In this article, we explore:
The common issues and claims that can arise following the completion of a development or project.
The various features and scope of coverage Latent Defects Insurance has to offer.
The advantages and policy benefits of purchasing Latent Defects Insurance.
About Latent Defects Insurance (LDI)
Latent defects insurance (LDI) protects property developers or owners against damage resulting from defects in design, materials, or construction that only become apparent after completion.
LDI can normally only be purchased if an insurer’s engineer carries out a technical audit throughout the construction phase. Once they have signed off on the project’s construction, cover can be arranged from the date of practical completion for a period of 10 to 12 years.
The insured can be any party with an insurable interest in the project, and policies can be assigned to the new owners if a development is sold. Tenants can also be included as insured parties.
It is important to arrange an LDI policy before commencing a project or development.
This enables the insurer’s engineer to review the design specifications and to get a better understanding of the scheme as they carry out the essential technical audits throughout the project’s lifetime.
Arranging a policy once a development has commenced will be more challenging, as this falls outside insurers’ normal appetite. If an insurer is willing to provide cover, the premiums are likely to be much higher, and a higher request for information, as well as terms and conditions, is more likely to be even more onerous than usual with certain exclusions applied.
Damage and/or loss during the construction phase of a development project will be insured under a Contract Works (CW) insurance policy that will repair or reinstate any damage to the works. At practical completion, the contract works cover will fall away and a property policy will subsequently be arranged.
However, a frequently encountered exclusion in property policies is the lack of coverage for damage resulting from inherent or latent defects in the building.
This exclusion in a traditional property policy means a building owner or tenant could face significant issues when discovering a defect in the building, this could be instances such as glazed cladding or deficiencies in pipework. These problems will be heightened if the building cannot be used by its owner or tenants.
In some scenarios, a large amount of money might be required to cover the cost of repairing the damage or ensuring the structural stability of the building.
Having said the above, it may be possible to recover from the main contractor and/or sub-contractors responsible for the defect, but this could take a number of years and be incredibly difficult to prove fault.
Furthermore, if that particular contractor/engineer is no longer in business, it becomes a balance sheet risk for the owner as there will be no recourse, leaving significant issues to owners and tenants as well as mounting costs. A problem that can fortunately be solved with LDI.
We are now seeing more funders/lenders and tenants (with full repairing leases) requesting LDI from the property developer at the pre-construction stage.
Common claims
There’s a whole range of latent defects that can lead to structural damage which only becomes apparent after a project’s completion.
This can land property owners with very significant costs unless LDI cover has been arranged. One common example occurs when properties have been built on inadequate foundations, resulting in subsidence. The cause could be any combination of poor design, poor workmanship, or poorly specified materials.
Not only will an LDI policy cover such eventualities, but simply having an insurer’s technical auditor involved during the construction process reduces the risk of latent defects.
A comprehensive inspection of the foundations during the construction phase provides peace of mind for the building owner and insurer but also helps identify any risks relating to materials, workmanship, or design, which can then be rectified before construction proceeds.
Another common cause of LDI claims is ingress of water. This could involve water getting in through the cladding of a commercial building or through a leaky roof in a private residential property.
Again, the insurance engineer provides a valuable second pair of eyes. For the auditor to sign the property off for LDI, its waterproof membrane will need to have met Building Control installation standards and been designed by a competent professional.
An LDI policy normally covers damage resulting from water ingress from 12 months after practical completion until expiry.
Scope of coverage:
There are various features of coverage that will benefit the owner, and these are highlighted as follows:
The sum insured (i.e., building reinstatement value) is usually indexed to automatically provide for inflation.
Policy periods are usually 10 or 12 years from the date of practical completion.
The policy is non-cancellable.
It is a first-party policy, and insurers will meet a valid claim before understanding who is responsible for causing the defect.
Where rights of recovery may exist, they will be considered by the insurers at their own expense, not by the building owner or tenant.
Legal professional fees and debris removal costs incurred in carrying out remedial work can be included.
Policy benefits:
There are a host of advantages to an LDI policy, some of which are detailed below:
The policy is assignable to future owners and/or tenants of the building. These entities are more and more reluctant to assume the risks associated with building defects and can be attracted to a building where LDI has been arranged.
It is a first-party policy, and therefore it is not a concern whether the contractors and/or professional team are in business at the time the defect manifests itself. This is particularly relevant for the construction management procurement process where the supply chain for the owner/developer can be significant.
No requirement for the policyholder to establish fault, negligence or liability.
Time-consuming and expensive litigation does not need to happen before repairs can be started, this enables the structure to be returned with the minimum of disruption.
The technical audit process may detect issues prior to practical completion, meaning defects are corrected before the owner takes over responsibility for the building from the contractors.
Cover can be widened to include a waiver of subrogation against the contractors.
Final thought:
Given the number of contractor insolvencies and defects arising within the construction space, Lockton anticipates that it will be increasingly uncommon for funders and tenants to request LDI from the property developer at the pre-construction stage.
