Matthew Thomas is Vice President at Admiral Insurance Group, a Berkley Company. He has 16 years of experience in professional liability insurance. He leads a talented team out of Seattle, responsible for underwriting professional liability insurance for the excess and surplus sector. Matt also serves as the product lead for Admiral’s architects and engineers’ PL and contractor’s E&O practice. He loves being active with his family in the beautiful Pacific Northwest.
There is a common misperception amongst construction business owners and the insurance agents who represent them when it comes to liability insurance; If you wear boots to work, you need CGL. If you only roll up your sleeves to avoid smudging the lines on your drafting paper, you need E&O. While these coverages remain critical to the insurance programs of these respective businesses, the either/or rule of thumb is increasingly inadequate. Emerging trends in construction project delivery methods and the scope of services performed by contractors has expanded the potential liability faced by construction firms. The commercial insurance marketplace has responded by offering an innovative insurance product to meet this need, Contractor’s E&O. Each carrier takes a proprietary approach to this line of business but generally Contractor’s E&O is based in Professional Liability. It may also include a suite of additional coverage parts to address specific risks faced by General or Specialty Contractors.
Expanding Scope of Services
Since the 1920’s the term “Blue-Collar” has been used to describe a worker who performs a manual labor job. In the 1930’s Upton Sinclair first coined the term “White-Collar Worker” to describe a salaried professional who typically performs an administrative or managerial task. Historically, the Construction Industry has been divided into similarly distinct categories. Architecture & Engineering firms use their specialized knowledge to develop plans for buildings and facilities and Contractors use their skills to construct those plans in the physically built environment. Today, this division is often less clear cut. Many contracting firms perform multiple services which are professional in nature. Design & Build firms provide a one-stop-shop solution from concept design and engineering through construction of a project. They may employ licensed architects or engineers or they may take on the responsibility of selecting and carrying contracts with subcontracted design firms. Even when a separate design firm is hired, a General Contractor may assume some level of responsibility either explicitly by contract or implicitly by their involvement in pre-construction phase activities (i.e. planning and budgeting, design consulting, constructability review) through construction phase services (i.e. value engineering, design change orders, construction management, scheduling and project oversight). Specialty or Artisan contractors also often consult on the constructability and design elements of their specialized trade. Each step of the process poses exposure to economic damages which are not addressed by CGL.
Gaps in CGL
The CGL form and standard endorsements specifically exclude losses of an economic nature as well as claims arising out of professional services such as Construction Management, Architecture, Engineering and Surveying (CG2234, CG2243, CG2279 and CG2280). However, a contractor may be held liable for financial damages incurred by the project owner. Depending on the delivery method of services the liability could arise out of an error or omission on the part of the contractor or vicariously for services performed by subcontractors on their behalf. Addressing alleged damages from cost overruns, business interruption or loss of income can have a significant impact on a contractor’s already thin profit margin as well as their relationships and reputation.
The CGL policy also generally excludes the cost to repair or replace the insured’s own faulty work. Coverage A of the CGL form stipulates that coverage only applies if:
the “bodily injury” or “property damage” is caused by an “occurrence” that takes place in the “coverage territory”;
In other words, CGL carriers have contended and courts have upheld that coverage only applies to the resultant damages following a BI or PD occurrence but not the repair or replacement of the causal faulty work. Work that is not performed well, the use of defective materials or damage to a contractor’s own work is considered a “business expense” rather than an insurable accident (Weedo v. Stone-E-Brick, Inc., 405 A.2d 788 NJ 1979).
The increase in Design/Build contracts for many projects has also opened contractors up to losses arising out of engineering errors or omissions even when a 3rd party A&E firm is contracted to provide the plans. Savvy contractors carefully select the engineering firms they engage as subcontractors based on experience, reputation and personal working relationships. Even so, as a matter of due diligence they take the prudent precaution of requiring subcontracted firms to carry Architects & Engineer’s Professional Liability Insurance to indemnify any potential losses from their mistakes. But, what if the engineer’s mistake leads to a lawsuit against the General Contractor who hired them? The GC may look to the engineer’s E&O policy for indemnification but what if that policy limit has been eroded or even exhausted by a claim from another job? What if the engineer decided not to renew their E&O insurance policy? This first party exposure is excluded under CGL.
Architect’s & Engineer’s Errors & Omissions
Some firms that perform construction along with design and/or construction management may consider purchasing an A&E Professional Liability policy in addition to CGL to cover both aspects of their services. While this may be an acceptable solution in certain scenarios, for most contractors it is the wrong tool for the job. The typical A&E Professional Liability policy defines a Claim as arising out of the delivery of a narrowly defined Professional Service (e.g. services as a licensed Architect or Engineer). It is also common for the policy to exclude claims arising out of construction or manufacturing. Faulty Workmanship and Construction Management are also often excluded exposures.
