Insurance policies for builders – what to bear in mind with professional indemnity

Insurances in perspective

The building industry carries a significant degree of risk for all participants. Most common risks arise from the daily movement of labour and machines around the structural elements of a building site in full progress. There is an ever present risk of damage to property and injury to persons, together with less foreseeable risks including potential consequences arising from a fault in design or building methodology.

Insurance policies are available to cover many (but not all) construction risks. However, it is surprising how often builders and developers are unaware of the extent of cover their policies provide, or of the essential pre-requisites under the policy terms for making claims.

Most construction contracts require builders and owners to take out various types of insurance. Most commonly, public liability and workers compensation insurances are mandatory for building contracts in both the commercial and residential domains. Other types of insurance are common, including material damage cover, contract works insurance, plant and vehicle insurance and professional indemnity.

Failure to closely examine policies for the extent of cover provided (particularly in the COVID-19 era) or adhering to policy conditions following insurable events may leave builders exposed without appropriate cover, despite paying a healthy premium for their policy coverage.

This article focuses on the nuances of professional indemnity insurance, an area of risk commonly misunderstood by builders and developers, both in terms of policy coverage and operation, as well as claims procedure after an insurable event.

Professional Indemnity

Professional indemnity insurance is designed to cover a builder’s risk with respect to negligence or fault found in the design of the building or building methodology. In construction contracts (rather than design and construct contracts), there is little scope for faulty design, or the responsibility for such design fault typically rests with the design consultants (engaged directly by the Principal). Where the responsibility of the builder extends to design and construction (via a Design and Construct form of Contract), design responsibility rests with the builder. In this circumstance, the builder normally engages all design consultants.

It is typical that a professional indemnity policy will provide a short description of the purpose of the policy. The description of the cover generally uses wording to the following effect:

“All cover under this Policy is afforded solely with respect to Claims first made against an Insured during the Policy Period and notified to the Insurer as required by this Policy. (emphasis added)

The Insurer will indemnify the Insured against civil liability resulting from any Claim arising from the performance of Professional Services”.

Key terms of the policy are defined and capitalised to give particular meaning to key policy terms.

It is common in construction contracts involving the use of specialised trades to have a hybrid contractual situation. That is, whilst the construction contract selected is not strictly a Design and Construct contract, there are design elements resting with the builder, usually in relation to specialised trade work (such as piling and shoring, cladding, drainage and the like).

Given an industry wide tendency toward bespoke contracts, particularly for projects of greater value, many builders overlook the need for securing their own professional indemnity insurance policies. Given that this type of insurance is also one of the more expensive insurances to carry, there is commercial reluctance in the industry among builders who typically do not see themselves as being at risk from maintaining PI policy coverage.

When should builders carry their own PI insurance?

Builders should seriously consider taking out professional indemnity insurance under any of the following scenarios:

1. for all design and construct contracts entered into

2. for all construction contracts having a term requiring the builder to take out professional indemnity insurance

3. for any construction contracts involving significant design elements. 

Given that the rectification of faulty or defective design in buildings sometimes involves demolition of significant parts of (or the whole) structure at the time the fault is identified, claims can be very costly and, for issues requiring an almost entire rebuild, rectification can easily exceed 100% of the contract sum. Having to carry a claim of that magnitude, can naturally cause a small to mid-tier builder significant financial distress, if not cause it to become insolvent.

Notification in compliance with policies

Most insurance policies, and particularly professional indemnity policies, have a two-tiered indemnity trigger, generally being:

1. Notification - this is a requirement to disclose to an insurer any fact or circumstance which can or may give rise to a claim. Usually notification simply needs to be in writing, without requiring the insured to complete a claim form. The typical scenario in which notification is required will be upon receipt of a letter of demand or the occurrence of a significant event (such as, partial or full collapse of a structure or significant water ingress into a building). Even notification of an incident or allegation of defective design causing an incident, will be sufficient to trigger a requirement to notify the insurer of a potential claim.

   A typical example of the wording of a notification clause is as follows:

   “The Insured shall, as a condition precedent [emphasis added] to the obligations of the Insurer under this Policy, give written notice to the Insurer of any Claim first made against the Insured as soon as practicable and during the Policy Period [emphasis added] or, if applicable, any Extended Reporting Period. All notifications must be in writing and reference the Policy Number and addressed as required in the “Claims Notice” Item on the Schedule.”
   
   

2. Claim – in respect of a claim, the requirement of the above policy wording to notify a claim “first made” places greater responsibility on the holder of the policy to notify facts and circumstances which may give rise to a claim [claim “first made”] as soon as the suggestion of a claim has been made by the party intending to make the claim (typically the party suffering the loss or damage). Upon making a claim, the insurer usually undertakes an enquiry as to whether the policy is triggered and indemnity is extended before assessing the quantum of the claim. Indemnity can be denied in circumstances where an insured has failed to notify within a reasonable time or within the policy period, or otherwise failed to comply with other policy preconditions.

