the extent to which these limitations of liability provisions have restricted the insurers right to recovery, coverage afforded under the PI policy could be substantially reduced.
A limitation of liability extension ensures an lnsured's right to claim under its policy will not be prejudiced by contracts entered into by the Insured with other parties that limit the other parties' liability.
Loss Mitigation & Rectification
Standard Pl policies only indemnify lnsured's for claims for compensation by third parties; specifically, the claim needs be a formal demand or legal proceeding issued against the Insured during the policy period for the policy to be triggered. This type of insuring clause is normally adequate for most other professional service companies by itself, however, for construction contractors, the discovery of the act, error or omission of the professional services often occurs during the construction period, prior to any formal demand or legal proceeding.
The contractor is normally obliged under its contract with the principal (and arguably under the PI policy) to rectify the issues caused by the provision of professional services, largely avoiding/mitigating any potential future claim under the policy. Whilst the contractor will have incurred significant costs to rectify the professional service issues, the absence of a third party claim means a normal Pl policy would not respond.
A loss mitigation and rectification extension covers the direct costs and expenses incurred by the Insured in taking action to rectify or mitigate the effects of any act error or omission that would otherwise result in a claim covered under the policy.
Some insurers will only offer this coverage with a relatively low sub-limit. This coverage can often be critical for contractors and low sub-limits for this extension may be inappropriate for contractors delivering large and/or complex construction projects.
The proximate cause of a loss discovered at a project will often initially be unclear; it usually takes several months (if not years) to resolve. The parties directly involved in rectifying the problem are normally the same parties who’s failure is likely to have caused or contributed to the loss in the first and will often look to point the fingers at others involved in the project, such as the sub-contractors, suppliers, manufacturers or other consultants. It is important that potential issues are notified to insurers as soon as possible and that they are kept involved throughout the rectification process (even if it is unclear whether the PI policy will respond).
Novation occurs when the contractual rights and obligations of one party are transferred to another party. Novation is a significant feature in the construction industry, particularly in relation to Design & Construct delivery models, whereby a principal may novate the appointment of its design consultants to the head contractor.
Other examples of novation agreements include the purchase or acquisition of a business with the purchaser agreeing to be liable for any breaches of contract of the vendor prior to the novation.
Most Pl policies specifically exclude novated contracts. Therefore, in order to be covered for liabilities assumed by reason of a novated contract, lnsured's must seek a specific extension to their policy.
However, lnsured's should be aware that having a novated contract extension under its Pl policy doesn't necessarily mean automatic coverage is provided for all novated contracts; many wordings still requiring each novated contract to be declared, pre-approved and separately priced by insurers prior to cover being granted.
lnsured's should also be aware that even in the event of acceptance of the novated contract, coverage will still only be subject to the terms and conditions of the lnsured's policy. The terms of the contract being novated may contain warranties, indemnities or professional services that may be outside of the scope of the lnsured's Pl policy.
Every State and Territory including the Commonwealth has a form of Civil Liability Act that deals with proportionate liability. The legislation operates in principal by replacing the common law rule of joint and several liabilities of civil wrongdoers with one which limits the liability of a concurrent wrongdoer by reference to its degree of fault for the loss.
What this means is that having previously been able to pursue a single 'deep-pocketed' wrongdoer for 100% of the claim, a claimant must now sue each and every wrongdoer who contributed to that loss.
Proportionate liability generally advantages downstream parties and disadvantages upstream parties. It is therefore not surprising that most companies try to avoid proportionate liability when they are upstream and affirm it when they are downstream.
Although contracting out of the legislation is prohibited in Queensland, legislation in Tasmania, NSW and WA include a contracting out provision and there is no express provision, either way, in the ACT, the NT, SA or Victoria, nor in respect of the Commonwealth provisions.
Although often a commercial reality, agreeing to contract out of proportionate liability legislation can affect an lnsured's insurance cover as most Pl policies exclude liabilities assumed by an Insured beyond that of common law. For example, a contractor could find themselves uninsured for 90% of a claim made against them if they would have only been liable for 10% of the claim had they not agreed to contract out of the legislation.
Having a proportionate liability extension resolves this gap by covering liability the insured has assumed by contracting out of proportionate liability legislation.
Multiple Causes of Loss
The Wayne Tank principle is a legal precedent established in 1974 following the trial of Wayne Tank & Pump Co Ltd vs Employers Liability Assurance Corp Ltd. This legal precedent is often used by insurers to deny a claim where there are two or more proximate causes of loss; providing at least one of the causes is excluded under the policy the entire loss can be rejected in full, regardless of whether any other cause(s) of the loss was covered by the policy.
Although more recent case law** has tested these underlying principles; these cases have not provided any additional clarity as their success/failure has largely been determined by the unique facts of each case and the terms and conditions of the relevant Pl policy.
Multiple Causes of Loss or Allocation clauses attempt to override the Wayne Tank principle by clearly stating that the policy will indemnify the insured for that part of any loss which is insured under the policy.
** Mccann v Switerland InsuranceAustralia Limited (2000), Hams v CGU Insurance Limited (2002), McCarthy v St Paul International Insurance Co Ltd (2007)
Insurance Market Conditions
D&C PI insurance is one of the most complex and challenging policies in the insurance market. As demonstrated above, there are a number of unique risk and coverage features that need to be carefully considered; speifically:
• Liabilities are often imposed on/accepted by the contractors for a long list of professional services purely as a result of the contracts they sign up to;
• The professional services for which the insured is responsible are often performed by other parties;
• The liabilities of these professional services sometimes pre-date the insured's involvement in the project; and
• The contractor may be required to repair and/or mitigate losses as a result of failure or breach of these professional services prior to the cause of the loss being established or formal demand issued by a third party.
Overlay these risk and coverage complexities with the broader challenges facing the construction industry, such as:
• Uncertainties surrounding how liabilities will be allocated by the courts for non-compliant cladding systems on buildings;
• The increasing number of high profile cases of under designed high rise residential apartment buildings in Australia; and
• Large PI losses on a number of complex and mega projects around the world (eg. Waste to Energy);
and it’s not surprising that we are currently experiencing significant hardening in the insurance market for this class of insurance.
There is uncertainty over the near term future of D&C PI insurance. We have seen a number of insurers significantly remediate their book or completely withdraw from this class of insurance altogether; meaning many specialist PI underwriters have become redundant. The ones that continue to write this class of insurance are cautious and are generally unwilling to take on high risk or claim heavy programs. Insurers are demanding both better clarity about the projects and risks being accepted by the insured as well as how they managing these risks with consultants and subcontractors.
Determining “Value for Money” – As highlighted earlier, D&C PI insurance policies are not all the same and coverage can vary dramatically between the policies and policy extensions available in the market. There is no one size fits all solution for D&C PI and it is therefore critical that contractors fully understand and evaluate the impact of any change in coverage as it relates specifically to their risk profile. In the same way that a cheap policy often doesn’t provide the right solution, broader coverage does not always represent value for money. It is important that contractors work with construction insurance specialists that fully understand the risks and insurance solutions available and design and negotiate a solution that meets their specific needs.
Lockton is a specialist construction insurance broker. We would welcome the opportunity of meeting with you to discuss how insurance may be better utilised to protect your project.