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RICS Practice Standards, UK

Construction insurance
1st edition, guidance note

Construction insurance RICS guidance note


1st edition

Published by the Royal Institution of Chartered Surveyors (RICS) under the RICS Books imprint Surveyor Court Westwood Business Park Coventry CV4 8JE UK www.ricsbooks.com No responsibility for loss or damage caused to any person acting or refraining from action as a result of the material included in this publication can be accepted by the author or RICS. ISBN 978 1 84219 499 7 Produced by the Project Management, Construction, and Building Surveying Professonal Groups of the Royal Institution of Chartered Surveyors. Royal Institution of Chartered Surveyors (RICS) July 2009. Copyright in all or part of this publication rests with RICS, and save by prior consent of RICS, no part or parts shall be reproduced by any means electronic, mechanical, photocopying or otherwise, now known or to be devised. Typeset in Great Britain by Columns Design Ltd, Reading, Berks

Acknowledgments
RICS would like to express its sincere thanks to the following for their contributions to this guidance note: Editor and co-author Ray Robinson, Technical Consultant, Aon Limited. Ray Robinson, a Fellow of The Chartered Insurance Institute, is a technical consultant with Aon Limited, working for the Commercial Property Group, which specialises in the insurance requirements of property owners and developers. He has spent nearly 50 years in the insurance industry, including over 30 years with RSA and has held management positions in underwriting, business development and technical development. At various times his career has focussed on insurances for property owners, latent defects covers and consequential loss. He is a member of the Steering Group of the RICS Insurance Forum. General Construction Tom Wylie, Executive Director, Construction, Aon Limited. Laurence Gilmore, Account Director, Construction, Aon Limited. Mark Courtneidge, Director, Construction, Aon Limited. Directors and Officers John Dexter, Account Executive, Financial Services, Aon Limited. Employers Liability Teresa McAuliffe, Director, Aon Limited. Engineering Derek Cornwell, Technical Consultant, Risk Management, Aon Limited. Environmental Simon Johnson, Director, Environmental Services, Aon Limited. Professional Indemnity Christine Paine, Associate Director, Aon Limited. Peter Sharpe, Director, Aon Limited. Public Liability Teresa McAuliffe, Director, Aon Limited. Surety bonds Shane Foley, Account Executive, Surety and Guarantee, Aon Limited. The editor and fellow contributors from Aon can be reached by contacting Aon 8 Devonshire Square, London EC2M 4PL, t: +44 (0) 207 623 5500, www.aon.com.
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Other acknowledgments Latent Defects Joe Bellhouse, Construction Lawyer and Partner, Wedlake Bell T +44 (0) 207 395 3073 www.wedlakebell.com John Parsons, RICS Project Management, Construction, and Building Surveying Professonal Groups.

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Contents
RICS guidance notes 1 Introduction 1.1 Introduction 1.2 Rights and obligations of principal parties 1.3 Contract conditions 1.4 Overseas issues 1.5 When the various insurance covers need to be considered and when each cover starts and finishes 1.5.1 Contractors all risks insurance 1.5.2 Consequential loss 1.5.3 Directors and officers (D&O) liability insurance 1.5.4 Employers Liability (EL) insurance 1.5.5 Environmental insurance 1.5.6 Existing buildings 1.5.7 Latent defects insurance 1.5.8 Non-negligence insurance 1.5.9 Professional indemnity (PI) insurance 1.5.10 Public liability (PL) insurance 1.5.11 Surety bonds 1.5.12 Unexpected archaeology discovery insurance 2 Insurances personal to members 2.1 A surveyors guide to professional indemnity (PI) insurance 2.1.1 Where and how is the cover obtained? 2.1.2 What does PI Insurance do? 2.1.3 What is the right level of cover? 2.1.4 When should I consider cover and what will it cost? 2.2 Professional indemnity insurance for project managers 2.3 Directors and Officers (D&O) liability insurance 2.3.1 What is D&O exactly and who is covered? 2.3.2 What type of company should be purchasing D&O cover? 2.3.3 What should I be looking out for to ensure I have adequate cover? 2.3.4 Obtaining terms for a D&O policy 2.3.5 Market trends 2.3.6 Key issues 3 Construction risk insurances 3.1 Consequential loss insurance for construction risks 3.1.1 Three important points 3.1.2 Relevant events 3.1.3 Specified perils and force majeure 3.1.4 Extensions of time 3.1.5 Measurement of liquidated and ascertained damages 1 2 2 3 3 3 4 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 8 9 11 11 14 14 14 15 15 15 16 17 17 17 18 18 19 19 |v

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3.2

3.3

3.4

3.5

3.1.6 Loss of rent and loss of use of sale proceeds, including assessment of indemnity period 3.1.7 The developers choice as to basis of settlement 3.1.8 Expediting costs (additional cost of working) 3.1.9 Costs incurred in raising or extending loans 3.1.10 Additional overhead costs (sometimes referred to as soft costs) 3.1.11 Higher cost of development finance 3.1.12 Additional increase in cost of working cover 3.1.13 Damage away from the site including prevention of access 3.1.14 Damage at suppliers premises 3.1.15 Time excess 3.1.16 Unusual consequential risks 3.1.17 Key issues Contractors all risks or contract works insurance 3.2.1 The cover 3.2.2 Joint Code of Practice on Fire Prevention 3.2.3 Additional cost of construction of unbuilt works 3.2.4 Defective design, materials and workmanship 3.2.5 Defective design, materials and workmanship clauses 3.2.6 LEG clauses 3.2.7 Legal challenges 3.2.8 Key issues Employers liability insurance 3.3.1 The Employers Liability (Compulsory Insurance) Act 1969 3.3.2 Workplace legislation outside the UK 3.3.3 Social security 3.3.4 Compensation funded by insurance policies 3.3.5 Summary of schemes Environmental insurances 3.4.1 Environmental and underwriting information understanding the risk 3.4.2 Environmental exposure 3.4.3 Insurance solutions 3.4.4 Historical contamination 3.4.5 Operational contamination JCT non-negligence insurance 3.5.1 History 3.5.2 Perils insured 3.5.3 Activities giving rise to loss 3.5.4 Policy exclusions 3.5.5 Relationship to material damage and public liability policies 3.5.6 Position under ICE contracts 3.5.7 Key issues

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3.6 Public liability insurance 3.6.1 Extent of cover 3.6.2 Restrictions in cover 3.6.3 Limits of liability 3.6.4 Who should be covered? 3.6.5 Premium implications 3.6.6 Key issues 3.7 Surety bonds 3.7.1 Types of bond 3.7.2 Performance bonds 3.7.3 Retention bonds 3.7.4 Advance payment bonds 3.7.5 Maintenance bonds 3.7.6 Bonds and counter indemnities 3.7.7 The benefits 3.7.8 International bonds 3.7.9 Key issues 3.8 Unexpected archaeological discovery insurance 3.8.1 The process 3.8.2 Risk management 3.8.3 Identifying the risk of unexpected discovery 3.8.4 Potential cover requirements 3.8.5 Key issues 4 Further guidance on construction insurance issues 4.1 Insurance of existing buildings undergoing refurbishment or redevelopment 4.1.1 Implications for current cover on existing buildings 4.1.2 The problems with joint names insurance on existing buildings 4.1.3 One sum insured for both contract works and the existing buildings 4.1.4 Advantages of insuring existing buildings under a CAR policy 4.1.5 Key issues 4.2 Project insurance and property developer all risks policies 4.2.1 A word of warning 4.2.2 The advantages of employer controlled insurance 4.3 Risk management and insurance 4.3.1 Stage 1 Risk identification 4.3.2 Stage 2 Risk evaluation 4.3.3 Stage 3 Risk control and elimination 4.3.4 Stage 4 Risk transfer 4.3.5 Stage 5 Risk monitoring 4.4 Statutory inspection of plant and machinery 4.4.1 In the UK

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4.4.2 The Lifting Operations and Lifting Equipment Regulations 1998 (LOLER) 4.4.3 The Pressure Systems Safety Regulations 2000 (PSSR) 4.4.4 The Control of Substances Hazardous to Health Regulations 2002 (COSHH) 4.4.5 The Electricity at Work Regulations 1989 (EAW) 4.4.6 The Provision and Use of Work Equipment Regulations 1998 (PUWER) 4.4.7 Inspection service providers/the competent person 4.4.8 Legal responsibility 4.4.9 Outside the UK 4.5 Third party interests and joint names under construction policies 4.5.1 The means by which other interests are recorded 4.5.2 The degree of protection afforded 4.5.3 Protection of bank interests 4.5.4 Outside the UK 4.5.5 Key issues 5 Latent defects insurances 5.1 Introduction 5.1.1 The cover in brief 5.1.2 The cover in more detail 5.2 Latent defects insurance and collateral warranties/third party rights 5.2.1 The rationale for collateral warranties or third party rights 5.2.2 The drawbacks to reliance on collateral warranties and third party rights 5.2.3 Is latent defects insurance a panacea for developers? 5.2.4 Getting best value from the policy 5.2.5 Some questions answered 5.2.6 Clearing up the misconceptions 5.2.7 Key issues 5.2.8 Further information

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RICS guidance notes


This is a guidance note. It provides advice to members of RICS on aspects of the profession. Where procedures are recommended for specific professional tasks, these are intended to embody best practice, that is, procedures which in the opinion of RICS meet a high standard of professional competence. Members are not required to follow the advice and recommendations contained in the guidance note. They should, however, note the following points. When an allegation of professional negligence is made against a surveyor, the court is likely to take account of the contents of any relevant guidance notes published by RICS in deciding whether or not the surveyor has acted with reasonable competence. In the opinion of RICS, a member conforming to the practices recommended in this guidance note should have at least a partial defence to an allegation of negligence by virtue of having followed those practices. However, members have the responsibility of deciding when it is appropriate to follow the guidance. If it is followed in an inappropriate case, the member will not be exonerated merely because the recommendations were found in an RICS guidance note. On the other hand, it does not follow that a member will be adjudged negligent if he or she has not followed the practices recommended in this guidance note. It is for each individual chartered surveyor to decide on the appropriate procedure to follow in any professional task. However, where members depart from the good practice recommended in this guidance note, they should do so only for good reason. In the event of litigation, the court may require them to explain why they decided not to adopt the recommended practice. In addition, guidance notes are relevant to professional competence in that each surveyor should be up to date and should have informed him or herself of guidance notes within a reasonable time of their promulgation. In the opinion of the approving professional bodies this guidance note represents best practice.

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1
1.1

Introduction
Introduction
These guidance notes are written for project management surveyors, quantity surveyors, building surveyors and all other property professionals who need a better understanding of the many classes of risk that are available under the general heading of construction insurance. Insurance is a mystery to many people and construction insurance is probably one of the most complex classes of business there is. A construction site has been described as a place that often brings together many people, with different ideas, who have never worked together before, to build something that has never been built before, and often in adverse conditions. In many ways those responsible for the insurance requirements of such a site face a similar range of problems. There will be different interests to be protected and each party will have its own way of doing things and its own insurance advisers. Pulling it all together to make sure any particular party has the protection it needs, whilst avoiding too much reliance on other parties insurances, is no easy task. It is rather an obvious statement but it is essential that everyone seeking the protection of a policy should have its name shown as an insured in the schedule to the policy. Otherwise they may find they have no valid claim. The insurance covers for any site will need to protect all parties against a range of possibilities that embrace material damage, consequential losses, third party liabilities stretching far into the future and even non-negligent liability. To make matters worse the responsibility for arranging the insurances will usually rest with several different parties and, arguably, the insurance requirements of the contract conditions are not always helpful, as they do not necessarily deal with all the covers required or available to transfer risk. Further, just because a contract states that a particular insurance should be arranged by one party does not mean that that arrangement is necessarily best for everyone with an insurable interest in the works. For example, the arrangement of material damage cover on the contract works by the contractor is not wise if the employer requires any form of consequential loss insurance It is the intention of these guidance notes to help readers find their way through the maze. Various types of insurance that may be required are introduced and some of the problems that can arise are explained, in the hope that they can be avoided. We recommend that the notes are read in conjunction with the relevant contract conditions, be they JCT, NEC or FIDIC. The only other strong recommendation is that insurance should be taken seriously and consideration should be given to insurance covers early on in the procurement and construction process. Let the insurance professionals be part of the team, alongside the architects, engineers and the lawyers. Spend time helping them to understand the precise nature of the works being undertaken, the timescale involved and the financial arrangements. Make sure they are aware of all the parties involved and have an opportunity to comment on all

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relevant documentation before it is signed off. There is then a greater possibility of securing adequate protection at the best price and with the minimum of inconvenience. To assist those readers who are responsible for arranging insurance in good time, guidance on when to consider each element of cover starts on page 4.

1.2

Rights and obligations of principal parties


The principal parties to any development will depend on the nature of the development but, apart from the developer, could include funders, tenants, prospective purchasers, design consultants (architects, structural/civil engineers, mechanical and electrical engineers and often others such as specialist acoustic consultants), non-design consultants (cost/quantity surveyors, project managers and/or employers agents, planning supervisors, party wall and/or rights of light consultants and sometimes others), a main contractor and a number of important subcontractors (e.g. for piling/ground works, main frame, M&E services, cladding, stonework, and so forth). Contracts and the relevant local laws govern the rights and obligations of the above participants. The touchstone for these rights and obligations is usually the relevant contract, under which risk and responsibilities and rights are allocated between the various parties.

1.3

Contract conditions
Whilst the UK government has its own set of conditions, other governments and private developers in Europe tend to use FIDIC. The old colonial countries often use a hybrid version of FIDIC and an international version of NEC. In the USA they also prefer an international version of NEC. All other contracts used around the world are normally based on either JCT, NEC or FIDIC. Whatever conditions are used it is rare for them to specify all the insurance that should really be arranged and it is also unlikely that any policy limits will be specified. However, any limit specified does not act as a limit of liability.

1.4

Overseas issues
As these guidance notes have been written in the UK it is inevitable that they have a UK bias. However, the insurance requirements of contract conditions used throughout the world have much in common, and construction sites, wherever they are, face the same risks. The main variants will depend on the legal and commercial frameworks within which each countrys construction industry operates. Whilst the risks faced may be similar, the actual cover arranged will vary considerably according to the relative sophistication of local insurance markets and to the natural hazards in the area, e.g. earthquake in Japan or windstorm in parts of the USA. Capacity may also be a problem as local insurers may not be able to write larger risks and additional capacity or reinsurance may have to be sought from global markets, often London. Insurer security may also be an issue. Undeveloped countries may have an insurance market made up of insurers that have low security ratings, if any. This may be unacceptable to lenders, overseas employers and others.
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With the exception of risks that are outside the scope of standard construction covers acceptable to insurers, most of the problems encountered overseas can be overcome. Specialist advice may be necessary.

1.5

When the various insurance covers need to be considered and when each cover starts and finishes
As a general rule the earlier that decisions are made about insurance, the better it is. Expensive mistakes can be avoided; there is more time to find the best markets and less chance of duplicating covers or paying unnecessary premium. In this note more specific guidance is given for each class of business.

1.5.1

Contractors all risks insurance This is a physical damage all risks policy on the materials used in the construction works. The cover is effective during the period that the works are carried out until practical completion but is also effective during the agreed maintenance period. However, a decision on whether it is to be arranged by the employer or the contractor ideally needs to be made before contracts are finalised. As the relevant guidance note explains, it may be difficult or even impossible for the employer or other parties to buy consequential loss cover if the contractor arranges the contract works insurance.

1.5.2

Consequential loss There is a wide range of consequential loss covers to suit different requirements. They are available to any party involved in the construction process that could suffer a loss of revenue or profit of any nature if completion of a project is delayed by fire or any other insurable peril. Cover should commence at the same time as the contract works and will continue until practical completion. However, as explained above, we recommend making a decision as to whether cover is required early on as this may influence whether the employer or the contractor is to place the contract works insurance.

1.5.3

Directors and officers (D&O) liability insurance Cover is provided under the D&O policy for awards of damages, costs or settlements (including defence costs) for which a director or officer is legally liable resulting from a claim made against them during the policy period for any act, error or omission whilst in their capacity as a director or officer of the company (whether committed prior to or during the policy period). There may be an extension for retired directors. See section 2.3 for further details.

1.5.4

Employers liability (EL) insurance An EL policy covers the legal liability of the employer for any illness, injury or death suffered by their employees. EL insurance is always on an annual basis so it is divorced from specific projects. However, most EL policies are issued on a causation basis. This means that it is the policy in force at the time any event giving rise to a claim is caused that will have to meet the claim. Particularly in the case of illness, the claim may not be made until many years after the illness or disease was caused so the insurance effectively remains live long after the period of insurance has expired.

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1.5.5

Environmental insurance Environmental insurance can be used to cover historical conditions that manifest themselves during the period of insurance. In the case of a policy taken out by a contractor the cover will also include new conditions created by, or existing conditions exacerbated by, the contractor. The owner of a site becomes responsible for the site from the date of purchase whereas a contractor is responsible as soon as they start work on it. Ideally, the commencement of the policy should coincide with the start of those responsibilities so we recommend early consideration be given to insurance matters. It can take as little two to three days from the date of proposal to the inception of cover, however, this depends on all the information being available and therefore more usually the process takes place over two or more weeks. The insurance cover is site-specific for policy periods up to ten years on a claims made basis, with an automatic extended reporting period of three months to enable late claims to be notified.

1.5.6

Existing buildings If there are any existing buildings on site that are not being demolished, they may remain insured under an existing policy for the duration of the works, although the policy wording may automatically restrict or exclude elements of the normal cover depending on the nature and extent of the works. However, it may be beneficial to insure both an existing building and the contract works under one material damage policy with one sum insured. In this case an early decision is required as this may influence contract conditions.

1.5.7

Latent defects insurance The basic policy covers actual physical damage to a building (including the internal and external services) caused by inherent defects that originate in the structural parts of the building. The defect may be caused by a failure of design workmanship or materials. Although this class of business is dealt with at the end of this publication, we recommend that a decision on whether or not it is to be taken out, and which parties are to be protected, is made at the conception stage, even before the professionals are appointed. This is because the existence of the cover may impact on the fees being charged and the terms of appointment of those parties responsible for seeing any development through. The actual cover does not commence before practical completion and continues for the agreed period thereafter, usually 10 or 12 years.

