Professional Liability Insurance – What are a Developer’s Options?

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by Jeffrey Cavignac, CPCU, RPLU, ARM

When it comes to developing real property, proper insurance is critical.  Insuring the contractors on a project is fairly straightforward.  You can either rely on the contractor’s operational general liability policy or consider some form of project specific insurance such as an Owners Controlled Insurance Program (OCIP).  Every contractor will have an operational general liability policy and OCIPs are widely available from a number of sources, even for condominium projects.

For damage to property under development, Builders Risk insurance is required.  Every Builders Risk policy needs to be tailored for the specific project, but as is the case with Project Specific General Liability insurance, Builders Risk coverage is currently available from a number of different insurance companies.

Insuring the errors or omissions of the design team, however, is more complicated.  The complexity is further exacerbated by the type of project being developed.  For example, a commercial office building is considered significantly less hazardous than a “for-sale housing” or condominium project.  Regardless of the type of project, the developer has several options.

There are four basic options an owner may consider and some of these can be used in conjunction with another.

  1. The Design Professional’s Practice Policy (AE Policy) – Relying on the individual Design Professional’s Practice Policy is the lowest cost option and the least effective in protecting the developer’s There are several significant disadvantages to this approach from the owner’s perspective including:
  1. Limits on these policies may be inadequate for the project in question.
  2. AE PL policies are written on “claims made” policy forms and if coverage is canceled or non-renewed and not replaced, the AE would be uninsured.
  3. There is no guarantee that the AEs will continue to renew coverage as required by their contract.
  4. Claims on other projects could exhaust available limits leaving nothing for the owner’s project.
  5. Absent a formal review of the design professional’s PL policy, the owner will have no idea what type of policy form (broad or narrow) the AE PL policy is written on.

Despite these disadvantages, this is the most common option for large commercial projects or condominiums.  It is prudent for the developer to work with reputable, established and insured design professionals and to make certain that those design professionals renew their coverage as required by their contract.

  1. Project Professional Liability Insurance (PPL) – PPL insurance is written to cover the design professionals on a specific project for their errors or omissions arising out of the design of that project.  It replaces the practice policy of each design professional.  It is generally written to provide coverage from design through substantial completion of the construction plus an extended reporting period which is typically 3-5 years, but in some cases can be negotiated out as far as 10 years.  Limits can be selected to fit the exposure of the project in question. Coverage can be negotiated and is uniform for the entire design team.  In the event of a claim, the design team is jointly defended under the terms of a joint defense agreement.  One of the key advantages of a PPL is that the limits are dedicated to the specific project and, absent fraud in obtaining the policy or non-payment of premium, the policy cannot be cancelled.  This is the best way for a developer to make certain the design professionals on his project will have appropriate coverage with adequate limits for the duration of the contractual requirement. Unfortunately, it is not widely available and will cost substantially more than the alternative of relying on the individual design professional’s practice policy.
  1. The third option is an Owners Protective Professional Indemnity (OPPI) policy.  The OPPI option can be used to supplement either the Design Professional’s Practice Policies or a Project Professional Liability policy.  An OPPI policy provides additional coverage to the owner for damages arising out of errors or omissions of the design team.  The AEs are required to have minimum limits of professional liability insurance in place (MIR or Minimum Insurance Requirements).  The OPPI sits on top of those limits and provides excess coverage for the benefit of the owner as if the design professional had higher limits.  The OPPI policy is triggered by a claim made by the owner against the design team.  At the same time, this claim is made against the Design Professional’s Practice Policy, a claim is also filed with the OPPI carrier.*  Third party claim defense and indemnity can also be provided under an OPPI.  Basically this provides the owner with defense and indemnity if the owner is sued for the negligence of the design team.  Unfortunately for residential for-sale housing, this is not readily available and if an underwriter is willing to provide it, the upcharge is approximately 50% of the primary OPPI pricing.  Benefits of the OPPI policy include:
    1. The ability to layer higher limits to protect the developer for substantially less than it would cost to purchase a Project Professional Liability Policy.
    2. The OPPI policy may provide broader coverage than a Design Professionals Practice Policy and in those instances it can drop down and provide primary coverage subject to the policy deductible.
    3. The OPPI policy can be written on a project specific basis or on an annually renewable basis to cover all the projects a developer is working on.
  1. The final option a developer might consider is a Developers Professional Liability Policy (DPLP).  This is an emerging coverage and not widely available.  Coverage can be tailored to cover a variety of exposures.  These might include a developer’s direct design exposure (if they perform design in-house) and their vicarious design exposure (similar to the defense and indemnity that can be included in an OPPI policy).  It could also include a developer’s pre design phase exposures and services, conceptual land planning, zoning changes, financing models, title insurance and demographic surveys.  Unlike an OPPI policy, it would not provide “protective” coverage (limits excess the design professional’s limits for suits brought by the developer).

Final Comments:  The key to managing the professional liability exposures on a new construction project follows basic risk management principals.  First, the exposures to loss (what can go wrong) need to be identified. Secondly, the developer needs to work with his design team and contractor to try and reduce the frequency and severity of those exposures.  Once steps one and two have been completed, then consideration should be given to step three, which is the Risk Finance options.  This involves exploring the insurance marketplace for the various options explained above.  It is only after considering the options available and their associated premiums that you can select the best option for your specific project.

Developing real property is complex.  Every project is unique and between the ownership, the contractors and the design team, there are a significant number of stakeholders.  This underscores the importance of working with both the right contract attorney and a specialist insurance broker.

 

*In the event of an OPPI claim that exceeds the Design Professional’s Practice Policy limit, the owner is going to need to negotiate with the OPPI insurer to collect the difference between the AE’s limits and any amounts the owner is “legally entitled to recover.”   In other words, the owner is going to have to prove to the OPPI insurer what their actual losses are.  The OPPI insurer will pay the difference between the agreed upon damages and what the Design Professional’s Practice Policy paid.