Latent defects insurance

It is the nature of construction projects that faults and defects caused by failures in design, workmanship or materials, may not become apparent or readily detectable (even with the exercise of reasonable care) until many years after completion of the project, long after the end of the defects liability period. Such defects are known as latent defects. Latent defects can be extremely expensive and disruptive to rectify.

Latent defects insurance provides cover for new buildings (or new works to existing buildings) in the event that latent defects become apparent. Latent defects insurance is seen to provide more complete cover for defects than other methods, (such as collateral warranties) which may require proof of breach of contract. This can take considerable time, and can be subject to complications such as net contribution clauses and insolvencies.

Latent defects insurance was proposed in 1988 when the Construction Industry Sector Group of the National Economic Development Council published their report Building Users' Insurance Against Latent Defects. At the time, there was little take up, as the premium, was in the order of 1.3% to 1.7% of the rebuilding cost. So, for example, on a £10 million rebuilding cost, the premium would be of the order of £150,000. In addition, there were fees and expenses for independent design checkers.

However, there is now much more flexibility in the insurance market as to the range of available cover available. There are several insurers writing building defects type insurance and premiums are reducing. As a consequence, latent defects insurance is becoming more prevalent.

Cover will usually be provided for 8 to 12 years from the issue of the final certificate or certificate of practical completion (although longer policies are now available). Typically, the insurance provides cover, up to the full rebuild cost, for repairs and for work to prevent imminent damage.

Basic policies cover the structure and weatherproofing but this can be extended to include non-structural elements and mechanical and electrical services (such as heating, ventilating, air-conditioning, water systems, lifts, escalators, electrical distribution systems, building management systems, and so on), and some policies will provide cover for loss of rent, loss of profit or revenue, and the costs of working from alternative premises.

Premiums can either be payable annually, or through a single, one-off payment, and policies are generally freely assignable.

In addition to the premium, technical auditors will have to be paid for by the insured to check the design for insurers. There is, inevitably, an element of duplication of fees here in the sense that the building owner is paying professionals for the design and then paying other professionals to vet the design for insurers. However, it can be argued that this audit process is good for risk management of the design, workmanship, installation, choice of materials and testing.

Waiver of subrogation rights against architects, engineers and contractors is available but at increased premiums. At present this does not appear to reduce professional indemnity insurance premiums.

The use of latent defects insurance does not mean the end of collateral warranties. Most lawyers take the view when advising developers and tenants, that collateral warranties are still needed to plug any gaps there may be in the extent of cover provided by latent defects insurance. Unlike claims for breach of contract, cover under latent defects insurance is limited to the maximum sum insured, and only certain specified losses are covered. In addition, policies may include an excess (sometimes around 1%).