Fixing Design Errors Before They Cost Big Money
Rectification insurance is filling a need on more design-build projects
Mistakes made by architects or engineers in the design process can often come back to haunt a general contractor later during construction.
Whether it’s a miscalculation in the dimensions of a building’s foundation or the choice of the wrong rebar, such design errors can lead to serious delays while the problem is fixed and even trigger additional damages down the line if the opening is seriously delayed.
However, a growing number of contractors, especially those working on design-build projects, are turning to rectification coverage in their construction insurance to keep projects on track, says Jeff Slivka, president of New Day Underwriting Managers, Hamilton, N.J.
Rectification insurance provides a contractor with the up-front cash needed to correct errors and mistakes before they snowball into more serious problems, he said.
Also known as mitigation of damages coverage, rectification insurance is now offered by as many as two dozen major carriers, up from just a handful five years ago when it was first launched, Slivka said.
More contractors are also buying these policies, including a growing number of mid-sized and smaller builders, he said.
“It is becoming very common now to see that (rectification coverage) in most of your policies for middle market and smaller companies, $250 million and below,” Slivka said.
Implications of Project Delivery Method
When a project is built using the traditional design-bid-build method, contractors look to owners first to recover any losses or damages due to design errors.
In that context, says Jack S. Kannry, a partner with Warshaw Burstein in New York City, the contractor would look to the owner, in the first instance, to recover for any losses and damages due to design errors, even though the errors were caused by the design engineer. The reason, Kannry explains, is that the owner has a direct contractual relationship witht he designer and the contractor has "neither privity with nor responsibility for that entity's performance."
The owner under those circumstances is responsible to the contractor for any liability caused by design errors, not the engineer.
In that case, the “need for rectification insurance would be more likely in the private sector because the owner’s ability to pay for the loss may be limited,” says Kannry.
Rectification or mitigation coverage is usually part of liability insurance and is most often bought for design-build projects. From an insurer's perspective, such coverage must arise from an act or error or omission where there is damage or where there could be damage or loss by others.
Speed of Resolution
One key advantage for contractors who buy such coverage is the speed of resolution: traditional claims and claims processes can sometimes take years to resolve.
In the meantime, the contractor is forced to pay to correct any problems out of its own pocket or wait until the claim is paid.
A contractor with a rectification policy can’t expect an immediate payout, with the insurer first having to agree that the issue at hand is serious enough to result in a claim being filed at some point.
“The insured and the carrier must agree this would result in a claim,” Slivka said. “There has to be some immediate investigative studies done by the carrier. It is really on the shoulders of the contractor to provide the carrier with all the information they need.”
Still, the waiting time may be a few months compared to years for other types of claims.
With the money in hand to pay for the work needed to correct problems with a project, the contractor then has the ability to correct a problem at a relatively early stage, heading off a more expensive and complex fix down the line or after the project has opened.
And by helping keep a project on time, this can head off another round of damages later on.
Time Element is Key
A contractor, for example, could face expensive claims for lost business by the owner or user – say a new restaurant or factory files – if there are serious delays in the opening of the project.
That said, there is a potential downside contractors should also keep in mind, with the potential for taking a hit to their future insurability,
If the rectification insurance carrier is unable to later claw back the up-front payments it laid out from the designer or other subcontractor that made the mistake, this will be recorded as a loss on the contractor’s insurance record.
Nor is rectification insurance necessarily cheap either – it can add another 10% to 20% percent to a contractor’s general liability insurance.
For a mid-sized firm with $200 million in revenue, that could mean another $10,000 to $20,000 a year, Slivka estimated.
But that, in turn, can be weighed against the benefits of maybe cutting in half the cost to fix an expensive design error while heading off loss of business claims later after the project opens.
Design or engineering errors can run into the millions, such as the geotechnical error that one contractor Slivka is working with which is now paying to fix with a rectification insurance policy.
Some contractors also keep their costs down by putting a sublimit on their rectification coverage, say at $250,000.
“The contractors most likely doing heavy design build work, they should have some level of rectification coverage,” Slivka said.