The following are often seen as issues which can cause problems with indemnification of insured parties:

1. admission of claims or material admissions compromising the insurer’s position

2. agreement as to quantum without referral to the insurer

3. settlement of claims without prior concurrence of the insurer

4. failure to comply with a duty to disclose a particular fact or circumstance.

The appropriate selection of levels/type of cover

Many insurance policies of application to builders, developers and subcontractors are generically named such as professional indemnity insurance, public liability, materials damage, contractors all risks and plant and motor vehicle insurance. These are all common types of insurances applicable to building contracts. However, it is important for builders to carefully scrutinise key inclusions and/or exclusions from the terms of cover. This has proven particularly so since the advent of COVID 19, an occurrence previously foreign to the insurance industry.

As a case in point, policies in force very rarely included (or excluded) cover specifically in relation to the concept of a “pandemic”. Most policies contained the more familiar (and broader) term “force majeure”. This has proved problematic from the perspective of a number of losses occasioned to parties under building contracts as a result of COVID 19. Losses resulting from supply chain delays, labour absences from site, delays resulting from ensuring building sites are COVID 19 compliant and the like, were being claimed under “force majeure”, or insurers were seeking to exclude claims on the basis of “force majeure” in attempting to recover the costs of COVID-19 related events.

In light of the above and the continuing circumstances surrounding COVID-19, we are starting to see the construction industry adapt to the new normal. With increased cost-base, productivity and scheduling challenges consequent of COVID-19, many parties are looking to address pandemic impacts upfront in their contracts. This approach has required adjustments to standard form and bespoke contracts, often seeing the inclusion of a tailored COVID-19 clause.

Recently we have identified an immediate exclusion to cover with respect to circumstances concerning pandemics and human disease. A practical example is as follows:

“We shall not be liable to indemnify the Insured in respect of a Claim, liability, loss, cost, expense, Fine or Penalty directly or indirectly arising out of, related to, or in connection with a Listed Human Disease or any directly or indirectly related condition or threat or fear thereof (whether actual or perceived).”

Listed Human Disease is then subsequently defined as “…any disease identified or listed in a state of emergency, public health emergency or pandemic declared by any governmental authority or identified by the World Health Organisation or its current equivalent as amended or replaced.”

The withdrawal of this cover has an immediate and significant impact on insureds and is likely to cause implications should we be subjected to government introduced restrictions once again. 

Additionally, from a construction contract perspective, we have also seen adjustments to the wording of standard general conditions due to COVID-19, which also may impact the key inclusions and/or exclusions of a builder’s policy. In particular:

1. Compensation – parties to a construction contract now allow for known costs associated with COVID-19 mitigation efforts, such as social distancing, testing measures and relevant PPE, within the terms of the contract. Typically, these costs are allowed for in fixed price amounts. Alternatively, these costs may be included as an allowance item or be included as a reduction or increase depending on circumstances surrounding government related restrictions.

2. Delay Entitlements – many new construction contracts now allow for delays that can be anticipated due to COVID-19. In cases where delays resulting from COVID-19 are reasonably foreseeable, the contract terms will afford the parties the right to claim additional extensions of time.

3. Force Majeure – since the onset of the pandemic, many parties have sought to rely on force majeure clauses including commercial contracts to suspend their contractual obligations. The term force majeure means "superior force" and encompasses "acts of god" (such as earthquakes or tsunamis) and certain acts of man of a disruptive and unforeseeable nature. Prior to 2020 it was very unlikely to list a pandemic as an act of god within a force majeure clause. However, in light of recent circumstances, many force majeure clauses have been revised to include epidemics, pandemics and related government orders. We note, although a pandemic specific clause will better address the impacts of dealing with COVID-19, there will be certain similarities between both provisions.

4. Suspension/Termination – parties have now given greater consideration as to whether the impacts of COVID-19 on a building site can give either party the right to suspend or terminate the contract. Specifically, contracts are more regularly particularising whether a party has the right to suspend or terminate a contract due to COVID-19 related impacts and which party will bear the added costs resulting from suspension of work or increased costs for labour, materials, security, additional safety measures or constructions permit extensions should works be halted. We advise that the consequences regarding suspension and termination of the contract be given careful consideration.

Lessons learned

The key takeaways from the above analysis are:

1. Builders and developers considering when they are undertaking design work and building projects, whether the contract is strictly design and construct or some other form of contract. What is the possible level of exposure to a design claim? If in doubt it may be useful to speak with an insurance broker.

2. The importance of notification of claims or potential claims under policies of insurance, particularly professional indemnity policies where notification of an event is often within a “reasonable time” or in any event within the policy period.

3. In light of the most recent circumstances surrounding the pandemic, we advise that careful consideration is given to pandemic clauses and if not included, negotiations take place to include a clause addressing the impacts of COVID-19. In the event a pandemic clause is not successfully included, we recommend reviewing the force majeure clause to ensure it includes epidemics, pandemics and related government restrictions.

If you need assistance with you building contracts, especially modifying them to align with your insurance contract requirements or drafting changes due to COVID-19, or advice with respect to dealing with your insurer or broker while making a claim, our experienced team will be able to assist.

Authors: Rob Kalde & Gabriella Porcu