Insurance for Architect- and Engineer-Led Design-Build Projects

Design-Build Architect/Engineers Liability Insurance

Most A/Es maintain several basic types of insurance coverage, including the following:

• General liability
• Auto liability
• Employers liability
• Workers compensation
• Umbrella or excess liability
• Professional liability

Taking the lead in design-build projects increases the amount of risk being insured by an A/E's policies and, in some cases, it also changes how liability insurance responds to a loss.

Commercial General Liability Insurance

General liability insurance is usually purchased by all of the parties in the construction process. It is designed to protect the insured party against liability arising out of direct bodily injury and property damage to third parties caused by an occurrence (accident).

Generally, an A/E's normal operations do not generate a substantial loss exposure for the risks covered by general liability insurance. Although A/Es always purchase general liability insurance to protect against normal commercial liability, the limits of this coverage (even with umbrella or excess coverage) are frequently not high enough to meet the design-build contract requirements, requiring the purchase of additional limits.

Typical Liability Insurance Program for a Design Firm Graph

General liability coverage can cause some confusion in the design-build setting because it does provide limited protection for losses arising from design error. For example, an unamended general liability policy will insure against a loss resulting from a design error, as long as the design error results in bodily injury or property damage to a third party and is the result of an occurrence. If the loss is purely economic (i.e., delay without bodily injury or property damage), there is no general liability coverage.

To avoid overlapping with professional liability coverage, an A/E's general liability policy includes the Insurance Services Office, Inc. (ISO), Form CG 22 43, "Engineers, Architects or Surveyors Professional Liability" endorsement, which excludes any liability arising from professional services. For a pure A/E, this does not present a problem, but for a design-build A/E, it can. As with a contractor, the professional services exclusion needs to be clarified so that excluded professional services will not include any activities included within construction means or methods (ISO Form CG 22 79, "Exclusion-Contractors-Professional Liability" endorsement).

Most insurers will not, however, delete the professional services exclusion entirely or even use the "Limited Exclusion-Contractor-Professional Liability" endorsement (ISO Form CG 22 80) that allows coverage for bodily injury or property damage from professional design services in connection with a project the insured is designing and constructing.

Another important coverage for design-build A/Es is contractual liability. In the definition of an "insured contract," the 1998 edition commercial general liability policy form CG 00 01 contains exclusions that affect design-build contracts. Specifically, the policy states that coverage will not apply to contracts:

1. That indemnifies an architect, engineer or surveyor for injury or damage arising out of:
   1. Preparing, approving, or failing to prepare or approve maps, shop drawings, opinions, reports, surveys, field orders, change orders or drawings and specifications; or
   2. Giving directions or instructions, or failing to give them, if that is the primary cause of the injury or damage; or
2. Under which the insured, if an architect, engineer or surveyor, assumes liability for an injury or damage arising out of the insured's rendering or failing to render professional services, including those listed in 2. above and supervisory, inspection, architectural or engineering activities.

This wording is rarely amended, or even considered, for its impact on design-build risk. A design-build A/E should request that the wording be amended in two ways: clarify that ordinary means and methods will not be considered a professional service (similar to ISO endorsement CG 22 79) and amend the policy to confirm that this wording will not apply to design-build joint ventures. Underwriters are more likely to agree to the first change suggested but may resist on the second.

The design-build A/E must also be concerned with completed-operations insurance coverage. Completed-operations insurance covers bodily injury and property damage caused by defects in the completed work, including losses arising from damage that occurs during the operation of the finished product, usually provided for a term of 1 to 3 years after substantial completion.

Owners must be aware that some design professionals do not carry completed-operations coverage on their general liability policies. However, most general liability insurers will agree to add completed-operations coverage without additional charge.

Professional Liability Insurance

Typical A/E professional liability insurance provides broad protection for liability arising from the rendering or failure to render professional services. Normally, the scope of coverage includes all professional services offered by the A/E, and coverage provides long-term protection as long as it is continuously renewed by the A/E. In the design-build setting, however, A/E professional insurance presents several problems.

• Third parties cannot be added as additional insureds.
• Insurers frequently add restrictive "design-build" endorsements.
• Low policy limits need to be shared by several parties.
• Coverage only applies to third-party liability.