1.5.8

Non-negligence insurance This cover is designed to cover existing buildings or neighbouring buildings (and consequential losses) that could be damaged by some of the hazardous activities that are inevitable in construction no matter how much care is taken. It is worth considering the need for such cover as soon as the nature of the work being done is known. The architect usually makes the decision. Cover will need to commence when work starts and continue until practical completion. By then the activities likely to lead to a claim will have ceased.

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1.5.9

Professional indemnity (PI) insurance Cover is provided under PI policies for awards of damages, costs or settlements (including defence costs) for which the practice is legally liable resulting from a claim made against them during the policy period for any act, error or omission arising out of the conduct of the business. Cover is for matters notified to the insurers in the policy period. The event giving rise to the claim may have occurred during the same period of insurance but is more likely to have occurred before (perhaps many years before). It is because of this that PI insurance is described as being on a claims made basis.

1.5.10 Public liability (PL) insurance The standard cover will provide indemnity in respect of liability at law for damages or compensation arising from accidental injury to third parties (not employees) or accidental damage to their property arising in connection with the project. We recommend this element of cover be considered very early on in the procurement process, as decisions made about who is to purchase what cover and in whose names should be reflected in the contract conditions. The policy may be annually renewable or project-specific. The period of insurance should commence when cover is first required and will need to continue until practical completion and then beyond to cover any relevant maintenance period. Standard PL policies are issued on an occurrence basis which means that the policy in force at the time of the injury or damage will respond. 1.5.11 Surety bonds A surety bond is a financial guarantee that the contractual obligation of a principal will be fulfilled. Issued by insurers, they are an alternative to bankers guarantees. It can prove valuable to consider performance bonds at an early stage in proceedings as they feature in the tendering process. However, the actual cover does not commence until work starts on site and it will continue until practical completion and then beyond to the end of the defects or maintenance period. It is worth considering other bonds as and when required and the period of cover will last as long as the beneficiary is at risk of any default. 1.5.12 Unexpected archaeology discovery insurance No matter how much is known about the archaeological history of a site and how much investigation is done there is always the risk that unexpected remains will be found once works starts. This can have all sorts of financial consequences that can be insured. Refer to Key issues at the end of section 3.8.

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2
2.1

Insurances personal to members


A surveyors guide to professional indemnity (PI) insurance
Any member of RICS will be aware of the need for PI insurance, both as a requirement of membership and to protect themselves in the event of allegations of wrongdoing being made against them. The need is clear-cut. In this guidance note the cover itself is examined and advice is given on arranging a policy.

2.1.1

Where and how is the cover obtained? This is, on the face of it, the simplest of the queries to answer. You can approach any insurance broker and ask them to arrange PI cover for you. RICS does not recommend any particular broker, although it can supply a list of brokers in your area, or you can pick one from the phone book. Alternatively you can approach an insurance company yourself and ask them for a quotation. However, before you embark on any of these actions it would be wise to consider the following. Is the insurance broker I am talking to experienced in arranging PI insurance? PI insurance is a specialised area of expertise, and many high street brokers either do not deal with this type of cover, or deal with it so rarely that they are not experienced in the various nuances of the cover. Quite often the brokers who are the most experienced in this area are not found on the local high street. Is the broker I have chosen arranging the cover direct with insurers, or is he going through another intermediary? Many brokers will tell you that they can obtain a quotation from a Lloyds syndicate, but only certain authorised brokers can obtain figures directly from Lloyds. Many brokers pass the enquiry onto one of these authorised brokers to obtain terms for them, this may lead to misunderstandings and/or incorrect or inadequate passing on of information on both sides, especially if the broker you are dealing with is inexperienced in PI insurance. Does RICS approve the insurance company? RICS has compiled a list of approved insurers, who are a mix of Lloyds syndicates and insurance companies, all of whom have agreed to provide a minimum level of cover to RICS members. As part of your duty to comply with RICS requirements, we recommend that you place your insurance with one of these approved insurers. A full list of these can be found on the RICS website. Before making any decisions regarding brokers or insurers it is a good idea to talk to other members to see if they can recommend a particular organisation, or to contact RICS who will supply a list of experienced brokers in your area. Whilst RICS do not recommend any particular company all the names they supply will be experienced in arranging PI insurance for surveyors. It is important to check that the Financial Services Authority regulates the broker selected.
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Once a choice has been made it will be necessary to complete a proposal form. These forms follow a fairly standard format, and can, at first sight, seem daunting as they do run to several pages. If it is any consolation, insurance brokers find them just as daunting if they are unfamiliar with them. The task is made easier if worked through systematically. Not all questions will be relevant to everyone as certain sections of the form apply only to people carrying out certain disciplines. It is extremely important that forms are completed fully and legibly, as this is the information on which the underwriter will set the premium. Forms that are badly completed or illegible, and some of them are, give a bad impression; a well-completed, neat and tidy form makes a favourable first impression and may save you some money. If it is considered necessary to elaborate on certain aspects of the work then it is advisable to put extra information on separate sheets of paper. It is important not to be tempted to conceal any matters that might be felt detrimental to the proposal. Insurance is a contract of utmost good faith, and any omitted information that would have influenced a decision made by insurers and that later comes to light, as it often does, could mean that the policy does not respond to an otherwise legitimate claim. Some companies will offer a quotation over the phone. We recommend that you answer all their questions fully and completely as otherwise any quotation may not subsequently be valid. Any company operating in this manner will usually send a written quotation and a full copy of the information given in the telephone call, which you are advised to check, amend if necessary, sign and send back to them. Legally this is exactly the same as completing a proposal form. 2.1.2 What does PI insurance do? The policy wording should be on a civil liability basis, which means that it covers claims from third parties for matters arising out of the conduct of the insureds professional business. The insured does not have to have been negligent to have a successful claim made against them. There will be a limit of indemnity shown in the policy and this should be on an each and every claim basis, in other words the amount of cover selected is the maximum amount that insurers will pay for any one single claim. There is no limit to the number of claims that can be made in any one year of insurance. Costs and expenses incurred by insurers in dealing with the claim, for example expert witness fees, solicitors fees, are in addition to the amount of cover purchased. For example, if there is protection for 1m for any one claim and the claimant successfully claims 900,000 and the costs to insurers in various fees, etc. are another 300,000 then they will pay 1,200,000 in total. If the insured is VAT registered they may be asked to pay the VAT applicable to their costs and expenses and claim this back on their VAT return. There will be a claims excess on the policy. This is the amount that the insured has to pay in the event of a claim. This will vary from insurer to insurer, and will almost always be a higher amount for higher risk work, so there could be a policy where the excess is the first 1,500 of each and every claim but rising to 5,000 for each and every claim arising out of mortgage valuation work. This excess normally applies only to the actual claims payment, so if insurers incur fees in defending a claim and no payment is made to a claimant the insured is not asked to pay the excess. 8 | CONSTRUCTION INSURANCE

The insureds professional business will be defined in the policy as work normally carried out by a member of RICS, or as declared to insurers on the proposal form dated . . .. It is very important that the full extent of activities is declared on the proposal form to ensure that everything done is fully covered. Cover automatically extends to all partners/directors/LLP members and employees. It also includes personal appointments such as, but not limited to, quinquennial inspections (which are always an individual appointment), adjudication and arbitration. Pro-bono work carried out on an individual basis, such as for the local church or school, is also covered, provided insurers have been told about it. The watchword for any insured is: If in doubt always tell your insurers what you are doing you cannot be wrong for giving as much information as possible. One thing to be aware of is that PI policies are almost invariably written on a claims made basis. This means that it is the policy in force at the time the claim is made or notified that deals with it, not the one that was in force when the work was done. This is in direct contrast to virtually all other UK insurances, which are on an occurrence basis, where the insurer at the time of the incident pays no matter when the claim is made or notified. This claims made basis means that it is imperative that continuous cover is maintained, even into retirement. Indeed, RICS require members to maintain cover for a minimum of six years from the date of cessation of any practice. As mentioned previously, RICS and its approved insurers have agreed a policy wording that will be offered as a minimum by all approved insurers. Some insurers do give wider cover than the minimum in certain areas, and we recommend that proposers always ask if the cover is the approved minimum or if it is wider and, if so, in which areas. 2.1.3 What is the right level of cover? RICS has laid down minimum levels of cover for members to carry in order to be compliant with its requirements. However, these are minimum levels only and may not be appropriate for particular members circumstances. The minimum levels are based on fee income bands and are as follows: Fees up to 100,000 Fees between 100,000 and 200,000 Fees over 200,000 Cover required Cover required Cover required 250,000 each and every claim 500,000 each and every claim 1m each and every claim

The definition of fees excludes VAT and disbursements. A sole practitioner earning around 20,000 per annum dealing with low risk work, such as expert witness, planning and development (where there are no detailed plans) or land agriculture management would be happy at the minimum limit of 250,000 each and every claim. On the other hand a large company doing mortgage valuation work on properties with a value of several million pounds would need to carry a much higher limit than the 1m minimum laid down by RICS.
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Some clients may insist on higher levels of cover. Most local authorities, for example, require anyone contracted to them to carry at least 5m any one claim. No insurer or broker can advise on the level of cover required as only the insured can assess their potential exposure. The cost of insurance is directly related to fee income, the type of work done, the level of cover and past claims experience. Surveying encompasses a range of disciplines, and insurers rank these from low risk through to high risk. The very highest risk work, which will attract the highest premiums and claims excesses, is survey and valuation work, whether commercial or residential, and in particular valuations for lending purposes. Experience has shown that this is the area that produces most claims, be it a negligent survey (i.e. a missed defect in the property), or negligent valuation (under or over valuation). Commercial valuation work is a higher risk than residential as this leads to higher value claims, and has also produced more fraud claims. Valuations for matters such as probate, divorce, asset register, compulsory purchase, or the more specialist areas such as milk and sheep quota valuations are not regarded as such high risk and do not attract such high premiums. Medium risk work encompasses such things as estate agency (commercial and residential), property management, CDM work (Construction, Design and Management (Health and Safety) Regulations), project management and project supervision and land surveying. Low risk work is quantity surveying, expert witness work, auctioneering, loss assessing/adjusting, agricultural disciplines and architectural work. One type of work that must be mentioned separately is anything connected with asbestos. The wording agreed between insurers and RICS limits cover for claims arising out of asbestos to 250,000 in the aggregate (meaning that all claims in a year cannot come to more than 250,000 in total) and it specifically excludes claims arising out of asbestos surveys. This cover is designed to give indemnity purely for incidental asbestos exposure (i.e. missing some asbestos lagging in a loft or similar). Working with asbestos is a very specialist area and is regarded as such high-risk work that only a very few insurers offer the specialist cover needed, and their requirements are extremely stringent. As may be expected the premiums are also very expensive, reflecting the risk involved in working with this material, and the potential cost of claims. RICS has arranged such a policy for its members, and details can be found on the RICS website: www.rics.org. From time to time a contract will come along where a higher limit of indemnity is required. Unfortunately, most underwriters are not prepared to increase the cover just for one contract, it has to be done for all work. If a collateral warranty is required then this will mean that the higher cover has to be kept in place for a minimum period of time from practical completion, usually 12 years. This extra cost needs to be factored in when deciding the fee for such a contract. The exception to this is if the contract is of such a size that single project cover is attractive to underwriters. Given that there are very high minimum premiums for this cover, normally 25,000 upwards, the contract needs to be of a size, and attracting a fee of the size, that justifies this level of premium, again 10 | CONSTRUCTION INSURANCE

bearing in mind the potential 12-year cover period. Very few insurers offer this cover, it is a specialist area written by some Lloyds underwriters. Once cover has been arranged and paid for a policy document should be received within 30 days of inception of the cover. The documents received should comprise a full policy wording, a schedule and any applicable endorsements. The schedule will show the amount of cover (limit of indemnity), the policy excess, the insureds name and address, the effective dates of the insurance and who to contact in the event that a potential claim needs to be reported. Endorsements can be either general updates to the policy wording that apply to everyone taking out such a policy, or specific to an insured. For example, if the proposal form revealed a potential claim on a previous insurer then the new policy will exclude anything related to this as the previous insurers are already dealing with it. If subcontractors are to be covered under the policy then there will be an endorsement noting them by name. Other typical endorsements will confirm that previous trading names used by the insured are still covered, or will include work done overseas (the standard policy wording covers work in the UK only). It is important that all the documents sent to you are read through immediately and if anything is incorrect or not understood it is worth querying straightaway. An error in the policy that is not noticed or that is not queried and corrected may affect cover in the event of a claim. Finally, mention must be made of surveyors working in the public sector. Traditionally, local authorities and similar bodies have not purchased PI cover on the grounds that all work is internal (i.e. you cannot claim against yourself). However, if work is done for any outside agency then cover for this is needed, and it is worth remembering that even if the work is internal an independent third party could make a claim. For example, if a surveyor carries out condition surveys on council houses, which are later sold to the occupiers (or others), and a defect, for example asbestos lagging or unmentioned subsidence or dry rot, comes to light the council could be sued by the purchaser for the cost of rectification, as well as being asked for financial restitution for loss of rental income, alternative accommodation, etc. 2.1.4 When should I consider cover and what will it cost? We recommend that you ensure adequate cover that conforms to RICSs minimum requirements is in force before you carry out any work. The cost will vary according to your fee income and type of work carried out but starts from as little as 495 per annum for a limit of 250,000 any one claim for a sole practitioner with fees of around 50,000 per annum doing low-risk work.

2.2

Professional indemnity insurance for project managers


The remaining paragraphs are devoted to construction project managers, as the nature of their work requires special consideration. Such managers are responsible for co-ordinating the construction of building projects of various sizes, but usually they are appointed to larger contracts such as, but not limited to, hotels, factories, office blocks, housing developments, schools and hospitals. They are appointed by the client, who is often, but not always, the developer, and their duties may include:
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+ the appointment of the contractor, architect, structural engineer and other sub-contractors needed to complete the contract; + interpretation of plans; + estimation of costs and quantities of material needed; + planning constructions methods and procedures; + co-ordination of the supply of labour and materials; + supervision of the construction site itself and the direct site managers and sub-contractors; + negotiation with building owners and sub-contractors where necessary; + controlling the preparation of costs estimates and other documentation for contract bids; + controlling payment to sub-contractors by way of valuation of completed works; + ensuring that building regulations, standards and by-laws are enforced in building operations; + consultation with architects, engineers and other technical workers to ensure that design intentions are met; + ensuring that the contract is completed on time and within budget; + keeping the client advised at all times so that if there are delays, budget discrepancies, etc. these are dealt with swiftly and efficiently. Many construction project managers work in private organisations such as large construction and development companies, but equally a good number are employed by government/local authority departments/housing associations, or are self-employed. Where the project manager is a direct employee of a private sector construction or development company then the professional indemnity insurance taken out by that firm should automatically cover these activities. However, if the firm for which he is working is a non-regulated company he should ensure that: (a) the company has professional indemnity insurance; and (b) the project management activities have been fully declared to insurers and are indemnified. The pitfalls come for project managers who are employed by public sector employers. As mentioned earlier, many local authorities, housing associations, governmental departments and the like do not carry professional indemnity insurance on the grounds that their work is internal and you cannot claim against yourself. The project manager, however, comes into contact with a vast number of external organisations and people, any and all of whom could make a claim against him if things go wrong. For example, a contract on a new office block being built to let by the local council over-runs by six months due to the contractor failing to put sufficient labour resources on site. The council for whom the project manager works have already signed a lease on the building, and the head lessee has sub-let several units. The delay means that the head lessee is failing to receive rent for the period of the over-run, and he comes to the project manager for recompense, as he should have ensured that the contractor supplied sufficient labour to complete the contract on time. 12 | CONSTRUCTION INSURANCE

Or, the project manager is in charge of a refurbishment project involving social housing. Everything is completed on time, the local authority hand the properties over to a housing association and the tenants move in. Six months later it is discovered that there is harmful asbestos in the properties and everyone has to move into alternative accommodation while the asbestos is safely removed and replaced with a suitable material. The housing association come to the local authority for reimbursement of their outlay on safe removal and alternative accommodation costs, stating that the project manager should have ensured that any asbestos was identified and removed during the refurbishment process and he has therefore been negligent. Or, the project manager is in charge of the building of a major new housing development. The local authority will retain some of this for social housing; some will be sold to private purchasers. Everything is successfully completed, the housing development is finished on time, but a few months later the occupants of the houses find that their properties are subsiding badly. Investigation reveals that there are disused mine workings under the development site which are collapsing. The houses become uninhabitable and unsellable and will eventually have to be demolished. The private purchasers all sue the local authority for their losses citing the failure of the project manager to identify the mine workings in the preliminary investigations of the site as the main cause of their loss. These are, of necessity, only brief scenarios of the pitfalls for project managers. Because of the interaction of project manager and organisations/persons outside of the organisation for which he works it is essential that professional indemnity insurance is arranged, even where he is a public sector employee where such cover is not normal. It is perfectly possible to arrange cover that limits claims to those emanating from an independent third party, i.e. anyone outside the public sector employer. The final scenario is where the project manager is a public sector employee but is appointed by a private sector company. This can happen where a local authority or similar invite tenders from the private sector to carry out a project, such as new school, new hospital etc. and the contractor/developer appointed has the services of the local authority project manager, and a fee is charged for this. Under these circumstances the contractor/developer can make a claim against the project manager, as he is giving advice or design for a fee and again professional indemnity insurance should be purchased to cover such claims.

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2.3

Directors and officers liability (D&O) insurance


Company directors on the boards of both publicly listed and private companies are becoming more wary than ever of their potential exposures to litigation. The Company Reform Bill and well-documented increases in DTI investigations, stock options backdating allegations and extradition proceedings have all highlighted the risks that directors face. The dramatic downturn in the economy starting in 2008 magnified these risks even further. Unsurprisingly, this has led to greater scrutiny of the cover provided by a companies D&O liability insurance to ensure that directors that are making decisions on behalf of the company are sufficiently protected should they be named in litigation arising from these roles. It is also more common for prospective new board members to instruct their lawyers to undertake a thorough examination of a companys D&O policy prior to accepting a role on a new board to ensure the cover provided is satisfactory. In the notes below the cover is explained.

