BLP: Rethinking insurance - the revival of latent defect cover

There are some pretty interesting messages in the recently published review ("Never Waste a Good Crisis" ) of progress since the Rethinking Construction report of 1998. In summary, whilst the original report was influential in raising awareness of the need for widespread improvements in the quality and efficiency of output, the sense was that there has been too much talk and not enough action, that commitment to the principles was only skin deep and that the industry appears to have failed to engage in the true spirit of the report. Sir John Egan gives the industry 4 out of 10, and Sir Michael Latham suggested that more was achieved than he expected, but less than he'd hoped.

Of the most widely perceived benefit of Rethinking Construction - the greater emphasis on integration, collaboration and partnering - progress was thought to be "patchy". And, amongst other recurring themes, the importance of quality, design and whole life costing is noteworthy although the differing drivers across sections of the supply chain meant that the perceived benefits were either not seen universally across the sector or were not evident below senior levels of management.

The exception appears to be major clients with repeat business whose in-house teams have integrated their processes. Additionally, it is suggested that those developers who retain an interest in the property are more likely to concern themselves with whole life cost and sustainability. The review team believes that the incentive to raise quality standards can effectively be undermined through a focus on the upfront costs of construction (and therefore the commensurate failure to apply whole life costing).

While recognising the difficulty of identifying the need for change at a time when the industry was concerned primarily with shorter term survival, the review proposes some quick wins. A key theme is one of leadership, but rather than waiting for clients to ask for change or for government to show the way, the core message is that all elements of the supply chain should take the lead by looking for innovative solutions and focussing on longer term value through business models that are based on integrated team working. In that context, the insurance market might enable a quick win or two.

It is fair to say that Latent Defects Insurance (LDI) has a chequered history. Its use is rather more common practice in some other jurisdictions, notably France, and attempts to bring it to this side of the Channel in the early '80s seemed to flounder rather, thanks largely to over-hype and over-pricing - it didn't quite seem to do what it said on the tin, and the tin did cost a lot of money. The product has, however, gone through something of a revamp in the last year, and now has added appeal as the acceptance of the .risk of defects by very large and stable insurers can offer better protection than reliance on recovery through collateral warranties provided by parties struggling to survive the

commercial realities of an economic downturn. Furthermore, not only is survival a continuing issue, but as work remains rather more scarce than it was just a few years ago, suppliers may be "reluctant to offer a value-based solution through fear of being undercut by the competition on initial price" . So perhaps LDI is now worth another look?

In essence, the risk of defects in design, materials and workmanship is acknowledged as being significant enough to attract plenty of time and resource to minimising the chances of loss. There is a sort of matrix of checks and balances such as contractual provisions, collateral warranties, guarantees and retentions on which professional teams are traditionally encouraged to rely. The point is that these are approaches are known in some circumstances to be inadequate, flawed or insufficient - and they are potentially adversarial. If professional teams are conditioned to look for protections and avenues of redress against other parties involved in the project, it is hardly surprising that it can be sometimes difficult for there to be a cooperative or partnering approach, or a sense of sharing in a common venture. Furthermore, there seems to be a range of cost , often hidden, in putting together this spaghetti of obligations, guarantees and PI insurance. Later on, when problems arise, the costs are less hidden: there are delays in finding someone to accept responsibility or proving fault, with attendant legal costs and uncertainty in outcome

The developments in Latent Defects Insurance have been such that there is another way of looking at this. By analogy it's doubtful that, if the law allowed, a car driver would ever choose a solution to his motor claims that involved first agreeing responsibility and damages with the other driver, and then checking the recovery position with his own 3rd party insurer. What if the other driver was not insured, or insured to insufficient limits; what if either insurer didn't agree with a settlement. And, what if the other driver went insolvent? A latent defects policy on a new build or major refurbishment would get around all of these types of issues. We all know that we much prefer simply to make the phone call to the insurance company rather than contemplate a punch-up.

It is possible now to buy a single LDI policy that protects all the construction team to very high limits for a one-off premium, and that responds to proof of defect rather than proof of fault; and it covers defects in the M&E and non-structural elements as well as the structure itself. Importantly, an original builder client is also protected from claims made by the insurer, and funds for repairs are provided at an early stage thereby minimising disruption. It's not well known in the industry that this sort of solution exists, although this is beginning to change, and consequently it isn't used on a majority of construction projects.

The other benefits that flow from this sort of solution include cover for professional fees, removal of debris and clearance of site, and decanting and alternative accommodation costs. There is additional comfort provided to financiers who will see an independent and secure source for a remedy from defects. Tenants can be persuaded of the additional advantages that accrue from the existence of 1st party cover in which their interest can be noted. The insurer is looking at defect minimisation on the property, and not at who is minimising the defects; the policy will survive the replacement of a contractor during the project. Furthermore, the insurers' technical auditors are actually protecting the interest of the insured as well as the insurer, since interests are aligned in ensuring right-first-time construction: their aim is zero defects.

Insurance needs to be regularly reviewed and revamped to ensure that it provides a relevant, prompt and efficient resolution of construction defects disputes. Furthermore, the continued and rapid development of regulations in relation to sustainability, carbon reduction and renewable energy are examples of changes which construction insurers will need to keep in mind. Indeed, it would be interesting to take a more radical approach and to evolve a new insurance product which does even more to encourage integration and collaborative team working and innovation than one which simply protects everyone from the losses arising from defects. If there can be an early decision to using such a tool, the cost can be dealt with at a much earlier stage in the project, with agreed contribution to the price of the insurance.

Staff Author

Thomas Miller Group