Design Risks Every Contractor Should Watch Out For

Contractors take on more design responsibilities on projects using new delivery methods. But along with the new influence, comes new risks.

New project delivery methods are reshaping the role of the contractor. Throughout most of the 20th century, design-bid-build was the standard way of running projects. This model relied on architects working with the owner under separate contract for the design phase. From there, the project was put out for bid to contractors to do the building.

So Many Roles

Today, more contractors find themselves as construction manager, assisting with design, or acting as partners with other participants. Generally called design-build delivery methods, these place design and construction services within one contract. Design-build use has risen rapidly over the past decade. In 2005, it accounted for 29% of the nonresidential construction market. More recently it is used on about 40% of the projects in nonresidential, according to a Chubb Construction report entitled, “New Business Models, Technology Raise Professional Liability Risks for Contractors.”

When using design-build, there are several ways contractors stray from their traditional role of builder. These include:

• Formulating and recommending construction materials and processes.
• Consulting with others during the design phase.
• Managing construction instead of actually doing the work.
• Adding architectural and engineering services to their business offerings.
• Providing professional advice.

So Much New Risk

While all of these new roles that contractors perform originate from efforts to improve the efficiency of projects and to bring more profitability to them, they have a downside. In all cases, contractors are increasing their exposures to risk. General liability, builders risk, and auto liability insurance don’t cover it.

When closely tied to the design process, contractors gain more control over the materials and methods used during construction, and that helps with scheduling, planning resources, and project efficiencies. 

For example, while participating in the design phase, the contractor may help develop a particular design aspect. If later, a contractor employee approves a minor change in that aspect, the contractor faces liability for any negative issues arising from that change. So, under these new delivery methods, contractors can easily increase their risks if they aren’t very careful with how they manage their role throughout the project.

Risks From Others

One of the new risks that contractors undertake when they work on projects using these new project delivery methods, is related to errors and omissions. These types of risks can extend beyond just the contractor’s work to include work done on behalf of the contractor. It’s not a stretch to assume that the contractor might engage subcontractors to participate in design aspects affecting their portions of the project. The contractor then becomes responsible for errors and omissions by subcontractors.

Some of the biggest losses happen when third parties are injured, according to the International Risk Management Institute. In one instance, a subcontractor put in an HVAC system that led to mold building up in the chillers. People got sick and filed suit against the contractor, as well as the owner. In another case, a contractor missed a mistake by a masonry subcontractor, which led to the building needing to be torn down and rebuilt.

Coverage Here, But Not There

Since general liability coverage only covers losses that come about through ordinary construction means and methods that cause bodily injury or property damage, it doesn’t cover damages that come from providing professional services or failing to provide professional services. Typical general liability policies don’t cover professional design and engineering services.

Typical general liability policies don’t cover professional design and engineering services.

Even though adding a professional exclusion amendment to general liability policies can provide some protection for design errors, insurers often attach endorsements to contractor policies that exclude liability stemming from design errors. This effectively reduces, even further, the protections of the professional exclusion amendment.

In many cases, a contractor that is leading a design-build project will rely on the “design firm professional liability policies” of architect and engineer subcontractors. But, those policies come with limitations.

• Their single aggregate limits include the cost of defense––as well as all current and past work––so you could be sharing any settlement with many other entities
• Most design firms have policies with low limits, often $1 million or less
• You have no protection if a design firm doesn’t renew their policy, or they change the retroactive date once your project is finished
• You most likely won’t be named as additional insured

Insurance Options

To keep up with the changing risk environment of these new project delivery methods, the insurance industry has come out with new products. One called rectification provides coverage for the insured when redesign is needed as the project is underway. This helps stop issues that go on to create more expensive claims.

While architects and engineers have traditionally carried errors and omissions insurance, contractors involved in the design aspects of projects should also consider that coverage themselves.

Another route is to purchase professional liability insurance. These can be an add-on to your general liability or umbrella policy, stand-alone policies, or handled on a per project basis. There are pros and cons to each…

The add-on provides high limits at low cost, but it’s more restrictive than stand-alone, won’t cover contractors that have their own in-house design and it has limited availability.

The stand-alone policy covers a wide range of potential liabilities including pollution and indemnity, but is more expensive and is not straightforward when you are trying to recover under the indemnity coverage.

Project “specific coverage works well for large complex projects, but contractors should be sure that they and their sub consultants are named, that there isn’t an “insured versus insured exclusion,” and that there is a sharing agreement for the policy deductible.

Contractors are in a unique position to help with design because they know the realities of building. When closely tied to the design process, contractors gain more control over the materials and methods used during construction, and that helps with scheduling, planning resources, and project efficiencies. But, they must be careful not to overlook the added liabilities of design work. This is where legal counsel and savvy insurance professionals can help!