2 Construction insight Thrive in growth economies: Part 2: Professional indemnity

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1 1 2 Construction insight Thrive in growth economies: Part 2: Professional indemnity

2 Construction Insight Thrive in growth economies Introduction This three part Construction insight series has been produced to guide and advise international construction firms and financiers, particularly those considering new territories or who are looking to keep pace with trends and opportunities to improve their insurance and risk management programmes: Part one: Effective Political Risk Management Part two: Professional indemnity Part three: Infrastructure and tunnelling in an urban environment The topics we have chosen created much interest with large Spanish contractors at a seminar organised by March JLT and the JLT Global Construction Practice that was held in Madrid on 29th November 2012, Successfully Managing International Construction Project Risks. Delegates at this event were able to meet construction sector and country risk experts and they all agreed that whilst there was growth opportunity in some parts of the world, it was vital to understand the risk environments and the business practices and laws in these different countries so that you can properly control risk and cost. This is particularly true of some of the emerging or higher growth economies, which present distinct and complex political and environmental risks and where a thorough understanding of the insurance practices, laws and claims trends are vital in achieving a competitive insurance and risk management programme. We hope that the series of papers helps your understanding in these key areas and that you find the Construction insight series useful in your planning. If you have any specific questions about these or other construction insurance and risk issues then please do get in touch.

3 Professional Indemnity 1 Understanding the benefits of professional indemnity insurance for construction contractors As the activities of contractors diversify and new opportunities are sought in global markets, the need to understand exposures in a professional context has never been more important. Contractors may have historically occupied a blue collar space in the construction industry, but with rapid development in design and build services, consultancy and facilities management, these businesses find themselves facing many of the same exposures as traditional construction industry professionals. Consequently, contractors have had to integrate professional indemnity insurance into their risk management framework, to meet their own business needs and those of an expectant client base.

4 Construction Insight Thrive in growth economies 2 Drivers for purchasing PI It is true to say that professional indemnity (PI) insurance has had a relatively low take up amongst contractors outside the US, Canada, UK and Australasia. Many have simply argued that Third Party Liability insurance alongside a Contractors All Risks policy should cover every eventuality. PI also has an association with low claims frequency, so relatively few contractors have a lengthy claims experience to speak of. However, when professional errors or omissions do occur the quantum can be substantial and may be unrelated to the size of the contract value. Typically claims will include complex and expensive mitigation measures to pay for the cost of rectifying professional errors prior to handing over a project. The upshot is that PI insurance is becoming more relevant to contractors. Increasingly sophisticated employers demand it; lenders and development finance providers consider it a pre-requisite before, during and after the construction process and contractors themselves are recognising it is a sensible form of balance sheet protection. What Does PI Cover? PI is a claims made policy. Differing from Third Party Liability which responds dependant on the occurrence of a loss, PI responds in the year a legal liability claim is made against the insured. PI is designed to indemnify an Insured for the liabilities it incurs as a consequence of the professional acts, errors, or omissions of the Insured and/or parties for whom it is vicariously liable. Covering the liabilities which arise from professional acts isn t as simple to articulate for contractors as it is for construction consultancies, as all activities undertaken by construction consultancies are deemed professional in nature, whereas contractors conduct both professional and non-professional services. Engineers or architects providing professional consultancy services frequently operate in a recognised framework, where everything they sell is deemed a professional service, so the relevance of PI requires little emphasis. When challenged with underwriting PI insurance for contractors many insurers use a standard contractor PI policy wording, covering a specific list of professional activities and duties such as architecture and engineering. However, this approach has proven inadequate in the face of modern contractor dynamics, where contractors are often required to provide a cradle to grave service encompassing feasibility, design, construction and facilities management services. As contractors become involved in non-traditional construction activities, their service offerings expand and their professional liability exposures increase. The solution is to draft a wording which covers all activities and duties conducted by professionals, rather than named activities only. Due to the nature of contracting activities, contractors can find themselves responsible for the rectification of professional errors and omissions prior to handing over a project. Such rectification costs will normally be borne by the contractor directly, however, a liability claim will not be made. Therefore a standard PI claims made (legal liability claims from a third party) policy will not cover such rectification costs prior to handover. As a consequence of this, it is critical that a contractor's PI policy is extended to cover the first party costs incurred by a contractor to rectify professional errors and omissions a contractor discovers during construction. Without such coverage, contractors will be obliged to meet the additional costs to deliver a project which is otherwise defective. This coverage is unique to contractor's PI and requires specialist drafting.

