Professional Documents
Culture Documents
Part 4 - RICS Construction - Insurance - Black Book PDF
Part 4 - RICS Construction - Insurance - Black Book PDF
rics.org
Construction insurance
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.
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.
iv | CONSTRUCTION INSURANCE
Contents
RICS guidance notes 1
1 Introduction 2
1.1 Introduction 2
1.2 Rights and obligations of principal parties 3
1.3 Contract conditions 3
1.4 Overseas issues 3
1.5 When the various insurance covers need to be considered and 4
when each cover starts and finishes
1.5.1 Contractors’ all risks insurance 4
1.5.2 Consequential loss 4
1.5.3 Directors’ and officers’ (D&O) liability insurance 4
1.5.4 Employers’ Liability (EL) insurance 4
1.5.5 Environmental insurance 5
1.5.6 Existing buildings 5
1.5.7 Latent defects insurance 5
1.5.8 Non-negligence insurance 5
1.5.9 Professional indemnity (PI) insurance 6
1.5.10 Public liability (PL) insurance 6
1.5.11 Surety bonds 6
1.5.12 Unexpected archaeology discovery insurance 6
CONSTRUCTION INSURANCE |v
3.1.6 Loss of rent and loss of use of sale proceeds, including 20
assessment of indemnity period
3.1.7 The developer’s choice as to basis of settlement 21
3.1.8 Expediting costs (additional cost of working) 21
3.1.9 Costs incurred in raising or extending loans 22
3.1.10 Additional overhead costs (sometimes referred to as ‘soft 22
costs’)
3.1.11 Higher cost of development finance 22
3.1.12 Additional increase in cost of working cover 22
3.1.13 Damage away from the site including prevention of 23
access
3.1.14 Damage at suppliers’ premises 23
3.1.15 Time excess 23
3.1.16 Unusual consequential risks 24
3.1.17 Key issues 25
3.2 Contractors’ all risks or contract works insurance 26
3.2.1 The cover 26
3.2.2 Joint Code of Practice on Fire Prevention 27
3.2.3 Additional cost of construction of unbuilt works 27
3.2.4 Defective design, materials and workmanship 27
3.2.5 Defective design, materials and workmanship clauses 28
3.2.6 LEG clauses 29
3.2.7 Legal challenges 29
3.2.8 Key issues 29
3.3 Employers’ liability insurance 29
3.3.1 The Employers’ Liability (Compulsory Insurance) Act 29
1969
3.3.2 Workplace legislation outside the UK 30
3.3.3 Social security 31
3.3.4 Compensation funded by insurance policies 31
3.3.5 Summary of schemes 31
3.4 Environmental insurances 32
3.4.1 Environmental and underwriting information – 32
understanding the risk
3.4.2 Environmental exposure 33
3.4.3 Insurance solutions 34
3.4.4 Historical contamination 35
3.4.5 Operational contamination 35
3.5 JCT non-negligence insurance 36
3.5.1 History 36
3.5.2 Perils insured 36
3.5.3 Activities giving rise to loss 37
3.5.4 Policy exclusions 37
3.5.5 Relationship to material damage and public liability 37
policies
3.5.6 Position under ICE contracts 38
3.5.7 Key issues 38
vi | CONSTRUCTION INSURANCE
3.6 Public liability insurance 38
3.6.1 Extent of cover 38
3.6.2 Restrictions in cover 38
3.6.3 Limits of liability 38
3.6.4 Who should be covered? 39
3.6.5 Premium implications 40
3.6.6 Key issues 40
3.7 Surety bonds 40
3.7.1 Types of bond 40
3.7.2 Performance bonds 40
3.7.3 Retention bonds 40
3.7.4 Advance payment bonds 41
3.7.5 Maintenance bonds 41
3.7.6 Bonds and counter indemnities 41
3.7.7 The benefits 41
3.7.8 International bonds 42
3.7.9 Key issues 41
3.8 Unexpected archaeological discovery insurance 42
3.8.1 The process 42
3.8.2 Risk management 42
3.8.3 Identifying the risk of unexpected discovery 43
3.8.4 Potential cover requirements 43
3.8.5 Key issues 44
CONSTRUCTION INSURANCE |1
1 Introduction
1.1 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.
