Most architects maintain $1 million or less in professional liability insurance, and the large firms typically carry no more than $5 million. Simple human mistakes, like miscalculating a structural load or specifying the wrong type of concrete, can cause huge losses. On significant construction projects, say $50 million or more, losses caused by design errors can far exceed these limits, and their occurrence is not uncommon.
Many developers are exposed to the risk of design defect losses that are largely uninsured by the architect. Unless the architect has substantial assets — which is rare — the developer will be left holding the bag and bear the loss. Moreover, the professional liability policy is shared among all the architect's clients. A loss on another project, therefore, could deplete the insurance and leave your project completely uninsured.
Every major construction project today contends with these issues. Here are five ways to close the gap between the potential loss from design defects and the insurance coverage for it.
ncrease insurance coverage — Purchasing additional insurance is an obvious, but far from complete, solution. Even major architectural firms are usually unable to secure more than $5 million in coverage or unwilling to due to cost-prohibitive premiums. If the architect carries $2 million in coverage, then increasing it to $5 million is certainly better, but affords little added comfort on a large project. Thus, increasing the liability limit is, at best, a partial solution for many projects and does not eliminate the risk of another project wiping out the insurance.
Buy a project policy — Policies are available that insure the entire design team for a specific project under one liability limit. They avoid the problem of sharing the standard policy with other projects and, by insuring the entire design team, the common “finger-pointing” of blame among them is eliminated. However, the premium for project specific policies is much higher — perhaps $2 million for a $20 million policy — than that of standard policies, and liability limits usually do not exceed $20 million. They are too costly for many projects and provide inadequate coverage for others.
Consider Owner's Excess Insurance — An Owner's Protective Professional Indemnity policy (OPPI) may be purchased that provides excess liability coverage for the owner. It responds if, and when, the professional liability insurance limit of the architect is depleted. OPPI coverage costs roughly one-half that of a project specific policy and represents the best solution for many owners. However, liability limits generally do not exceed the range of $20 to $50 million. Thus, on larger projects, the owner could easily come up short.
Pursue a wrap-up insurance program — The owner of a large project should consider an Owner's Controlled Insurance Program (OCIP) or similar wrap-up policy. This type of policy may cover both design and construction risks, but normally covers only construction risks. These policies can generally provide a professional liability limit up to roughly $20 to $50 million or more. However, OCIPs impose significant and undesirable administrative burdens on the owner.
Embrace design/build — The design/build delivery method provides a practical solution for some projects. Design/build calls for one company to perform all design and construction services for the owner. Few companies do both, so usually a general contractor subcontracts or joint ventures with an architectural firm. A broad indemnity may be given by the design/builder to the owner that covers both design and construction errors. If it has a strong balance sheet to stand behind the indemnity, as some major contractors do, then the owner effectively gains insurance coverage equal to the equity of the contractor and pays no premium for it.
Besides insurance and indemnification, avoiding design errors in the first place must be a high priority. Owners should look beyond the artful renderings and select highly qualified architectural firms with low claim histories and use the best people at those firms.
Some owners follow the old adage that “two heads are better than one” and hire a second architectural firm to provide “peer review” and ensure quality control. Additional plan review fees may be more cost-effective than additional insurance premiums.
Professional liability claims are resulting in the quagmire of high premiums and low liability limits. Consequently, many projects are not adequately protected against design error losses. Hopefully, the alternatives discussed above will help guard against them.