It’s a tough claims market out there with insurers taking a strict approach to the policy wording. Contractors should think twice before they splash out to resolve a design defect
When there is less building activity, insurers of construction risks must fight harder to maintain their income. Less activity leads to more competition and this leads to lower premiums. But less construction activity and lower premiums generates fewer reserves to pay claims. Many brokers now consider that there is serious imbalance leading to conflict.
Insurers are the subject of regulation so insolvency is rare, but they may be less able to pay up. In this case damage limitation is necessary, meaning insurers will look more closely at their policy wordings and will be stricter in their approach. There will also be a greater tendency to challenge claims both in terms of liability and quantum. It looks like this tough claims market is set to continue.
There is a misconception that parties backed by insurers are fair game - the reality is that insurers are as hard-nosed as anyone. Insuring construction design risks causes the insurance industry many problems.
There is a misconception that parties backed by insurers are fair game - the reality is that insurers are as hard-nosed as anyone
This is because the liability assumed by the contractor is often greater than the indemnity under the insurance policy. There is also ignorance of the indemnity that the policy provides.
One major source of disagreement is when the contractor spends its own money to overcome a design defect and then seeks to recover this loss from its insurers. In such circumstances, prudent contractors will wish to alter the design in order to avoid a claim at a later stage. The policy not only indemnifies against claims but also seeks to allow recovery of costs incurred - with the consent of insurers - in order to avoid third party claims and mitigate the loss. The cost of opening up and investigating a design defect once the building has been completed will usually far exceed the cost of a design change. But if the contractor changes the design without the prior consent and authority of insurers, it risks not being paid.
Contractors should also bear in mind the probability that insurers will be even less sympathetic if they receive a request some weeks or even months after the remedial work has taken place.
But there could be a further complication. What happens if it emerges that the liability is because the contractor has under designed - it has not included something within the building that it should have? Do the insurers still have to pay? They may argue that the additional expense would have had to be incurred in any event and should not fall to them to pay.
Let’s take foundation design as an example. If the contractor has priced the contract on the basis of the incorporation of strip or shallow foundations, only then to find that the foundations must be piled, or if it has underestimated the quantity of steel reinforcement needed, this - so the argument goes - is a pricing risk that the contractor took in order to secure the work.
Insurers will argue that the cost of incorporating the more expensive option should be a burden that falls upon the contractor and not them. It is not for them to subsidise the building cost and provide a better building.
Insurers frequently use this “betterment” argument. There may be some merit in it if it can be demonstrated that a contractor deliberately chose a cheaper option, ignoring the obvious design risks. Otherwise, there are flaws. There is also a clear distinction to be drawn between failing to correctly price the job and the making of a genuine design error. The key is to consider whether the costs expended have been incurred in the mitigation or the avoidance of what would otherwise be a claim under the policy. Policy wordings typically cover losses incurred as a consequence of acts, errors or omissions in the conduct of the contractor’s professional activities. If there is betterment, this is not a benefit that the contractor has received.
On the contrary, this is a benefit that has accrued to the employer. Were it not for the contractor’s failure and breach of contract, it would have priced the work to provide for the extra expense and included it within the contract price.
There are many other arguments that insurers may and will use. It could prove to be a busy time.
Jeffrey Brown is a partner at Veale Wasbrough Vizards in London