Contractors’ expanding role in the construction process often means additional exposure to professional liability. Several options can help contractors finance professional liability losses.
Indemnity Provisions
Contractors engaged in simple low-rise or cookie-cutter designs often do not see a need to do more than transfer risk via indemnity provisions. This is fairly common, but may leave an indemnitee with little or no protection if the indemnitor has questionable financial strength. Consequently, contractors should avoid accepting an indemnity provision with no external backing from insurance products.
Evidence of Professional Liability from Design Professionals Having the design professional, design-build firm or contractor evidence a specific limit of professional liability insurance is probably the most prominent alternative when an indemnity provision does not offer sufficient coverage. However, this insurance has some limitations.
Many owners and design-build firms engaged in multimillion-dollar projects allow prime design professionals to carry only $1 million or $2 million in professional liability insurance. Even if the entire design team, usually comprised of five or six major firms, carries $1 million or $2 million in limits, it still may not pay for damages from negligent acts or errors and omissions committed by the design firm.
In addition, unlike commercial general liability insurance, which has unlimited defense, professional liability policies cap defense costs at the limit purchased.
It is also difficult to determine if the limit or insurance required by the owner in the contract will be available when needed. Coverage may not exist for these reasons:
- impairment or exhaustion of the evidenced limits due to claims on other projects;
- coverage restrictions/exclusions in the insurance policy, such as habitational, contractual, pollution or mold/fungus;
- annual renewals on the design professional’s policy brought about by changes in its professional liability insurance without the owner’s knowledge; or
- the design professional may not hold all contracts for design services on the project, including mechanical, electrical, plumbing (MEP) services and fire protection services. In many cases, the MEP contractor performs both design and construction under contract and might not carry professional liability insurance.
Professional Protective Insurance
Given the skyrocketing costs of project professional liability insurance during the past 10 years and the lack of competitive insurance options, alternative products have gained support from some owners. These include “protective” programs offered to owners of construction projects that hold contracts directly with the design professional.
These policies provide first-party indemnity as part of the contractor’s professional liability policy for damage incurred as a result of negligent design professionals. In most cases, the premiums are 30 percent to 40 percent lower than a typical project professional liability placement.
However, other benefits exist for owners of large construction projects that want to ensure they are properly protected from the professional liability of the design team. These benefits include consistent coverage, supplements to the design team’s professional liability insurance and extended reporting periods of 10 years.
Companies offering protective policies provide capacities of up to $10 million. Because coverage terms and conditions vary, a sound understanding of the contractual relationship must exist between the named insured and design professional prior to the pursuit of the coverage.
Project Professional Liability Insurance When an owner chooses to purchase a project professional liability policy for the design team, it replaces the design team’s coverage with a separate and specific professional liability program dedicated to the project. As a result, the owner need not worry about exclusionary language in the design professional’s policies or any other potential problem. If structured properly, this also may provide the broadest coverage for all design firms on a construction project. Other benefits of project professional liability insurance include:
- Primary protection for the design professionals and the elimination of coverage inconsistencies from one design professional to another.
- Financial security against professional liability throughout the life of the project.
- Limit of liability dedicated to the specific project.
- Replacement of the design team’s professional liability programs, which allows their programs to act as excess. The cost charged back to the owner then should be reflected accordingly.
- Contractors pollution liability (including mold liability) can be included to cover pollution conditions arising from construction work.
- Defense costs based on third-party claims related to the design team’s errors.
- Project-specific coverage ranging 10 years and beyond (the extended reporting period is included in that term).
- Secured limits of liability of up to $25 million with one single carrier. Higher limits may be obtained through the use of multiple carriers.
As with any insurance product, the broader the coverage, the higher the cost. All things being equal, project professional liability—whether secured by the owner, design-build firm or design professional—can be the most costly alternative in terms of premium. But, it could end up being the least costly in the event of a major design flaw that results in catastrophic damages.
Even though the professional liability marketplace offers few alternatives, construction project owners can benefit from combining various techniques that yield the optimal protection for all parties affected by the project’s potential liabilities.