Lessons from the Opal Tower loss - plugging the gap in construction cover

Inherent defects can be traced back to faults in design, plans, materials, specification, or workmanship during the planning and construction of a building or structure, which are discovered or result in material damage after practical completion has occurred. 

A property policy, purchased upon completion of construction, usually excludes damage arising out of an inherent or latent defect in building, which can result in significant issues to owners and tenants as well as mounting costs. Inherent Defects Insurance (IDI) is designed to overcome such problems. Damage and/or loss during the construction phase of a development project will be insured under a Contract Works insurance policy. It is this policy that will repair or reinstate the damaged works. At practical completion a property policy will be arranged. However, this policy normally provides no protection for damage arising out of an inherent or latent defect in newly completed buildings or civil projects. IDI will cover defects of a new building which have not been discovered at the date of practical completion, but which come to light as a result of physical damage at a later stage.

Opal Tower
Opal Tower Homebush

 

 

 

 

 

 

 

 

 

 

The exclusion in a traditional property policy means a building owner or tenant could have a significant issue when discovering a defect in the building, such as glazed cladding or deficiencies in pipework or in the case of Opal Tower defects in the concrete floor slabs (poor design, construction of hob beams and damage to structural members). These problems are heightened if the building cannot be used by its owner or tenants. 

Potentially a large amount of money will need to be made available for the cost of repairing the damage or making the building structurally stable. 

Whilst it may be possible to recover some of these losses from the main contractor and/or sub-contractors responsible for the defect, this could take a number of years and be difficult to prove fault. If that particular contractor/engineer is no longer in business, it becomes a balance sheet risk for the owner as there will be no recourse. 

Inherent Defects Insurance can overcome these obstacles. The policy will cover the cost of repairing a building should an inherent defect in the structural works cause damage, or threaten imminent collapse, during a period of up to 10 or 12 years following practical completion of construction. 

The policy can also be a key consideration for build-to-rent developers who may want to flip from the rental market to residential sales in the future. 

Policy Benefits
There are many advantages to an IDI policy, some of which are detailed below:

•  The policy is assignable to future owners and/or tenants of a building. These entities are now likely to be more reluctant to assume the risks associated with building defects and will be attracted to a building where IDI has been arranged. 
•  IDI is a first party policy, and therefore it is not a concern whether the contractors and/or professional team are in business at the time the defect manifests itself. This is particularly relevant for the construction management procurement process where the supply chain for the owner/developer can be significant. 
•  As a first party policy, there is no requirement for the policyholder to establish fault, negligence or liability of the party(ies) to the construction contract.
•  Immediate access to repair funds can minimise business interruption or cover the loss in rental income if tenants cannot occupy a building.
•  Provides a high performance alternative to collateral warranties.
•  Time consuming and expensive litigation does not need to occur before repairs can be started, this enables the structure to be returned to use with minimum disruption and in a timely manner. 
•  The technical audit process may detect issues prior to practical completion, meaning defects are corrected before the owner takes over responsibility for the building from the contractors (consider the recent Opal Tower loss in this context). 
•  Cover can be extended to include a waiver of subrogation against the contractors.
•  Provides balance sheet protection. 

Scope of Coverage 
Inherent Defects Insurance covers damage or imminent damage caused by defects of materials, design, plan, workmanship, and specification. Whereas a Construction/Contract Works policy will generally cover these risks during construction plus a maintenance period of 12 to 24 months (there are varying levels of defect and maintenance cover available), an IDI policy will typically provide cover for 10 to 12 years after practical completion. 

There are various features of coverage which can benefit developers, funders, owners and tenants and these include: 

•  The sum insured (i.e. building reinstatement value) is usually indexed to automatically provide for inflation. 
•  Policy periods are usually 10 or 12 years from the date of practical completion. 
•  The policy is non-cancellable. 
•  It is a first party policy and insurers will meet a valid claim prior to determining who is responsible for causing the defect.
•  Where rights of recovery may exist, they will be considered by the insurers at their own expense, not by the building owner or tenant. 
•  Legal professional fees and debris removal costs incurred in carrying out remedial work can be included. 
•  Component parts, such as Mechanical & Electrical equipment, can be included.

Inherent Defects Insurance is designed to respond quickly in the event of damage effecting a building or structure due to structural defects discovered after project completion. Funds are made available quickly and the insured is relieved from the uncertainty of whether a contractor is able to meet its legal liability post completion of a project/development.

This coverage is prominent in the United Kingdom and in some countries procurement of IDI is set to become mandatory for contractors and engineers. Although not currently a strict requirement, recent developments in Australia, including the Opal Tower loss, should place IDI insurance at the forefront of the minds of developers, funders and owners as a means to mitigate the risk of inherent or latent defects. 

For further information contact Peter Jeeves or Richard Shillington

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