To better illustrate these exposures, consider the following scenario:
TLC LLC, a telecommunications system contractor, was hired to install an underground coaxial cable and Internet system for a large office complex at the cost of $400K. Their services included designing the system, though they subcontracted Bolt Electrical Engineering, Inc. to provide a PE stamp for the final plans. Following installation and before construction completion, the coaxial system was tested by a technology infrastructure engineer. The system failed, and an investigation determined that the cable called for in the design was not appropriate to be buried underground, it was rated for above‐ground‐only systems and inadequate for underground shifts in temperature. Removal and reinstallation cost $250,000. Additionally, the project was delayed by 3 weeks costing the property owner $150K in missed lease income. Not only was TLC, LLC forced to absorb the cost to remediate their defective work, they were also held liable for the missed lease income and the $10K cost for a forensic engineer to diagnose the cause of the issue. Since the case did not involve a BI or PD occurrence, these damages were purely economic and the claim was denied by the CGL policy. To make matters worse, when the contractor attempted to collect reimbursement for a portion of the damages from the Bolt Electrical Engineering, Inc.’s A&E Errors & Omissions policy they discovered that the limit had been exhausted by a separate claim and the firm had filed for bankruptcy.
Contractor’s E&O Coverage Parts
As the above scenario demonstrates, the scope of a contractor’s potential liability goes well beyond BI/PD resulting from their completed operations. Despite their best efforts to deliver quality work on time and on budget, mistakes happen and they can be very costly. Thankfully, Contractor’s E&O insurance offers multifaceted protection of a contractor’s assets as well as their reputation. I will highlight the most important components of Contractor’s E&O next but keep in mind that as with all Professional Liability coverage the policy forms are proprietary. There is significant variance between the appetites of different carriers, the availability of specific coverages and nuances to the wording of each form which materially affects the coverage afforded.
The Professional Liability coverage part of the Contractor’s E&O addresses the lack of coverage in the CGL for claims of economic damages arising out of “professional services” performed by the Insured. In the example above, mistakenly listing cable material rated for above ground use in the communication system design would be considered an error in the delivery of a Professional Service and therefore excluded under the CGL since the error did not result in physical damage to people or property. Professional Liability would respond to this claim scenario as economic damages are generally the basis of all claims covered in an E&O policy. The Contractor’s E&O form should include a broad definition of Professional Services which includes design/engineering, related consulting and Construction Management services.
As explained above, the cost to correct self-performed work is excluded under the CGL policy. It also does not fit the traditional definition of third party liability as covered by E&O policies. Therefore, contractors are forced to absorb the cost of replacing defective work, products or materials installed by their employees, as well as loss of use associated with the impaired property. For specialty contractors who perform a trade Faulty Workmanship coverage provides reimbursement for the costs associated with removal, repair and replacement of the Insured’s own work due to unintentional defect. Mistakes happen and Faulty Workmanship coverage enables a contractor to proactively rectify defective work in a timely manner while protecting their bottom line.
In the above hypothetical scenario involving TLC, LLC, suppose that rather than a design error initiating the need to dig up and replace the coaxial cable, a cold snap caused the ground to freeze which damaged the cables. Upon inspection it was discovered that they were not buried at sufficient depth for local building code and a portion of the lines were not properly insulated. TLC, LLC must incur the cost to demolish sections of concrete walkway already installed in order to access the cables, reinstall conduit insulation, repair damaged lines, replace the cable at the proper depth then replace the concrete. The rework costs a total of $300K and the 2-week delay of the project cost the owner $150K in missed lease income. The CGL carrier denied coverage entirely.
If TLC, LLC carried Contractor’s E&O with Faulty Workmanship Coverage, the policy would pay for the costs associated with the repair including removal of concrete to access the cable, replacement of damaged cable materials and the owner’s missed lease income due to loss of use of the impaired property.
Protective Indemnity (First Party Protective)
In a Design/Build contract scenario such as the above, it is the General Contractor who is contractually responsible for satisfactory completion of the project. As far as the owner is concerned, it is up to TLC, LLC to remedy the financial damages caused by the error in the coaxial cable system design. TLC, LLC was left holding the bag when they realized that Bolt Electrical Engineering’s E&O policy was no longer valid and collectable. Protective Indemnity coverage under a Contractor’s E&O policy is a first party coverage that reimburses the Insured for a claim made against them for damages due to a design error by one of their subcontractors. Normally the GC would make a claim against the design firm’s E&O policy but in the absence of coverage or inadequate limits the Protective Indemnity coverage would apply. In this scenario, Bolt Electrical had no coverage available due to exhaustion of limits. Had TLC, LLC carried Protective Indemnity coverage they would have the assurance of being able to settle the matter with their client in a timely and amicable manner, then seek reimbursement for the loss on a first party basis with their insurer.
Contractor’s E&O, a key component of a well-rounded insurance program, offers protection against the risks inherent to this evolving business and can make a construction business more competitive. Project owners, developers and general contractors often require coverage be carried by a contractor in order to win a bid. Coverage for Faulty Workmanship, previously considered an uninsurable business risk, enables contractors to quickly rectify mistakes, keeping their projects on schedule and keeping them out of court. Finally, for General Contractors and At-Risk Construction Managers Protective Indemnity is a smart risk management strategy to safeguard a company’s assets in the event of an uninsured or under-insured design error claim.
Contractors today bring a broad set of capabilities to their projects and their insurance program should adapt to meet the evolving risks. They’ve outgrown the blue collar but the white one doesn’t quite fit either. Contractor’s E&O is a well-tailored jacket perfectly paired with either, along with a sturdy pair of boots.