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Latent defect insurance

  • United Kingdom
  • Construction and engineering - Articles

01-02-2007

What is latent defect insurance?

Latent defects insurance is a form of insurance taken out in respect of specific new-build premises to provide cover in the event of an inherent defect in the design, workmanship or materials becoming apparent after practical completion. It indemnifies the insured for the cost up to the total sum insured (typically the full reinstatement value) of the repairs to the damage caused or for repairs to prevent imminent damage by the defect and is typically available for between 8 and 12 years from the date of final certificate or practical completion.

The insured can be any party who has an interest in the property such as the owner or developer, but can also be the funder or an incoming tenant with an obligation to repair under the lease.
 
What are the alternatives?

The owner or developer may have appointed the contractor and professional team directly and have contractual rights as a result, or the funder and tenant may have received collateral warranties or have the benefit of third party rights under the Contracts (Rights of Third parties) Act 1999.

However there are many situations where these aren't sufficient to protect the beneficiary's interest such as where they are restrictively drafted with net contribution clauses and limitations on liability or where there are members of the team who simply haven't provided warranties at all. But most of all, they rely on the client proving breach of contract and seeking redress themselves against the individuals with all the inherent risks and costs associated with it.

What does insurance offer?

With the increasing prevalence of net contribution clauses in warranties, latent defects insurance in contrast provides a single point through which to recover the costs of repairing, replacing and or strengthening the premises following discovery of a latent defect that has caused or is about to cause major damage or destruction to the premises.

The policy typically covers damage to the whole building caused by an inherent defect in the structure (all internal and external load bearing elements essential to the stability and strength of the premises) as well the non-load bearing fixings and finishings necessary for the waterproofing and weatherproofing of the building envelope.

What isn't covered?

In two key respects, a latent defects insurance policy is more limited than a typical collateral warranty:

  • cover is limited to a maximum sum insured, whereas warranties do not generally contain caps on liability
  • the policy only covers certain specified losses, whereas warranties generally cover all losses attributable to defective workmanship and/or negligent design.

However, the insurer's covenant is likely to be stronger than a contractor's and in that respect alone insurance may offer greater security than a warranty.

The policies also limit claims in two key respects in that the policies do not cover:

  • consequential or economic losses arising from the defect other than the costs of repair; or
  • defects to the non-structural parts such as wiring, gas, water, ventilation and heating fixtures, nor internal windows, floor coverings and drains.

As such, damage caused by inherent defects in non-structural, non-building envelope parts  and those losses suffered due to an inability to trade or damage to items stored on the premises (which could be substantial and in excess of the cost of repairing the premises) would not be covered.

Points to remember

The insurer will either appoint a surveyor (at the insured's expense) to visit the works and certify them on completion, or rely on Building Regulations approval (depending on the policy) to determine whether to offer cover.

Policies typically penalise those who under insure their property by not fully declaring the build cost. Penalties, known as 'Average' provisions calculate the amount by which the premises were under insured and proportionately reduce the amount of any payment made under the policy.

Consider how long ago the premises were built, as insurance will only be available for a maximum of the first 12 years of a property's life.

A latent defects policy on a contract works value of £1,250,000 is likely to cost in the region of £12,500 to £15,000, and when bearing in mind the excess is normally 1% ie £12,500 of the sum insured, the first £25,000 (in this example) of any claim will still need to be met by the insured.

The insurer will often have a right to recover any sums it pays to the insured by starting an action at its own expense in the insured's name to exercise any right the insured has to make a recovery from a third party (such as under a warranty). The insured should not do anything that would diminish the insurer's rights after the policy is taken out and if the insured subsequently recovers any monies which reduce the insured loss (whether before or after the insurer pays out on the claim) it must then account to the insurer for such sums.

The policies also typically exclude cover for any defects of which the insured is aware before the certificate of insurance is issued, and any fit out works should be fully notified to the insurer as well as any subsequent modifications, alterations or additions.

Conclusion

Latent defects insurance provides a single point through which to recover the costs of repairing, replacing and or strengthening the premises following discovery of an inherent defect that causes damage or threatens the structure's imminent collapse, but it typically excludes a variety of non-structural fittings and infrastructure as well as any consequential losses or economic loss. However, providing the limitations and cost are acceptable, and the policy is properly taken out, insurance provides a secure and straightforward alternative to relying on the contractual provisions of warranties, building contracts and appointments.

 


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