There was a time when contractors didn’t need to be too concerned about professional liability insurance, traditionally carried by architects, engineers and other design professionals for errors and omissions. But these days, construction companies need to consider this coverage to complement their general liability insurance.
With contractors now performing design-build work and managing all aspects of a project, the risk of professional liability exposure has increased. The International Risk Management Institute (IRMI) notes, “As the lines of responsibility between design firms and contractors merge, contractors are assuming nontraditional risk that their core coverages may not address.”
The upshot, IRMI says, is that professional liability coverage has become “just as essential to a contractor as it is to an architect or engineer.”
Even if you’re a small contractor, you may need professional liability insurance. Any firm involved in the design of a project – or responsible for changes in the design – probably needs coverage. Contractors can also be held liable for damages caused by third parties they hire or partner with, such as an architect, engineer or surveyor.
The difference between general and professional liability
When considering whether to purchase professional liability coverage, it’s wise to review what’s covered in your commercial general liability (CGL) policy or business owners policy (BOP) and what’s not. CGL is a common coverage nearly every contractor carries and one that’s required on many construction projects. BOPs include CGL coverage but usually not professional liability.
CGL covers bodily injury or property damage caused by your company. This includes injuries to individuals on the job site other than your employees. CGL covers the cost of your legal defense and pays damages up to the limits in your policy if you are found liable. But CGL doesn’t pay for negligent or errant professional acts. For those, a professional liability policy is needed.
Let’s consider a few potentially expensive claims that wouldn’t be covered by your CGL but could be covered by professional liability:
- You hire an engineering firm to design the heating, ventilation and air conditioning (HVAC) system for a building. The engineer makes a mistake in calculating the building’s HVAC needs, and the tenants aren’t able to properly heat or cool the building. The owner sues you because the engineer didn’t have enough professional liability insurance.
- You hire a cement contractor to design and pour the foundation of a building. It’s later discovered the foundation wasn’t adequately reinforced and won’t bear the load of the walls. You have to tear down what you’ve built and repour the foundation.
Professional negligence and the limits of relying on others’ insurance
According to IRMI, professional negligence occurs “when services are not performed with the standard of care exercised by any other design professional facing the same or similar facts and circumstances.” While there are many examples of things that could go wrong on a project that stem from professional negligence, most of them fall into three categories:
- Design delegation – When you delegate design and other professional services to a subcontractor or third party.
- Design error – When you make a design mistake or changes to the design that lead to damages. With many construction firms now offering both design and build services, this is a significant liability exposure.
- Construction management – When the owner hires you to manage the entire project, including the design work.
Design errors can be far more serious, life-threatening and expensive than other types of construction errors. Think about claims such as “sick building syndrome,” where a contractor may be held liable for millions of dollars in claims from a poorly designed or improperly installed HVAC system.
In the past, contractors have relied on the professional liability insurance carried by the architects, engineers and other subcontractors they hire, and these policies do provide some protection. However, there are limits you should be aware of, and you may find yourself sharing the limit with other firms. In fact, many liability limits are set at $1 million or less. In addition, if your subcontractor terminates coverage after its work on your project is finished, you might not be covered for a future claim at all.
How to get coverage and what to look for
The good news is the insurance marketplace has responded to these risks with contractors professional liability (CPL) coverage. CPL can be purchased as a stand-alone policy or added to your GCL or umbrella policy. As you might expect, a stand-alone policy allows for higher limits and has fewer restrictions. For example, if you have in-house designers, you may have to purchase a stand-alone policy.
Policies can be written on an annual basis to cover all of your operations or on a project basis to cover a specific job. CPL covers your legal defense, settlement costs and judgments from lawsuits that claim negligence, errors, omissions, inaccurate advice, failure to complete work or misrepresentation.
CPL policies have dollar limits, which can be exhausted by high legal and settlement costs. Be sure to discuss the two main types of limits with your insurance professional: aggregate and occurrence. The aggregate limit is the maximum amount your policy will pay during the policy’s term (usually one year). The occurrence limit is the maximum it will pay for a single claim.
Here’s what’s typically covered in a CPL policy:
- Your in-house design work
- Design work you delegate to another party
- Subcontracted design work under a design-build contract
- Faulty workmanship by subcontractors when you manage the contract
- Third-party and first-party indemnity coverage
- Pollution coverage (sometimes as an add-on)
Keep in mind that most CPL policies are written on a claims-made basis. Only claims made while the policy is in force will be covered. Since errors and omissions may not be discovered until after your project is complete, you’ll need to keep your policy in force for an extended period.
For large projects, a controlled insurance program, or “wrap-up,” may be worth considering. Wrap-ups ensure adequate insurance coverage for all of the parties on the project and are managed by the general contractor or owner.
You can reduce your liability risk by properly vetting your designers and having a well-documented work process. Make sure those you hire are bonded and insured, carry their own professional liability insurance, and understand the scope of work in their contract. Institute a formal process for change orders and meet regularly with the owner to keep lines of communication open.
Contractors often overlook professional liability coverage when purchasing insurance; however, it can be just as important as general liability and workers' compensation. Ask your insurance professional about CPL. With rising legal costs and increased project responsibility, you may find it to be an essential part of your insurance program.