Professional indemnity market update — part three: A focus on construction and property

As we have outlined in parts one and two of this update, the UK professional indemnity (PI) market is now entering a soft market cycle. More insurers are able to return to the market and negotiate to win new business — with coverage also improving in some areas. Part three of this PI market update discusses how much of this specifically relates to the construction and property PI insurance markets, such as design and build (D&B) contractors, architects, engineers, surveyors, and other construction and property professionals.

Geopolitical and economic outlook

In 2024, half of the world’s population could experience a change in government through various elections. Uncertainty related to state policy can affect key issues in the built environment – increasing cost pressures on sustainability in construction, especially house building – which can “spook” investors. These factors pose a risk to short-term growth in construction. Additionally, ongoing high borrowing costs and a possible downturn in the UK economy could also lead to a reduction in building.

According to the Royal Institution of Chartered Surveyors (RICS), in 2021 during the COVID-19 pandemic, construction costs hit a 40-year high, with materials costs experiencing an annual inflation rate of circa 20%. Now in 2024, thankfully, in the housebuilding sector at least, there are reduced materials costs, or at least a more manageable inflation rate rise. However, the effects of the pandemic was particularly relevant to imported steel and timber, and supply issues remain today. Also, the post-Brexit labour shortage has driven up labour costs, while rising fuel and energy prices — compounded by the Russia-Ukraine conflict — have contributed to increasing input costs.

ESG pressures and improving technology continue to move the industry towards modern methods of construction and offsite manufacture. Given this trend, it is important for PI buyers to check that their PI policy language adequately copes with new methods of working.

The above factors can raise costs and put pressure on the bottom line of projects — which typically stimulates legal action to recover losses via any way possible, such as a PI policy.

Fire safety coverage: Market improvement

We are now starting to see various forms of fire safety coverage being offered to firms, contractors, and design consultants alike. Insurers are all offering their own versions and coverage differences can be nuanced — it would be prudent to involve PI specialist brokers in these discussions.

Positively, this improvement is relevant to all size firms — not just the top tier — and marks a move away from full exclusions. It is common that such opening of coverage is subject to only work carried out after a “retroactive” date — so while it may not write back in protection for liability on past projects, it does improve peace of mind going forward. Also, another positive is that this levels the playing field once again for smaller firms in relation to tender propositions.

The RICS also changed its minimum terms and conditions with regards to PI cover as of 1^st July 2024, which is discussed in the RICS section of this article.

This market change regarding fire safety coverage is still incomplete. A report last year from the Department of Levelling Up, Housing, and Communities (DLUHC) stated:

“Overall, 1,603 buildings (42%) have either started or completed remediation works. Of these, 777 buildings (20%) have completed remediation works. The total number of buildings reported to have started or completed remediation works has doubled since the end of December 2022.”

This report also stated that of the UK’s 496 high rise (18m or over) buildings that have aluminium composite panels (ACM) cladding systems, 85% of these buildings have had rectification done — with a relatively small number remaining. Therefore, the coverage improvement is the expected lag response from PI insurers now being more comfortable to write fire safety cover.

However, we are hearing concern from some underwriters that it is too soon a market change ahead of risk stability. For example, the Grenfell Inquiry Phase 2 is to be published soon, which could affect precedent for strength of liability and, therefore, size of losses that are already in PI actions. Furthermore, the effects of the Building Safety Act (BSA) 2022 enforcements, including extended limitations and building liability orders, may increase liability on design teams with more actions brought by tenants and development purchasers. It is something that insurers are taking a “watching brief” on for now and is relevant to key regulatory factors impacting construction and property PI.

Regulation: The Building Safety Act

As mentioned above, the impacts of the BSA 2022 are a big industry talking point, and some recent case law is in play. Our previous articles on the BSA and 2023 enforcements have discussed elements of this in detail.

These articles provided a summary of the URS Trading Corporation Ltd v BDW Trading Ltd case. This case has recently been confirmed as under appeal to the Supreme Court — to be determined hopefully by the end of the year. The final decision could elicit a reaction from the PI market. It may impact how the extended limitations, regarding breaches of the Defective Premises Act 1972 or Building Act 1984, can end up as civil liability losses payable by a PI policy.

Additionally, some in the industry are familiarising themselves with their new obligations as principal designer and principal contractor. Occasionally, some contractors have attempted to “pass down in contract” their principal contractor duties to their appointed architect firm. We do not believe this should be accepted unless this is a common and intended service proposition. Overall, the concerns we hear indicate the need for BSA-focussed specialists to be available for projects, whether in-house or by sub-appointment. There are also concerns regarding a lack of clear guidance for smaller firms — who may be taking on more potent regulatory duties for the first time. We advise our clients that adequate training and resourcing specialisms should form the blueprint of their project managing process. Firms based in Scotland should be especially aware of the new duties when working on projects in England and Wales.