2.3.1

What is D&O exactly and who is covered? In essence, the cover provided by the D&O policy is for awards of damages, costs or settlements (including defence costs) for which a director or officer is legally liable resulting from a claim made against them during the policy period for any act, error or omission in their capacity as a director or officer of the company. Fines and penalties are typically excluded. D&O cover is taken out in the company name, but the main beneficiaries of the policy are the individual directors and officers (as well as the company should they indemnify a director for such loss). It also provides protection for employees who are acting in a managerial capacity or who are named as a joint defendant in an action against a director or officer. Further, although the policy is usually taken out in the name of the holding company, it then automatically provides protection for all directors and officers of any subsidiary companies on a global basis. Cover is provided for past, present and future directors and officers. Retired directors are commonly also provided with an automatic six-year period to cover claims made against them for acts committed whilst they were a director or officer of the company in the event the policy is non-renewed (for whatever reason). Such period should be provided for no additional cost and would apply from the date of such non-renewal. D&O is also a claims made cover (i.e. only claims notified during the policy period are covered) as opposed to the large majority of insurances, which are arranged on an occurrence basis.

2.3.2

What type of company should be purchasing D&O cover? When D&O cover was first made available it was only the largest publicly listed companies who sought to purchase it. This purchasing philosophy has changed radically over the years and now it would be extremely unusual for any UK listed company not to buy D&O. Although it is common for a high percentage of claims to be brought by shareholders, there are many other third parties that can look to bring actions. This has resulted in many private companies also purchasing this cover as

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standard. An example of these third parties would be regulators/government bodies, employees, customers, competitors, co-venture partner companies and liquidators. 2.3.3 What should I be looking out for to ensure I have adequate cover? Care is needed because the breadth of coverage provided by D&O policies can vary enormously between insurance carriers. There are many differentiators that can have a substantial impact on the extent of cover provided. The following are just a few of the coverage areas that can vary substantially between insurance policies: + definition of insured person; + cover for pollution-related claims; + insured v. insured (claims by one insured person against another); + automatic cover for new acquisitions (often restrictions for size/domicility of acquired company); + public/private offerings of securities (these will often be excluded); + transactions (cover will often cease if the company is sold or the majority of its shares sold); + non-rescindable contract language. Specific to the property/construction sector, in the first quarter of 2009 several high-profile companies in this sector sought to shore up their respective balance sheets through significant rights issues. We recommend that you ensure cover is provided under a companys D&O policy for any wrongful acts committed by the directors and officers associated with such capital raisings that occur during the policy period. Such additional exposures are often not automatically covered as standard. 2.3.4 Obtaining terms for a D&O policy In order to procure terms for a D&O policy for companies with less than 750m total assets it is possible to obtain terms with just the company registration number. For companies larger than this a copy of the companys latest report and accounts as well as a completed proposal form would be required. 2.3.5 Market trends The five years prior to 2009 saw a dramatic softening in premium rates in the London market for D&O insurance combined with a dramatic influx of insurers offering capacity to this product in light of the relatively benign claims environment in the UK during this period. At the beginning of 2009 there were in the region of 3540 insurers that could offer D&O cover in the London market and this has been a considerable factor in driving premiums for this product down. However, this time also saw early signs that the majority of these insurers were looking to reverse this softening in light of some significant losses sustained for their financial institutions clients. Insurers started being far more selective about the companies that they would be prepared to insure and companies in certain sectors have been affected more
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than others. The construction/property sector was targeted by many insurers for premium increases in light of the particularly tough trading conditions that companies in this sector experienced. Certain insurers also sought to use this opportunity to attempt to impose more restrictive policy conditions following several years of their policies offering continually greater breadth of cover. For example, the imposition of insolvency exclusions on their renewal terms, if accepted by the broker/company, have the potential to expose directors and officers to a significant un-insured risk. This onerous limitation seeks to exclude any cover for the directors and officers for any wrongful acts arising out of or based upon the insured company becoming insolvent. Given that this is when the directors would most likely seek to call upon the D&O policy (due to indemnification from the company unlikely to be available) this provision should be vehemently resisted at all times. It is important therefore in challenging market conditions that companies seek to partner with a broker that has both the depth of experience and resource to combat such pressures being imposed by the market. 2.3.6 Key issues Whenever market conditions are challenging it is far better to prepare a renewal strategy with a broker earlier than usual to ensure insurers are furnished with all information necessary to provide competitive renewal terms. We recommend that care is taken over new wordings offered by insurers as these may contain onerous limitations in cover which if accepted could have serious implications for covered persons. It is worth ensuring that your broker provides latest information relating to the security credit ratings of each insurer quoting renewal terms. Ensure also that suitable provisions are contained within the policy to make certain that in the event of a subscribing insurer becoming insolvent during the policy period the broker has arranged solutions to enable swift replacement of said insurer should this be required.

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3
3.1

Construction risk insurances


Consequential loss insurance for construction risks
Developers are used to carrying risk. It is part and parcel of their business. The consequential loss risk on a construction site is a high one as there are so many factors that could delay completion and then so many headings under which additional expense or actual loss of anticipated income could arise. The measurement of each potential loss can be a problem. If it is not correctly assessed there may be underinsurance or an unnecessarily high sum insured that results in far too much premium being paid. In this guidance note the potential losses and the measurement of them are considered. The focus is on the development of buildings that are to be let or sold but potential occupiers and others may also need to consider the implications of any delay and at the end some interesting variations on the usual theme are included.

3.1.1

Three important points There are three important points to be made at the outset. If any party involved with the construction will require consequential loss cover of any kind it is very unlikely that any insurer will be willing to assist unless it also holds the material damage insurances on the contract works. This is reasonable because it is only by the insurer controlling the settlement of the material damage claim that the size of the consequential loss can be minimised. Therefore, if the contract conditions call for the contractor to arrange insurance on the works, it may be impossible for the employer to arrange any consequential loss cover. The employer will then have to arrange its own cover on the contract works in order to secure that consequential loss protection. To avoid the possibility of the employer effectively paying enhanced premiums for such contract works cover it is worthwhile making clear to the contractor from the outset that the employer is paying for its own cover, if this is the intention. The contract price quoted by the contractor should then reflect this. It is usually very difficult, if not impossible, to persuade the contractor to reduce its price at a later date. In any case the contractor may prefer to arrange its own cover on the works so that it has control over any claims that arise. This is understandable and the contractor may also argue, possibly with some justification, that it can buy the contract works insurance more cheaply than the employer. Faced with the problems of changing contract conditions, arranging cover on the works and, possibly, paying more premium for the privilege, any employer could be forgiven for giving up the idea of arranging consequential loss cover. However, this brings us to the second point, which is that it is not good practice to rely on liquidated damages instead. Apart from the fact that the contractor may find it impossible to purchase insurance against liquidated damages, making recovery of a genuine loss uncertain, there is the possibility that the contractor will be entitled to an extension of time and will not be liable to pay any damages anyway.
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The final point is that a properly arranged insurance on consequential loss will more accurately reflect the employers loss than liquidated damages can and by arranging both contract works and consequential loss insurance with the same insurers there is the added advantage that the insurers will be looking for a quick resolution to the works claim in order to reduce the size of the consequential loss. 3.1.2 Relevant events Before considering policy covers and providing some advice to avoid common pitfalls, it is prudent to consider the nature of the risk exposure that developers can face. The range and variety of building contracts is immense, although, by and large, when considering property development work, one of the standard JCT forms will be utilised as a basis. Section 6 of the Standard Form of Building Contract 2005 Edition deals with damages if the contractor fails to complete the works by the completion date. Subject to certain conditions the contractor is obliged to compensate the employer to the extent of liquidated and ascertained damages at the rate specified in the contract. However, if the delay is due to certain relevant events an extension of time for completion of the building will be given. In that event the damages do not have to be paid. These relevant events typically include the following: 1 force majeure; 2 exceptionally adverse weather conditions; 3 loss or damage occasioned by any one or more of the specified perils (see below); 4 civil commotion, local combination of workmen, strike or lock-out affecting any of the trades employed upon the works or any of the trades engaged in the preparation, manufacture or transportation of any of the goods or materials required for the works; 5 terrorism. Contract conditions do vary and therefore the proposal that an extension of time may be available is not necessarily correct in every instance. Where it is known that an employer is effecting a delay in start-up insurance the contractor may be able to agree a waiver of liquidated damages in circumstances where the insurance coverage is available. This may have premium implications but may be the best value for money. 3.1.3 Specified perils and force majeure The specified perils are usually defined as: fire, lightning, explosion, storm, tempest, flood, bursting or overflowing of water tanks, apparatus or pipes, earthquake, aircraft and other aerial devices or articles dropped therefrom, riot and civil commotion, but excluding excepted risks. The excepted risks include, amongst other things, radioactivity and pressure waves. There is no definition of force majeure perils in JCT contracts although they are usually specified in PFI contracts. For insurance purposes the principal force majeure perils include: fire and allied perils, strikes, lockouts, labour disputes, change of law, order of any court enforcing a change of law and any other cause beyond the control of the contractor. At one time it was possible to buy cover for the consequential losses flowing from late completion or permanent abandonment of a project following the occurrence of force majeure perils or restricted to specified perils (howsoever 18 | CONSTRUCTION INSURANCE

specified in the policy document) but following some huge claims it appears that cover of such breadth is no longer available. In addition clause 22D has been deleted from the 2005 JCT form. It is worth mentioning at this point that care is needed with the term specified perils. The specified perils in a lease may be defined differently to above. Reference to all risks of specified perils will almost certainly include not just those mentioned above but, in addition, malicious damage, impact, subsidence, landslip, heave and, possibly, other accidental damage. 3.1.4 Extensions of time Clause 2.25 of the JCT form is also relevant as it deals with applications for extensions of time. The contractor is obliged to give notice as soon as it becomes reasonably apparent that the progress of the works is being, or is likely to be, delayed. The notice must give details of all material circumstances and state whether or not, in the contractors opinion; the event is a relevant event. Leaving aside those clauses that deal with loss and expense caused by matters materially affecting regular progress of the works that may leave resultant loss and expense claims sitting firmly with the contractor, the possibility for the developer sustaining the loss is clear to be seen. Whilst it is not the subject of these notes, developers should be aware of some differences with the Standard JCT Form of Management Contract (2005 Edition). Under this, the certifying officer will not consider such an extension to the extent that the delay arises from any omission on the part of either the management or works contractors, even if the delay has been caused by an otherwise permitted event of delay. For example, a situation could easily arise where a pipework joint was improperly made, leading to bursting or overflowing of water apparatus, so that whilst a peril operated, workmanship error could deny the management or trade contractors being absolved from liquidated and ascertained damages. 3.1.5 Measurement of liquidated and ascertained damages Equally, even if liquidated and ascertained damages can be applied to any delay scenario, the reality of the impact upon the developers financial position can often be beyond the level of liquidated and ascertained damages set during tender negotiations. Whilst every effort is made to set the level of damages at an appropriate level, the full consequences are not often appreciated until a loss is sustained. Equally, it can be the case that on smaller projects it is difficult to reach agreement with the contractor involved for an appropriate level of damages. This is because, if set accurately, they may preclude the contractor from undertaking the development or, alternatively, the imposition of such damages would adversely affect any tender submitted. One example of such a scenario would be the fit out of an existing office building to accommodate, for example, a traders dealing room where actual losses for delays may be truly significant. Consequently, another avenue for shortfall and irrecoverable losses for the developer arises. The case for the developer undertaking a careful risk analysis and then securing appropriate insurances for potential exposure is clear. The effect of the relevant events is that the contractor is not responsible to the developer for the consequences of delays in completion that are outside its control. Not all of the remaining exposures can be insured so the developer has a significant amount of risk itself. Unfortunately, developers often carry more
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risk than is necessary by failing to insure at all or failing to insure adequately, even though insurance cover can be purchased. An examination of the potential losses that may be insured begins below. 3.1.6 Loss of rent and loss of use of sale proceeds, including assessment of indemnity period Loss of rent is considered first. If insured damage occurs, completion of the development may be delayed, the lessee cannot move in on the date expected and the developer suffers a loss of rental income for the period of the delay. The basis of settlement is the loss of that income and the sum insured should be calculated on the basis of the anticipated annual rent multiplied by the indemnity period in years. Assessment of indemnity period The indemnity period is defined in the policy and, broadly speaking, it should represent the maximum period after a loss that the insureds business will be affected in consequence of insured damage. For a developer intending to let, the first consideration is how long would it take to repair damage to the development occurring at the worst possible time? This will usually mean contemplating a total loss just before completion. Suppose that a complete rebuild would take three years taking into account all factors. In other words, rent will begin to be paid three years later than originally planned. The minimum indemnity period is therefore three years and that is the number of years rent the developer could expect to recover from insurers if the worst happened. However, there may be other factors to consider. For example if a prospective and definite tenant is lost as a result of the delay it may be that another tenant cannot be found when the building is finally ready. Alternatively, another tenant may be found in time but at a lower rent than the original would have paid. The developers real loss may continue for more than three years so a longer indemnity period may be chosen. Of course, insurers may not be willing to grant cover for the longer period. If they do the premium will be higher and the developers would still have to prove any loss is entirely due to the original damage. Loss of use of sale proceeds If the developers intend to sell the development on completion and the sale is delayed in consequence of damage, the developers no longer receive the sale price on the date expected. They lose the use of those funds that they could have put to good purpose, i.e. to pay back a loan, to invest in another project, or merely to put in a deposit account in the bank to earn interest. The highest loss would arise if the whole of the sale proceeds were due to be invested immediately in the purchase of another site and the completion of the first site was delayed for the maximum indemnity period. For example, if the sale proceeds would have been 10m and that sum of money has to be borrowed at 9% interest for three years whilst the insured development is rebuilt, a loss of 2.7m is suffered. This figure would be the sum insured. In practice such a loss is unlikely. Settlement of any claim for loss of use of sale proceeds would be based on a combination of the continuing cost of financing existing loans, the cost of new projects and the interest lost on investing the balance. If a developer is unaware whether the completed building is to be sold or let it is usual to calculate a sum insured for both possibilities and insure for the higher 20 | CONSTRUCTION INSURANCE

amount. An example of a loss of use of sales proceeds claim follows, based on the figures of 10m and 9% just mentioned. Assume that the developers expected to receive 10m on the sale of a completed development on 1 January 2010. They were going to use 5m of this money to pay back an existing loan of 5m on that development; 3m would have been used to purchase another site for future development and the balance of 2m would have been banked in their deposit account. Instead they have to continue to borrow the 5m at 9% and they borrow another 3m also at 9% interest per annum. The interest of, say, 3.5%, that they would have earned on the 2m on deposit is lost. Assume that the sale of the damaged building is delayed two years until 1 January 2012 whilst the damage is reinstated. The developers then sell the building at last and receive their 10m. In simple terms the measure of this loss is: 8m at 9% interest for 2 years = 1.44m 2m at 3.5% interest for 2 years = 0.14m Total claim = 1.58m There is also the possibility that any delay in completion may result in a lower sale price because of an economic downturn during the period of delay. 3.1.7 The developers choice as to basis of settlement The best market wordings for developers consequential loss assume that at the time the insurance is taken out the insured does not know for certain if the development will be sold or leased. These wordings allow the insured to select the basis of settlement at the time of the damage in the light of circumstances at that time. The sum insured has to be based on the higher of the two figures mentioned earlier, i.e. the annual rent or the annual cost of borrowing the sale proceeds, in both cases multiplied by the indemnity period. The other advantage of the flexibility of such wordings is that the claim may be based on loss of rent for the initial period and loss of use of sale proceeds if the building was due to be sold when, say, it was 50% occupied. The losses detailed above clearly fall on the developer. Rather than rely upon liquidated damages from the contractor, which it is difficult, if not impossible, to obtain insurance for, it would seem sensible for the developers to buy protection themselves on an all risks basis. Such protection will include the specified perils but will not, of course, cover all the circumstances in which those provisions would require payment by the contractor. Provided the developers insurance advisers are given sufficient information to measure the potential loss properly and provided they understand the workings of the policy being purchased, the insurance should provide an adequate indemnity. 3.1.8 Expediting costs (additional cost of working) Cover under the above item should also include provision for expediting costs (over and above any amount recoverable under the construction insurance covering the contract works). However, the amount recoverable is limited to what is reasonable compared to the saving produced on the claim for loss of rent or loss of use of sale proceeds. In practice this means that insurers will be reluctant to pay for expenditure that did not produce at least a corresponding saving on another part of the claim. This is similar to the so-called economic limit under other business interruption policies. No separate sum insured for this element of the risk is usually necessary because it is included within the cover under the loss of rent item. The proposed wording should be examined.
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3.1.9

Costs incurred in raising or extending loans The legal and other costs incurred in continuing existing loans or raising new ones as a result of delay by insured damage should also be covered. These may be included within the basic cover outlined above without the need for a separate sum insured. We recommend that the proposed policy wording is examined to make sure. However, unless there is a separate sum insured, insurers overall liability will be limited to the sum insured on the basic cover for loss of rent or loss of use of sale proceeds.

