Heightened insurance requirements

Having a clear understanding of some key insurance concepts can help your firm navigate heightened requirements and hard insurance market conditions more effectively.

With the economy rebounding in several parts of the country, many design firms are seeing projects start up or restart. Yet, the good news comes with a new challenge: An increasing number of insurance specifications now require professional liability insurance limits that are significantly above what design firms typically carry.

Unfortunately, these requirements coincide with a hardening insurance market. Underwriters are now holding the line or reducing the professional liability insurance limits they’re willing to offer.

In your contract negotiations with clients, having a clear understanding of some key insurance concepts can help your firm navigate these requirements and the current hard insurance market conditions more effectively.

Reality check: Putting heightened requirements into context. In light of high project costs, owners and their advisors (especially, legal and insurance) inherently sense the need to update contractually required insurance limits to address increased exposures. By their assessment, the risk is defined by potential damages they may sustain or that the general contractor or others may claim against them (allegedly, at least partly due to design errors or omissions).

Nonetheless, there still should be some logical correlation between the size of the project and the professional limit required. Consider, for example, a recent $10 million university project where the professional liability insurance limit (required from the architect) was also $10 million.

Realistically, the likelihood of a claim or series of claims totaling 100 percent of the entire project cost is remote. In its negotiation, the architect should use this fact to explain that the additional costs of obtaining the required limit isn’t justified. Although professional liability insurance limits often vary depending on project type, location, and the goals of the owner, the following table reflects “rule of thumb” limits that may be expected:

Be proactive in finding coverage solutions. If your firm works in the larger project arena but has traditionally “gotten by” with limits lower than $5 million per claim/aggregate, now is the time to check the pricing on raising your policy limits.

The first option may be to increase your overall policy limit so that all your projects are eligible for the higher limit. This is best accomplished during your annual renewal when your broker may be engaging multiple underwriters competing for your coverage.

While not ideal, to shave costs off the increased premium, consider restricting the increased limit to apply only to work done after the date of the limit increase. Thus, only those claims arising from work performed after that effective date are entitled to the full limit. The drawback is that only “new” work is covered under the full limit.

A second option is a “split-limit.” Many owners realize that other claims could exhaust your coverage since in the U.S. the professional limit is subject to an aggregate cap (and is not an each and every claim limit). Explaining to your client that you carry (or can carry), for example, a $2 million per claim/$4 million aggregate “split-limit” may convince them to accept your current coverage amounts.

A third alternative is to see if the underwriter can offer the limit on a project-specific basis. You may need to complete a project-specific application for your broker to secure accurate pricing details. While this may take a few days, it can also potentially be used to convince the client that the costs are too high to justify the higher limit. Although the costs could be as low as $2,000 per year for each extra $1 million in limit, given the changing market conditions, the starting point tends to be closer to $3,000 to $5,000.

Meanwhile, some “wrinkles” to project limits are worth noting. Most underwriters are willing to offer the limit not just for a single project but for all projects done for the same client.

Lastly, some underwriters can offer a “blanket” additional limit endorsement in which the extra limit can be shared by multiple projects among multiple clients/contracts. This is significantly less costly than having separate additional limits for individual projects or clients.

Leveraging the power of subconsultants. Many clients stipulate not only your required types and limits of insurance, but also those of your subconsultants. Yet, they often fail to realize the ripple effects of these requirements. In fact, your subs by definition have a narrower scope of service – and requiring increased limits from each of them may be overkill.

Even if higher limits for subs are available, the cost increases significantly as each sub seeks assurance that the client will pay these extra premium charges. As these potential costs add up your client may be persuaded to revisit the need for higher limits. Furthermore, it’s worth reminding clients, especially public entities, that many WBE/MBE firms will be left out of the project if they cannot meet the elevated insurance limit requirements.

Another key consideration is the combined power of the collective insurance brought to the project across the design team. While it’s likely the client will bring a claim against the designer under contract, if the alleged professional negligence involves one or multiple subs’ discipline, then their limits are also at issue.

Show the client what all that adds up to: i.e., Architect ($5 million limits) + Structural ($3 million) + MEP ($2 million) + Electrical ($2 million), and so on. Thus, a delay or cost overrun claim (often, the most severe E&O claim) may already have combined limits in place exceeding the client’s requirement of you as the prime.

Rob Hughes, senior vice president and partner, Ames & Gough. He can be reached at rhughes@amesgough.com.