Contractors’ and Consultants’ PI insurance – how much is enough?

Solicitors advising in relation to new buildings, whether acting for developers, purchasers, tenants, funders or the construction industry, are often asked what level of PI insurance their clients should ask the contractor, design sub-contractors and consultants to maintain. This is a commercial rather than a legal question,but clients still ask it and there are some sensible guidelines which a solicitor can give without actually quoting a figure (which we are not really qualified to do).

We should begin by reminding the client that PI insurance covers only the design work or other professional services provided –it does not cover workmanship or materials. Therefore when I refer below to a contractor, it is only a contractor with design responsibility, either under a design and build contract or under a contractor’s designed portion within a traditional contract.

Next, the key points we should advise the client to consider are as follows, stressing that they should be considered separately for the contractor and each of the consultants and designing sub-contractors, because they all have different roles and the risk profiles of their work are all different. Therefore how much PI insurance they should have will be different in each case.

The starting point, or theoretical answer, is to work out what is the biggest loss the client could suffer if the consultant, contractor or sub-contractor got their design or other services as wrong as they could in the worst possible circumstances. A couple of examples may help.

1. A design and build contractor and the structural engineer are responsible for the foundations and the structure – they could get things so wrong that, either during construction or a few years later, the building has to be demolished and rebuilt. That would not be covered by any insurance policy which most clients are likely to maintain so the client’s loss would be the cost of demolition and rebuilding. Whilst that was going on, the client would have to hire alternative space and/or incur business disruption costs. Therefore the design and build contractor’s and structural engineer’s PI insurance needs to be for a figure well in excess of the construction cost.
2. The M&E services engineer could not make the building fall down, no matter how badly he performed (he could perhaps design the electrical system so badly that it causes a fire which burns the building down, but that should be covered by a normal buildings insurance policy). Therefore the worst he could do in reality would be to design the services so badly that they had to be ripped out and re-fitted. That would cost a lot, and could require relocation whilst the work was carried out, but would be quicker and the total cost including business disruption would be nowhere near as much as in example 1 above. The client can therefore accept a lower PI figure for the M&E Engineer than for the Structural Engineer.

The client can consider the contractor, consultants and sub-contractors and make judgments accordingly, producing a list of appropriate figures.

However, having produced the list of appropriate figures, we may then run into the problem of reality. Whilst most consultants advising on and contractors carrying out commercial developments will have at least £5m of PI cover, some of the smaller ones have less. Some go up to £10m and the big consultants and contractors can go significantly higher, but sooner or later there is a limit. If the limit of the PI which they have is less than what the client has calculated as being appropriate, then the client has to choose between:

• (a) insisting on the consultant or contractor in question taking out a project-specific policy extension (which will cost money, which they will add to their fee/price so the client will end up paying it); or
• (b) the client taking out a “latent defects” insurance policy, but these policies are expensive and do have some significant limitations; or
• (c) accepting the lower PI figure which the consultant or contractor actually has and taking a commercial view that: even £1m, let alone £5m or£10m, buys an awful lot of remedial work; bigger disasters than that are incredibly rare and unlikely to occur; and perhaps the risk is therefore small enough to take in order to avoid having to pay the increased costs of covering the risk by method (a) or (b) above.

In other words, it is like deciding about any other kind of insurance – the client has to balance the ideal amount of cover, the likelihood of the event occurring, and the cost of the cover, and find a position which he or she is willing to live with.

The client can also normally take comfort from the fact that the levels of PI which the consultants and contractors actually have in place will reflect the position which most of their customers accept (and which the contractor or consultant themselves view as adequate to protect themselves).

We can also point out to the client that most people take a view and live with £5m or £10m of cover, but there are a few who don’t. Most people do not take out latent defects policies or ask for project-specific PI extensions, but there are a few who do. I usually add that only once in the last 20 years have I personally come across a major building so badly designed and built that remediation was not possible and demolition and rebuilding was the only solution, but once in 20 years is not the same as never.

There is also another issue which should be considered. It is not just the amount of cover which is relevant, but the basis of cover.

If PI insurance is on an “each and every claim” basis then there will be the full amount available to cover any valid claim the client may make. However,if the PI insurance is on an “aggregate” basis then the consultant or contractor will only have the stated PI figure in total, to cover all claims against them during the policy year. That means that a claim relating to work they did elsewhere, for someone else, would reduce the amount left in the pot to cover any claim by our client. The pot could even be empty by the time that our client made a claim. Therefore in cases where the consultant or contractor has aggregate cover, it is normal to require a higher figure, i.e a bigger pot, to reduce the risk of it being empty by the time our client’s claim is made.

We should nevertheless note that aggregate limits for claims relating to pollution, contamination and asbestos related claims are fairly common and are generally accepted, as the availability of cover for those risks in the insurance market is very limited.

There is one further gloss on this. Sometimes there is aggregate cover with “automatic reinstatements”. This means that if there is a claim in any policy year, the pot is “topped up” again to the full stated PI figure. For example, if the contractor had £5m aggregate cover and there was a claim for£50,000 in January, then the pot would be topped up to £5m again so that a £5mclaim in February would be paid in full. However, the number of automatic reinstatements is usually limited, for example to 2 reinstatements – the effect of this is that there can be 2 claims in the policy year before the pot starts to get emptied. Therefore the more automatic reinstatements there are,the more comfort it gives that there is likely to be something left in the pot by the time our client’s claim is made. An aggregate policy with a number of automatic reinstatements is therefore not as good as an “each and every claim” policy but is better than a pure aggregate one.

Accepting something other than”each and every claim” is therefore is a balance of risk, but a client might for example be willing to accept £5m aggregate with 3 automatic reinstatements whereas if it was a pure aggregate policy with no automatic reinstatements the client might want to ask for more than £5m.

As solicitors we cannot make the commercial judgments for our clients, but there is useful guidance we can properly give when we are yet again asked “is that PI figure OK?”.

This article was produced by Chris Holwell, a partner in Freeths Construction department.

It was first published by Solicitors Journal on 28.10.14 and is reproduced with kind permission.

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