3.1.10 Additional overhead costs (sometimes referred to as soft costs) Any delay in completion of a letting or sale may involve an increase in marketing, leasing, selling and legal costs. To the extent that these will be incurred in order to diminish a loss of rent claim they may be recoverable under expediting costs. They are sometimes insured by a separate item. Underwriters are entitled to extra premium for this. There may be circumstances in which an insured wishes to spend money or may incur costs over and above those they feel could be justified under expediting costs. Each case has to be examined separately and a post-loss situation considered. 3.1.11 Higher cost of development finance Many covers that are arranged ignore the fact that development finance can cost more than completed building finance and the fact that it is usually possible to borrow more against a completed building than it is against a planned development. The consequences of this are twofold. In the first place if a developer borrows to finance a new development then, when it is completed and let, the rate of interest on that loan may go down to reflect the lower risk that the financier is running. If completion and letting is delayed the developer not only loses the rent but also loses the benefit of the lower rate of interest. Secondly, the developer may be able to borrow, say, 70% of the cost of a development and then use its own funds to finance the other 30%. When the development is finished it may be the developers intention to borrow more money against the completed development thus releasing some of its own funds towards a further new development. If the original project is delayed, the developer cannot do this. Even if more money can be borrowed against the new development the cost of finalising the project will be higher. These two consequential losses should be insured against. The policy wording should provide for this under the basic loss of rent/loss of use of sale proceeds cover. No separate sum insured should need to be calculated and there is not usually anything in the policy that would restrict the amount recoverable. No specific premium should be charged. The problem is that many policies do not provide the cover at all. The developer should consider the possibility of a loss under this heading and ensure cover is in force if necessary. 3.1.12 Additional increase in cost of working cover Under the heading of expediting costs it was explained that the reasonable cost of expediting completion of the works is covered under the basic policy but the amount that may be recovered is limited by the so-called economic limit. It is possible to obtain cover over and above this to further expedite the works by means of an additional item although sometimes the matter is dealt with by means of an extension with an inner limit. There may be a requirement for the insured to contribute a percentage to each claim. The expenditure 22 | CONSTRUCTION INSURANCE

under this cover is limited to what is necessary and reasonable without reference to any corresponding saving in the indemnity that would otherwise be payable for loss of rent or loss of use of sale proceeds. We recommend that developers consider this cover. The ability to make a claim under expediting costs might give them useful options in the event of a loss. For example, the ability to make extra payments to speed up completion may enable them to avoid losses in the future that would fall outside the indemnity period and would therefore not be recoverable from insurers. If underwriters require a separate sum insured, an additional premium will be charged. 3.1.13 Damage away from the site including prevention of access Most insurers policies include free extensions of cover under the advance profits covers to pick up losses that result from damage off site. This could be damage to contractors offices, materials or equipment stored off site, vehicles or plant in transit or whilst stored and damage to other phases of development. However, the range of free covers can vary. Some policies may include cover for denial of access and/or failure of utilities although care is needed to ensure whether losses are subject to only a 24-hour excess or the much higher time excess imposed by underwriters referred to below. Clearly the maximum time excess should be 24 hours if the cover is to be worthwhile. 3.1.14 Damage at suppliers premises The basic cover will sometimes include cover for delays incurred following damage at the premises of suppliers of materials to be used in the contract works. The most serious losses are likely to occur if there is a delay in the arrival of crucial or bespoke supplies such as lifts, boilers, windows and cladding. However, an inner limit, usually a low one, will apply. Some large losses have been incurred following damage at suppliers premises where the free cover given has not been enough. Cover can be purchased for delays as a result of damage to all suppliers to the development not named on the policy. This can be very expensive and where the anticipated loss from particular suppliers could exceed, say, 1m it is better to name the supplier or suppliers in the policy with a specific limit or limits. This may be cheaper. 3.1.15 Time excess Almost invariably cover will be subject to a time excess that varies according to the length of the contract. This is the period immediately after a loss during which insurers will not pay for the consequential losses described above. Generally speaking, the longer the period of the contract, the longer the time excess will be. The minimum time excess is usually 14 days but expect to see 28 days or more. The excess should apply to the total of all delays caused by insured perils and not individually to each loss. When there are several buildings the time excess may be applied separately to each one. The reason for the time excess illustrates why construction consequential loss covers are difficult to write and why some insurers do not willingly write the cover at all. Construction projects are subject to delays for all sorts of reasons, bad weather, labour shortages, accidents on site, difficulties in obtaining supplies, etc. Further, not all damage by an insured peril will necessarily delay completion. It may be possible for the developer to change the sequence of working so that any potential delay is negated or to catch up with the programme of work anyway. Whatever the circumstances, if there is damage by
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an insured peril and the final completion date is subsequently delayed the developer will, understandably, want to allocate a fair portion of the delay, or all of it, to the insured damage. It may be difficult to prove the loss at the best of times if there have been other delays before or after the damage. Attempts to track the progress of a development against the programme of works are not as straightforward or successful as everyone would like, although insurers may require this monitoring to be done. Often the poor quality of, or even the absence of, adequate site records and data works against the developers in substantiating a claim. Early advice of a claim is essential, backed up by real substantiated records where possible. The time excess serves two purposes. It eliminates small claims and assists the insurers hand in negotiations. 3.1.16 Unusual consequential risks The above paragraphs have covered pretty thoroughly the consequential risks faced by a developer when damage occurs on site. But they are not the only party on site that may benefit from such insurance. Project managers, investors, prospective tenants and others may stand to make money from a development if it is completed on time or to suffer a financial loss if it is not. Sometimes they are quite surprised that there is an insurance solution. In principle, any kind of consequential loss can be covered by anyone who stands to suffer a loss as a result of damage by an insurable peril. Generally speaking there has to be physical damage as delays by strikes or other non-damage perils are difficult to insure against, if not impossible at times. Further, the compensation sought has to be based on indemnity rather than some arbitrary amount plucked from the air and the precise measurement of that loss can be difficult to calculate let alone define in a policy wording. Below are some examples of what has been requested in the past. 1 Two developments with the same project managers, but different funders, were being built on adjoining sites. The first development had already been let but there was concern that the lessee might exercise a right not to take up the lease if the completion of the site next door was delayed beyond a certain date. The reason was that the lessee did not want to move in if construction work, with the attendant noise, dust and inconvenience, was still going on next door. Cover was agreed for loss of rent at the first development following damage by an insured peril next door if such damage led directly to a delay in completion and a decision by the lessees to invoke their right not to take up the lease. The basis of settlement was loss of rent, but the trigger was damage at the site next door rather than the insureds own premises. It was pointed out to the insured that proof of cause of loss might be difficult. However, a letter from the lessee explaining that the lease was not going to be taken up because of the delay in completion of the site next door would have been hard for insurers to counter. A bank planned to move from two existing leased properties into new premises being built. If the new building was ready on schedule the bank would be able to terminate the two existing leases at no cost to them. If completion of the new premises was delayed the bank might have been obliged to renew the two leases and then incur penalties when they finally moved out. In the worst scenario they might have been left paying the rent on the two properties until the leases finally expired many years later. They

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were able to buy insurance that would cover their additional costs if such a delay occurred. The concept was simple but in practice an accurate assessment of the banks potential loss had to take into account a lot of factors. The challenge was to calculate the sum insured correctly and present insurers with an accurate assessment of the risk so that they could arrive at an equitable premium. It needed the full cooperation of the client, their lawyers and the managing agents in order to do this. A project manager was responsible for the construction and letting of a development and when 50% of the premises were let the developer was selling the building to an insurance company for their property investment portfolio. The project managers profit from the deal was to be calculated according to a formula that meant that the sooner the 50% letting was achieved the more money he made. Delay by fire, etc. would therefore have affected that profit adversely. Appropriate insurance was purchased. A developer was building a shopping arcade most of which was pre-let to top quality tenants whose covenant strength was reflected in the purchase price agreed by a pension fund. There was concern that severe damage and failure to finish the development by an agreed date would cause the lessees to trigger an opt-out provision. Their replacement by other tenants with lesser covenant strength, albeit at an equal rent, would have adversely affected the purchase price. This had been agreed in advance based on an agreed formula. In the worst instance the formula would have reduced the agreed purchase price by several hundred thousand pounds. Cover for payment of this loss as a capital sum was agreed and the formula used in the policy wording as the basis of settlement.

3.1.17 Key issues 1 Any employer seeking consequential loss insurance will be better off arranging its own contract works cover. 2 Consequential loss insurance is a more certain route to recovery than reliance on liquidated damages. 3 Consequential loss insurance will be a more accurate reflection of the employers loss than liquidated damages. In order to secure adequate insurance cover at a competitive price we recommend that those arranging the policy have a full understanding of how the development is to be financed, the programming of the works and the financial implications of any delay. An accurate assessment of the sum insured is essential to avoid under- or over-insurance.

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3.2

Contractors all risks or contract works insurance


There are several terms used in the insurance world that mean different things to different people and one of these is contractors all risks (CAR) insurance. The term is sometimes used to refer to both the material damage and liability covers required by a contractor. Most insurance practitioners would regard CAR as referring only to the material damage cover on the contract works unless the real intention was obvious from the rest of the text. Anyone using the term, whether verbally or in writing, should make their intention clear, so as to avoid any ambiguity in interpretation. In this guidance note only the material damage cover is examined.

3.2.1

The cover A CAR policy responds when the works being constructed, as defined in the contract, are damaged by an insured peril and require replacing and/or repairing. It is normal for the project contract to stipulate who will provide this cover. If it were the contractor then it would be normal for them to have an annual policy covering all their contracts up to a specific limit. However, should responsibility fall upon the employer then cover would normally be under a policy arranged specifically for that project. When arranging the cover, we recommend that care be taken in identifying the correct contract value, construction period, defect period and description of the works. The policy will normally respond to any physical loss or damage unless the cause is specifically excluded so the term all risks whilst commonly used, is to some extent, misleading. Nevertheless the cover is very wide and embraces protection against fire, aircraft, explosion, earthquake, riot, malicious damage, storm, flood, burst pipes, impact and other accidental damage. However, policies can be issued covering loss or damage by particular and specified perils, e.g. fire, flood, storm. In both cases the policy will need to be extended to provide protection in respect of damage by terrorists. In either case it is imperative to fully understand what exclusions apply or which perils are listed to ensure that the cover gives sufficient protection to the employer and the contractor. The policy should always be in the joint names of the employer and contractor although the contract may stipulate that other parties, e.g. financiers, are also named in the policy. All policies will have an excess that will be deducted from any claim settlement. On occasions insurers will apply more than one excess under a policy for specific losses, e.g. flood claims may have a higher excess than any other claim where the risk of flooding warrants this. The following extensions of cover should be included in the policy but may be subject to inner limits that may be amended by negotiation with insurers prior to the project starting: + professional fees; + automatic reinstatement of the policy limit following a loss; + debris removal; + free issue materials; + discovery of munitions of war;

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+ inflation clause; + plans and documents; + public authority clause. Insurance brokers specialising in this class will also have their own list of extensions that they will negotiate with insurers. 3.2.2 Joint Code of Practice on Fire Prevention Insurers themselves may impose certain conditions on the employer/ contractor in respect of specific requirements, e.g. compliance with the Joint Code of Practice on the Prevention from Fire on Construction Sites and Buildings Undergoing Renovation. This was introduced by the Fire Protection Association after full consultation with interested parties and has proved successful in combating the huge losses being suffered by insurers. Expect insurers to apply the Code and seek compliance with its terms. The basic cover of loss or damage to the works can also be extended to include the following additional costs. 3.2.3 Additional cost of construction of unbuilt works There are two elements to this cover as explained below. 1. Inflation only The need for this cover is best illustrated by an example. Suppose that an eight-storey office block is being constructed but it is badly damaged by fire after only four storeys have been completed. The contract works material damage cover will pay for the cost of reinstating the damage (including any inflationary aspects). However, by the time that work is completed the cost of building the upper four floors may have increased as a result of inflation. Underwriters normally require the insured to bear a proportion of each claim. Care is needed in assessing the sum insured, which must reflect the worst possible scenario and the insureds estimate of future inflation on building costs. 2. Out of sequence working Successful delivery on time of a development depends on all site activities running to time in the right sequence. If this sequence is thrown out by damage the cost of development can increase substantially. It is possible to insure this risk but, again, the insured will almost certainly have to bear a proportion of each loss subject to a minimum contribution. Care is needed as the breadth of cover offered by insurers is restricted by standard exclusions. 3.2.4 Defective design, materials and workmanship It will often be the case that the material damage covers available under either an annual or project-specific contract works policy will be subject to a standard defects exclusion. The effect of this will depend upon the precise exclusion used but a typical DE3 wording (see below) will exclude the cost of replacing, repairing or rectifying any part of the works that are in themselves defective in either design, plan, specification, materials or workmanship. This exclusion can only be properly understood if we consider the wordings of the exclusions used in the contract works policy and the practical effect of the exclusions in use.
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The actual wordings are set out below and the practical effects are below that. It is DE3 that is standard to most policies. Any variation on this will save premium in the case of DE1 or DE2 or cost more for DE4 or DE5 (see below). 3.2.5 Defective design, materials and workmanship clauses 1. Outright defect exclusion (DE1) This policy excludes all loss of or damage to the property insured due to defective design, plan, specification, materials or workmanship. 2. Extended defective condition exclusion (DE2) This policy excludes the costs necessary to replace, repair or rectify any of the property insured which is in a defective condition due to a defect in design, plan, specification, materials or workmanship, or which relies for its support or stability on any of the remainder of the property insured which is in itself in a defective condition. This exclusion shall not apply to the remainder of the property insured which is free of such defective condition but is damaged as a consequence of such defect. 3. Limited defective condition exclusion (DE3) This policy excludes the costs necessary to replace, repair or rectify any of the property insured which is in a defective condition due to a defect in design, plan, specification, materials or workmanship, but this exclusion shall not apply to the remainder of the property insured which is free of such defective condition but is damaged as a consequence of such defect. 4. Defective part exclusion (DE4) This policy excludes the costs necessary to replace, repair or rectify any component part or individual item of the property insured which is defective in design, plan, specification, materials or workmanship, but this exclusion shall not apply to other parts or items of the property insured unintentionally damaged as a consequence of such defect. 5. Design improvement exclusion (DE5) This policy excludes the costs necessary to replace, repair or rectify any defect in design, plan, specification, materials or workmanship, but should unintended damage result from such a defect, this exclusion shall be limited to the additional costs of improvements to the original design, plan or specification. Example of the application of the aforementioned exclusions Imagine a site with a steel-framed building. The perimeter boundary wall around the site and the roof has been completed. The cladding has been partially completed. The bolts used in the construction of the steel framework prove to be inadequate and the whole structure collapses, damaging everything. The various defect exclusions would pay as follows: + DE1 all the damage would be excluded; + DE2 all damaged items would be excluded except the perimeter wall; + DE3 the steel framework would be excluded. The roof, cladding and perimeter wall would be paid for; 28 | CONSTRUCTION INSURANCE

+ DE4 only the nuts and bolts would be excluded; + DE5 all damage would be paid for. The improvement costs would be excluded. 3.2.6 LEG clauses The London Engineering Group (LEG) has developed their own version of these clauses known as LEG 12/3 which effectively mirror DE1, DE3 and DE5 above. 3.2.7 Legal challenges Various legal challenges are ongoing as to the effectiveness of these clauses and therefore whilst the description of coverage above may not reflect the current or future legal interpretation. As with all contractual documentation, we recommend you seek professional advice. 3.2.8 Key issues If the contractor arranges this cover it restricts or even removes the ability of the employer to purchase any consequential loss covers required.

3.3

Employers liability insurance


Throughout most of the developed world, employers are legally responsible for providing safe working conditions for their employees and they also need to ensure compensation will be available if the employee suffers death, injury or disease. In this guidance note the implications for employers are explained. In the UK all employers, other than a few specified public bodies and, since 2004, sole traders, are required by the law to take out an employers liability (EL), insurance policy. An EL policy covers the legal liability of the employer for any illness, injury or death suffered by their employees.

3.3.1

The Employers Liability (Compulsory Insurance) Act 1969 EL insurance was made compulsory under the Employers Liability (Compulsory Insurance) Act 1969. In this way, the government ensured that compensation would be available to employees who suffer illness or an accident in the workplace. + Its not just accidents. Employees can contract work-related diseases from dermatitis through contact with certain chemicals to mesothelioma through inhaling asbestos fibres. + Its not just current employees. Employees who moved on many years ago may have contracted a work-related disease that has only just come to light and been diagnosed. + Its not just employees under a contract of service or apprenticeship. The courts will define an Employee to be someone working under the employers control so it is worthwhile making sure that the definition of an Employee is as wide as possible and that the same definition is used on the employers public liability policy. In that way, injury or damage caused by an employee, for which the employer is vicariously liable, will be insured. + Its not just head office. It doesnt matter where the accident happened or the illness was caused whether it was on site or off site: if the employer is
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legally liable, the EL policy should apply. The only exception is drivers suffering a motor accident whilst at work. EU harmonisation means that compensation for work-related motor accidents is now covered under a motor policy another class of insurance made compulsory by law to ensure compensation is available. + Its not just UK companies. Foreign companies sending their employees here need to purchase the cover if they have a place of business in the UK. Such a place could be a building site or just a nameplate. Indeed, EL policies are unique in that insurers are severely restricted by law in the exclusions and conditions they can apply. Trade exclusions can be applied, e.g. work above a certain height or below a certain depth, work with explosives or asbestos, demolition activities or work offshore. However, these exclusions are designed to make sure the employer has shared all the information about the risk with his insurer and the correct premium is charged for hazardous activities. And, if the employer is working offshore, for example, he must take out EL cover for such work, otherwise he is breaking the law. The Employers Liability (Compulsory Insurance) Act 1969 ensures that the employer has at least a minimum level of insurance cover against any such claims. The statutory minimum amount is currently 5m any one occurrence although, in practice, most insurers offer cover of at least 10m. However, with court awards for serious injury to just one person exceeding 10m in the UK, employers should look carefully at their risk exposures and consider whether higher limits are needed. Particular attention should be given to the maximum number of employees on site at any one time. Further information regarding cover in the UK may be obtained from the Health and Safety Executive website (www.hse.gov.uk/pubns/hse40.pdf). This includes advice on what is required for employees working abroad and the categories of employers that need covering. Similar government websites may be found in other countries and we recommend that these are consulted for the latest requirements. But, just because an employee is injured at work, it doesnt necessarily follow that the employer will have to pay compensation. The employer has to be legally liable for the illness or injury: in essence this will usually involve some form of negligence on the part of the employer. This type of legal system is fault-based. 3.3.2 Workplace legislation outside the UK The UK and the Republic of Ireland are unusual in having a fault-based system of unlimited damages in tort and/or breach of statutory duty as the remedy for claimants suing for injuries sustained in the course of their employment. Most other industrialised nations, where compensation is available to those injured or contracting disease as a result of their employment, have no-fault systems, usually with pre-determined (liquidated) damages according to the nature and extent of such injury or disease. Most of these allow for regular amounts to be paid during the period of disability rather than a lump sum. Some of these schemes are funded by the state, others are financed by private insurance purchased by the employer. In the following paragraphs a few of the schemes are explained and the differences between these systems and the system used in the UK and Republic of Ireland are examined. 30 | CONSTRUCTION INSURANCE

3.3.3

Social security The most common system is government-funded social security. For example: + New Zealand operates a scheme that provides benefits for all injury/disease regardless of cause and precludes the injured/affected from suing in New Zealand courts; and + many European countries such as France, Italy, Spain and Germany operate similar systems with a scale of benefits according to the severity of the disability. These systems do not proscribe civil action by the injured party, but suits do not arise because there is no point. Some of these schemes allow recovery, in whole or in part, of amounts paid by the government from negligent or grossly negligent employers. Italy and Spain are two examples of this. These schemes are commonly known as workers compensation, workers comp or WCA.

