Latent Defects Insurance (LDI) provides protection against the costs of remedying damage which occurs due to a fault in the design or construction of a building, which only manifests following completion of the project.
While LDI is not mandatory by law, it is increasingly required by lenders and commercial tenants. As such, taking out LDI is now vital to help developers access financing options, ensure project marketability, and protect against losses down the line.
How does LDI work?
LDI policies are typically written for a period of 10 or 12 years. For all but the largest of buildings, policies offer protection for the total reinstatement value of the building. Cover is provided for damage arising from structural defects, and against the threat of imminent collapse requiring immediate remedial action to prevent damage. Cover is also provided for ingress of water through the waterproof envelope of the building.
Cover applies to the structural elements of a building, and is usually extended to provide consequential damage to non-structural elements. The cover can be further extended under a separate section of the policy to include defects in the mechanical and electrical plant within the building. Insurers will not pay claims where a defect existed and was discoverable at the time the building works were completed.
During the works, the insurer will instruct an engineer to make regular visits to the development site. The engineer’s role is to monitor the construction of the building and detect any issues which may give rise to defects that manifest themselves post completion. The engineer will provide a final sign-off at practical completion of the development, which enables the insurer to make a formal offer of cover.
A key benefit of an LDI policy is that it is written for the benefit of the property, rather than a specific legal entity. Making a claim is more straightforward than with many other insurance policies, as there is no requirement to establish who is at fault, or to prove negligence. One simply needs to demonstrate that damage has occurred due to the manifestation of a defect in the way that the building was built.
Key benefits of LDI for construction firms
While LDI isn’t mandatory by law, it is often a practical necessity for developers and purchasers. LDI is a key part of robust and thorough risk management, providing reassurance to buyers, investors, and lenders in the construction industry.
Benefits of LDI for construction companies include:
Meeting lender requirements – While LDI isn’t legally mandatory in Ireland, it is often required under funding agreements. Therefore, taking out LDI can widen access to coverage and financing options. Increasingly, commercial tenants are also requiring LDI, particularly when entering into a full repairing lease.
Property marketability – A LDI policy is assignable to the future owners and tenants of a property. If a development is to be sold on completion, LDI can therefore prove attractive to potential purchasers, as it protects them against many of the risks associated with building defects.
Robust risk management – Standard property insurance typically excludes damage arising out of a latent defect. This can result in significant issues for owners and tenants, who might have to incur substantial costs in rectifying any defects. By contrast, LDI will strengthen risk mitigation, providing recourse for issues found at a later date.
Why Buildings Insurance may not suffice
With Buildings Insurance in place after completion, you might wonder why you still need LDI.
Buildings Insurance policies typically insure against material damage perils, including fire, escape of water, storm damage, and malicious damage. However, they do not cover damage arising from an inherent or latent defect. If a defect comes to light after completion, owners or tenants of the property could therefore face significant financial costs to rectify that defect.
Defects could arise for a wide variety of reasons. Examples include: poorly designed floor slabs that move and consequently cause damage to floors and walls; damage caused by inadequate wind-posts or wall-ties; defective cladding; and roofing which allows the ingress of water into the building. These types of incidents would not be covered under standard Buildings Insurance.
What about contractual warranties?
If your contractor offers a warranty via the building contract or a collateral warranty, it is likely that you still require LDI cover.
A contractor’s or collateral warranty will not protect you if the relevant contractor or consultant has gone out of business. Lenders are becoming increasingly nervous about lending on new developments where the ability to rectify latent defects depends on the contractor’s long-term financial strength. As a result, many lenders have no appetite for lending on buildings without an LDI policy in place.
What about contractors’ Professional Indemnity Insurance?
It is often wrongly assumed that if your contractor and consultants all have adequate Professional Indemnity (PI) insurance cover in place, then you can claim against them if a latent defect comes to light.
However, PI insurance is written on a ‘claims made’ basis. This means that if you need to make a claim, it will be the policy in force at that time that applies – not the policy in force at the time of the breach of contract. If the contractor or consultant responsible for a latent defect has subsequently become insolvent, there’s likely to be no insurance policy in place to cover your losses.
Even if you are able to claim against a third party’s PI insurance, this may involve legal proceedings against the contractor and/or consultant to establish the loss. It could be months – or even years – before an agreement is reached. In the meantime, your building could be left exposed, uninhabitable or, at best, in a deteriorating state of repair. By contrast, an LDI policy will respond without the need to establish which party was responsible for the loss. Its ability to provide an immediate payment without establishing negligence or a breach of contract makes an LDI policy beneficial for everyone concerned: developers, buyers, lenders and tenants.
In addition, PI policies only cover the insured party up a fixed limit, which in the case of major developments could be significantly less than the cost of repair works. This is unlike LDI policies, which include annual indexation of the sum insured, which allows for the increase in construction costs over the term of the policy. The PI cover belonging to the contractor or consultant may also include an annual aggregate limit, as opposed to cover on an ‘each and every claim’ basis. This means that if there are multiple claims made against the PI policy, there may not be sufficient cover to meet all their clients’ losses.
Protection beyond completion
For all these reasons, LDI remains vitally important if you want to be sure of being adequately protected from faults that might emerge after the construction phase of any development project has concluded.
For further details about our Latent Defects Insurance offering, click here (opens a new window).