Additionally, we are seeing a variance of language in our clients’ contracts regarding the roles mentioned above. This includes adding the extended limitation periods enforced by the BSA expressly into contracts alongside the normal 12-year deed limitation and offering warranties as to competence in carrying out duties. Before accepting and signing on to such language, we advise that firms seek legal counsel and discuss with us or their current PI broker.

Recent BSA updates:

• Legislative changes to new build home warranties are expected in 2024. These warranties provide cover against structural defects arising from faulty materials and workmanship in new build homes. Secondary legislation under the BSA will soon impose a period of cover of 15 years, extending them from 10 years and dovetailing with extended liabilities under the Defective Premises Act 1972 or Building Act 1984. These only apply to leaseholds of 21 years or over, but they do cover both new-builds and building conversions. A developer who fails to provide this warranty will face financial penalties of £10,000 or 10% of the sale value of the building. This extension in warranty time, as well as expected changes to what the warranty covers, will have a dovetail effect on latent defect insurance and PI policies.
• A recent building liability order (BLO) raised a £47 million case that would have otherwise been impossible to bring. This highlights that BLOs are now contributing to more legal action, which could impact the PI market downstream.
• On 6^th April 2024, high-risk building projects fully transitioned from the old building control regime to the new building safety regulator. Following this transitional period, some issues may emerge, but hopefully no systemic ones for the PI market. Additionally, the move from the “approved inspector regime” to “registered building control approvers” also occurred. While there are still reports of delays in the accreditation of building control inspectors, the fallout remains to be seen. However, a backlog of project phases is possible, which may result in future indirect loss recovery actions on PI policies.
• D&B contractors are carrying more liability for latent defects due to the imposition of BLOs and other statute changes. It is possible these will increase “pass down” claims under PI.
• Contract questions emerging about Defective Premises Act breaches under the BSA. Recent cases and precedent “suggest” that contract net contribution clauses may not actually be applicable to such actions, as they are under civil liability contract claims.

As the BSA is a core issue in the sector, we will provide future detailed updates as issues emerge.

Technological: Artificial intelligence (AI)

Architects and other design consultants have always been aided by design software. However, beyond basic image creation software, there are now some very complex AI systems available to create detailed design input from an initial set of parameters. While these tools can present cost saving opportunities, innovative design, and reduce human error, there is concern in the PI market.

• These tools often utilise innovative or untested design methods — sometimes “hidden” within the algorithm. As the insurance industry can be hesitant to insure new concepts, this could be viewed with an attaching rate by some PI insurers.
• As AI evolves, the use of these tools could create a genuine test of basic legal principles of negligence. An architect using such tools may have a contractual liability if the design methodology output by the software fails. However, questions exist surrounding whether the PI insurer can recover losses paid on an architect’s PI claim from an AI algorithm. Also, whether an AI can be “negligent” — a human concept. Additionally, trying to recover from the tech companies developing these tools can be difficult, as they will often only have sale and supply agreements that they are liable under. They can also allege the AI is “self-learning” once out of their hands. These are all questions for the future, but we do suggest an interrogation of your current PI wording by your PI broker to “future proof” it as much as possible.

Construction product: Reinforced autoclaved aerated concrete (RAAC)

The issues of RAAC that have emanated from the education build sector have been well documented. This material was widely used in the 1950s and 1960s, but did tail off by the 1990s. It was considered a cheaper alternative with an intended shorter lifespan of 30 years, at most.

With the government-funded review of schools, there has been some concern from PI insurers across the wider construction sector, but no extreme reaction like we saw regarding fire safety after the Grenfell Fire tragedy. As engineers do not commonly specify what mix of concrete is used on projects, and the fact that liability limitation under contract will likely have now passed since RAAC was specified and put into projects, it is not seen as a likely huge loss generator at least against design teams.

However, some insurers do ask questions at renewal, and it is important to challenge your PI broker if these questions are too open in scope, as this can lead to unnecessary exclusions. The general view as to where exposure to claims would lie is more a failure on property managers to maintain buildings and engage inspections, but also possibly for surveyors in the failure to identify its presence. However, regarding the latter, because these blocks were often coated, our view is that one could not expect to pin liability easily on a RICS member appointed to do a “sight only” general building survey.

This is an area that may develop — though presently we see minimal exclusions on PI policies related to RAAC exposure. However, in the remediation of RAAC, certain parts of the industry are concerned that this could expose unknown asbestos. As PI policies still contain exclusions in this area, or at least restricted coverage, it may be something to think about at renewal.

RICS surveyors: Survey and valuation

As we know, certain RICS members’ activity has often been considered as high risk by some insurers. Over the last decade, short-term and bridging loan lending activity has rocketed, totalling £400 million in 2010 and now £4 billion today. While the period of risk is low because most loans are for six to 12 months — plus low “loan to value” — these types of loans tend to experience a higher rate of defaults compared to traditional lending. Unfortunately, this often stimulates spurious claims against valuers. Therefore, it is an area of concern for PI insurers, but we do find that a targeted data profile in broking submissions can get results.