3.3.4

Compensation funded by insurance policies Belgium, Denmark, each of the states of the USA, and Australia are examples of territories that have workers compensation statutes that provide scale benefits as outlined above, but where the insurance is provided by policies purchased by the employer from a commercial insurer.

3.3.5

Summary of schemes To conclude this brief outline, the differences between these systems are as follows: + The fault-based system requires the claimant to be able to prove their case and afford to mount the action, and provides uncertain results in the form of a single monetary payment. It costs the government nothing to administer, and, in the case of Great Britain, provides the government with a prospect of recovery of social security payments and hospitalisation costs from the compensator. It is relatively cheap for the employer. + The no-fault-based system with private insurance provides certainty to the injured party, can be tailored to social needs and is a lot more expensive for the employer to buy than cover under a fault-based system. + The social security schemes share the same benefits for the employee as the no-fault scheme. It is a choice of government policy whether the scheme is funded out of general taxation or from specific employment taxes. The cost is similar to no fault; it is mainly a question of who pays.

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3.4

Environmental insurances
Government policy in the UK over the last decade or so has been to promote the economic reuse of previously developed land, commonly referred to as brownfield sites, with well-documented and specific targets set for the number of residential developments to be built on such sites. These brownfield sites, many formerly occupied for a range of industrial uses, become available for redevelopment as the nature and needs of industry, particularly heavy industry, change and will continue to change. A good example is the coalfields legacy, where significant areas of brownfield land have been redeveloped over the last 10 to 15 years. A consequence of our industrial heritage is that many brownfield sites have, and will continue to be found to have, some degree of contamination of the ground and underlying groundwater. This guidance note examines environmental insurance and the role it can play in protecting and facilitating the reuse and redevelopment of such sites. For the purposes of the following paragraphs environmental insurance is defined as protection against an insureds exposure to the legal liabilities arising from the ownership and/or development of brownfield land and any consequential loss and damages. In simple terms this means: (a) exposure to third party claims for property damage, bodily injury or even loss of business; and (b) exposure to regulatory action by an authority that requires investigation, clean-up of contaminated ground/water or the restoration of environmental damage. A third category of loss protected by environmental insurance is the legal and other costs associated with defending an alleged claim by a third party or a requirement to take action by a regulator. The types of insurance policy available are addressed in later paragraphs.

3.4.1

Environmental and underwriting information understanding the risk Before quoting for any environmental insurance the insurers will require underwriting information specific to the risk that is being proposed. The information required has to be sufficient for the underwriter to understand both the nature of the risk(s) and the context of that risk, which will depend on whether the proposer is a buyer, seller, owner or developer. Environmental reporting is typically split into three phases, each of which can be iterative. A general description of each phase is set out below. Phase I: Desk-top reporting In this phase historical data is collected and interrogated. Such data will include maps showing previous uses, geological and hydro-geological maps, information from local authorities such as the proximity of landfill sites to the site in question, previous environmental incident and planning history. Environmental sensitivity, i.e. proximity to sites of special scientific interest, will also be of interest. Following this interrogation a site-specific report will be produced. There are a number of providers of these types of report, which, if necessary, can be supplemented by a site visit in order to gather more direct information. At this first stage potential risks are identified, for example the possibilities for site contamination as a result of its previous use. A qualitative assessment of

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the risk, as low, medium or high, may also be made. Depending on the outcome this may be all the technical data an underwriter will require to make a decision and offer terms. However, it is common for questions to be raised, which require a further level or phase of investigation. Phase II: Site investigation In this phase, a more detailed assessment of the site is made. This will often necessitate some level of intrusive investigation, i.e. taking soil and water samples, digging trial pits or boreholes. The outcome will be a report, which is both factual, in terms of what was done and the data obtained, and interpretative, in terms of what are the implications of the data. The interpretative report may also contain some form of qualitative and quantitative risk assessment. Indeed, the authorities may require the latter. Where a site is particularly contaminated the level of risk will need to be formally demonstrated and argued through the planning process together with any remediation (clean-up) proposals. Phase III: Remediation and validation At this stage any problems identified through phases I and II are remediated appropriate to the proposed use and the surrounding environment. Any remediation will be required to be documented as a full remediation plan before execution and then end-result validated. There may be a requirement imposed by the authorities for post-completion monitoring, particularly where there is ground gas or contaminated ground water, so that the authorities can be confident about the long-term situation. 3.4.2 Environmental exposure A range of possible exposures, for owners of brownfield and contaminated sites and land, to environmental risk and liability, is listed below. + Historical pre-existing gradual pollution Third party off-site property damage and loss of use of property Third party off-site bodily injury Third party on-site property damage and loss of use of property Third party on-site bodily injury Regulatory/legal liability for off-site clean-up costs Regulatory/legal liability for on-site clean-up costs Legal defence and expenses Change of law Migration from off-site third party property leading to on-site third party damage and/or regulatory or other legal action Contractual liabilities, e.g. warranty or indemnity exposure Cost certainty, cost cap on planned remediation cost overruns in remediation and clean-up can result, for example, from finding more contamination than the investigations suggested or higher concentrations and either may change the nature of the treatment or the cost of disposal
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Construction risk of the contractor creating new contamination on site or exacerbating an existing situation. This could arise, for example, if the contractor inadvertently provides a new pathway for pre-existing contamination to migrate and cause a loss or damage + New gradual pollution Third party off-site property damage and loss of use of property Third party off-site bodily injury Third party on-site property damage and loss of use of property Third party on-site bodily injury Regulatory/legal action off-site clean-up costs Regulatory/legal action on-site clean-up costs Environmental and biodiversity damage and losses under the EU Environmental Liability Directive (ELD) Legal defence and expenses

In addition, all these exposures can create significant and consequential business interruption. When assessing the liabilities and risk of exposure, it is important to distinguish between known issues which have been clearly identified, qualified and quantified and unknown issues, which can range from the suspected but unproven to the totally unexpected. Known issues are those which insurance is unlikely to be able to cover because they are (i) known to the insured and (ii) will have to be addressed, even if not immediately. There is no fortuity to any loss, just a question of when and how much. The nature of environmental insurance is that there will always be some intrinsic level of residual uncertainty by the very nature of the problem it is trying to address. 3.4.3 Insurance solutions There is a range of insurance policies to cover the environmental exposures of developers, property owners and contractors as described above. Whilst separate policies can be purchased to cover pre-existing pollution conditions (historical contamination) and new pollution conditions (future contamination) it is possible to purchase both policies to provide seamless cover for a site. Environmental insurance has proven a valuable tool for the transfer of the risk of environmental legal liability. It has proven particularly applicable in the context of the sale and purchase of land and property. When considering the types of risk that are insurable, it is important that any claims, losses or damages are both unexpected and fortuitous. Where this is not the case then the insurer is underwriting the cost of known conditions and expected or anticipated works. Where the risk is unexpected and fortuitous, known pollution conditions or contamination can be covered as long as: + the known conditions are defined and understood by the underwriters (this requires information); + the site remains in a suitable for use condition even with these known conditions; and 34 | CONSTRUCTION INSURANCE

+ the known conditions are not causing harm or have a significant probability of causing harm to the environment, human heath or controlled water. As an example, where there is a known condition that is assessed to be adequately controlled and contained by an engineered cap and cover, then the insurance can be provided for the unexpected and fortuitous event that the control mechanisms fail to adequately contain or prevent damage, which becomes apparent only after the insurance is incepted and in place. 3.4.4 Historical contamination Pollution legal liability insurance can be purchased to cover environmental liabilities associated with the ownership or transfer of ownership of contaminated land. These policies are often called contaminated sites/property transfer policies for pre-existing pollution conditions. They cover on-site and off-site bodily injury, property damage and clean-up costs, future legislation and legal and professional fees as a result of pre-existing conditions. Business interruption for loss of rental income can also be covered. Policies can be purchased for periods of up to ten years, 20m cover and with deductibles (excesses) of between 25,000 and 100,000. Portfolio cover: As for property transfer above but the policy will cover a portfolio of sites and is annually renewable. Such a policy will, generally speaking, also cover new pollution conditions as well as pre-existing pollution conditions. New sites can be added to the portfolio as they are acquired. Contractors pollution liability: This provides cover for exacerbation of pollution conditions during development including on-site and off-site bodily injury, property damage and clean-up costs, future legislation, legal and professional fees. Generally cover is for the period of the development and the limits will match those on the pre-existing conditions cover. Contingent cover can be provided for developers. Remediation cost cap: This is cover for remediation costs that exceed a level agreed by the insurer up to the limit of indemnity provided in the policy. The agreed level is the estimated cost of remediating the contamination plus a buffer, or deductible. Warranty and indemnity wraps: These provide cover for indemnities not being fulfilled. 3.4.5 Operational contamination Often insureds believe that their public liability (PL) insurance provides sufficient cover for sudden and accidental events but understand and take the risk that it excludes any cover for gradual pollution. However, it is not that simple and this is illustrated by two recent examples. First, the Bartoline case (Bartoline v. Royal Sun Alliance) which went to the High Court, demonstrated that costs for action by the regulators, where this is no property damage and no claim, might not be covered under a PL policy. In a second case, in France, a sudden and accidental pollution incident caused environmental damage under the EU Environmental Liability Directive, which was not covered by the general liability insurance programme but, fortunately, was picked up by their additional EIL programme. This case is currently being investigated and final losses determined.
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The range of products available for operating new conditions is similar to those for historical pollution providing similar coverage, but limited to new conditions. Combined solutions can be constructed to cover both pre-existing and new conditions. Contracting risks, particularly for contractors actually causing gradual pollution or exacerbating an existing problem, can be covered using a contractors pollution liability form (CPL), which can also be adopted within an owner-controlled insurance programme if required.

3.5

JCT non-negligence insurance


Construction is an inherently dangerous process, particularly when it involves working on or near to existing or neighbouring buildings or other structures. No matter how much care is exercised there is always the possibility that such property will suffer damage. Nobody has been negligent but nevertheless the owner has suffered a loss for which there is almost certainly no cover under their material damage insurance. It was this set of circumstances that led to the legal case of Gold v Patman & Fotheringham in 1958. This landmark case and the cover it gave rise to are summarised below.

3.5.1

History Gold was the owner of a property that was to be modified. The defendants entered into a contract with Gold to carry out the work and it included piling. Although the contractors were not negligent in any way, the adjoining third party property suffered damage as a result of their piling activities due to the weakening of support. The owners of the property had no right of action against the contractors, as they had not been negligent. However, they succeeded in a claim against Gold on the grounds that the damaged property had acquired a right of support from Golds land and that Gold removed that support at his peril, however this was done. Gold tried to recover from the contractors who had, in fact, arranged such cover in their own names but not in the name of Gold as well. The wording of the contract had not required them to procure a joint names policy.

3.5.2

Perils insured This case led naturally to the inclusion of a clause in some contracts that requires the contractor to take out a policy that protects the developer in these circumstances, although there is nothing to stop the developers arranging cover for themselves. The insurance provides an indemnity to developers in respect of any expense, liability, loss, claim or proceedings incurred as a result of damage to property (other than the constructional works) arising from the works being done and due to collapse, subsidence, heave, vibration, weakening or removal of support and lowering of ground water. Cover from the perils of explosion, flood, backing up of drains and bodily injury to third parties caused by an insured peril, can also be requested. The cover may be in respect of existing buildings being worked upon and/or property on adjoining land. Cover is not always taken out as the kind of activities which give rise to such losses may not be present. It is usually left to the architect to recommend whether or not the cover is required but sometimes no consideration at all is given to the matter. Although the policy is issued in joint names it is the developer who is indemnified.

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3.5.3

Activities giving rise to loss The insured perils can arise in a number of ways, but it is work involving any of the following that is more likely to cause such damage: + + + + + demolition close to neighbouring property; excavation works near to existing foundations; piling; underpinning; de-watering;

+ shoring; + work affecting the load-bearing capacity of an existing structure; + work on listed buildings and buildings in poor condition. 3.5.4 Policy exclusions This is a non-negligent cover and the exclusions are, therefore, important to help understand the intention of the wording. The main ones are damage: + caused by the negligence, omission or default of the contractor or any subcontractor; + attributable to error or omissions in the designing of the works; + which can reasonably be foreseen to be inevitable having regard to the nature of the work or the manner of its execution. There is also an exclusion in respect of penalties incurred under contract and damages for breach of contract. These can arise where a developer enters into contracts affecting the developers liability to the owners or tenants of neighbouring property. However, this cover may be purchased if required by payment of an additional premium. The limit of indemnity selected should take account of the value of the surrounding property at risk. The cover is not that expensive bearing in mind the nature of the business but insurers will normally require a survey before they agree to anything. This type of insurance is exclusive to JCT contract forms and in the 2005 Edition is contained within clause 6.5.1. However, other contract forms could have a similar requirement brought in as an amendment. 3.5.5 Relationship to material damage and public liability policies Some of the perils referred to in the perils insured at section 3.1 above may appear to be covered by any material damage all risks policy on existing buildings. However, such policies will include a change of risk or similar condition requiring the insurers to be advised of any works that increase the risk of damage. The insurers will then have the opportunity to exclude the cover from the said material damage policy on existing buildings until the risk returns to normal on completion of the work. Alternatively, there may be an outright policy exclusion. For example, the perils of subsidence and accidental damage will always exclude such cover when any property is undergoing construction or structural alteration or repair. Similarly, there will be an exclusion of these perils under any public liability policy.
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3.5.6

Position under ICE contracts An ICE form of contract passes the non-negligent risk to the contractor. Therefore provided that he has a contractual liability extension on his public liability policy the non-negligent public liability risk stays with the contractor and is insured accordingly.

3.5.7

Key issues It is important when arranging this cover that the policy is issued in the joint names of the employer and contractor. Circumstances have arisen where a policy was issued in the name of the contractor only. A claim occurred by which time the contractor had gone out of business. The employer submitted the claim to the insurers who refused to deal with it as the employer was not a named insured and therefore had no rights under the policy.

3.6

Public liability insurance


Contract conditions invariably make reference to public liability insurance in both the indemnity and insurance clauses. They also state who is responsible for making sure such cover is in force and in whose names. In this guidance note the extent of cover available and who should be protected is examined.

3.6.1

Extent of cover A typical policy will provide indemnity in respect of liability at law for damages arising from accidental injury to third parties (not employees) or accidental damage to third party property arising in connection with the project. It may also cover liability for damages arising out of any nuisance or trespass committed by the insured and any rights (such as a right of way) with which the insured may accidentally interfere in the course of the development. Other elements of cover usually provided include: + claims defence costs; + the use of plant on the site; + legal defence costs in respect of prosecutions brought under the Health and Safety at Work etc Act 1984 and other specified legislation such as Consumer Protection legislation.

3.6.2

Restrictions in cover For some time, many insurers have excluded claims arising from sources they regard as particularly hazardous, such as terrorism, asbestos, gradual pollution, mould, e-commerce transactions and, potentially, financial loss where there has been no injury or damage as defined in the policy. Insurers may restrict their liability for particular risks by imposing inner limits much smaller than the overall policy limit. It is important to be aware of these and of whether they can be removed by payment of additional premium.

3.6.3

Limits of liability The policy may be arranged on an annual basis with a specific limit being the maximum amount payable in the event of any one claim or series of claims arising from one occurrence. It is normal for this limit to apply in respect of any one claim but some limits do apply to all claims in the period of insurance.

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There may be a limit on any one claim and then a separate aggregate limit. Sometimes there are elements of cover that insurers may be particularly concerned about, e.g. sudden and accidental pollution may be subject to lower limits of liability and/or separate aggregates. For larger projects the policy will often be project specific with primary cover written as part of a construction insurance package. Separate excess of loss policies would then be issued for the balance of cover required. For example, if a 50m limit of indemnity is required, the project policy may pay claims up to 2.5m with two other policies paying claims above 2.5m up to 25m and from 25m up to 50m, all for the same period of insurance. Whatever type of policy is issued, it is the insured party or parties that decides on the level of cover to be purchased dependent upon the risk exposure arising from the work being undertaken. When deciding upon the limits to be purchased it is best not to rely on any figure requested within a contract document, as this is normally the minimum amount required. A construction site is potentially an inherently dangerous place for: + visiting third parties; + surrounding roads and railways; + surrounding buildings; + the general public, particularly children. The limit of liability purchased is often determined by: + the cost of the cover; + the potential for third party injury or damage; + the nature of the works being undertaken; + the proximity of third party persons and property; + the values of surrounding properties; and + the probability of loss. The policy will be subject to an excess that will be deducted from the total amount claimed and may apply only in respect of claims for property damage or in respect of all claims. 3.6.4 Who should be covered? Every party on site with a potential liability to the public will require an insurance policy. Additional responsibilities for each party will also be set out in the contract. It is traditional and still common for the contractor to arrange a cover on behalf of the employer. However, it has to be asked if this is in the best interests of everyone, whether the employer who may find he has only nominal cover or a claimant who may find they are passed from one insurer to another if there are different policies in different names. One option is to effect a project policy arranged by the employer/owner or developer, as more specifically described elsewhere in these guidance notes. The parties protected by the policy will vary according to the developers requirements and the nature of the contract forms being adopted. The indemnity can apply to: + the developer, owner, employer only; or + as above and the main or management contractor; + as above and all trade/subcontractors.
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Apart from the above there may be freeholders, superior landlords, financiers plus professional consultants and suppliers (on site exposures only) to be added to the list of insured. The policy will set out the names of all insured and specify in which policy covers they have an insurable interest. N.B. Any party listed as an insured under a policy has duties under that policy, specifically to provide the insurer with all material facts. 3.6.5 Premium implications Public liability insurance is not cheap and if one party does arrange cover in two or more names the cost of this and the potential savings to the other names needs to be reflected in tender prices. 3.6.6 Key issues It is important to decide responsibilities for placing public liability insurance before contracts are signed, rather than just follow the provisions of the basic contract conditions. Whoever is making the decision as to who must arrange the cover must consider all those who may need to be protected. The list may well include freeholders and head lessees, apart from financiers and they may have concerns about the insurers. There may even be lease requirements calling for particular insurers to be used.