The additional insured issue is not a problem from the A/E's point of view, but can be frustrating to owners and/or contractors requesting additional insured status similar to a general liability policy. The best resolution for this issue is for each entity to buy its own coverage or for the owner or lead design-builder to purchase project specific professional liability insurance (see IRMI.com, Project-Specific Professional Liability: Who Really Pays for Design Errors? May 2000).

Both the design-build A/E and the project owner must also recognize that many professional liability policies carry a design-build endorsement which specifically excludes the "build" aspect of design-build services from coverage. While these endorsements may vary in their particular wording, they are generally similar in that they seek to exclude claims based on or arising out of faulty workmanship and construction performed by both the insured design-build A/E or its subcontractor.

There are several reasons cited in support of this exclusion. Some types of faulty workmanship will be covered by the applicable general liability policy or builders risk policy. Also, because design professionals are often in a position to control and eliminate many of the situations and factors that can directly cause faulty workmanship, the faulty workmanship exposure is often perceived as an uninsurable risk with respect to design professionals.

The problem with some design-build endorsements is that they inadvertently eliminate coverage for certain professional activities and/or losses (e.g., delay or review of shop drawings). As recommended in the comments about contractor professional liability insurance, any exclusions added by the underwriter (or included in the policy form) that are intended to limit coverage by excluding construction activities should always be clarified by adding the phrase, "unless such loss or liability arises from the rendering or failure to render professional services."

Another key issue for design-build A/Es is how their insurance works when they are leading a fixed price or guaranteed maximum price (GMP) project. For example, consider the following scenario.

An Elm Street A/E agrees to design and build a $20 million commercial building on a GMP basis. The expected profit from the job is $1 million. During construction, a design error (committed by Elm Street) is discovered, and it costs $2 million to repair and get back on schedule. As the design-builder, Elm Street absorbs the increased costs and still completes the job on time and within budget.

In the scenario described above, Elm Street gets no benefit from its own professional liability policy because it was not sued by the owner or any third party. One leading A/E insurer has verbally stated it will cover the type of claim described above, but to date, this issue has not been addressed by the insurance community. A/Es planning to lead design-build projects should discuss this risk with their insurers and request "first-party" coverage to pick up a loss that would otherwise be insured except for the structure of the design-build contract.

Surety Bonds

The potential for exposure to liability for design problems makes some sureties reluctant to issue bonds securing the performance of design-build contracts. This reluctance is not diminished by the fact that the design-build team is headed by a design-build A/E rather than a design-build contractor.

Even if the surety is confident that the language of the bond and the design-build contract precluded a claim on the bond due to design defects, the surety may still be hesitant to issue the design-build A/E a performance bond for the construction portion of the project. The two fundamental elements considered by sureties when determining whether to issue a bond to secure the performance of an entity are (1) the capability of the bonded entity to perform the contract requirements, and (2) the financial ability of the bonded entity to indemnify the surety if the surety must pay a claim on the bond.

In this regard, the surety may harbor reservations about the design-build A/E's ability to effectively manage and administer the construction aspects of the project because the activities are beyond the scope of the design professional's traditional expertise. Furthermore, many design and engineering firms do not possess the financial capability to adequately indemnify the surety in the event of a large claim. Taken collectively or individually, such factors could lead to design-build A/Es encountering particular problems in securing a performance bond for their design-build project.

A design-build A/E can improve its ability to procure a performance bond in three ways.

1. The design-build A/E should establish a relationship with a reputable surety before the bond is actually needed and increase the surety's confidence in its financial capability.
2. The design-build A/E should procure smaller bonds while successfully performing projects and prove that it is a good performance risk.
3. The design-build A/E should procure bonds with the construction subcontractor so that the surety can look to both entities for performance of the contract and indemnity if the surety has to honor a claim on the bond.

Conclusion

Design-builders and owners using design-build construction techniques must carefully consider the form of the design-build entity to determine the adequacy of the insurance purchased for the project. Who leads the design-build team-a contractor, a design professional, or a joint venture-will have an impact on the insurance and bond coverages available. Thus, both owners and design-builders must carefully analyze risks and insurance available for design-build projects.