Traditional property insurance policies obtained on construction projects (for example, “builder risk” or “course of construction”) are designed to provide insurance coverage to the owner of a project, and other stakeholders involved, for direct physical loss or damage to the property from any fortuitous loss, subject to usual policy language, conditions, and exclusions.
There are situations where an owner may suffer damages or loss (including financial loss) arising out of an error, omission, or breach by one of the professionals engaged in the project, but the error does not cause physical loss or damage to the project.
In one example, a project owner relied on their geotechnical engineer’s report which stated the caissons needed to be a certain depth to reach the bedrock subsurface and properly support the structure to be built above ground. After drilling and filling the caissons it was discovered by the general contractor that the caissons were not deep enough and did not hit bedrock. It was eventually determined that the caissons needed to be 3 feet deeper than the original recommended depth. The existing caissons had to be removed and new ones poured to the correct depth. The additional costs to the owner were approximately $1 million. These costs were not recoverable under the owner’s builders risk policy as there was no physical damage which occurred to trigger the policy. The caissons were not damaged – they simply were not deep enough.
In another example, the owner’s mechanical engineer failed to properly design the HVAC system for a building and the entire system had to be removed and re-designed. The court determined that the damages to the owner were in the amount of $5 million. Again, this loss would not covered under the builders risk policy, as there was no physical damage to the project to trigger coverage. The HVAC system was in working condition – but the system was not adequate to suit the needs of the building it was installed in.
In absence of coverage under a builders risk policy, a project owner (or other stakeholder) will often seek indemnity or recovery from the professional that caused the loss or damages. These types of losses are contemplated under a professional liability insurance policy (also called errors and omissions or E&O policy). The E&O policy is designed to cover the professional/consultant for amounts which they legally liable due to an error, omission, or breach of professional duty. As professional services become more and more specialized (from architects and engineers to geotechnical, environmental, traffic, building code, signage, landscaping, cost consultants, and any sub-consultants of the foregoing) it is becoming common practice to have dozens of different firms providing professional services on the same project.
There are pros and cons to the three different methods professional liability can be approached on any given project. While various project stakeholders are involved, we will explore the various pros and cons from the perspective of the owner of a project.
Annual Practice Policies
Relying on each firm’s own professional liability policy is by far the most common method employed in the construction industry. Practice policies are annual policies carried by professional consultants which cover all of their business operations. Each discipline of professional is typically required to carry errors and omissions insurance and as such the cost of these policies is typically already included in their fees charged to the project owner.
The practice policy is designed to protect the individual consultant/firm from claims alleged against them by third parties (which may include a project owner and/or contractor). As a result, the practice policy does not provide any direct coverage to the owner, any other party who may suffer loss arising out of the consultant’s error, omission, or breach of professional duty.
The owner would have to first allege wrongdoing on the part of the consultant in order to trigger the design firm’s E&O coverage. The consultant then has the option to offer a settlement or defend themselves, or report the claim to their professional liability insurer who will do both on their behalf (if coverage applies). If the consultant refuses to cooperate with the owner, the owner would need to pursue legal action and incur their own costs to do so. If a true third party claim arises (meaning not the owner or the consultant) out of the professional negligence of the consultant, the consultant’s policy does not offer any protection to the owner who may be required to defend themselves and seek indemnity from the consultant after the fact.
The limits of the typical practice policy are not dedicated to any one specific project and apply across all their services rendered on any project or assignment. This means the limits of insurance carried may be eroded by various claims on other projects for which the firm is engaged even if unrelated to the work where the claim originated. In addition, practice policies are written on a “claims- made” basis meaning the claim has to be made within the year the policy is in force and therefore the project owner or stakeholder would need to ensure coverage is maintained into the future to protect against claims that are brought after completion of the consultant’s services. It is common for these annual practice policies to carry relatively low limits of insurance, ranging from $250,000 (or less) to $2 million (typically including defence costs).
Consulting firms tend to limit their liability in contract which acts to further reduce the amount recoverable under the firm’s professional liability policy (since after all it only pays amounts the consultant is legally liable for). Many standard professional services contracts contain a limit of liability.
Project-Specific Professional Liability Policies
Project Specific policies are placed for individual projects and provide protection for all consultants and the owner. The limits of the insurance are dedicated to the project and procured in accordance to the size and scope of the project (usually $5 million to $10 million or greater). The inception date coincides with the date of first design and the policy expiry date is to coincide with the project’s completion.
After completion of the project, the policy will typically provide an extended reporting period for claims reported after completion of the project (length of the reporting period vary by jurisdiction). Terms are negotiated to provide broader coverage and includes all professionals engaged on the project. Owners are typically included on the policy allowing direct access to the policy limits. Therefore, if an owner suffers financial loss arising out a professional error the owner can make a claim under the project specific professional liability policy rather than having to pursue recovery from the individual consulting firm which caused the claim or loss. However, because the policy is also providing coverage for the professional firm defence costs can erode limits of coverage (which then would reduce the amount available to owner in the event of large claims).
The policy is often paid for and controlled by the owner or developer and procured on a non-cancellable basis. Coverage under the policy begins at “dollar-one” (subject to any deductible) and therefore each individual consultant’s policy is not expected to provide coverage for the project. The owner may be able to reduce consultant’s fees to exclude any insurance costs if the owner maintains the project-specific policy. The cost for such a policy ranges between $4-$6/$100 of consulting fees, but varies based on who the consultants are, project scope, and their lost history.
Owners-Protective Professional Indemnity (OPPI) Policies
Owners’ Protective Professional Indemnity (OPPI) policies are common ground and an option affording protection somewhere between annual practice policies and project specific professional liability policies. OPPI policies “sit” on top of the annual practice policies of each firm on the project and are designed to provide coverage to the project owner in the event the annual practice policy limits or coverage is inadequate to fully cover the project owner. These types of policies are more common in the U.S and less common in Canada, but a very good alternative.
The OPPI policy typically carries similar limits to those procured on a project specific policy between $5 and $10 million. Coverage is provided on a first and third party basis to the project owner, however, in order to trigger coverage, they must exhaust the underlying limits of coverage or indemnity provided by the specific consultant that caused the loss. The benefit to the OPPI approach is that since no coverage is provided for the design professional that caused the loss (who are still using their annual practice policies), their defence costs do not erode the OPPI limit available to the owner.
The OPPI policy can only be purchased and controlled by the project owner (however there are contractor-protective variants called CPPI) but coverage is 30-50% less expensive than the project specific professional liability policy. The policy is project specific and offers an extended reporting period similar to the project-specific policies noted above.
The following is a summary of the three different methods presented in this article:
Professional errors, omissions, and breach of duty are some of the most common losses/claims to occur on construction projects and there are numerous ways to protect project owners from financial loss incurred as a result. Each approach has their own benefits and shortfalls and ultimately it will be up to the project owner to decide what approach is in their best interest and within their budget. It is important to keep these considerations in mind during the early stages of the project when the design contracts are being executed. Intech can review an owner’s project structure and identify professional liability considerations, contractual limitations, and which approach may best suit the owner.