3.7

Surety bonds
A surety bond is a guarantee from the surety in favour of the employer/beneficiary that the contractual obligation of the principal will be fulfilled. Effectively, bonds are agreements between three parties for the benefit of one of them: the employer. There are numerous bond wordings to meet the needs of specific industries and the construction industry is one of the main purchasers of them. In this guidance note the purpose and benefits of bonds are explained.

3.7.1

Types of bond In the construction industry the following are the bonds most commonly found.

3.7.2

Performance bonds These guarantee that a project will be performed according to the terms and conditions of the contract and provide a cash indemnity to the employer in the event of a default by the contractor that leads to the employer suffering a loss. Bonds are usually effected for 10% of the contract price but could be more or less. The default is usually caused by the insolvency of the contractor.

3.7.3

Retention bonds These are issued in favour of an employer that has agreed to waive its right to deduction of retention monies from sums owed to the contractor for work carried out. The bond will be for the retention percentage, which usually ranges from 3% to 5% of the contract price.

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3.7.4

Advance payment bonds These are appropriate where an employer makes a payment to a contractor or subcontractor in advance of construction. This advance might be made to purchase an expensive piece of machinery essential to the work being done. The bond amount would be the sum advanced.

3.7.5

Maintenance bonds These are a form of performance bond relating solely to the maintenance period. They provide a remedy for defective workmanship or faulty materials discovered after practical completion during the maintenance period. The bond amount would be assessed according to the risk.

3.7.6

Bonds and counter indemnities A bond is not the same as an insurance policy as risk is not transferred from the principal to the surety. The latter has a legal right to seek reimbursement from the former, usually via a counter indemnity. However, like an insurance policy the bond does protect someone (the beneficiary) against an unwanted event, e.g. non-completion of a contract by guaranteeing that money will be available, thereby giving the same peace of mind. A counter indemnity is a written agreement signed by the principal entitling a surety to reimbursement if it has to pay claims under any bonds it has issued. Such agreements are complex and can vary with each surety. They range from standard documents to indemnities incorporating undertakings and financial covenants.

3.7.7

The benefits Bonds offer an alternative to bank guarantees so the benefits are best understood by a comparison of the two. Surety bonds do not reduce the working capital of the principal or restrict its borrowing capability. They are conditionally worded, which gives the principal the protection of the underlying contract conditions. Surety companies rely on a counter indemnity, whereas banks often and additionally require a charge over the principals assets. Banks usually issue on demand bonds, which are payable on first demand and independent of contract conditions (which means the beneficiary does not have to establish any breach of contract). The surety bond can be a higher percentage of the amount at risk than a bank will offer. Further the employer is effectively being given an underwritten and independent opinion that the principal has the financial and operational ability to complete the contract satisfactorily. If it did not the surety company would not be prepared to issue the bond.

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3.7.8

International bonds International bonds vary enormously depending on the legal framework in the country concerned and the nature of the guarantee.

3.7.9

Key issues The requirement for bonds needs to be considered early as the benefits of these may need to be compared to those issued by banks before irreversible decisions are made.

3.8

Unexpected archaeological discovery insurance


In order to appreciate the need for the above insurance it is necessary to understand the role played by archaeology in the planning process, the potential losses that may be insured and the point at which insurance cover should be sought. All these issues are dealt with below. To a large extent the risks that the developer runs can be identified, assessed and mitigated but, as explained, a degree of risk is still left and it is this residue that may be insured.

3.8.1

The process The UK is very rich in archaeological remains and much of it still lies undiscovered. This evidence of our past is an irreplaceable national asset. It is protected by a host of legislation that is designed to trace and preserve it. Archaeology is an essential part of the planning process, a material consideration that cannot be ignored. Whereas some archaeological sites are scheduled ancient monuments or otherwise protected under specific legislation, most sites come under the government Planning Policy Guidance, Note 16 (PPG16), on Archaeology and Planning. This is arguably the most important publication relevant to archaeology and development in England. PPG16 establishes procedures to ascertain the archaeological impact of a development so that the planning authority can make an informed decision about how best to safeguard archaeological interests. It rests on the principle that archaeological remains are a valuable and finite part of our heritage that should ideally be preserved in situ even if they are not scheduled. Basically, it requires the developer to discuss the proposed development with the planning authority and, if requested, to include relevant information with the planning application. This often means that an archaeological study of the site has to be commissioned and is where specialist commercial archaeologists such as MoLAS (the Museum of London Archaeology Service) come in.

3.8.2

Risk management PPG16 sets out a number of stages in archaeological risk management. Stage one a desk-based study will assess the likelihood and extent of any remains on the site based on the archaeological and historical background of the site, the extent of disturbance caused by any earlier construction work and the impact of the proposed scheme. This study should be designed to provide the local authority with all the information it needs to decide on the appropriate archaeological treatment of the site. The study may suggest options in accordance with the clients wishes but it is the local authority that will have the last word. There are three likely outcomes of this study: + the local authority may approve the application with no further investigation;

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+ if the site is felt to have archaeological potential, the authority may require the applicant to submit a field evaluation report, which could involve digging test pits and trenches and other physical work on the site. This could be difficult or even impossible prior to planning permission if access to the land is restricted and it will certainly add to costs, with no guarantee that planning permission will be granted; + permission may be granted subject to a planning condition or agreement to deal with the archaeological requirements. Stage two a field evaluation may be required. This will usually be carried out in accordance with a brief set by the local authority, along with the proposed research objectives and method statements set out in the project design produced by the archaeological contractor. The evaluation whether required pre-or post-determination will then be submitted to the authority and they will either require further work or the archaeological planning condition will have been discharged subject to archiving of appropriate material and publishing results as specified. Stage three if further work is required, the developer and the archaeologist should now get together to identify measures to mitigate the impact of the proposed development on the archaeology. This third stage can go two ways: either the local authority will specify that archaeological deposits must be preserved in situ, without being disturbed, or they will specify that they should be excavated and recorded by professional archaeologists, normally under a planning condition. This can involve a lot of expense in changing working methods on site in order to preserve remains or in redesigning the foundations and other parts of the works. Their proposals, once agreed with the authority and the curator, have to be set out in detail in an archaeological project design that may then be appended to the ensuing legal agreement between the archaeological contractor and the developer. 3.8.3 Identifying the risk of unexpected discovery It is worth pointing out that early consultation between developers and archaeologists is beneficial. It may then be possible to anticipate events. Money could be saved by combining the desk assessment with the field study or by combining archaeological evaluation with geotechnical investigation work. Money can also be saved by having professionals with experience in smoothly integrating archaeological fieldwork into complex construction programmes. Sometimes, for example, archaeological excavation takes place within standing buildings before demolition. Once the archaeological work has been agreed, the use of a legal agreement has the effect of placing most of the risk with the archaeologists carrying out the work within the agreed programme and budget. However, the developer remains at risk if there is an unexpected archaeological discovery on site that causes further delay or additional cost or even a permanent loss of site value. It is against these possibilities that insurance can be taken out. The insurance requirements may be considered under the following headings. The most commonly purchased ones are delay and redesign, followed by additional archaeological costs and cancellation.

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3.8.4

Potential cover requirements 1 Delay costs additional costs incurred in relation to the delayed completion of the development, which the insured is legally liable to pay. This is likely to be the most significant unexpected cost to the developer and would include additional interest payments. 2 Additional archaeological costs incurred in undertaking a scheme of archaeological work, including fieldwork, post-excavation work and preparation of results to an agreed standard for publication, as required by the planning authority or other statutory or curatorial organisation. 3 Cancellation costs can be incurred as a result of the necessary cancellation of all or part of a project because of revocation of planning consent or the spot designation of unexpectedly discovered remains as a scheduled ancient monument. 4 Redesign costs the developer can incur this cost as a result of a requirement to revise the layout or constructional details of a project in order to ensure the preservation of unexpectedly discovered archaeological remains. 5 Loss of profit the nature of the profit would vary according to the insureds business but would include loss of rent. 6 Loss of value in extreme circumstances an unexpected discovery might mean a loss of space or even a whole storey with the result that the market value of the development is reduced. Before any quotation for insurance can be given, an independent risk survey by the underwriters archaeological consultant is required. The consultants fee, which is usually between 500 and 2,000, has to be paid in advance and is non-refundable. Underwriters minimum premium for this class of business is 5,000. References and contacts Planning Policy Guidance, Note 16, Archaeology and Planning, Department for Communities and Local Government, 1990 (www.communities.gov.uk /documents/planningandbuilding/pdf/156777.pdf).

3.8.5

Key issues Insurers do only cover the unexpected so it is important to get cover in place after the basic work described above but before someone starts digging foundation trenches. In the sequence of stages set out above it makes most sense to deal with insurance requirements as soon as possible in stage three. There can often be delays while the local archaeological or planning authorities decide exactly what their requirements are, but as soon as these are sorted out insurers should be in a position to get things done quite quickly.

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Further guidance on construction insurance issues


Insurance of existing buildings undergoing refurbishment or redevelopment
Where an existing building is to be the subject of contract works care is needed by those drawing up the contract conditions and those responsible for insuring the building. In this guidance note the problems that can arise are explained. It is far better to avoid them in the first place than to seek a remedy that may be expensive or partial or both.

4.1

4.1.1

Implications for current cover on existing buildings The insurance of contract works is relatively straightforward compared to the difficulties that can arise when a building is being worked upon. Such a building will probably be insured under a commercial all risks property owners policy whilst occupied or temporarily unoccupied pending the works. There will be a number of conditions in that policy that will apply when works are being carried out and these should be examined. If the contract does not involve much of an increase in risk the current insurers may be happy to continue the cover without additional charge but it will require reasonable precautions to be taken. On the other hand if there is hot work, e.g. work involving welding equipment or blowtorches, they may require an additional premium and/or risk improvements. If there are to be structural alterations, particularly if they involve foundations, insurers may wish to reconsider the cover and, say, exclude subsidence occurring as a result of the works. The remaining subsidence risk may then be insured under a non-negligence policy at terms reflecting the insurers assessment of the revised risk. The precise action will depend on the particular circumstances and the attitude of the insurers. However, it is also possible that the current insurer will wish to exclude the cover altogether on the grounds that the building is now a construction risk and best insured under a construction policy. The problem with this is that the construction insurance market is limited in size and does not always have the capacity to insure a substantial building.

4.1.2

The problems with joint names insurance on existing buildings A further problem flows from the same factor. A contractor working in a large building will worry about being sued if its negligence causes serious damage. Even if it could secure adequate public liability insurance, the premium may be prohibitive. To get round this the contractor will seek to pass the risk to the building insurers by asking for its name to be shown jointly on their policy alongside that of the employer. This is so-called joint names insurance. This is all very well if the employer is also the insured under the policy and is prepared to pay any additional premium and/or to accept restrictions in cover and/or to pay for additional risk precautions during the contract period. Either way it should be made clear that this is at the employers risk/cost.
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Problems start if the insurers of the building do not want to carry the additional risk. Alternatively the employer may not control the buildings insurance and the landlord or freeholder that does may refuse to agree to joint names status for the contractor. If either of these eventualities arises, a solution has to be found. There are solutions or partial solutions but they may be very expensive and still leave the employer carrying some risk. 4.1.3 One sum insured for both contract works and the existing buildings If the completed works will include very little of the original building, perhaps just the exterior walls or the facade, it may be better to cover both the existing building and the contract works under one policy with one sum insured. It should be cheaper and make settlement of any claims easier. 4.1.4 Advantages of insuring existing buildings under a CAR policy A CAR policy is designed for construction works and the cover is drawn up to reflect the risks inherent in construction. There are elements of the cover, e.g. DE3/5, additional cost of working, expediting costs and suppliers extensions, that may make it beneficial to insure the existing building under such a policy, 4.1.5 Key issues The insurers of the existing building must be advised of the nature and extent of the contract works or the policy could be invalidated. However, it may be better to cover the existing building under a contract works policy, as mentioned above. If the employer is undertaking to arrange a joint names cover on the existing building to protect the contractor, make sure this is possible. If the employer is a lessee or has not arranged the policy there could be problems that are both time consuming and expensive to resolve.

4.2

Project insurance and property developer all risks policies


The basic contract conditions used widely throughout the world usually call for contractors to arrange much of the insurance specified. The contractor is likely to pass on some of the insurance obligations to subcontractors and suppliers. Directly or indirectly the employer will pay all the insurance costs of the project. This is not necessarily in the best interests of employers. Increasingly, the conditions are being amended so that the employer arranges more of the cover and more is heard of so-called project and property developers policies. This guidance note warns of the need not to make assumptions about the cover under such policies and summarises the perceived advantages for employers of taking more responsibility for arranging insurance.

4.2.1

A word of warning There is no universally recognised meaning of project insurance and different people use it to mean any one of a number of things. It is sometimes used to describe a latent defects policy on a development project. Occasionally, it is meant to refer to a project professional indemnity (PI) policy, in other words a policy that protects the professionals on a particular project, rather than have each professional effect a separate PI policy to protect them in relation to all the work they do.

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The term has also been employed to refer to a property developers all risks policy, a product issued by some insurers that is effected by a developer and usually offers cover against all risks of material damage to the contract works and any existing building, loss of income (usually rent), public liability (for the developer only or both developer and contractors, etc.) and the JCT clause 6.5.1 perils. There was once a carefully drafted exposition on project insurance that explained that it was a policy that covered everything on site, if not in sight, including the four risks mentioned in the previous paragraph, latent defects insurance, professional indemnity insurance and, if required, environmental insurances. They may be the covers that need to be most considered but there will never be one policy that meets all these needs, let alone one insurer that offers the best cover at the best price for each. 4.2.2 The advantages of employer controlled insurance + There should be cost savings as duplication and overlap of insurance programmes is eliminated. A build up of minimum premiums for each participant is avoided. Staged premium payments are more achievable. + An improved standard of administration is achieved, as the insurance will be placed by one broker who will fully understand the activities involved in the project and who will provide proper administration of the insurance programme through a single channel of communication and a uniform system of claims handling. + The need to check the insurances otherwise arranged by contractors and subcontractors is avoided or reduced. The management fee of the contractor is reduced, as there will be less premium cost in the preliminaries. + There is certainty as to the scope of insurance protection (particularly if the public liability insurance extends to all contractors and subcontractors) and less risk of errors, omissions, unexpected exclusions, warranties, unknown excesses or problems arising from misrepresentation, nondisclosure or liquidation. The risks arising from mid-term cancellations and unpaid premiums are also reduced. + There is freedom to choose an insurer with good security, to dictate the basis of cover and to ensure that it is maintained at an adequate level throughout the period of the contract. + There will be direct control over settlement of claims and the use of claim monies. One adjuster can be used. + Potential disputes between the parties to the contract and between insurers can be avoided. + The above advantages are even greater for phased developments or major infrastructure projects let in lots or sections, e.g. Channel Tunnel Rail Link, where the difficulties are otherwise compounded.

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4.3

Risk management and insurance


The risks involved in construction are many and varied. They range from the risk of bodily injury to defective design materials or workmanship and from physical damage to the consequential losses that will follow on from that damage, particularly delays in completion. Those risks may be carried by the party on whom they fall or insured by that party. Alternatively, the responsibility for carrying some risks may be transferred to others. Those others then face similar choices. On a construction site, where so many different parties come together, often for the first and only time, and where the risks are so high, it is particularly important that the risk management process identifies all the potential risks and makes the right choices. In the following notes the role of risk management is summarised. Risk management is really a five-part process.

4.3.1

Stage 1 Risk identification The risks of physical damage, third party liabilities and defective design, etc. are well known but the consequential risks are often ignored. This is partly because reference to them is rarely made in the contract conditions and partly because there is a lack of awareness of all the possibilities, even those for which insurance cover is available. It is important to consider risks arising from external sources, such as suppliers and supply chains.

4.3.2

Stage 2 Risk evaluation This covers the likelihood of the risk materialising and an estimation of the potential cost. Some of the potential costs, such as for material damage, will be obvious and easily calculated. Some, such as third party liability are, strictly speaking, virtually unlimited and may be decided by how much insurance cover it is reasonable to purchase. Others, such as for consequential loss, are often difficult to quantify without a full understanding of the financial arrangements. If insurance is being effected it is important to understand how the policy deals with aspects such as inflation and the basis on which claims will be settled. Sums insured need to reflect what insurers will pay. Otherwise there is scope for underinsurance or the payment of unnecessarily high premiums.

4.3.3

Stage 3 Risk control and elimination This stage deals with the ways in which the risk can be avoided, reduced, prevented or minimised. Clearly CDM 2007 (Construction, Design and Management Regulations 2007) and loss prevention practices such as the UKs Joint Code of Practice on Fire Prevention will feature when the project is large enough or of more than 30 days duration in the case of the former. If insurance is to be arranged this may be impossible without certain measures being required by insurers. In the coming years expect to see much more emphasis on the avoidance of water damage on construction sites. The incidence and magnitude of water damage claims, arising from internal water services on site, has led to a

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guidance note being jointly published by the UK CAR Underwriters Group and CIREG (Construction Insurance Risk Engineers Group). The note is intended for projects during their design and construction stage and for ongoing construction projects. It calls for a wide range of risk improvement and loss prevention measures, including the nomination of an experienced individual to accept responsibility for managing/overseeing the exposure. This can be found at: www.msilm.com/pdfs/Water_Damage_Guidance_Note_4.pdf. 4.3.4 Stage 4 Risk transfer This is an assessment of the risks that are left, and which can be transferred to others by contract or by insurance. Careful consideration is essential before any risk is transferred. Why transfer a risk to a third party if that will involve proving negligence, when there may be a first party alternative available? Why let a third party arrange cover if that means having no control over the precise scope of cover or, worse still, the settlement of any claims? Why cover what is essentially the same risk twice or more by having several policies in one name when one policy in joint names or protecting several interests might be better? 4.3.5 Stage 5 Risk monitoring This really embraces two tasks. There is the all-important task of ownership, identifying and appointing those people within the organisation who will be given responsibility for implementing all the tasks arising from the risk management exercise and a review of the decisions taken in the light of any material changes.

