How much is enough? Contractors' and consultants' PII

Solicitors advising on new buildings are often asked what level of professional indemnity insurance (PII) their clients should ask the contractor, design sub-contractors and consultants to maintain. This is the case whether acting for developers, purchasers, tenants, funders or the construction industry.

It is a commercial rather than a legal question, but clients still ask it, and there are some sensible guidelines that a solicitor can provide, without actually quoting a figure, which we are not really qualified to do.

Design work

We should begin by reminding the client that PII 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, there are several key points clients should bear in mind, and advisers need to stress that they should be considered separately for the contractor and each of the consultants and designing sub-contractors. This is because they all have different roles and the risk profiles of their work are all different, meaning the level of PII they should have will be different in each case.

The starting point 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. For example:

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 that most clients are likely to maintain, so the client’s loss would be the cost of demolition and rebuilding. While 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 PII needs to be for a figure well in excess of the construction cost.

 

2. The mechanical and electrical (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 they had to be ripped out and re-fitted. That would cost a lot, and could require relocation while the work was carried out, but it would be quicker, and the total cost including business disruption would be nowhere near as much as in the example above. The client can therefore accept a lower PII figure for the M&E engineer than for the structural engineer.

 

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

Reality check

However, having produced the list of appropriate figures, we may then run into the problem of reality. While most consultants advising on
and contractors carrying out commercial developments will have at least £5m of PII 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 PII 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 that they will add to their fee so the client will end up paying it); or

(b) the client taking out a ‘latent defects’ insurance policy, although these policies are expensive and do have some significant limitations; or

(c) accepting the lower PII 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 are incredibly rare and unlikely to occur, and perhaps the risk is therefore small enough to take 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 on 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 they are happy with.

The client can also normally take comfort from the fact that the levels of PII consultants and contractors have in place will actually reflect the position that 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 can live with £5m or £10m of cover, but there are a few who can’t. Most people do not take out latent defects policies or ask for project-specific PII extensions, but there are a few who do. 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.

Aggregate basis

In addition, it is not just the amount of cover which is relevant, but the basis of cover.

If PII 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 PII is on an ‘aggregate’ basis, then the consultant or contractor will only have the stated PII figure in total to cover all claims against them during the policy year. That means 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, in other words 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 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 PII 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 £5m claim in February would be paid in full.

However, the number of automatic reinstatements is usually limited, for example to two reinstatements; the effect of this is that there can be two claims in the policy year before the pot starts to get emptied. Therefore, the more automatic reinstatements, 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 a balance of risk, but a client might for example be willing to accept £5m aggregate with three automatic reinstatements, whereas if it was a pure aggregate policy with no automatic reinstatements the client might want to ask for more than £5m. SJ

Chris Holwell is the head of construction procurement at Freeths