Protecting against in-house design liability
More and more contractors are entering design-build agreements, often unaware of the depth of their responsibilities.
Design-build has become an ever-growing phenomenon within the commercial building industry. As reported on the Design Build Industry of America (DBIA) website, “over half of owners have already or will use design-build in the next five years.” This also represents approximately 44% of the construction spending expected to take place in the nonresidential, highway/street and water/wastewater marketplace by 2021.
As a result, an increasing number of contractors and construction firms are now incorporating in-house design capabilities into their services and business initiatives.
According to the 2019 AGC Risk study conducted by FMI, “over 43% of contractors are implementing in-house design capabilities,” with 25% of the remaining respondents saying they were likely to consider those services in the future. This is due to the methodology’s many advantages, which range from the streamlining of the entire building process to the fast-tracking of projects for early completion.
Now the issues: Contractors often enter design-build agreements without fully understanding the full depth of their responsibilities or even properly implementing the methods needed to establish a direct line of contact between the construction and design teams. This is particularly concerning in an environment that is terribly unforgiving of the big and small errors that can result in costly delays, overrun budgets, and the dire financial consequences that, in extreme circumstances, can actually ruin companies and businesses.
Increased accountability in a design-build world
With design-build, everything from design to construction to the management of subcontractors and specification of materials is under the prime contractor’s purview. While blurring the lines between the traditional roles of all the players, the contractor also stands as the single-point-of-contact for every project detail. The success and financial rewards, as well as the liability, complaints and potential litigation all, fall squarely on the prime’s shoulders.
For these reasons, the risks have never been broader, more intense and costlier for design-build contractors. This is especially true for the builders looking to expand their in-house capabilities with design services, while increasingly supporting a methodology in which they have little experience.
Subsequently, many firms are strengthening their risk management strategies with Contractor’s Professional Liability CPrL policies that cover the damages arising from the negligent acts, errors and omissions performed by or on behalf of any construction firm.
This includes construction firms that are currently expanding their services with in-house design capabilities to better accommodate the market’s growing design-build opportunities. In fact, some CPrL programs now even offer first-party coverage, such as “protective” or rectification coverage (otherwise known as mitigation) to better protect against design problems and challenges. As an example:
- Protective Indemnity (first-party) protects against the damages incurred by the insured (contractor) that the insured is legally entitled to recover from errors created by design professionals. As an excess coverage, it also pays for the delta between the total damages and the damages paid by the professional liability limits available to the insured from the design professional. This is especially pertinent for contractors, who subcontract design/build activities to third-party design professionals
- Rectification/Mitigation (first-party) pays for the expenses reasonably incurred during the mitigation or rectification of a negligent act, error, or omission arising from professional services (performed by or on behalf of the insured) that would otherwise lead to a professional liability claim. In addition, rectification coverage essentially replaces the DP’s insurance solely with respect to the costs incurred by the named insured to remedy the design errors discovered during the course of construction and would have otherwise resulted in professional liability claims.
Design-build liability: Greater responsibilities & enhanced exposures
During a recent analysis of RT Specialty’s ECP book of business, it was found that nearly 40% of the CPrL claims made throughout 2016/2017 consisted of design and in-house engineering errors. These findings were also further supported by the AGC/FMI’s 2018 risk study, which stated that 92% of survey participants admitted that the design documents they received were less complete than in the past.
Some of the contributing factors surrounded the increase of owner-driven schedules demanding quicker delivery times and an inadequate sharing of the associated design and construction risks.
In the past, problems such as these have led to numerous claims and settlements. For instance, a contractor hired an engineer to develop the preliminary design of a bridge to be built over an inter-coastal waterway.
The contractor, however, used the plan to win the design-build contract that was $6 million less than other bids. Since the preliminary plan was under-designed, the contractor was responsible for supplying the 400,000 pounds of steel needed to complete the project. Given the design-build bid was won with a guaranteed maximum price, the contractor was obligated to finish the project with little room built-in for errors or delays. Given the engineer’s exposure was in excess of policy limits, the claim settled for $1,091,000.
Another example occurred when an architect was retained by a design-builder to design loft condominiums. Built-in a commercially zoned area, the sleeping spaces were constructed as live/work lofts. Once completed, the homeowners association sued the developer due to the noise complaints of all 46 unit owners. Given that the architect’s counsel determined that a jury would have decided against their client, the claim was settled for $125,000.
Expanding CPrL coverage terms
Ever-evolving to support the needs of design-build contractors, insurers have steadily expanded the coverage terms of CPrL policies by loosening protective and rectification restrictions; widening professional service definitions; and providing more consistent offerings with competitive pricing options.
Today’s market also consists of approximately 30 domestic and international carriers that regularly supply rate reductions to the firms demonstrating consistent revenue increases pending the absence of adverse claims and a static palate of services. This includes increased project-specific coverages for smaller-sized projects (construction values under $100 million), stable rates for larger projects and limited faulty workmanship coverage.
In a market always looking for the next competitive advantage, CPrL is also becoming the go-to risk management method for protecting against the potentially catastrophic claims that commonly entail eight-figure demands. Quite frankly, design as an afterthought or add-on is not recommended for any firm new to the design-build marketplace unless the proper precautions are in place.
The addition of design into an already complicated mix of services can produce numerous levels of additional liability and exposure that can prove crippling. CPrL is among the many safety nets available to contractors. This includes the firms that are both exploring design as a new service form or looking to create a niche in the design-build world. In either case, the stakes are too high and the risks too broad to proceed without the contingencies needed to overcome even the slightest of errors.
Joseph Nawa is vice president within RT Specialty, LLC’s National Environmental and Construction Professional Liability Practice. RT Specialty is a specialty intermediary for insurance agents and brokers with expertise in environmental insurance, environmental risk management and construction-related professional liability. Contact Nawa at joseph.nawa@rtspecialty.com.
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