4.4
4.4.1

Statutory inspection of plant and machinery


In the UK There are various regulations requiring periodic inspection (sometimes referred to as thorough examination) of plant and machinery in the UK that will apply to construction sites. These are summarised below.

4.4.2

The Lifting Operations and Lifting Equipment Regulations 1998 (LOLER) These regulations state that any equipment used for lifting and/or lowering loads must be inspected: 1 Where the safety of the equipment depends on the installation conditions (such as a tower crane, builders hoist, etc.): (a) after installation and before being put into service for the first time; or (b) after assembly and before being put into service at a new site or in a new location. Whilst in service: (c) in the case of equipment used for lifting persons or an accessory for lifting (equipment used to secure a load to the piece of lifting equipment such as chain slings, fibre lifting slings, shackles and the like, often referred to as miscellaneous lifting tackle) every six months; or (d) in the case of all other equipment every 12 months; or
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(e) each time that exceptional circumstances which are liable to jeopardise the safety of the equipment have occurred (such as its involvement in an accident or after significant change in conditions or use). Alternatively, a written scheme of examination can be drawn up which will specify the frequency of inspection but in practice this is unlikely to be feasible for construction site operations. 4.4.3 The Pressure Systems Safety Regulations 2000 (PSSR) These regulations require a written scheme of examination to be drawn up or certified as suitable by a competent person and periodic inspections to be carried out in accordance with the written scheme. Pressure systems containing relevant fluids are defined in the regulations and would include items such as air receivers or reservoirs, steam boilers, steam or other pressure vessels. 4.4.4 The Control of Substances Hazardous to Health Regulations 2002 (COSHH) These regulations require periodic inspection of local exhaust ventilation equipment designed to remove noxious substances at or close to their point of release to prevent or minimise exposure to persons. Inspection frequency is normally every 12 months. 4.4.5 The Electricity at Work Regulations 1989 (EAW) Although there is no statutory duty to have inspections carried out (other than in specific situations such as quarries), and therefore no prescriptive period between inspections, a duty of care is imposed to ensure that all electrical plant and installations are safe and do not give rise to danger or injury. The regulations state: as may be necessary to prevent danger all systems shall be maintained so as to prevent, so far as is reasonably practicable, such danger and regular inspection of equipment is an essential part of any preventative maintenance programme. The environment in which the systems are operated should determine the period between inspections. IEE guidance recommends that construction site electrical installations be inspected every three months. 4.4.6 The Provision and Use of Work Equipment Regulations 1998 (PUWER) Although these regulations do not contain any prescriptive inspection regime (other than for power presses) all owners/users of plant and machinery have a duty to ensure they maintain safe systems of work and it is their responsibility to identify items of work equipment which may require particular attention including periodic inspection. In some cases the inspection may need to be carried out by an independent competent person. 4.4.7 Inspection service providers/the competent person It is important that a competent person who is independent from manufacture, installation or maintenance carries out inspections/repair of the plant and is able to operate without fear or favour in completing and reporting on the inspections. 50 | CONSTRUCTION INSURANCE

It is strongly recommended that any service provider selected to carry out inspections is accredited as a type A inspection body by the United Kingdom Accreditation Service (UKAS) to BS EN ISO/IEC 17020:2004. This provides assurance that the service provider is competent to carry out the inspections. 4.4.8 Legal responsibility Legal responsibility to ensure that inspections are carried out on time (and that any defects revealed by the inspection are rectified within any stipulated timescale) rests with: (a) the employer (or, as applicable, the self-employed) in the case of LOLER, COSHH and PUWER; (b) the owner of a mobile pressure system or user of an installed pressure system in the case of PSSR; (c) additionally in the case of PUWER, the employers of those who have control of the equipment or those using or supervising or managing the use of the equipment; (d) where plant is hired in, the plant owner normally arranges inspections and evidence of inspection should be supplied with the plant. The user should ensure that this evidence is available. 4.4.9 Outside the UK Regulations requiring inspections are broadly similar in European Union countries, but can vary widely in other parts of the world. In some countries inspections are carried out by commercial organisations, as in the UK, but in others government bodies carry them out.

4.5

Third party interests and joint names under construction policies


In theory it is possible to add the names of third parties to any insurance policy provided that they have an insurable interest. However, both the party taking out the policy and the insurers must agree. In this guidance note the issues arising are explained. The first part deals with some general principles. The second part deals specifically with the protection of bank interests, as this is where many of the problems arise.

4.5.1

The means by which other interests are recorded There are two ways in which third party interests are specifically added to policies. Their names can be added by means of memorandum to the policy, which notes that they have an interest in the insurance. Alternatively, they can be added as another insured by being named as such in the schedule to the policy. If they are so named then in insurance speak they become a co-insured and a composite policy has been created. In JCT and FIDIC construction contracts there is often a requirement for joint names insurance. It has been the subject of case law and is generally understood. In the context of these contracts the term does lead to the creation of two divisible interests. In that sense it is the equivalent of co-insured. It is important to avoid the use of the term joint insured. Whilst the term is sometimes given the same meaning as co-insured it is incorrect to do so. A joint interest is actually an indivisible interest. The joint interests share only
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one contract with the insurer and any action by just one of them that contravenes the policy conditions will void the cover for all. 4.5.2 The degree of protection afforded There is a fundamental difference between the above two methods. An interest noted by memorandum gives that party no separate contract with the insurers. This means that they have no right to make a claim in their own name and they have no greater rights of recovery under the policy than the actual insured. In other words if the insured under the policy do not have a valid claim because they have contravened the terms of the policy, the third party noted by memorandum do not have a claim either. On the other hand co-insureds are in the same position as if they had taken out a separate policy in their own name. In effect, if there are four co-insureds, there are four separate policies. If three of the co-insureds all invalidate the policy for whatever reason, the fourth co-insured still has a valid claim. From an insurers point of view the creation of four contracts for only one premium is contrary to their best interests. However, they have to live with the reality of the markets and their main concerns are to what extent the possibility of a claim is increased and whether any extra premium is warranted. There are two different circumstances to examine. Direct risk This is best illustrated by an example. A developer may take out a public liability policy in its own name and the premium will be assessed accordingly. However, if it is decided that the policy should also protect the main contractor as a co-insured, the risk is obviously greater and it becomes greater still if subcontractors are also named. This can be dealt with by higher premiums. The public liability policy will, however, provide protection for the developer should they be vicariously liable for the actions of his contractor or subcontractors, even though these parties are not co-insured. Indirect risk This is best illustrated by considering what happens when a bank is lending money on a new development and wants to protect its investment. It is doubtful if naming any lender as a co-insured actually increases the risk of damage by an insured peril. The risk to insurers is that they might have to indemnify the bank to the extent of the outstanding loan in circumstances where they would not have to indemnify the developer because there has been a breach of policy conditions. Generally speaking insurers do not charge for this additional risk but reserve the right to do so in the future. 4.5.3 Protection of bank interests The following paragraphs are for the benefit of those readers who need a greater understanding of the issues around the protection of bank interests and the rationale behind lenders demands to be named under the borrowers policies. When a developer borrows money on the security of a development it is natural enough that the lenders want to make certain the insurance is in order. Their requirements generally fall under the headings below. 52 | CONSTRUCTION INSURANCE

Breadth of cover The demand for the borrower to take out adequate cover is perfectly reasonable. The usual risks would be those covered by a contractors all risks policy as explained in para. 3.2.1. In theory any one of the perils insured could be unavailable for a particular building but in practice it is rare to find restrictions in the UK. The main threat to the availability of all risks cover in the UK is flooding. Increasingly banks will find that flood cover may not be available in areas where the risk is high, particularly if there are no plans for flood improvement. In some territories outside the UK it is quite possible that all risks protection will be unavailable or that some perils will carry high deductibles or loss limits. Lenders have to decide if they want to carry that additional risk. Security of insurer Again it is reasonable for the banks to demand the insurances be placed with a reputable insurer with an agreed security rating. However, not all the insurers you would expect actually meet these ratings, and care needs to be taken, especially where more than one insurer is involved. Status The status that lenders seek is that of co-insured, which is achieved once the lenders name appears in the schedule to the policy. Loan agreements will usually seek such status on both material damage and public liability policies. Whilst the need to be a co-insured on a contract works policy is obvious, it is less so for the third party cover. However, third parties suffering injury or damage may take action against everyone connected with the development, including the lenders. Even if negligence against the lender may be difficult to prove, the lenders will benefit from being able to claim defence costs from the insurers. Subrogation waivers Whilst subrogation waivers are often requested these are unnecessary if the lender is a co-insured. Insurers cannot exercise subrogation rights against a co-insured. Non-invalidation clauses Banks insurance undertakings usually demand a clause protecting the bank against the possibility that the insurance will be invalidated by acts of the insured. Such clauses are variously known as non-invalidation, non-vitiation, mortgagees or multiple insured clauses. Other names can be used but they all fall into the same family of wordings that seek to protect a certain party or parties against the possibility that the policy is invalidated by the insured or another of the co-insured. Care is needed because there are no standard wordings and some would only protect the lender against certain breaches of policy conditions, but not all. This would only be of consequence if the bank had been unable to secure co-insured status and had to rely on its interest being noted by way of memorandum. If any party is named as a co-insured then, strictly speaking, it does not need the protection of a non-invalidation clause, but such clauses do give added peace of mind.
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Payment of claims monies Claim monies are usually properly distributed because they are spent on repair of the damage. Insurers do not want to pay any claim more than once so where they have to satisfy more than one insured or interest noted they make sure everyone is happy before paying the claim. Some banks seek loss payee provisions. The intention of these is that, to the extent that insurance proceeds would otherwise be paid to the borrower, they will be paid direct to the lenders. The lender can then ensure that the money is spent on repairing the damage. Caution should be taken if a lender requires an economic reinstatement test whereby insurance monies are diverted to the lender for debt repayment rather than damage repair. The insurance claim is based on damage reinstatement and therefore the recovery in the event of non-reinstatement may be less. Non-cancellation Once the banks achieve co-insured status insurers usually undertake not to cancel or lapse the cover without giving notice to the bank. However, insurers do not like giving greater protection in this respect to the banks than they would give to the insured that actually took out the cover so they will not hold cover indefinitely, probably only for 30 days maximum. Summary The protection of lenders can become time consuming and frustrating for borrowers, lenders, lawyers, insurers and brokers. Sometimes projects are delayed as a result. The problems are often exacerbated because documents and demands are inconsistent with insurance principles and practice. 4.5.4 Outside the UK The concept of granting co-insured status to lenders is virtually unknown outside the UK and, generally speaking, lenders are only given assurances over the destination of claims payments. In other words, lenders are protected against the possibility of any claims monies being used in a way that is contrary to their interests. Professional advice is essential. 4.5.5 Key issues Where another party is to be added to a policy and will bring additional risk the original insured should consider who will pay the extra premium and the consequences for their claims experience as this could impact on future premiums. This also applies should annual policies with premiums based on loss experience be exposed to these additional risks. To avoid unnecessary expense and potential delays it is best to take advice on the requirements of lenders insurance requirements and seek to amend any that are inconsistent with insurance practice.

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5
5.1

Latent defects insurances


Introduction
Latent defects insurance, sometimes referred to as building defects or inherent defects insurance, has been readily available from a limited number of major UK and other insurers since 1989. In spite of some increase in its use, there are still many who are not aware of it or do not fully appreciate the benefits it can offer when used early in the procurement of a wide range of projects. Instead, many project sponsors rely only on contract claims and the use of collateral warrenties or the Contracts (Rights of Third Parties) Act 1999 for security and redress in respect of the consequences of defective design and construction. As the subject is one that gives rise to more questions and misunderstandings than most other classes of business, a special section has been included to deal with these. Special considerations apply when a development is wholly or partially residential. Potential mortgagees belonging to the Council of Mortgage Lenders (CML) will almost certainly expect that a particular form of latent defects insurance is in place and is compliant with their requirements. A limited number of insurers provide suitable cover, which will carry far lower excesses, usually a maximum of 1,000 per unit, and may be for a maximum of 10 years. It may even be necessary to issue two policies on the same building, one for the residential parts and one for the commercial parts. The cover for the residential parts will be different in other respects to that summarised below, which is for commercially occupied properties only. The differences should be explained by the broker arranging the cover.

5.1.1

The cover in brief Imagine that you are building a four-storey office block. During the design stage the wrong information is fed into a computer and as a result understrength beams are used in the roof. During the foundation stage the excavations are inadequate and there is also soil contamination. Whilst the cladding is being installed a workman is supplied with fixings, some of which are of poor quality and not strong enough. In other words there were respective failures in design, workmanship and materials. These existed at practical completion but were undiscovered at that time. A few months later, after tenants had loaded up the building, the foundations started to subside and crack. The roof started to sag one year after that. Two years down the line some sections of the cladding parted from the framework and a few fell into the car park. After each incident, the owner of the building phoned its insurers and made a claim under their latent defects policy. The claim was handled in much the same way as if the building was damaged by fire. The insurer appointed adjusters, further investigations into the exact cause and the possibility of more damage from the same cause were carried out and estimates for repairs were obtained. In each case the insurer paid for repairs minus the deductible. It was also established that there would be further and imminent damage as a result of poor quality fixings if they were not replaced. Insurers agreed to pay the cost of installing new ones. The insured did not have to prove negligence against anyone and as subrogation rights had been waived
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by insurers there was no recovery from the contractors or professionals. In addition the insurers paid the loss of rent as a result of the operation of the rent cesser clause. That is what latent defects insurance can do for a new development. Of course there is a good chance that the faults would have been uncovered by the technical auditors and remedied before completion, in which case a degree of inconvenience and the cost of the deductibles would have been avoided. 5.1.2 The cover in more detail Those who have purchased latent defects insurance will know that the policy document is relatively short and quite easy to understand once the fundamental concept of the cover is appreciated. Further the cover does not vary much from one insurer to another. The following summary of cover and cost plus details of the technical auditors role is broadly correct for the class but there are slight variations between insurers and these may change further from time to time. Therefore the details below are for general guidance only and should not be relied upon for all insurance covers. It is important to complete a proposal form, obtain firm quotations and compare policy wordings before making any decision as to how to proceed. 1. The basic protection + The basic policy covers actual physical damage to the whole of the building (including the internal and external services) but only when such physical damage is caused by inherent defects that originate in the structural parts of the building. A typical definition of structural parts is shown below but it does vary from one insurer to another. + An inherent defect is one that exists prior to the date of practical completion but that remains undiscovered at that date and manifests itself during the period of the policy 10 to 12 years. + The inherent defect may be in the design, materials or workmanship. + There is no need to prove negligence against a third party. Whoever is named as the insured in the policy makes a claim against the insurers in the same way as they would claim for fire or storm damage under a property damage policy. The structural parts are usually regarded as: + foundations, columns, beams; + external walls and cladding including glazed curtain walling and non-load bearing facings and their fixings; + external doors and windows; + stairs and floors including screeds designed to the strength of the floor of which they form part; + roof structures; + other external and internal load bearing elements essential to the stability of the property. A precise definition will appear in the policy for each insurer. The definitions used by some insurers are wider than that shown above and include features that other insurers would regard as non-structural. 56 | CONSTRUCTION INSURANCE

(a) Weatherproofing and waterproofing cover Damage resulting from ingress of water caused by a defect in the weatherproofing and waterproofing is usually, but not always, included as standard within the basic cover. As inherent defects in wall cladding and roofing are a major source of damage it is always best to include it. There is an exclusion of cover for the first 12 months after practical completion. This is seen by some as an important exclusion that detracts from the value of the policy. However, it is not possible to remove the restriction. Insurers take the view that the developer must take care to appoint a contractor that will be around long enough to rectify defects during this initial period. Cover operates in the event that physical damage is caused by water entering the building due to a defect in the weatherproofing envelope of the building at or above ground level or the waterproofing seal below the ground floor. (i) Weatherproofing The weatherproofing envelope will normally include: + roof coverings; + skylights; + external walls and cladding; + external windows and doors excluding moveable elements; + the ground floor slab. (ii) Waterproofing + These are the waterproofing elements that are designed to prevent water from entering the building below ground level. 2. Optional covers Some insurers offer the following in addition to the basic cover: + Damage to the whole building (including the internal and external services) caused by a defect in the non-structural parts of the building. (In practice such defects are unlikely to have catastrophic consequences.) + Damage to the whole building caused by a defect in the mechanical and electrical services. (In practice such defects are likely to damage only other parts of the services themselves unless they lead to the operation of a peril such as fire that would, in any case, be covered under an annual all risks material damage policy. However, anything is possible.) (a) Non-structural parts These are generally regarded as being all other parts of the building not included under the heading of structural parts, weatherproofing and waterproofing. It is unlikely cover will be available for damage to protective coatings, decorative finishes and floor coverings apart from permanent floor finishes. As mentioned above, some definitions of structural parts include items that other insurers may define under non-structural parts. Clearly, this is an important differentiator and may influence the choice of insurer.