The “SAAMCO Cap” has, for some time, been a basic principle in setting a valuers’ liability — where losses claimable by a lender are hopefully capped at the difference between the alleged negligent valuation and the true value of the property, in hindsight. However, recent legal precedent (such as the cases outlined in part two of this update series) is positive for the market, at least re-asserting such principles if nothing else. These cases also highlighted that the valuation is not the only reason a bank can say it has decided to lend, with things like the lender’s exit route and due diligence being just as important to the cause of loss. Hopefully, this could mitigate PI market losses in the future, with regards to valuation work in general and perhaps slightly widen appetite to write it.

Finally, as mentioned prior, the RICS have released changes to the minimum terms for PI coverage. Subsequently, all RICS members should have as a starting point:

• The aggregate limit fire safety coverage must now be given on heights of all buildings. For buildings above four storeys, this coverage is reduced from full civil liability to negligence only, and only in respect of claims arising from work performed.
• Retroactive dates remain, so the opening up of cover to buildings above four storeys is only for work done after such date.
• Practitioners carrying out external wall system fire review (EWS1) and fire risk appraisal of external walls (FRAEW) work are now covered, subject again to aggregate limits, sub-18 metre buildings, and conditions with regards to RICS training programmes being completed.

There is, however, some nuance to these new RICS conditions and how the new coverage is being applied by insurers, including around how fire safety claims arising from internal v external envelope are treated. We believe this may unfortunately lead to differing PI policy language for RICS members depending on which insurer they are with. We strongly advise RICS members to contact us for further discussion on this, or to instead discuss with their current PI broker.

Legal case precedents in construction and property

There are numerous precedents set by legal cases in the sector, as we have already discussed throughout this portion of the market update. In part two, we also reviewed the scope of duty of care across the PI sector via Manchester Building Society v Grant Thornton and Khan v Meadows (2021).

We focus here on two other specific cases that are particularly relevant to construction projects.

Triple Point Technology Inc v PTT Public Company Ltd (2021): Liquidated damages?

A tech services case, this involved PTT seeking to claim for liquidated damages (LDs) arising from a penalty clause in the contract. This is noteworthy as LDs are common in some areas of construction. The decision led to confirmation of the orthodox interpretation of the LDs clause — that such damages are recoverable only up to the point that the contract is terminated, and not after. This would be a positive for most D&B contractors who sign on to these clauses.

It does also stress the need for correct drafting of any such clauses in contracts. Unlike in the tech PI market, PI policies for the construction and property sectors do not commonly cover liquidated damage contractual penalties, but they can stimulate knock on claims down the chain that may be covered.

Lendlease v Aecom (2023): Duty to warn?

This case tested multiple principles in regard to a design consultant’s or contractor’s liability, among these being:

1. Limitation: In this case, the deed was not signed correctly. Despite this, the judge confirmed that the intent was to operate under a deed and, therefore, the “12 years running from practical completion long stop” was the liability period to apply. That said, it does highlight the importance of contract documentation being drafted and signed properly — to avoid unnecessary legal arguments like this. It also warns one cannot rely on arguments like “we have no liability because the services were done ‘informally’ before a contract was drawn up and signed.” 
2. Duty to warn: This concept relates to the duty (sometimes just implied, but often expressly stated in engagements) of a design consultant to warn of either:
   • integration issues of their designs with others when designs are implemented to build, or
   • any faults in isolated design work provided by other members of the project.
   • The judge determined that if: 
     • the scope of services is “design only” in pre-construction phases of a project, up to and including Royal Institute of British Architects (RIBA) stage 4, and,
     • the scope of services or contract engagement language does not expressly indicate a “duty to warn”,

then once designs are handed over, the design party is unlikely to have an implied duty to warn.

However, at this point we should stress there are other relevant factors, such as regulation or rules of trade bodies. For example, there is the Architects Registration Board (ARB) code of conduct, which imposes a heightened implied duty to warn on architects compared to some other consultants in projects.

Conversely, the judge determined that if the role is to be involved at any point in the construction phases of the project — RIBA stage 5 and onwards, then there is legally an implied duty to warn, even if the contract engagement or scope of works does not expressly make this clear.

3. Reasonable skill and care clauses in contract: The decision on this case highlighted the importance of a correctly drafted, overriding duty of care clause in contracts. Omission of this could lead to strict liabilities, that a developer or contractor signs to in a head contract, being passed down to design consultants. Such strict contract liabilities are not covered under most PI policies. This is something a design consultant should always seek advice on from us or their current PI broker.

Key takeaways and actions

After many years of shocks to the construction, property, and wider professional services industries, the market has calmed. That said, potential pressures always remain that could harden market rates.

With regulatory changes forthcoming, it is important that processes are established in each firm’s business model — ahead of any event. Also, it is crucial to understand the wider political, cultural, economic, and technological trends that are likely to affect professional risk, and possible future PI issues. This allows for proactive risk management — ultimately protecting the bottom line of any professional firm.