History
Latent Defects Insurance (sometimes referred to as Structural or Inherent Defects Insurance) for commercial buildings was introduced to the UK by French insurers during the 1980s.
The main purpose of the cover is to allow the owner of a new building to have 'peace of mind' that, should their development / investment suffer from damage caused by a defect in design, workmanship or materials, then they have in place a first party generally non-cancellable ten (or increasingly 12) year insurance policy to remedy that defect.
A structural defects warranty is an insurance policy which provides cover in the evnt of a defect occurring on the property. It does not rely on Architects Certificates or Collateral Warranties and Professional Indemnity. Should the owner of the property decide to sell the property within the period of the policy, it is transferable to the new owner and will be acceptable to the vast majority of mortage lenders.
If the proposition is as straightforward as all that then why is this cover not very common in the UK?
The answer to this question is quite complex and one which has been exercising the minds of numerous people associated with the construction industry.
Historically, Contract Works Insurance (or Contractors All Risks) has provided an ‘all party’ cover in respect of new works, during the construction phase and the maintenance period, of a new building. After handover an owner would have to prove that any damage manifesting itself was the result of negligence on the part of one or more parties to the construction contract.
The options would then be to:
- negotiate a settlement directly with one or more of the parties to the construction contract
- sue them if they denied liability
Either way this is likely to be a protracted process with no guarantee of success but this, believe it or not, is what most developers rely on.
They choose to ignore the facts that:
- third party claims typically take 5-7 years to settle
- third party covers are arranged on an annual basis and may not be renewed
- third party limits of indemnity may be too low to provide adequate redress
- the third party may no longer be in existence.
The good news is that severe post construction building defects are rare so that the likelihood of suffering is comparatively remote but, unlike a serious fire, which is also a very remote occurrence, building defects are not visible and rarely receive much publicity.
From time to time items appear in newspapers illustrating defects in buildings, such as the design defects in Great Ormond Street Children’s Hospital extension; the cladding failure on BP’s building in London; the nickel sulphide inclusions causing shattering of overhead glass in the Eurostar terminal at Waterloo Station.
These are high profile examples and sell newspapers. But for each high profile example there are dozens which do not make the headlines.
There were few memorable examples of high alumina cement but many instances of its effects. Whereas its effects may not have been caused by negligence, because its use could be defended by the plea of state of knowledge within the industry being limited at that time, its effects would undoubtedly be covered, under a Latent Defects policy, as a defective material - with damage manifesting itself after the construction period.
No one knows when the next high alumina cement type product will occur!
Commercial Property
Traditionally developers of commercial property have sought protection through Collateral Warranties, which are limited in their benefit as they rely on the continuous trading of the signatories as well as the continuing renewal of their Professional Indemnity policy. The structural warranties are designed to transfer the risk of future defects to an insurer rather than being retained by the parties involved. Cover may also be provided on completed commercial property, occasionally up to several years after completion.
New Homes
New Homes policies have been created for developers working on residential developments and conversions including new build and mixed use developments. The most common insurer is NHBC but there are several alternatives acceptable to mortgage lenders.
Social Housing
Specifically for Housing Associations and Registered Social Landlords with up to 12 years cover on residential developments and conversion projects. At least one insurer includes a 'Right to Acquire' facility which provides tenants who decide to purchase their property within the first five years of occupancy with a new ten year warranty which in effect provides up to 15 years of cover.
Completed Housing
For residential properties which have been completed without a warranty having been arranged.
Self Build
Self-build policies have been designed for individuals building their own homes and applies to both new and 'conversions'.
How Cover is Arranged
To obtain terms for a new building underwriters will want to know details of:
a) the Proposer
b) the new building and
c) the parties to the contract.
These form the physical rating features.
In addition the following factors affect the premium rating level :
Simple proposal forms are available to collect all of this information
These factors all affect the rate charged which will typically fall between £5 and £10 per £1,000 sum insured - the sum insured being the reinstatement cost of the completed building - this should include an amount in respect of professional fees, debris removal and demolition costs.
The Technical Audit Function
In addition to the above premium, underwriters are likely to require a deposit premium to cover the cost of an audit of the design and construction. The purpose of this audit is to try to prevent damage which may detected by an extra pair of eyes employed specifically for that purpose.
It can happen that the original design team is too close to the action and can miss the obvious.
Examples which have been spotted by auditors have included:
- unrestrained columns
- poor reinforcement placement in a floor slab
- inadequate reinforcement specified
- absence of wall ties
- lack of movement joints
- cross bracing moved by architect
- gable end drainage channel omitted
- out of sequence work leading to inadequate flashing detail
- inadequate fixing of facade to structure
- roof membrane laid incorrectly
Not only have these saved insurers from potential claims but they have saved the building owner from considerable upheaval and discontent from their tenants - not to mention the deductible! Such errors can be put right by the builder prior to handover.