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(b) Mechanical and electrical services An extension of some insurers policies cover can be provided for damage caused by inherent defects in: + heating, ventilating and air conditioning systems and fresh and waste water systems; + lifts and escalators; + window cleaning equipment; + electrical distribution systems (including fixed lighting); + building management systems and building security equipment (including car park ticket machines and barriers and all types of electrical security doors) but excluding external services. 3. Main exclusions applying to all covers The main exclusions applying to all covers are as follows: + works which are outstanding at practical completion; + use of the property other than that for which it is designed; + load or application of pressure in excess of the design load or pressure; + inherent defects discovered during the defects liability (or maintenance) period and the remedying of which is the contractors responsibility under the terms of the building contract; + wear and tear and gradual deterioration; + fire, lightning, explosion, earthquake, storm, flood, escape of water or oil from any tank, apparatus or pipe; + pollution and contamination; + war and allied risks. The fourth exclusion, like the exclusion of weatherproofing and waterproofing cover referred to in 1(a) is perceived by some as too harsh. Insurers take a similar view on why it is justified, although, in practice, they may be prepared to limit its effect. (a) Exclusion applicable to the mechanical and electrical services cover only + Testing and intentional overloading of the mechanical and electrical services unless in accordance with manufacturers or suppliers instructions 4. What insurers pay for in the event of a claim In the event of a claim, insurers pay for: + + + + cost of repairing damage; cost of remedial action to prevent imminent damage; professional fees; cost of debris removal and site clearance;

+ extra cost of reinstatement to comply with public authority requirements; + cost of removing contents whilst work is carried out (there is a limit on this, which may need to be raised). The above are the main elements of protection but individual insurers wordings should be examined for the full cover. 58 | CONSTRUCTION INSURANCE

5. Who is protected by the insurance policy? + The policy will usually be in the name of the developer but is freely assignable to new and subsequent owners, lessees or financiers. + Insurers are usually (but not always) prepared to waive subrogation rights against architects, engineers, contractors and others (but not suppliers) on payment of an additional premium and, usually, the imposition of a higher deductible. 6. The benefits to the insured of buying the cover + It provides immediate funds for repairs and minimises disruption. + It means a phone call to a builder rather than a lawyer when damage is discovered. + It meets the insurance requirements being imposed by many financiers. + It can be a major advantage when negotiating a sale or letting. In fact, some major tenants are now insisting on the cover being in place. + The employment of the technical auditors required by insurers to protect their own interests has benefits for the insured as well. The risk of a defect arising is reduced and this is particularly important because if it is a defect that could give rise to damage the insured may be saved from having to pay for losses falling below the deductible as well as the deductible itself if larger claims are avoided. 7. The perceived benefits for the construction project if the cover is purchased + Developers do not need to rely to the same extent on the project teams professional indemnity insurance. + The potential for confrontation is reduced. + There is more peace of mind for all the project team. + Less time and money is spent on arguing about contract conditions and warranties. + Innovation is encouraged. + Everyone can concentrate on getting the actual design and construction right. 8. The premium and technical auditors fees for basic structural cover plus weatherproofing and waterproofing for 12 years Typical rates for the basic cover, including the fees, usually range from GBP 0.65% to GBP 1% on the total contract value rising to GBP 2% for completed buildings. Total cover including structural, weatherproofing, waterproofing, nonstructural and M&E services cover usually costs from 1% to 2% of total contract value inclusive of fees; 10% of the premium is usually paid when the insurance is taken out and the other 90% is paid soon after practical completion. The technical auditors fees are usually paid in stages as they carry out their tasks during the design and construction period. Some insurers now offer instalment facilities for the premium over the period of the policy and some may not require the 10% deposit. Some insurers charge the auditors fees separately from the premium. Others do not charge the fees separately but pay the auditors out of the deposit premium they receive.
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9. The role of the technical auditors The role of the technical auditors is: + to monitor the design and construction; + to check that communication within the project team is effective and that responsibilities are clear; + to visit the site at regular intervals; + to clear up problems arising with the contractors or professional team, preferably without the need to involve the insurers or the developers; + to issue a certificate of approval to insurers at practical completion; + if applicable, to issue a further certificate relating to weatherproofing/ waterproofing cover for 12 months after practical completion. The precise role will depend on the demands of individual insurers. 10. Consequential loss covers When buildings cover is purchased, it is usual for loss of rent to be insured as well. In addition, the basic policy will usually include minimal cover (say 250,000 or 10% of the sum insured) for the cost of removing contents from the building whilst repairs are completed. It is possible for occupiers to purchase any kind of business interruption cover just as they can for damage by fire or other perils. It is important that brokers are advised of any likely requirements for consequential loss covers, whether loss of rent or otherwise, at the outset. Such requirements may substantially increase the exposure and influence the markets to be used.

5.2

Latent defects insurance and collateral warranties/third party rights


Whilst latent defects insurance has been increasingly used in the UK, there are still many who do not know about, explore or appreciate its benefits and simply rely only on contract claims and the use of collateral warranties or the Contracts (Rights of Third Parties) Act 1999 for security and redress in respect of the consequences of defective design and construction and the assumption of continued availability of professional indemnity insurance for key parties in the project.

5.2.1

The rationale for collateral warranties or third party rights As mentioned in the opening pages to these guidance notes, the rights and obligations of the participants in a project are governed by the contracts into which the parties enter and the prevailing law. Where project parties want specific rights relating to a contract to which they are not a party, this is often dealt with by means of a collateral warranty, which creates a direct contractual link to enable the party granted the warranty to enforce certain rights against the grantor under certain circumstances. This type of contract is dependent upon (collateral to) the underlying principal contract such as a consultants appointment or a construction contract, a certified true copy of which must be provided to the beneficiary with the collateral warranty (otherwise the rights under the warranty cannot

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be clearly interpreted). Typically, the rights dealt with under a collateral warranty relate to workmanship, design standards and specifications and, in respect of parties with a close interest in ensuring the project is completed, an option to step-in and take over the underlying principal contract. An alternative to the use of collateral warranties is available through the Contracts (Rights of Third Parties) Act 1999, the use of which is growing. It is now an option in some standard form construction contracts. If this statute is used, third party rights may be enshrined in the principal contract (usually in a schedule). The given rights will then automatically be conferred on the specified third party (which may be identified as a class) when the principal contract is executed and dated without the need for a separate contract document to be engrossed and executed by the relevant parties to make those rights enforceable. If the third party is specified as a class (e.g. tenants) a further specific short notice should be given to notify the giver of the rights of the specific third party. Third party rights need negotiating in the same way as the rights under the collateral warranty. It is common to have to procure at least 30 and often 100 or more collateral warranty documents over various stages of a project. Some of these can prove troublesome (and hence extra costly) to obtain together with the appropriate certified copies of the principal underlying contract. This is particularly the case with subcontractors. Significant effort (and cost) is put into obtaining these, but the real long term value of many collateral warranties is questionable. 5.2.2 The drawbacks to reliance on collateral warranties and third party rights Once the project has been completed these warranties/rights will often only be of value if the party granting them is still supported by the requisite professional indemnity insurance and even this assumes that the warrantor is still in existence and not insolvent and that the cover is available on reasonable terms. The grantee then has to check every year that the warranties/rights are still so supported. This can be time consuming and creates further paperwork. A claim has to be made and liability established before the injured party will receive any compensation. In many ways professional indemnity cover and, therefore, reliance on warranties/rights is not a satisfactory solution for parties trying to secure against the risk of something wrong with the design and specification of a completed development over a period of up to 12 years from completion. Workmanship issues will not generally be covered by insurance unless they happen to fall under the all risks policy before completion or the buildings/ property insurance following completion and action would need to be taken against the appropriate party (ultimately the contractor). Often it is difficult to know whether a problem is a design or workmanship issue and this adds to the cost, time and difficulty in seeking and obtaining redress and monetary compensation from the parties who are liable and their insurers. Even if the collateral warranties/rights are well drafted and professional indemnity cover remains in force for up to 12 years, there is still one major obstacle that has to be overcome before their value is realised. Negligence or fault still has to be proved and that may be both expensive and timeconsuming, with no certainty of a positive result and an uncertain timescale. One of the big advantages of latent defects insurance is that it is not necessary to prove fault or negligence and compensation is available relatively quickly
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(and usually without great expense) to the insured provided, of course, the damage suffered is covered under the policy. The existence of this type of policy should be a significant attraction to a purchaser of the development or tenant of the whole or a substantial part of the development with a full repairing covenant. When banks start lending again they may be even keener than before on seeing the cover in place. 5.2.3 Is latent defects insurance a panacea for developers? It should not be viewed as a panacea. Latent defects insurance (LDI) is primarily for new build (see some questions answered para. 5.2.5 below) and cannot replace or cover all categories of liabilities that may otherwise be available via a claim under a collateral warranty/third party rights schedule. There must be physical damage for an LDI policy to respond and, at the moment, it is unlikely to respond to a defect during the rectification or latent defects period. But, if approached in an enlightened manner with a progressive project team there will be ways of getting real value out of a atent defects policy and seeking cost saving elsewhere. It needs a little forethought and planning and it will bring real benefits to, for example, an investor, tenants (with full repairing covenants), management companies and purchasers. Depending on market conditions it may be a factor influencing ease of rental or ease of sale. 5.2.4 Getting best value from the policy + Research and put into effect a latent defects policy at the outset of the planning and procurement process. This will provide a benefit not only in terms of obtaining the best possible premium for the policy, but also optimising the design and procurement process so costs can be saved. + Purchase the broadest cover available that is appropriate for the particular project and the needs of the key third parties (this might include mechanical and electrical). + Investigate and understand the role and responsibilities of the technical auditor and share this knowledge with everyone associated with the project and make use of the technical auditors role as widely as possible. + Consider and explore whether the party providing finance might use the technical auditors as their technical monitors and so seek to save costs. Make the approval of the technical auditors a condition of achievement of practical completion and reflect this in the building contract and the contract administrators appointment. + Use the Contracts (Rights of Third Parties) Act 1999 to avoid the need for collateral warranties and thereby save the cost involved in obtaining the completed warranties from consultants and contractors. + If a waiver of subrogation against the design team and contractors can be purchased from the latent defects insurer, consider and explore a discount on consultant fees and contractor pricing. Some questions answered How much does latent defects insurance cost? The cost will depend on a number of factors but 1% of the cost of construction will usually be enough to buy most of the cover normally purchased as well as paying for the auditors fees. The premium is initially calculated using a breakdown of figures from the contract price but is adjusted on completion to 62 | CONSTRUCTION INSURANCE

5.2.5

reflect the cost of rebuilding the completed construction. The cost can be far cheaper for larger developments, mainly because the auditors fees are proportionately less. When should I buy it? Although the cover does not take effect until practical completion or shortly afterwards, insurers should really be approached long before construction commences. Ideally the insurance should be considered at the outset of the planning and procurement process. There will then be plenty of time for the technical auditors to carry out their duties, which may have a bearing on their costs. Furthermore, the sooner the auditors start work the greater the potential benefits of their involvement. Finally, it is cheaper than buying the cover once building work has started. Is it possible to buy the cover for buildings where construction has already started or on completed buildings? The short answer is yes. However, the number of insurers willing to quote may be diminished, the cost will be more, possibly twice as high, the deductible for each and every loss may be doubled as well and some of the benefits of using a technical auditor may be lost. In fact the later the cover is purchased the more it costs and the less the benefits. Loss experience shows that insurers suffer more losses on buildings where the technical auditors had less opportunity to have input into the project and check the design and quality of the workmanship. Do refurbishments and redevelopments qualify for cover? The cover is designed for new buildings, but if there are new structures among the works it may be possible to buy protection for the new parts with consequential cover on the rest, should a failure of the new structures lead to damage elsewhere. Success in buying the cover is more likely if only a facade is being retained with a new building behind it. After that it becomes progressively harder. How long does the policy run? The period of insurance is usually for 12 years from practical completion. If cover is not purchased until after completion it will still have to expire on the same date as if it had been purchased from completion. Whilst it is possible to buy cover for shorter periods, this rather defeats the objective of the policy and the premium saved may not make it worthwhile. How do I go about buying the cover and what will happen then? The first step is to approach an insurance intermediary preferably one with a good understanding of the subject. You will then be asked to complete a proposal form; this is the best means by which insurers can gather the information they need to assess the risk. A number of documents will also be required, including plans, drawings, ground conditions report, method statements and bar charts. Insurers and auditors will make clear their precise requirements. Insurers will then advise provisional terms, including premium cost, extent of cover on offer, levels of deductible, deposit premium, if any, and the technical auditors fee. Sometimes the latter is included within the deposit.
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Once you have accepted the terms and paid any debits, you will need to supply any further documentation required and the technical auditors will commence work. Their task will be easier if the necessary introductions are made to those working on site, their role is explained and effective lines of communication are drawn up. The auditors will carry out their duties both in their office and on site. They will submit regular reports to the insurers but their intention is that at practical completion you will secure the cover you were seeking from the outset. Any problems they identify will usually be resolved immediately, with as little fuss as possible, and insurers may not even be advised. If there is a disagreement there will be negotiations and in the unlikely event of a compromise not being reached the implications for cover and terms will be explained. An important point is that once you have accepted the insurers offer of cover, they are bound to issue a policy in accordance with that offer subject to the audit being satisfactory. There should be no nasty surprises at the end! At practical completion the auditors should be able to sign off the risk as suitable for the policy. Insurers will then advise final terms, which rarely differ from those quoted. Once the premium is paid, a policy will be issued. Why is the whole building not covered against damage? The whole building is covered against damage caused by inherent defects as defined. Confusion sometimes arises because under the basic policy cover the inherent defect has to be in the structural parts of the building as defined. In other words there is no cover if the inherent defect is in the non-structural parts. However, some insurers offer non-structural defects as an add-on, although others feel that their policy definition of structural parts is so wide that the risk of a major problem arising from the remaining parts is negligible. 5.2.6 Clearing up the misconceptions One of the most frustrating things about handling latent defects enquiries is the number of misconceptions that have grown up around it. To a certain extent this is because insurers have not really promoted the cover. In the following paragraphs some of the misunderstandings are stated and the true facts explained. Does it really cost between 3% and 7% of construction costs? Cost has been dealt with elsewhere. It is usually 1% or less for a 12-year policy. Nobody will pretend that, even at 1% or less, the cost of the cover is a welcome addition to the budget. It is sometimes possible to pay by instalments and if the cost could be recovered from tenants it could add less than 1% to a tenants annual outgoings. However, if the insurance was regarded as an integral part of the package and not just as an add-on, there could be savings in other areas. The cover is not wide enough and does not give developers the certainty they require There is an argument that two of the policy exclusions, those relating to defects arising in the first 12 months after completion, remove cover that developers really need in order to remove uncertainty about their potential liability for defects after completion. In practice the exclusions refer to defects that should be put right by contractors. 64 | CONSTRUCTION INSURANCE

The technical auditors duplicate works unnecessarily (they also add to the cost of construction, interfere with the project and can be the cause of delays. Even without the auditors involvement, the insurers requirements for a risk-free building will add to costs) If all of the above were true the cover would have been dead in the ground years ago. No doubt some of these things are true some of the time, but they are unintentional. The auditors do duplicate some work because they are a checking agency, but the real concern is usually based on the belief that they are duplicating the work of other auditors who may be acting for a tenant or funder. In practice the other auditors are probably working to a different brief and their audits are unlikely to be nearly as thorough. If there is potential and unnecessary duplication this could be tackled and removed by negotiation with interested parties, including the insurers and their auditors. The audit should not increase building costs or cause delay, as the brief is only to make sure the building is erected in accordance with good practice and the building regulations. The deductible is applied to every claim and this, to a large extent, defeats the objective of the cover It depends on the wording of the policy but the usual position is that if there are a series of claims arising from the same cause, the deductible will only apply once. We already have collateral warranties and always follow up to make sure that professional indemnity covers remain in force for years after the contract is completed Fine, but that does not guarantee that if damage occurs the cost of repairs can be recovered quickly (or at all if the liable party becomes insolvent) even if negligence can be proved. A claim must be made and proved against the parties with potential liability, who may not be in existence years hance. The damage may still not be repaired in the meantime. A latent defects policy does not require proof of negligence and funds can be available relatively quickly for remedial works. The Contracts (Rights of Third Parties) Act 1999 gives all the protection needed Whilst it is true that this Act may help, there is still a reliance on negligence being proved and the guilty party having sufficient funds available by insurance cover or otherwise. The same drawbacks apply as with collateral warranties (see above). My professional team sees no advantage for them in the cover being in place and have a fear of being sued by insurers if they get things wrong There are several points to make here. First, there is no evidence that insurers do sue as a matter of course. In, fact experience seems to indicate they only do so in rare circumstances. Secondly, it may be possible to purchase a waiver of subrogation in favour of some parties involved in the project. Thirdly, the activities of the technical auditors should actually reduce the risk for everyone. Fourthly, as latent defects insurance becomes more common then in the longer term this may lead to a transfer of some risks away from PI policies and a subsequent reduction in PI premiums. In the meantime, of course, the
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professionals will no longer be first in the firing line when insured defects are discovered. Finally, if latent defects cover assumes the right place in the whole insurance umbrella, the professionals might be able to rid themselves of some of the worry and paperwork and devote more time to what they like doing and do best. 5.2.7 Key issues Do: + think about latent defects insurance at an early stage in order to minimise the cost and maximise the benefits. The cost can almost double if the insurance is purchased after the foundations have been started; + think of the cover as an integral part of the procurement and construction process. It should not be an afterthought purchased only to satisfy funders or tenants; + make sure that all those working on the project know from the outset that cover is being purchased and they understand the advantages and implications for them; + appoint someone to work with the technical auditors to ensure that the documents and information they require are made available in good time. Ideally, the same person should also liaise with the auditors on site visits; + make it clear from the outset if any consequential loss cover is required as this will have a bearing on the market placement. Do not: + buy it too late and pay higher premiums as well as losing some of the benefits of the auditors involvement; + dismiss the insurance out of hand. Experience suggests that once a client purchases the cover, they go on doing so; + advise insurers of the final sum insured on buildings, on which the premium will be assessed, until you are satisfied that it is calculated in accordance with the requirements of the particular insurers policy wording. It is important to appreciate how the basic policy cover provides inbuilt protection against inflation in construction costs during both the period that would be required for repair or reinstatement following damage and the period of insurance. Getting it wrong can be expensive in terms of unnecessarily high premiums or inadequate protection. 5.2.8 Further information For further information see Property Eye, issue 21 (autumn 2006) (Aon Limited) available at www.rics.org. Hard copies can be obtained from Aon Limited.

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Construction insurance
1st edition, guidance note
This guidance note is designed to outline best practice for property professionals dealing with construction insurance. It offers practical help and advice for each stage of a construction project from the initial development, through to project completion. The guidance note covers the following key areas: Introduction Rights and obligations of principal parties Contract conditions Global implications When the various insurance covers need to be considered Surveyors guide to professional indemnity (PI) insurance Directors and Officers (D&O) liability insurance Consequential loss insurance for construction risks Contractors all risks or contract works insurance Employers liability insurance Environmental insurances JCT non-negligence insurance Public liability insurance Surety bonds Unexpected archaeological discovery insurance Insurance of existing buildings undergoing refurbishment or development Project insurance and property developer all risks policy Risk management and insurance Statutory inspection of plant and machinery Third party interests and joint names under construction policies Latent defects insurance and collateral warranties/third party rights

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