Understanding Contractor's Protective Insurance
Jeff Slivka | June 1, 2009
For the past 10 plus years, many insurance professionals have used the acronym "CPPI" as though they truly understood all its benefits and coverage terms. For the record, "CPPI" is a service-marked product of Zurich American and stands for Contractor's Protective Professional Indemnity and Liability Insurance. It does not refer to an industry product in general and offers both professional liability and contractor's protective coverage. Its the contractors protective coverage part that is understood by most.
Since Zurich is the originator of this coverage, and up until last year the only one to offer it, this product is most commonly connected to the company. However, today there are now two markets offering Contractor's Protective—Zurich and Catlin USA.
After broking various Contractor's Protective policies ranging from the simple and complex to the small and large while working with numerous retail insurance brokers specializing in construction, I have found that a large number of professionals actually have limited contractor's professional liability and risk management insurance expertise. But the good news is that the industry overall has come a long way in its understanding of contractor's professional liability insurance issues. However, this knowledge must be constantly updated since there seems to be a new delivery method or fresh twist introduced to this coverage on a daily basis.
While I will never proclaim to be an expert (according to some business management gurus, an "expert" is a person who has made every possible mistake in a narrow field, and even though I have made some big ones, I still haven't made them all), I can tell you that there are several misperceptions or misunderstandings that have led to a distorted view of contractor's protective insurance. As a result, a better understanding of both its benefits and drawbacks are required.
Overview
First, let's consider a basic overview of contractor's protective. When many insurance professionals request contractor's protective coverage, it usually means they are looking for a true professional liability product with an additional coverage part: contractor's protective. Protective coverage is a first-party coverage that indemnifies the named insured, excess of the design professional's professional liability insurance, for costs the named insured incurs, and is legally entitled to recover, as a result of negligent acts, errors, and omissions of design professionals with which the named insured holds a contract.
In addition, it also affords a difference-in-coverage (DIC) above the underlying professional liability policy and extends coverage to the named insured in the event the underlying policy is deficient in coverage. Such deficiencies may include exclusionary language for mold or other pollution conditions, habitational exclusions, cost overrun exclusions, or quantity estimating exclusions that may exist in a design professional's practice program. Essentially, the protective supplements the design professional's professional liability insurance program by providing direct benefits to the named insured, the contractor (a.k.a. design-builder), for the costs incurred above what the design professional can provide via insurance proceeds of its professional liability insurance. As a result, this is much different than the typical liability coverage offered in a professional liability policy.
Illustration
One of the best and most oversimplified examples used to illustrate the value of protective coverage includes a contractor, who contracts with a design professional (DP) to provide the prime design of a mixed use retail/condominium project. The contractor carries a $5 million contractor's professional liability (CPrL) program including protective coverage. Unfortunately, the design professional designs the project with the improper sized rebar, which is not discovered until after extensive construction work has been completed.
After further inspection, it is then determined that the cost to demolish and rebuild would be approximately $3 million, which is significantly less than the costs associated with proceeding with altered design. Since the contractor is ultimately responsible for the design aspects of the project, and most design build contracts are guaranteed maximum price, the contractor has little or no recourse with the owner but to absorb the additional costs involved with demolishing the original structure and starting construction anew.
Therefore, one of the few options remaining to the contractor includes looking to the design professional, and subsequently the design professional's professional liability insurer, for the repayment of these additional costs. The claim is then made against the design professional's professional liability insurer, which carries a liability limit of $1 million per claim/aggregate. The DP's policy would pay $1 million (provided such policy does not exclude coverage and the limits are intact—not reduced by previous claims) and the protective coverage would then pay $2 million. However, there is an aspect of protective coverage that is often overlooked. It is an excess coverage. Therefore, the protective coverage will not respond until the coverage applicability of the underlying DP's policy is determined. In other words, it may take years to settle the claim under the DP's policy and, until then, the protective coverage will not respond. Even so, the value of such coverage is undeniable.
Other Features
Other important and usually misunderstood aspects of contractor's protective include the following.
Self-Insured Retention (SIR)
The protective coverage usually, but not always, carries a self-insured retention. The self-insured retention only applies in the event the underlying DP's professional liability insurance is not available as a result of previous claims, exclusionary language, canceled policies, and so forth. In the event the underlying DP's policy is intact, the SIR does not apply.
Minimum Insurance Requirements (MIR)
Typically, insurers offering protective coverage require contractors to work with design professionals that have a minimum of $1 million in professional liability insurance. This affects coverage in two ways: (1) no SIR will apply in the event the MIR is met at the time of claim and (2) during such circumstances, the insurer will agree to waive subrogation rights against the DP. If not, the insurer may subrogate back against the design professional for expenses incurred. However, many insurance professionals often mistakenly believe that the protective coverage applies excess of $1 million if stated in the policy as the MIR. In reality, the MIR is just that, a minimum. So, if the design professional is carrying $5 million in limits, which are intact at the time a claim is made by the contractor, then the protective will sit the excess of the $5 million.
Contractor's Pollution Liability (CPL) Endorsement
True CPL can be provided on a blanket basis. This includes coverage for mold liability, pollution conditions arising from physical operations, or the transportation activities performed by or on behalf of the named insured as well as the cleanup efforts or liability associated with challenges confronted at designated or nonowned disposal sites (NODS).
Conclusion
The overriding concept of contractor's protective that many risk managers have come to appreciate is that it provides a supplement to the insurance available under the design professionals' professional liability policy—putting the negligent design professional's insurance on the line rather than replacing it. This not only preserves the contractor's future insurability, but also enables the firm to additional funds in that worst-case scenario.
Since the value of the protective coverage is proportional to the amount of design/build activities a contracting firm provides, not all construction companies need contractor's protective coverage. However, please note that the inverse of this axiom also holds true. In other words, if a firm is involved extensively in design/build efforts, and this can include prime design activities or even design/build contracts with lower tier specialty subcontractors, then that company should certainly consider contractor's protective coverage as a method of insuring against the devastating costs associated with design errors, demolition, and the reconstruction of the original structure.
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