5 Professional Indemnity 3 Types of Policy Annual Policy In the vast majority of cases US, Canadian, UK, Australasian contractors will utilise an annual policy, renewed each year. Based on an unlimited retroactive date, this will cover each liability claim made against the contractor during the 12 month policy period (including the discovery of circumstances that may give rise to a claim) and problems discovered during the 12 month policy period where first party mitigation costs are incurred as a consequence of any professional activity carried out in the past. The annual PI policy is an advantageous approach from a cost perspective; there are around five times more underwriters who will provide cover on an annual policy basis as there are operating in the single project space, allowing brokers to negotiate more attractive premiums. This also influences coverage terms, which on annual policies are much broader than their project-based counterparts. Single project (multi-year) policy The single project policy is a rarely used option, but has its place in certain circumstances. It is a multi-year coverage which is sometimes requested by employers or financiers seeking additional protection, or by contractors entering into joint ventures with other companies. In the latter circumstance, PI claims made against a contractor due to the professional negligence of a JV partner can be covered under a contractors annual PI policy. However, a contractor may be reluctant to accept the risk of absorbing claims due to a JV partner s professional errors or omissions, so the single project policy mitigates this exposure. The single project policy is also appropriate for projects conducted under alliance contracts, where the stakeholders have a pre agreed allocation of liabilities and responsibilities under the contract. In this non adversarial contract arrangement, it is agreed that claims will not be made between the stakeholders and therefore a traditional claims made policy is not effective. Therefore specialised drafting is required to ensure that coverage for the costs associated with rectifying professional errors and omissions is provided. Typically a single project PI policy will commence at the beginning of the design and construction process, but with feasibility and front-end design also representing a substantial professional liability exposure, the retroactive date must incorporate those services. By way of explanation, a broker should stipulate that the retroactive date on the policy is the first date on which the first professional service associated with the project was conducted. The policy also must include a run-off period equivalent to the period during which a third party (such as an employer) can legally make a claim against a contractor. For example in the UK this is defined in the Limitations Act which sets out a time limit of six years for simple contracts and therefore it is appropriate to have a six year run off period post the completion of the maintenance period under a construction contract. For contracts under seal, the period is 12 years leading to an even longer run-off period requirement. Single project (annual) policy Rarer still is the annual single project policy. Although there are more underwriters willing to write this policy type than its multi-year counterpart, costs are less predictable and in the event of a claim the chances of renewal are significantly diminished. Links with other policies Third Party Liability Whilst Third Party Liability insurance has been designed to cover third party bodily injury and property damage, the aspects of a contractor s potential exposures from professional errors and omissions that are not covered represent a significant balance sheet risk. For a contractor, this is best represented by the fact a PI policy is most useful when covering the following exposures: Rectification costs: Can be significantly higher than original construction costs, especially where phased rectification is required or knock on risks exist as is the case for ground works. Consequential financial losses: Typically the most significant portion of a loss with little direct correlation to contract value.

6 Construction Insight Thrive in growth economies 4 Contractors All Risks insurance Contractors outside the US, Canada, UK and Australasia have historically taken comfort in the purchase of Contractors All Risks cover (CAR), which with the relevant wording does have an element of professional risks coverage (e.g. DE5/LEG3). However it only covers events causing damage. Where errors and omissions do not result in any damage, the policy will not respond. This leaves a substantial exposure given the fact that the cost of rectifying defective designs where there is no damage can be significant. This can often be the case where efficacy issues exist, especially on non-structural risks such as mechanical and electrical and process engineering. Furthermore, property can be defective without associated damage. It should also be noted that any consequential losses, which can typically be significant, will not be covered under a CAR policy. Secondly, CAR policies are typically only in force until the end of the maintenance period under a construction contract. If you have a claim subsequent to that, it will not be covered under the CAR programme. In that instance, a PI policy would also provide cover for damage which requires rectification, if it was caused by professional errors or omissions. About the author Andrew Harrison-Sleap is the Head of the Project Solutions team within the Construction Division at JLT Specialty Limited. The Project Solutions team provides contractor and construction consultancy (architects, engineers, project managers and quantity surveyors) clients with PI solutions on both a practice policy and project specific basis. Andrew also implements PI solutions for owners on a project specific basis. The team is unique in the London market, as it is the only specialist PI team that forms part of a construction division, thereby providing an unparalleled knowledge of professional indemnity insurance in a construction context. Andrew is a Fellow of the Australian and New Zealand Institute of Insurance and Finance. He also has a Bachelor of Economics from the University of Western Australia and a Graduate Diploma of Insurance from Deakin University. This report is published for the benefit of clients and prospective clients of JLT Specialty Limited. It is intended only to highlight general issues that may be of interest in relation to the subject matter and does not necessarily deal with every important topic nor cover every aspect of the topics with which it deals. If you intend to take any action or make any decision on the basis of the content of this report, you should first seek specific professional advice.

7 Professional Indemnity 5 About JLT Specialty JLT Specialty (JLT) annually place more than 400m of construction insurance premium in the market, which makes us London s leading construction broker and gives us the leverage to negotiate the most competitive rates on our clients behalf. Our personnel are responsible for arranging and managing insurance and risk management services for both project-specific and annual construction insurance programmes globally. Of particular benefit to our clients, we have: A dedicated Construction Claims Team co-located with the servicing teams The lowest staff turnover rate of our peer group, engendering close working relationships throughout the construction phase and into operations The only construction team with an integrated specialist Design & Construct Professional Indemnity capability A flat senior management structure, ensuring that Board-level contacts are accessible to our clients. We have extensive experience of designing, placing and managing insurance programmes for some of the worlds largest and most complex construction projects in the energy, power and utilities, civil engineering, real estate and heavy industry sectors. In recent years these have included more than 350 PPP projects as well as: New Doha Port Project, Qatar (USD 6bn contract value) Shatin to Central Link, Hong Kong (USD 7bn) Ras Laffan C 2730MW Combined Cycle and Desalination Project, Qatar (USD 3.1bn) Fehmarnbelt Fixed Link, Denmark/Germany (EUR 7bn) Singapore LTA Mass Rapid Transit (USD 10bn+) Jardine Lloyd Thompson Group plc is listed on the FTSE250 index of the London Stock Exchange and is one of the world s largest risk specialists and employee benefits consultants. Through JLT International Network we are able to provide our clients with services in more than 135 countries.

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