The benefits of inherent defect insurance cover
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To highlight the benefits of an inherent defect insurance (IDI) cover it is useful to consider a hypothetical claim scenario: Imagine a large mixed-use commercial development with three below-ground levels. The ground and upper floors comprise a hotel, residential and retail units. The basement levels contain function rooms and catering facilities for the benefit of the hotel.
The basement is constructed from reinforced concrete secant piles, which, whilst structurally sound, are not watertight. Consequently, ground water is able to reach the external face of the external concrete perimeter walls and, over time, penetrate into the lower basement(s) through construction joints. It is unclear whether this is due to a failing in design, materials or workmanship, or a combination of all three.
Damage to internal fixtures and fittings is first identified three years after Practical Completion. Sound complicated? Perhaps. But as water damage is one of the most common causes of claims on IDI policies, this type of situation is unfortunately all too common.
The benefits of a comprehensive, first-party solution
In our hypothetical claim situation, the benefits of IDI immediately become clear. The IDI policy provides a single point of recovery for all parties having a beneficial legal interest in the property. There is no need to spend time trying to establish fault, either contractually or in tort, in respect of the parties involved in the original build.
Whilst it will still be necessary to investigate thoroughly to establish what went wrong – in order to ensure any remedial scheme fully rectifies the defect and any subsequent damage – ascertaining whether the policy should respond and providing peace of mind to the insured by confirming coverage, should be straightforward.
Compare this to the scenario without an IDI policy in place. The parties impacted by the water ingress (typically the developer or subsequent purchaser) would be left with little option but to incur the cost of rectifying the defective work and consequential damage themselves: particularly as any operational property policy they may have purchased would typically exclude damage caused by defects in construction.
Could the developer then get their money back? Not easily. Pursuing a legal action to recoup any outlay would be complicated for a variety of reasons. Firstly, it may be evidentially difficult to establish culpability on the part of one or more of the original contracting team, particularly where construction records cannot be located or where the documentation that does exist is ambiguous or disputed. Secondly, establishing a cause of action in respect of purely economic losses may not be straightforward in the absence of a direct contractual relationship or collateral warranty. Thirdly, even if a contractual relationship can be established, there may be financial limitations of liability in deeds of appointment or the building contracts which ultimately restrict the extent of any recovery.
Lastly, even if these three hurdles can be overcome, you would need to be satisfied the potential target of the recovery is both (i) still trading as a going concern, and (ii) in a position to satisfy any judgment made against them or protected by insurance for their legal liabilities. That's before you consider the costs of pursuing a claim, which can be considerable – and the adverse impact this type of legal action may have on the commercial relationships between the parties involved, However, it is important to recognize that IDI is not the panacea to every claim problem. The material damage proviso as a trigger to cover means it is still necessary for a developer to consider whether appropriate contractual protections are in place to protect against the risk of discovering defective work that doesn't lead to physical damage. Equally, the IDI policy is unlikely to provide recompense for consequential or economic losses which the insured may incur beyond the direct cost of repair (albeit a comprehensive policy can provide cover for business interruption, loss of rent or damage to M&E elements). There will be a policy excess to deduct.
However, in terms of providing cover from day one, in a form which is capable of being used immediately or assigned to future tenants or purchasers if the asset is sold (and as a result, enhancing the sale value), and in a manner which allows for any rights of recovery to be waived against the original project participants, an IDI policy can be a very valuable asset.
What should you look for in an IDI insurer?
Technical knowledge – the ability to understand the commercial construction market, discuss and develop bespoke transfer solutions tailored to your needs. Aligned with this technical expertise is the ability to work closely with the appointed Technical Inspection Services (TIS) provider.
Longevity – the cover incepts at the end of the construction period, which may well be a number of years after the policy is sought, thereafter the cover can last over a decade. Having the highest level of confidence that your provider will be there to pay your claims after such a long duration is essential.
Claims handling expertise – having a claims team that understand the IDI product facilitates timely resolution to covered claims that will enable you to continue your business with the minimum amount of disruption.
This article has been published in "Building Blocks", issue 2/2019.