Latent defects insurance policies usually deal exclusively with the load bearing structure as well as building envelope. So, electrical connections and wiring, electrical and mechanical works, pipework, finishing trades, and decorations as well as items of plant aren’t covered.
However, some insurance providers do cover electrical and mechanical services or building components, but for an extra premium. Furthermore, the insurance company typically won’t pay out in case the defect existed and could be discovered at the time of completion of building works.
What Are the Benefits of Latent Defects Insurance?
Employers can derive benefits from getting and actually making a claim under a latent defects warranty instead of bringing your claim under a collateral warranty.
The insurance policy is typically written for the project’s benefit and is assignable. It is usually a condition of the policy especially where subrogation hasn’t been waived that the building contract should be assigned to a subsequent owner along with the policy.
With the waiver of subrogation, the insured would be the employer under the building contract, the contractor, or just about any party that has an interest in the property. This compares with professional indemnity insurance that’s primarily for the benefit of the consultant and contractor. If collateral warranties are granted, there’s generally a restriction on the number of assignments.
Latent defects policies typically provide 10 years cover with the payment of the initial premium. So, there’s no need to renew the cover each year.
One of the challenges with professional indemnity insurance is that claims are made on the basis of claims-made. In case a latent defect is discovered and a claim is made on a professional indemnity policy, it is the policy that’s in force at the time the claim is made as opposed to at the time of the breach of contract.
The possibility always exists that one or more of the consultants, contractor, and design subcontractors could become insolvent. If the loss was caused by a party that’s newly insolvent chances are their insurer will likely not respond therefore leaving gaps in the loss recovery ability.
If you have a claim under the latent defects policy, the policy will respond without the need to establish fault on behalf of the professional team or contractor. The reason for this is that the policy is for the property’s benefit as opposed to the various insured.
In contrast, making a claim against your professional indemnity insurance policy would likely involve bringing proceedings against one or more of the consultants and contractor to establish the loss. This would have these effects:
- Legal costs would be incurred pursuing the actions.
- Money would not be available to right the defect immediately, leading to a cash flow disadvantage.
- “Litigation risk” would be present for failing to achieve the right decision.
- Professional indemnity insurance may have been avoided for a variety of reasons such as late notification of the claim; and
- Subjugation is either waived or it’s the insurers risks of bringing proceedings to attempt recovery after paying the claim.
Policies generally have some annual indexation of the insured sum. If construction costs rise then the insured sum will increase accordingly. Under a professional indemnity insurance policy, the constraint is the sum insured on an annual basis.
In current market conditions, both the contractor and subcontractors may have aggregate insurance rather than cover on ‘each and every’ basis, and if there are multiple claims, this may be insufficient to cover the full extent of losses suffered by the client.
With the move to no claims and alliancing provisions in contractors that prevent parties from bringing proceedings against each other, a latent defects insurance plays an important role in guarding against latent defects that would otherwise leave the building owner or employer with a substantial bill for fixing the latent defect.
The Integrated Project Insurance procurement model was approved by the Government Construction Strategy (2016- 2020). It contained both a target cost structure with both elements of latent defects and cost overrun insured. Dudley College successfully trialed the model.
What Are the Drawbacks of Latent Defects Insurance?
Latent defects insurance can be expensive to put in place and restrictions are in place regarding what the policy applies for, as described above.
If you go the traditional route of obtaining a collateral warranty, it is very likely that some or all of the exclusions e.g., non-structural elements, would be warranted first by the main contractor and then by the relevant consultant or subcontractor.
The policy responds solely in relation to the cost of replacement and repair of the defective works as well as strengthening any affected areas. The policy doesn’t cover any consequential losses such as the loss of profit.
Disputes may arise as to whether a particular damage or defect is covered due to the exclusions of cover under the policy. Furthermore, issues may arise as to who is liable for the cost of repairing elements of the building not covered by the policy but have been damaged by a defect in an element covered by the policy. Such issues mean that policies aren’t as simple to operate in practice as it might seem at first sight.
In addition, if defects were present at the date of practical completion or inception, then they aren’t inherent defects. In that case, if LABC has issued the insurer with a reservation, then items covered by the reservation will be excluded unless they are subsequently rectified.
