Addressing the Latent Defects Blind Spot

While the private residential property market often mandates a structural warranty policy before construction begins to protect investments, this practice is far less common in the commercial and public sectors. Traditionally, stakeholders have relied on collateral warranties and professional indemnity insurance (PI) to address these issues.

This raises an important question: “Does this reliance leave local authorities and other publicly funded organisations in a vulnerable position?”

The Problem: Limitations of collateral warranties and professional indemnity insurance

Collateral warranties

• Reliance on solvency: The effectiveness of a collateral warranty hinges on the financial stability of the contractor or consultant
• Enforcement challenges: Enforcing collateral warranties can be complex and costly, often requiring lengthy legal proceedings
• Scope of coverage: Coverage is often limited to specific aspects of the work, potentially leaving gaps if defects fall outside the defined scope
• Transferability issues: Collateral warranties may not be easily transferable to new property owners, limiting their utility in property transactions
• Time limitations: These warranties typically have a limited duration, which may expire before latent defects are discovered

Professional indemnity insurance

• Proving negligence: Successful PI claims require proving negligence or breach of duty, which can be complex, time-consuming, and contentious
• Claims-made basis: Coverage is typically on a claims-made basis, requiring the policy to be active both when the claim is made and when the alleged error occurred. This necessitates that the main contractor and professional team maintain specific levels of cover for up to 12 years - but who is monitoring this
• Coverage limits: Financial limits may be insufficient to cover the full cost of rectifying significant latent defects
• Policy exclusions: Policies often contain exclusions that may limit coverage for certain types of defects or claims
• Insurer solvency: Recovery under the policy depends on the insurer's financial stability

The Solution: Latent defects insurance – The key to effectively managing unknown construction defects

Latent defects insurance (LDI) offers a more comprehensive and effective solution than relying solely on collateral warranties and professional indemnity insurance. The key benefits include:

• Comprehensive first-party coverage: LDI provides direct coverage for physical damage caused by defects, without the need to establish fault, negligence, or liability of the parties to the construction contract. This eliminates the complexities associated with legal disputes and lengthy litigation.
• No reliance on third-party solvency or policy upkeep: Unlike collateral warranties, LDI does not depend on the financial stability of contractors or consultants, ensuring that coverage remains intact regardless of third-party solvency issues. Additionally, there is no requirement for the professional team to maintain Professional Indemnity insurance for the policy period (10-12 years), ensuring peace of mind.
• Transferability and asset value protection: Policies are assignable to new property owners, enhancing the property's value and marketability. This feature is particularly beneficial in property transactions, providing assurance to potential buyers.
• Simplified claims process: Claims under LDI do not require legal action against contractors or consultants, simplifying the claims process and reducing associated costs. This allows for quicker resolution and remediation of damage due to defects, enabling proactive reinstatement and minimised business interruption.
• Financial certainty: Policies provide a predetermined level of financial protection, reducing the risk of uncovered losses due to policy limits or exclusions. This certainty is crucial for stakeholders managing large-scale projects.
• Improved quality: The technical audit process can identify defects before the project reaches practical completion, enabling these issues to be addressed before the owner assumes responsibility for the structure from the contracting parties. Conducting this independent audit during the construction phase ensures both quality and adherence to plans and specifications.

Conclusion

While collateral warranties and professional indemnity insurance have traditionally been used to manage the risks associated with latent defects, they have significant limitations. Latent defects Insurance offers a more comprehensive, reliable, and straightforward solution. By providing direct coverage for damage without the need for legal disputes or proof of negligence, LDI ensures that stakeholders can better protect their investments and effectively manage and mitigate the financial and operational impacts of latent defects.

Consequently, commercial developers, owners, financiers, and tenants are increasingly turning to this more robust and responsive solution in light of the limitations of the more traditional approaches and the challenges posed by increased contractor insolvency.

For more information, please contact us.