2 | CONSTRUCTION INSURANCE
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.
CONSTRUCTION INSURANCE |3
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.
4 | CONSTRUCTION INSURANCE
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.
CONSTRUCTION INSURANCE |5
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.
6 | CONSTRUCTION INSURANCE
2 Insurances personal to members
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 Lloyd’s
syndicate, but only certain authorised brokers can obtain figures directly from
Lloyd’s. 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.
CONSTRUCTION INSURANCE |7
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.
8 | CONSTRUCTION INSURANCE
The insured’s 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.
CONSTRUCTION INSURANCE |9
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 Lloyd’s 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 insured’s 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.
CONSTRUCTION INSURANCE | 11
+ 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.
CONSTRUCTION INSURANCE | 13
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 company’s 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.
14 | CONSTRUCTION INSURANCE
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 company’s 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.
CONSTRUCTION INSURANCE | 15
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.
16 | CONSTRUCTION INSURANCE
3 Construction risk insurances
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.
CONSTRUCTION INSURANCE | 17
The final point is that a properly arranged insurance on consequential loss will
more accurately reflect the employer’s 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.
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.
CONSTRUCTION INSURANCE | 19
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.
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.
CONSTRUCTION INSURANCE | 21
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.
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.
CONSTRUCTION INSURANCE | 23
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
insurer’s hand in negotiations.
24 | CONSTRUCTION INSURANCE
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 bank’s 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.
3 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 manager’s ‘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.
4 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.
CONSTRUCTION INSURANCE | 25
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.
26 | CONSTRUCTION INSURANCE
+ 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.
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 insured’s estimate of future inflation on building
costs.
CONSTRUCTION INSURANCE | 27
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).
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.
CONSTRUCTION INSURANCE | 29
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.
+ It’s 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 doesn’t 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’.
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.
CONSTRUCTION INSURANCE | 31
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 insured’s 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.
32 | CONSTRUCTION INSURANCE
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.
CONSTRUCTION INSURANCE | 33
– 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.
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.
CONSTRUCTION INSURANCE | 35
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.
3.5.1 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 Gold’s 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.
36 | CONSTRUCTION INSURANCE
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.
CONSTRUCTION INSURANCE | 37
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.
38 | CONSTRUCTION INSURANCE
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.
CONSTRUCTION INSURANCE | 39
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.
40 | CONSTRUCTION INSURANCE
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.
CONSTRUCTION INSURANCE | 41
3.7.8 International bonds
International bonds vary enormously depending on the legal framework in the
country concerned and the nature of the guarantee.
42 | CONSTRUCTION INSURANCE
+ 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.
CONSTRUCTION INSURANCE | 43
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
insured’s 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 underwriter’s
archaeological consultant is required. The consultant’s 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.
44 | CONSTRUCTION INSURANCE
4 Further guidance on construction
insurance issues
CONSTRUCTION INSURANCE | 45
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.
46 | CONSTRUCTION INSURANCE
The term has also been employed to refer to a ‘property developer’s 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.
CONSTRUCTION INSURANCE | 47
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.
48 | CONSTRUCTION INSURANCE
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.
4.4.2 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.
2 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
CONSTRUCTION INSURANCE | 49
(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.
4.4.6 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.
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.
CONSTRUCTION INSURANCE | 51
one contract with the insurer and any action by just one of them that
contravenes the policy conditions will void the cover for all.
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.
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
lender’s 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.
CONSTRUCTION INSURANCE | 53
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.
54 | CONSTRUCTION INSURANCE
5 Latent defects insurances
5.1 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.
CONSTRUCTION INSURANCE | 55
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.
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.
CONSTRUCTION INSURANCE | 57
(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.
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.
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 team’s
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, non-
structural 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.
CONSTRUCTION INSURANCE | 59
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.
60 | CONSTRUCTION INSURANCE
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 time-
consuming, 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
CONSTRUCTION INSURANCE | 61
(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.
62 | CONSTRUCTION INSURANCE
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.
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.
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.
CONSTRUCTION INSURANCE | 63
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.
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
CONSTRUCTION INSURANCE | 65
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.
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 insurer’s 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.
66 | CONSTRUCTION INSURANCE
rics_insurance_cover:Layout 1 10/7/09 19:13 Page 1
rics.org