The team of engineers used for this purpose tend to be very experienced structural engineers who have been carrying out technical audits for a number of years.
The technical auditor’s role is solely to try to prevent a claim occurring and not to cause disagreement. His function is to confirm to underwriters that to the best of his knowledge the building does not present any known defect in design or construction. If he is unhappy with any feature he will try and resolve the problem with the proposer’s nominated representative on site.
If this is not possible the matter will be referred back to the underwriter to resolve with the proposer. This tends to be very rare because both the proposer and the underwriter have the same aim - a building with no known defects and if our technical auditor has identified a potential problem, the proposer will normally want it resolved, rather than run the risk of a defect, either in design or construction, which has been identified.
At practical completion, if the technical auditor's considers the building or structure has been built to an appropriate standard and is in compliance with approved drawing and agreed specification, he or she will then issue the appropriate certificate of approval or acceptance and confirm to the insurer that the building is suitable for latent defects cover.
The cost of the audit varies from project to project and is affected by a number of factors. Except on small projects it is usually less than 25% of the premium.
The Policy
Once the audit has been completed and practical completion has been achieved a formal offer of cover is made. This offer usually reiterates the terms indicated at the outset and gives the proposer 90 days to decide whether or not to proceed.
The insured can be the developer, owner, tenant or provider or financier (or any combination of these). Once issued it is then freely assignable to any party acquiring an insurable interest in the building, during the currency of the policy.
The premium for the full period is normally payable at inception.
The cover is for
- structural defects
- ingress of water
- subsidence landslip or heave
- threat of imminent collapse requiring immediate remedial works to prevent damage
caused by a defect in design workmanship or materials but not discovered before the inception of the cover.
The main exclusions specific to Latent Defects Insurance are
- the deductible
- damage discovered outside the period of insurance
- anticipated or planned for movement, settlement, shrinkage or expansion
- abnormal use or overloading
- wear and tear or inadequate maintenance
- change in colour or ageing process
- the contractor’s contractual obligations for snagging
- damage to paint and other surface coatings
The basis of settlement
The cover is intended to operate on a reinstatement basis including the cost of remedial work to prevent further damage.
It includes
- professional fees
- removal of debris
- dismantling, moving, removing, storing, returning and re-erecting property belonging to the Insured
- costs of compliance with public authority
Optional Covers
Consequential Loss (Business Interruption) Covers
Cover can be arranged for landlords or tenants of buildings for which a material damage latent defects cover is provided against:
- loss of rent receivable
- loss of gross profit or revenue
- increased cost of working from alternative premises
- the waterproofing envelope above and below ground
- annual indexation of the sum insured and excess
- at additional cost, a waiver of subrogation rights against named or all parties involved in the design and construction process (this no fault cover offers comfort to all those signing up to a partnering agreement and can help to prevent the need for potentially drawn-out and expensive litigation.)
Other Benefits
The cover is provided on a first-party material damage basis and therefore there is no requirement to prove that there was either fault or negligence on the part of a member of the professional team. All that is required is to show that there is an inherent defect or damage as defined within the policy. Thus, the insured should receive the funds to replace the building faster, regardless of blame, than would happen if he or she had to resort to costly and time-consuming litigation to prove that a professional party was responsible, which is needed before professional indemnity insurance can respond. Therefore, discruption is kept to a minimum.
Provided the sums insured are adequate, the insured should obtain a full recovery under the latent defects policy. This may not be the case if professional consultants or contrcators do not have sufficient insurance or assets to enable a full recovery to be made.
It provides continuity regardless of the solvency of members of the professional team.
The cover is useful as a marketing tool and can be of a major benefit when negotiating a sale or a letting. The policy is freely assignable to both tenants and future purchasers.
It can reduce relaince on collateral warranties, guarantees and professional indemnity insurance provided by the professional team, although it should not be seen as a substitute for these.
It is con-cancellable for the period of cover.
In summary, Latent Defects Insurance can help to identify and manage both the construction and post-construction risks, thereby providing peace of mind to property developers, funders, future purchasers and tenants.
Claims
Examples of the types of claim -
- defectively designed floor slabs allowing movement and consequent damage to floors and walls
- omission of windposts allowing damage to the walls
- subsidence causing damage to the walls
- defective cladding allowing water to penetrate
- failure of basement tanking allowing water to penetrate
- defective roofting allowing water to penetrate
- failure of rainscreen allowing water to penetrate
- poorly fitting windows allowing water to penetrate
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